Thornburg Strategic Income Fund

2nd Quarter 2019

Jason Brady, CFA
Jason Brady, CFA
President and CEO
Lon Erickson, CFA
Lon Erickson, CFA
Portfolio Manager and Managing Director
Christian Hoffmann, CFA
Christian Hoffmann, CFA
Portfolio Manager and Managing Director
Jeff Klingelhofer, CFA
Jeff Klingelhofer, CFA
Portfolio Manager and Managing Director
Portfolio managers are supported by the entire Thornburg investment team.
JULY 16, 2019

During the second quarter of 2019, the Thornburg Strategic Income Fund returned 2.13%, underperforming both the 3.11% gain in the Bloomberg Barclays U.S. Universal Index and the 3.34% gain of the blended benchmark. While we certainly don’t dismiss the quarterly underperformance of the fund, we maintain our focus on delivering superior returns over longer periods. Over the last decade, the fund has returned 7.31% on an annualized basis versus 4.37% and 5.39% for the benchmarks respectively.

We remain skeptical about the U.S. Federal Reserve’s actions and motives. It seems policy decisions are no longer driven by economic fundamentals, but instead by market movements. In many instances, asset prices are widely disconnected from their fundamentals. What has gone from a tacit inference that the Fed will prop up swooning financial markets—the Greenspan, Bernanke and Yellen “puts”—has become more explicit under current Fed Chairman Jerome Powell, as he speaks increasingly openly about financial conditions and stability as part of the Fed’s decision-making process. A financial asset’s price should reflect more of its individual fundamentals and less of the tidal effect of Fed policy.

It now appears highly likely that market sentiment hinges on a 25-basis-point cut in the Fed’s key policy rate this month, not on the overall condition of the U.S. economy, which is in decent shape despite bearish headlines on trade and global growth. It is hard to imagine a quarter- point reduction in the Federal funds rate either helps or hurts the broader U.S. economy. It is, however, easier to imagine a century-old institution undercutting its credibility by seemingly allowing itself to be bullied by markets.

To be sure, some economic data have been weakening in the U.S. and abroad. The global Purchasing Managers’ Index is down a record 14 months in a row and has recently moved into contractionary territory. The U.S itself is also sitting on the precipice on some leading indicators. The most recent ISM New Orders Index came in at 50.0, the exact number that defines the difference between contraction and expansion. Yet strong U.S. labor force growth and a supportive capex cycle are driving productivity gains. And while wage growth has leveled off lately, consumer sentiment and balance sheets remain relatively healthy.

It’s important to note that slowing global growth has prompted many central banks, not just the Federal Reserve, to move toward monetary accommodation. A number of central banks have already cut their key rates or provided guidance suggesting an easing bias. Some countries are pushing macro-prudential measures or fiscal stimulus. The European Central Bank recently extended forward guidance, as did the Bank of Japan, suggesting their respective policy rates will remain exceedingly low for quite some time. Others, such as the Reserve Bank of Australia, lowered rates due to concerns about slowing growth.

While the economic backdrop is important for fixed income investors, it’s also crucial to look at both corporate and consumer health as leading indicators for the economy. Corporate fundamentals slipped a bit in the first quarter of 2019, as growth in revenue and earnings before interest, taxes, depreciation and amortization were roughly flat, with the trend continuing in the second quarter. One important area of concern in the corporate market is leverage and interest coverage. While we are at or near all-time highs in terms of leverage, it is in a very different market than we experienced a decade ago. What we find disconcerting is not the sheer amount of leverage in the system but how stretched the fundamentals become when one factors in a slowing growth environment. This will surely cause problems for those who have thrown caution to the wind and indiscriminately bought credit at current levels.

For example, U.S. High Yield bonds continued their stellar performance in the second quarter and ended the first half 2019 up 9.85%. High yield continue to benefit from the Fed’s dovish pivot and market expectations for an insurance- related cut of 25 basis points. With yields and spreads continually compressed, investors should consider taking some risk off the table as historic measures continue to indicate complacency amongst investors.

