Limited Term Municipal Fund - Commentary

3rd Quarter 2020

David Ashley, CFA
David Ashley, CFA
Portfolio Manager and Managing Director
Eve Lando
Eve Lando
Portfolio Manager and Managing Director
Portfolio managers are supported by the entire Thornburg investment team.
October 1, 2020
Market Review

Fixed income markets continued the rebound that began in the second quarter, with most domestic bond sectors posting positive performance in the three months through September. The market recovery has been awe-inspiring. Nearly every fixed income index is positive for the year with some areas, such as lower-quality credit, posting double-digit returns, despite record breaking unemployment and a fall in consumer demand. The aggressive actions of the U.S. Federal Reserve have produced the desired results, with money market fund yields back at essentially 0% and the 10-year U.S. Treasury range-bound between 0.50% and 0.75%. The reduction of short-term rates has driven down yields in investment-grade corporates and investment-grade municipals. By making short rates unattractive, the Fed is once again forcing investors out the risk spectrum in an effort to increase risk asset prices and create the wealth effect. The plan was successful following the Great Financial Crisis and initial results suggest success once again as high-yield corporates and high-yield municipals both posted strong quarterly performance and are now flat or up slightly for the year.

The Fed’s $4 trillion balance sheet expansion so far this year, double-digit unemployment and a steep decline in consumer demand that has alleviated near-term inflation concerns paved the way for long bonds to post strong performance for the quarter. But the Fed’s commitment to hold rates low until inflation tracks above its 2% goal for an extended period of time should give investors cause for caution. If consumption snaps back faster than expected amid the tsunami of Fed liquidity, and demand outstrips supply, will the Fed raise rates in timely fashion? If asset bubbles are prevalent, will the Fed be able to deflate them in measured moves, or will they pop, causing the economy to deflate? We think the best protection against uncertain outcomes of unprecedented policy stimulus is rigorous, bottom-up credit research to identify attractively priced bonds with sound fundamentals.

Third-Quarter 2020 Performance Highlights
  • Municipal yields began and ended the quarter at the same level but in early August the 10-year AAA hit 0.56% and in September yields did not move for 21 days—both new records. Rate movements throughout the quarter led duration to be a slight detractor to performance.
  • Credit spreads widened throughout the quarter as Republicans and Democrats sparred over details of a second stimulus bill that would provide assistance to municipalities. The rollercoaster ride surrounding the stimulus plan, combined with a second wave of COVID cases, led the high-quality bias of our portfolios to be a positive contributor to performance.
  • The market has rallied significantly from the March lows, but credit fundamentals have not recovered as broadly, or nearly as much as muni bond prices. While security selection produced mixed results for the quarter, we believe it will become more important as the election draws near.
Current Positioning and Outlook

The municipal market continued its run of positive performance and inflows through most of the quarter, which led to strong performance across Thornburg municipal bond portfolios. Despite the sharp sell-off in March, all of the strategies have recouped their losses, produced positive returns for the quarter and are now up on the year. Municipal yields fell throughout most of the third quarter, setting a new record low 55 basis points on the 10-year AAA, which created a tailwind for bond prices and led to nice price appreciation in most portfolios. The purchases we made during the market dislocation proved doubly beneficial as they both appreciated in price and generated higher levels of tax-exempt income. While price appreciation has been great for total return, the income component is far more important now that municipal bond prices have reached nose-bleed levels.

We remain cautiously optimistic on municipal credit and confident in our credit positioning because of the work done at the onset of the pandemic. We scoured our portfolio for credits we felt were vulnerable and exited positions, many involving debt related to convention centers, sports stadiums and hotel occupancy tax. Prices have recovered significantly across the entire market, but fundamentals have only improved in certain areas. Others of initial concern, such as hospitals and health care, have recovered through the reimbursement of COVID-related costs and removal of the ban on elective surgery. Some areas that were not initial concerns are now on shaky ground as there continues to be changes in behavior that could be long lasting. We question if private universities, whose value proposition was already under scrutiny, will be able to attract students willing to pay $70,000 per year to learn online.

As we’ve culled the portfolio of suspect credits, the market has been a difficult place to put new cash to work. Fixed income price appreciation has gained speed as new dollars are invested at lower yields, putting downward pressure on a portfolio’s cash flow. For investment managers, this challenge can be even greater when positive inflows dilute a portfolio’s current dividend and strategy mandates require action and the investment of new cash. We believe the best course of action today is to avoid the temptation to add risk to our portfolios by extending duration or lowering quality credit because the compensation isn’t there. Instead, we believe it is better to focus on being defensive by purchasing shorter-maturity bonds from higher-quality issuers. We believe it’s better to let cash build and create a liquidity buffer to protect our shareholders against any potential shenanigans surrounding the election, transition of power or a new stimulus bill. The market recovery over the last six months suggests that investor memories are short these days, but the lessons we learned in March are still front and center in our mind. We’d prefer to take risk when we’re being paid to do so and be a buyer in a market of sellers. That’s how we made percentage points, not basis points, for our shareholders in March, and we hope to have the opportunity to do so again.

Performance data shown represents past performance and is no guarantee of future results. Investment return and principal value will fluctuate so shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than quoted. For performance current to the most recent month end, see the mutual funds performance page or call 877-215-1330. The Low Duration and Limited Term funds have a maximum sales charge of 1.50%. The Intermediate Municipal Fund and the Strategic Municipal Income Fund have a maximum sales charge of 2.00%.

Important Information

Unless otherwise noted, the source of all data, charts, tables and graphs is Thornburg Investment Management, Inc., as of 9/30/20.

Investments carry risks, including possible loss of principal. Portfolios investing in bonds have the same interest rate, inflation, and credit risks that are associated with the underlying bonds. The value of bonds will fluctuate relative to changes in interest rates, decreasing when interest rates rise. This effect is more pronounced for longer-term bonds. Unlike bonds, bond funds have ongoing fees and expenses. Investments in lower rated and unrated bonds may be more sensitive to default, downgrades, and market volatility; these investments may also be less liquid than higher rated bonds. Investments in derivatives are subject to the risks associated with the securities or other assets underlying the pool of securities, including illiquidity and difficulty in valuation. Investments in the Fund are not FDIC insured, nor are they bank deposits or guaranteed by a bank or any other entity.

The views expressed are subject to change and do not necessarily reflect the views of Thornburg Investment Management, Inc. This information should not be relied upon as a recommendation or investment advice and is not intended to predict the performance of any investment or market.

Class I shares may not be available to all investors. Minimum investments for the I share class may be higher than those for other classes.

Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.

The laddering strategy does not assure or guarantee better performance than a non-laddered portfolio and cannot eliminate the risk of investment losses.

Income earned from municipal bonds is exempt from regular federal and in some cases, state and local income tax. Income may be subject to the alternative minimum tax (AMT).

There is no guarantee that the Fund will meet its investment objectives.

Please see our glossaryglossary (www.thornburg.com/glossary) for a definition of terms.

Thornburg mutual funds are distributed by Thornburg Securities Corporation.

Thornburg Investment Management, Inc. mutual funds are sold through investment professionals including investment advisors, brokerage firms, bank trust departments, trust companies and certain other financial intermediaries. Thornburg Securities Corporation (TSC) does not act as broker of record for investors.

The performance of any index is not indicative of the performance of any particular investment. Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. Investors may not make direct investments into any index.