Harbor Funds N-CSRCertified annual shareholder report (management investment company)

Throughout late spring and early summer, equity markets rebounded as many states initiated early phases of the reopening process. The worst-case scenario of the global pandemic crisis morphing into a liquidity crunch had thus been avoided as continued central bank support and improving economic data also provided some comfort to market participants despite a myriad of economic, social and political issues at hand.

The S&P 500 closed out the reporting period up after logging consecutive monthly declines in September and October. A resurgent COVID-19 pandemic, in Europe and the U.S., made for a downbeat backdrop as the market’s hopes for pre-election fiscal stimulus were dashed. U.S. technology stocks, which have benefited from the shift online caused by COVID-19 this year, also came under pressure throughout September and October, a reminder that the macroeconomic outlook remains uncertain and markets can still quickly become volatile. On a positive note, optimism around treatments and vaccine progress, have helped cushion the market somewhat amid darkening sentiment. Clearly, more positive news on this front could be optimistic for markets.

For the year ended October 31, 2020, Harbor Large Cap Value Fund posted a total return of 5.80% (Retirement Class), 5.72% (Institutional Class), 5.42% (Administrative Class) and 5.32% (Investor Class) outperforming the -7.57% return of the Russell 1000^® Value Index.

The vast majority of the portfolio’s outperformance relative to the Russell 1000^® Value Index during the year can be attributed to security selection, while sector allocation also contributed modestly. Security selection was positive in all but three sectors, with holdings in the Information Technology, Consumer Discretionary, and Energy sectors being the largest contributors to relative return. Conversely, security selection in the Consumer Staples and Industrials sectors coupled with an overweight position in the Consumer Discretionary sector detracted from relative return. (Relative weights are the result of bottom-up security selection.)

Digital media and digital experience software company, Adobe, was the top contributor to the Fund’s relative return during the period. The company reported strong results throughout the year despite the challenging macroeconomic environment, which we believe further demonstrates the resiliency of Adobe’s business model. In our view, the company has benefitted from its advantaged subscription business model and previous investments in products and services that allow customers to increase efficiency and productivity in normal work environments as well as the current remote work environment. Overall, we remain confident in management’s ability to continue to provide innovative solutions to its customers regardless of market environment, as the company’s migration from a license to subscription-based model continues to march on.

Capital markets continued to recover as investors received clarity on the economic impact from the coronavirus epidemic and began to look forward to how a post-COVID-19 environment would support future earnings growth. Many service and retail businesses adapted to the situation with standardized PPE requirements and social distancing standards, while white-collar businesses embraced a work-from-home environment, which enabled them to continue operations. Additionally, significant progress was made on vaccine candidates, several of which are currently being tested. Many areas of the economy saw a swift rebound in activity as the government’s stimulus measures supported renewed consumption of durable goods, and record low mortgage rates buoyed the housing market. With respect to monetary policy, the U.S. Federal Reserve’s (Fed) initial actions to curb the economic effects of the virus included a wide array of stimulative measures that included short-term rate reductions to near-zero and repurchases of U.S. Treasuries, mortgages and corporate debt, to include high-yield notes. In September, the Fed stated that it would hold rates near zero through at least 2022 and would continue to increase its fixed income holdings to provide liquidity to credit markets. These moves gave further confidence to equity and fixed income investors who understood that the Fed will continue to act as a lender-of-last resort and that stimulus measures were not a one-time deal. Additionally, the central bank projected a 6.5% contraction in GDP for 2020 and forecast a 5% gain next year followed by a 3.5% increase in 2022. After hitting a record high of 14.7% in April, unemployment fell to 7.9% in September. The Fed is projecting unemployment of 7.6% at the end of 2020, then falling to 5.5% and 4.6% in 2021 and 2022, respectively.

