"The portfolio posted its best absolute and relative performance of the year in the third quarter, as macroeconomic fears and risk aversion subsided."
-Jennison Associates LLC
Fund outperforms in strong third-quarter rally
After a sharp sell-off in the wake of Brexit, the U.K.’s June vote to exit the European Union, investors seemed to shrug off Brexit’s unknown long-term effects. Both global and U.S. equities rallied strongly for much of the third quarter of 2016, and major indexes closed out the first nine months of the year with gains. The price of oil futures continued to rebound during the quarter, although it appeared to be capped at approximately $50 per barrel. Late in the quarter, major Organization of the Petroleum Exporting Countries (OPEC) producers agreed to cut production to foster greater near-term price stability. At its September meeting, the U.S. Federal Reserve (Fed) signaled that the case for an increase in the Fed funds rate has strengthened, but chose to wait for further evidence of progress before raising rates. The Manager believes a 25-basis-point increase at the December meeting seems increasingly likely, despite the largely tepid pace of U.S. economic activity, with Gross Domestic Product (GDP) expansion of 1.4% in the second quarter. The Manager also believes it’s probable that profits of the broad market S&P 500 Index will contract for the fifth straight quarter.
Against that backdrop, the Harbor Capital Appreciation Fund posted an 8.16% advance for the period, outperforming its benchmark, the Russell 1000® Growth Index, a measure of larger, growth-oriented U.S. companies, which gained 4.58%, as well as the S&P 500, which closed the period at 3.85%. The primary driver of the Fund’s relative outperformance was a combination of security selection in and a substantial overweight to the Information Technology sector, which more than outweighed a modest relative detraction from the Health Care sector. Holdings in 10 of 11 sectors bolstered relative results.
Jennison Associates’ comments were made in an October, 2016 report. Highlights adapted from the report appear below. All comments relate to the quarter ended September 30, 2016, unless otherwise indicated. All references to the year-to-date are for the period January 1 through September 30, 2016.
HIGHLIGHTS
After a Strong Quarter, Room to Grow
The portfolio posted its best absolute and relative performance of the year in the third quarter, as macroeconomic fears and risk aversion subsided. With growth scarce in many sectors and businesses, we believe companies that are able to generate longer term, sustainable, above-average growth should become increasingly attractive. In our opinion, this appeal is likely to be heightened by the muted nature of global growth, which is limiting opportunities to capitalize on a cyclical rebound, as well as the recent run-up in dividend paying securities.
Staying the Course
We did not make major changes to the portfolio in the quarter. As fundamental, bottom-up investors, we examine company and industry prospects over the intermediate and long-term. Numerous factors, including company fundamentals, macroeconomic conditions, and market risk tolerance, cause variability in the way equity markets price securities in the short-term. We constantly assess if and how these factors will affect our investment thesis and the long-term value of companies.
Projected Earnings Growth Remains Solid
We believe the highly unconventional U.S. presidential race is likely to fuel further market volatility in the short-term. For example, as steep and questionable price hikes became a campaign issue, concerns about drug costs continued to pressure the entire Health Care sector. However, we maintain conviction in the fundamentals of the portfolio, including its Health Care holdings, many of which sell innovative, high-priced and often lifesaving drugs. Likewise, despite volatility and uncertainty, the portfolio’s projected earnings growth for this year and next has remained constant, in the mid to upper teens, which we believe is well above the expected profit growth of the benchmark.
This information should not be considered as a recommendation to purchase or sell a particular security. The holdings or sectors mentioned may change at any time and may not represent current or future investments.