Along with a decline in corporate fundamentals, consumer fundamentals have deteriorated, albeit much more modestly. The consumer is seeing increasing debt-to-income ratios as credit card rates are at a decade high. As expected, there has also been an uptick in delinquencies and losses. Despite these metrics, we continue to believe the consumer is on solid footing, bolstered by the tight labor market.

The strength of the consumer has led us to opportunities in the consumer loan asset-backed security (ABS) sector. Often issued by online credit providers, with proceeds used by credit-worthy borrowers for credit card refinancing or home improvement loans, the structures offer several attractive features. The credit profile of the bonds improves dramatically every six months through an amortization process. The bonds offer an attractive spread to other shorter-duration bonds that quickly deleverage. Lastly, the shorter history for online lending allows for pricing inefficiencies, providing us the opportunity to purchase issues that create a wide margin for error.

And margin for error is all the more important given the backdrop of interest rates. For much of the second quarter, rates have been in a free fall as the two-year U.S. Treasury has dropped from 2.41% in mid April to 1.75% by the end of June. While the decrease in rates has generated a boon in fixed income prices, the lower yields have created a less appealing environment for the marginal dollar being invested. More importantly, total return has been driven by price appreciation despite all that has been said about the decline in fundamentals. Factoring in credit spreads, which have fallen precipitously throughout much of the year, the margin of safety is narrow by all measures.

In light of tight spreads, weakening corporate and consumer fundamentals, and a slowing global economic environment, we remain defensively positioned. We continue to reduce corporate risk and move into short, senior tranches of ABS and residential mortgage-backed securities, where spreads have widened and offer a larger margin of safety. Given our skeptical view on the Fed and its motives, the duration of the portfolio has remained constant through much of the second quarter as we have focused more on diversifying the portfolio to weather many economic outcomes.

We continue to believe caution in the corporate sector, both within investment grade and high yield, is warranted. At this stage of the credit cycle, individual security selection across industries, credit quality, maturities and region are likely to be key drivers of future returns. We believe our unique approach and structure offers our investors an edge in this strange and tumultuous environment. Over time, we rely on our results to bear this out. On a three-year rolling basis over the life of the fund, we’ve managed to outperform both the Morningstar Multisector Bond category and Nontraditional Bond Category 100% of the time, a period that included several different market episodes, both risk on and risk off.

Thank you for investing alongside us in the Thornburg Strategic Income Fund.

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 maximum sales charge for the Fund’s A shares is 4.50%.

Important Information

Unless otherwise noted, the source of all data, charts, tables and graphs is Thornburg Investment Management, Inc., as of 6/30/19.

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 equity securities are subject to additional risks, such as greater market fluctuations. Additional risks may be associated with investments outside the United States, especially in emerging markets, including currency fluctuations, illiquidity, volatility, and political and economic risks. 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.

The Morningstar Multisector Bond Category is made up of funds with 35% to 65% of bond assets in securities that are not rated or are rated BB and below. Multisector-bond portfolios seek income by diversifying their assets among several fixed- income sectors, usually U.S. government obligations, U.S. corporate bonds, foreign bonds, and high-yield U.S. debt securities.

The Morningstar Nontraditional Bond Category contains funds that pursue strategies divergent in one or more ways from conventional practice in the broader bond-fund universe. Many funds in this group describe themselves as “absolute return” portfolios, which seek to avoid losses and produce returns uncorrelated with the overall bond market.

U.S. Treasury securities, such as bills, notes and bonds, are negotiable debt obligations of the U.S. government. These debt obligations are backed by the “full faith and credit” of the government and issued at various schedules and maturities. Income from Treasury securities is exempt from state and local, but not federal, taxes.

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.

High yield bonds may offer higher yields in return for more risk exposure.

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

Please see our 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.