Harbor Mid Cap Fund posted modestly positive returns, 5.86% (Retirement Class), 5.75% (Institutional Class), and 5.42% (Investor Class) while the Russell Midcap^® Index returned 0.53% for the period December 1, 2019 to October 31, 2020. The portfolio outperformed the benchmark, Russell Midcap^® Index, during the period by a wide margin as investors began to refocus on company fundamentals after the sharp market downturn early in 2020 as a result of COVID-19. Stock selection continued to drive relative returns in the period. Stock selection was strongest in the Consumer Discretionary, Industrials and Materials sectors. Sector positioning also contributed to the strong results, as an overweight to Information Technology and an underweight to Energy boosted relative returns.

Contributing to performance for the period, D.R. Horton is one of the largest homebuilders in the U.S. Founded in 1978, The company’s footprint now spans across the United States and has a presence in 29 states, giving it both broad diversification and significant economies of scale. D.R. Horton’s brands include: D.R. Horton America’s Builder, Express Homes, Emerald Homes and Freedom Homes. D.R. Horton reported better-than-expected earnings driving shares up more than 35% during the period. Top line and margin improvement was driven by low mortgage rates and strong demand in entry level homes. August new home sales rose 43% year-over-year which translates to a 40% rise in sales from the pre-COVID-19 period. Targeting the entry-level and mid-level price point homes, we believe that the company is well positioned to continue to benefit from families’ demand for more space combined with a historically low interest rate environment that is expected to remain low in the foreseeable future.

Capital markets continued to recover as investors received clarity on the economic impact from the coronavirus epidemic and began to look forward to how a post-COVID-19 environment would support future earnings growth. Many service and retail businesses adapted to the situation with standardized personal protective equipment requirements and social distancing standards, while white-collar businesses embraced a work-from-home environment, which enabled them to continue operations. Additionally, significant progress was made on vaccine candidates, several of which are currently being tested. Many areas of the economy saw a swift rebound in activity as the government’s stimulus measures supported renewed consumption of durable goods and record low mortgage rates buoyed the housing market. With respect to monetary policy, the U.S. Federal Reserve’s (Fed) initial actions to curb the economic effects of the virus included a wide array of stimulative measures that included short-term rate reductions to near-zero and repurchases of Treasuries, mortgages and corporate debt, to include high-yield notes. In September, the Fed stated that it would hold rates near zero through at least 2022 and would continue to increase its fixed income holdings to provide liquidity to credit markets. These moves gave further confidence to equity and fixed income investors who understood that the Fed will continue to act as a lender-of-last resort and that stimulus measures were not a one-time deal. Additionally, the central bank projected a 6.5% contraction in GDP for 2020 and forecast a 5% gain next year followed by a 3.5% increase in 2022. After hitting a record high of 14.7% in April, unemployment fell to 7.9% in September. The Fed is projecting unemployment of 7.6% at the end of 2020, then falling to 5.5% and 4.6% in 2021 and 2022, respectively.

Harbor Small Cap Value Fund posted negative returns of -4.22% (Retirement Class), -4.33% (Institutional Class), -4.54% (Administrative Class), and -4.67% (Investor Class) for the year ended October 31, 2020. The portfolio outperformed its benchmark, the Russell 2000^® Value Index, which returned -13.92% during the period, by a wide margin as investors began to refocus on company fundamentals after the sharp market downturn early in 2020 as a result of COVID-19. Stock selection continued to drive relative returns in the period. Stock selection was strongest in Consumer Discretionary, Industrials and Materials. Sector positioning also contributed to the strong results, as an overweight to Information Technology and an underweight to Energy boosted relative returns.

Contributing to performance for the period, Entegris, headquartered in Billerica, Massachusetts, is a leading supplier of contamination control solutions and microenvironments to the semiconductor chip processing industry. These solutions have positioned Entegris as a global leader in yield-enabling products and materials for the semiconductor industry. Entegris continues to see robust financial performance on the back of strong earnings which drove the stock up over 70% in the period. Revenues grew double-digits compared to a year ago, well ahead of consensus expectations. Entegris’ growth was driven primarily by the increasing adoption of proprietary leading edge semiconductor manufacturing processes. Entegris continues to benefit from the increasingly stringent requirements for contamination control in the fabrication of the chips based on advanced technologies. As a leader in the space and with their ability to invest in R&D, Entegris has strong pricing power and continues to gain market share over time and retain pricing power over its competitors.