Spiros Segalas’ Harbor Capital Appreciation Fund 2nd-Quarter Letter

MANAGER COMMENTARY

“While acknowledging the challenges of today’s complex investment landscape, we firmly believe the Fund’s holdings continue to embody the superior growth potential that has rewarded our clients during our long history.” Jennison Associates, LLC

Market in Review

Stock prices continued to suffer in the second quarter of 2022 from the war in Ukraine, unexpectedly high inflation, tightening monetary policy, and ongoing COVID-19 lockdowns in China. This has led to one of the largest sell-offs over a three-month period since the global financial crisis nearly fifteen years ago. The accumulation of these events started to weigh on global GDP growth. Lower-income households were hit hardest, with inflation rapidly consuming pandemic-driven savings and wages unable to keep pace. U.S. Federal Reserve (Fed) policy tightening increased markedly, with the unusual move of a 0.75% rate hike announced during the Fed’s June meeting, and predictions that an additional 0.75% rate hike could be necessary in July as well.

A U.S. recession is not inevitable in our view, but the prospects for one continue to build. Companies held in the Harbor Capital Appreciation Fund (“Fund”) are approaching their planning with the recognition that the intermediate-term outlook poses greater uncertainty today than it did when the year began. Adjustments in hiring plans and greater impacts from foreign currency translation on reported profits are among the shifts that are affecting full-year financial outlooks at this stage.

The advantages of high-quality growth companies tend to attract greater investor attention during periods of slowing growth, given their relative resiliency to economic headwinds. For much of the past 40 years, disinflation was the common theme, and interest rates trended lower, particularly during economic slowdowns. In the current cycle, however, a spike in inflation has forced policymakers and the market to respond with sharply higher interest rates, pushing up the discount rate investors apply to the value of future cash flows for many of the growth companies that make up the Fund. As a result, the overall valuation of this large-cap growth Fund has adjusted significantly over the past several months, returning to pre-pandemic levels.

Portfolio Performance

During the second quarter, the Harbor Capital Appreciation Fund (Institutional Class) returned -25.49%, underperforming the Russell 1000® Growth Index, which returned -20.92%, and the S&P 500 Index, which returned -16.10%. All sectors posted negative returns for the period. Among the benchmark’s largest sectors, Consumer Discretionary, Communication Services, and Information Technology underperformed the broad index, while Health Care outperformed the overall benchmark.

Stock selection in the Fund’s Information Technology, Communication Services, and Consumer Discretionary sectors, along with an overweight allocation to Consumer Discretionary, detracted the most from relative returns. Stock selection in the Health Care sector modestly benefited relative results.

Contributors & Detractors

Eli Lilly (

LLY, Financial) contributed to Fund returns and rose during the quarter, benefiting from the relative defensiveness of the Health Care sector, and the approval of the company’s diabetes drug in the United States.

UnitedHealth Group (

UNH, Financial) rose slightly during the quarter, as it is a U.S.-centric, quality compounder with limited macroeconomic exposure.

Tesla (

TSLA, Financial) detracted from Fund returns on lower deliveries due to the temporary shutdown of its Shanghai facility and investor concern about Elon Musk’s activities. We continue to expect full-year deliveries for 2022 to be approximately 1.5 million—more than 50% above 2021.

Amazon (

AMZN, Financial) underperformed during the quarter due to concerns about a tougher consumer environment and the company’s focus on operations with respect to inventory, delivery speed, and economics.

Buys & Sells

ASML (

ASML, Financial) was added to the Fund during the quarter on the back of its leadership position in the semiconductor equipment space, which we believe offers both growth and defensive characteristics.

We exited the position in Shopify (

SHOP, Financial) due to concerns about gross margins and the company’s longer-term path to profitability.

Outlook

Over the past year, the investment backdrop has transformed from one of stimulus and spending to one of inflation and tightening financial conditions, with the need to control inflation moving aggressively to the forefront. Investors remain concerned about the Fed’s willingness to take the measures necessary to combat inflation, despite the recently stepped-up magnitude and pace of rate increases, and language communicating a “whatever it takes” approach. The uncomfortable reality for policymakers is that the primary sources of elevated headline inflation this year are supply driven—tied directly to the war in Ukraine and related sanctions on Russia sanctions—which challenge the effectiveness of monetary policy as a tool for addressing the problem. Meanwhile, an intensifying slowdown in global economic activity and rising concerns about recession in many countries will confront investors and policymakers as the second half of the year unfolds. In that vein, the Fed’s task of bringing inflation back to its 2% target, without undermining the robust employment backdrop and precipitating a recession, underscores current uncertainty in the macro outlook.

Through our bottom-up research and analysis, we continue to hold companies that, in our view, are best positioned to withstand the slowdown through their exposure to unique products and services that address demands from growing markets through innovation and agility. The companies’ strong balance sheets and financial flexibility should allow them to gain market share from weaker competitors, while continuing to invest for future growth throughout the period.

We remain optimistic about the prospects for the Fund holdings over our multi-year investment time horizon. While acknowledging the challenges of today’s complex investment landscape, we firmly believe the Fund’s our holdings continue to embody the superior growth potential that has rewarded our clients over our long history.

Retirement Class shares commenced operations on March 1, 2016. The performance attributed to the Retirement Class shares prior to that date is that of the Institutional Class shares. Performance prior to March 1, 2016 has not been adjusted to reflect the lower expenses of Retirement Class shares. During this period, Retirement Class shares would have had returns similar to, but somewhat higher than, Institutional Class shares due to the fact that Retirement Class shares represent interests in the same portfolio as Institutional Class shares but are subject to lower expenses.

Performance data shown represents past performance and is no guarantee of future results. Past performance is net of management fees and expenses and reflects reinvested dividends and distributions. Past performance reflects the beneficial effect of any expense waivers or reimbursements, without which returns would have been lower. Investment returns and principal value will fluctuate and when redeemed may be worth more or less than their original cost. Returns for periods less than one year are not annualized. Current performance may be higher or lower and is available through the most recent month end at harborcapital.com or by calling 800-422-1050.

Views expressed herein are drawn from commentary provided to Harbor by the subadviser and may not be reflective of their current opinions or future actions, are subject to change without prior notice, and should not be considered investment advice.

The views expressed herein may not be reflective of current opinions, are subject to change without prior notice, and should not be considered investment advice.

This information should not be considered as a recommendation to purchase or sell a particular security. The weightings, holdings, industries, sectors, countries, and returns mentioned may change at any time and may not represent current or future investments.