Spiros Segalas (Trades, Portfolio) The six-month period ended April 30, 2017, saw gradually improving economic conditions in many major economies, especially the United States; steady improvement in business sentiment; and post-U.S.-election expectations that policies of the new administration would favor companies that would benefit from a less onerous regulatory environment, lower corporate tax rates, and infrastructure and defense spending.
PERFORMANCE
The Harbor Capital Appreciation Fund advanced 13.45% (Institutional Class), 13.32% (Administrative Class), 13.25% (Investor Class) and 13.50% (Retirement Class) in the six months ended April 30, 2017, underperforming its benchmark, the Russell 1000® Growth Index, which rose 15.23%.
In the benchmark, the Financials, Consumer Discretionary, Information Technology, Health Care, Industrials, and Materials sectors posted double-digit gains. Energy was the lone sector to lose ground.
A number of the Fund’s positions in the Information Technology and Health Care sectors advanced but lagged the benchmark’s sector returns, while other positions in the sectors outperformed the benchmark. In Technology, declines in Qualcomm (QCOM, Financial), Palo Alto Networks, and FleetCor Technologies had the effect of tempering strong advances in Apple, NVIDIA, Alphabet, and Adobe Systems. Qualcomm, which makes cellphone chips, fell on antitrust litigation. There is great incentive for Qualcomm and Apple (AAPL, Financial), the other party in recent legal action, to reach agreement, as their business models rely heavily on each other’s long-term success. Internet security hardware and software maker Palo Alto Networks declined on indications of slowing revenue growth. We eliminated the position during the period. FleetCor Technologies is a leading provider of fleet cards and payment-processing services for commercial and government fleets. The company’s cards function like charge cards and are used to purchase fuel and lodging. The stock’s weakness reflected lower-than-expected revenue and concerns that organic growth may be slowing. We believe FleetCor has distinct competitive advantages and leadership positions in businesses with attractive long-term growth prospects.
Apple’s share price performance reflects the proliferation of the iOS platform across mobile phone, tablet, and personal computer landscapes as well as the financial power and attractive margins of the company’s hardware products. Semiconductor maker NVIDIA has transformed itself from a personal-computer-centric graphics provider to a company focused on key high-growth markets where it is leveraging its graphics expertise to offer high-value-added solutions: gaming (where it has dominant market share), automotive, high-performance computing (HPC), and cloud and enterprise. We continue to believe Alphabet’s technological lead and dominant position in Internet search is a unique strength that has enabled the company (formerly known as Google) to monetize search traffic at a meaningfully higher rate than its competitors. We like its solid competitive position, strong advertising revenue, and YouTube monetization opportunities. Adobe Systems, best known for its Photoshop photo-editing tool and the PDF and Flash platforms, benefited as customers transitioned from perpetual license agreements to subscriptions.
In Health Care, Alexion Pharmaceuticals’ (ALXN, Financial) weakness reflected investor concern about a change in senior management and disappointment that the Food and Drug Administration did not grant priority review for the company’s drug Soliris as a treatment for an ultra-rare form of myasthenia gravis. Soliris is already approved to treat two rare, genetic, and potentially life-threatening blood disorders. Other approved drugs target a disease caused by genetic mutations and an ultra-rare metabolic disorder. Celgene (CELG, Financial) rose on positive results from a trial of an experimental compound to treat relapsed/refractory multiple myeloma. We consider Celgene, with its robust revenue and earnings, and deep pipeline, one of the biotechnology sector’s most fundamentally sound companies. As of the end of the period, the Fund focused its holdings in high-conviction biotechnology and specialty pharmaceutical companies. We expect that productive research and development activity will yield effective disease treatments that improve the quality of patients’ lives, characteristics that historically have been the source of longer-term outperformance in the sector.
Another detractor to Fund performance, American Tower (AMT), which operates broadcast and communications towers, wireless towers, and distributed antenna systems, was hurt by its sensitivity to interest rate increases and exposure to currency translation headwinds. We eliminated the position during the period.
Energy holdings rose modestly, faring better than the benchmark sector, although an overweight position relative to the benchmark detracted from the Fund’s relative performance.
In Consumer Discretionary, stock selection and an overweight position relative to the benchmark benefited the Fund’s performance. Amazon.com (AMZN, Financial) rose on strong execution, long-term revenue growth, margin-expansion potential, and development of a meaningfully important business opportunity in cloud infrastructure. Hotel operator Marriott benefitted from increased demand and limited supply growth in the U.S., which we believe should lead to accelerating revenue and operating income growth. Strong subscriber growth at Netflix reflected the appeal of the company’s original programming. We believe increasing pricing power, international expansion, and scale advantage have strengthened the company’s long-term competitive positioning.
In Industrials, Boeing’s 787 Dreamliner commercial jet generated cash, organically, for the first time since deliveries started in 2011. The world’s largest aerospace company and a leading manufacturer of commercial jetliners and defense, space, and security systems, Boeing (BA, Financial) reported strong revenue, free cash flow, and earnings leading to a positive contribution to Fund performance.
An underweight in Consumer Staples benefited relative return.
OUTLOOK & STRATEGY
As fundamental investors, we examine company and industry prospects over the intermediate- and long-term, working to understand and anticipate how industries and businesses will change over time. Our goal is to identify companies with sustainable above-average growth. We have constructed a portfolio of companies with what we believe are differentiated products and market opportunities.
We expect Fund aggregate EPS growth in 2017 to once again outpace EPS growth for the S&P 500 Index. With a modest price-to-earnings ratio premium, the Fund was, as of the end of the period, at the low end of its historical valuation range relative to the S&P 500 and Russell 1000® Growth Indexes. In the past, the Fund has performed well when its relative valuation has been low and its above-average earnings growth has been achieved.
This report contains the current opinions of Jennison Associates LLC as of the date of this report and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Such opinions are subject to change without notice and securities described herein may no longer be included in, or may at any time be removed from, the Fund’s portfolio. This report is distributed for informational purposes only. Information contained herein has been obtained from sources believed reliable, but not guaranteed.
Equity securities, such as common stocks, are affected by company specific events and by movements in the overall stock markets in which those securities principally trade, among other factors. An adverse company specific event, or downturn in those stock markets, can depress the value of a particular company’s equity securities. For information on the different share classes and the risks associated with an investment in the Fund, please refer to the current prospectus.
