2nd Quarter 2018

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For the second quarter of 2018, Thornburg Better World International Fund returned 0.27% (I shares), outperforming both the MSCI All Country World ex-U.S. (ACWI Ex-U.S.) and MSCI EAFE indices, which returned negative 2.61% and negative 1.24%, respectively. Since its end-September 2015 inception, Better World International Fund has returned an annualized 11.90% (I shares), compared with the ACWI ex-U.S. Index return of 10.64%.

In another down quarter, nine of the 11 sectors of the MSCI ACWI ex-U.S. Index showed negative returns, with performance ranging from negative 7.28% to positive 7.27%. The top-three performing index sectors during the quarter were energy, health care, and materials. The bottom-three performing sectors were financials, telecommunication services, and consumer discretionary. For Better World International Fund, the top-performing sectors on an absolute basis were consumer discretionary, information technology, and materials. Utilities, financials, and industrials rounded out the bottom performers during the period. Our performance was hampered by our exclusion of energy-related names as oil prices increased significantly during the quarter.

Our general avoidance of fossil fuel producers is primarily driven by our environmental, social, and governance (ESG) process. While Better World International Fund is not by prospectus a low-carbon portfolio, our ESG integration process naturally results in a much lower carbon footprint than many of our peers. Where we can, we attempt to reduce carbon exposure and focus on superior business models that are poised to take advantage of changing global energy dynamics.

Companies that are large consumers of electricity would do well to think strategically about their energy mix. For example, electricity availability is one of the key inputs in the semiconductor manufacturing industry. To diversify energy sources, large semiconductor manufacturers in Taiwan have become the largest purchasers of renewable energy, and the largest player has reduced its greenhouse gas per unit 10% since 2010. Such steps can potentially create a competitive advantage in sustainability of energy supply, reduce costs, and shrink their carbon footprint.

Financials also performed poorly during the quarter. Two macroeconomic reasons generally drove the underperformance. First, rising geopolitical risk in Italy spilled over to the broader eurozone. Second, recent European Central Bank commentary signaled a likely delay in an interest rate tightening cycle, pushing interest rates lower and yield curves flatter. These conditions usually create a tough environment for banks, and a couple fund positions in the space have underperformed.

ESG Corner

From an ESG perspective, we are keeping a sharp eye on additional financial regulatory requirements, namely Basel IV and IFRS 9. The regulations are spurring banks to increase capital buffers to withstand systematic risk. That increases costs and can lower returns. We take regulatory changes into consideration when investing in banks, attempting to pick those in better financial and regulatory shape than peers.

The European Union's recently implemented General Data Protection Regulation (GDPR) is designed to strengthen data protection for E.U. citizens through setting aggressive deadlines for firms to report data breaches. The regulation applies not only to E.U. firms, but any company that collects data on E.U. residents. Many companies across the world are potentially affected; but financial services and technology firms face the most significant exposure through the vast swaths of personal data they collect and store. To comply with the new regulation, we believe some companies' operating costs will increase as they increase staff. Specifically, recent analyst commentary suggests that the typical Fortune 500 firm is expected to hire five full-time privacy-tasked employees, including a data protection officer, to ensure GDPR compliance.

Another effect of GDPR is the potential financial and legal risk associated with penalties for breaching compliance of the new regulations. Companies in breach can be fined up to €20 million or 4% of annual revenue, whichever is greater. It remains to be seen how and if these fines will be applied, given 80% of affected organizations were estimated to be non-compliant with GDPR ahead of the May 2018 deadline.

GDPR may have raised the market's awareness of data privacy and security needs, but for many firms, it is likely to be the beginning of a much bigger conversation about how to compete in a cyber-insecure world. Data and privacy security—one of the significant issues we look at from an ESG standpoint—is becoming a critically important issue for investors to evaluate when considering potential investments. According to Sustainalytics, an independent provider of ESG and corporate governance research, many organizations are poorly positioned to navigate the data management environment. But firms with a sustainable competitive advantage in the area may be well positioned to outperform less-prepared peers. Thornburg Better World International Fund ultimately seeks to invest in those organizations with good data management procedures and avoid those lacking them.

Over full market cycles, we expect to add value through high active share and superior stock selection via bottom-up quantitative and qualitative analysis, and the proactive evaluation of ESG standards within our investment framework.

Thank you for investing alongside us in Thornburg Better World International 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%.

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