4th Quarter 2018

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In the fourth quarter of 2018, Thornburg Global Opportunities Fund produced a total return of negative 15.92% (class I shares) versus a negative 12.75% return for the benchmark MSCI All Country World Index (ACWI). For the full calendar year 2018, the total return for the fund’s Class I shares was negative 20.67%, trailing the negative 9.42% result for the ACWI benchmark. Following our gain in 2017 of approximately 22%, 2018 proved to be a disappointment. We are working to adapt and improve the future return prospects of the portfolio.

In December, the fund paid an income distribution of $0.652 cents per share (class I shares). Total returns assume the reinvestment of such distributions.

In July of 2018, we marked the fund’s 12th anniversary. Since inception, Thornburg Global Opportunities Fund has outpaced the ACWI by roughly 320 basis points (3.2%) per year, resulting in a cumulative total return of 162% (class I shares) versus 80% for the index, as shown in Chart 1..

Cumulative Fund Performance Since Inception

We believe our investment framework remains as relevant today as it was when we started the fund in 2006. We are frustrated with inconsistent results in recent periods, and particularly our underperformance over the past year. Shareholders may find it valuable to review our investment framework in the context of recent events and the global market backdrop.

OUR INVESTMENT FRAMEWORK

Flexibility

Geographic flexibility is a core tenet of our philosophy because it both enhances our risk management and allows us to consider a broad range of potential investments. The name “Global Opportunities” underscores our flexibility to invest where compelling ideas may arise. From a risk standpoint, our flexibility adds an element of diversification, which can reduce political or regulatory risk in the portfolio. The common-sense advantages of such flexibility have been supported by numerous academic studies.1

Focus

A focused portfolio can provide benefits from both risk and reward standpoints. In managing the fund, we attempt to capture the advantages of global diversification. However, diversifiable risk (known as “non-systematic risk” to finance wonks) declines as you add more holdings to a portfolio. Thornburg Global Opportunities Fund generally holds 30 to 40 investments, allowing us the benefits of diversification without falling prey to what Peter Lynch referred to as “diworsification.” Rather than owning 200 average companies, we strive to focus on a limited group of promising businesses.

Value

As fundamental analysts, we rely on our value framework to systematically manage the fund through changing market conditions. Simply put, we attempt to own good companies that are undervalued. Our framework incorporates business quality, valuation, and future prospects.

FOURTH QUARTER AND 2018 REVIEW

Performance dispersion ran high among global equity markets in 2018. Yet a common factor was declining valuations. Concerns about political risks were widespread, and some of the loftier expectations for global growth early in the year had to be tempered. Although geopolitical risks and events were essentially unavoidable, corporate fundamentals held up relatively well throughout the year.

Chart 2 illustrates the changing outlook for regional earnings (denominated in U.S. dollars) since the end of 2016. In 2017, international earnings growth appeared particularly strong because foreign currencies strengthened against the dollar. In 2018, U.S. earnings were buoyed by tax cuts, and the outlook for international earnings declined in U.S. dollar terms primarily because those currencies reversed course and weakened to mid-2017 levels.

Next 12 Months’ EPS, Indexed to 100

Chart 3 reflects the shift in price-to-earnings (P/E) multiples over the last 24 months. In the context of a stable outlook for company earnings (at least in local currencies), political uncertainty was a significant factor in the de-valuations.

Next 12 Months’ Price-to-Earnings Ratio

Investors have become less confident in the durability of European economic expansion. Consequently, money has flocked to the relative safety (and higher interest rates) in the U.S. Over the last year, a substantially larger spread developed in regional performance compared to the trend of the prior three years.

Thornburg Global Opportunities Fund did not keep pace in this environment. In addition to some fundamental shortfalls discussed earlier in the year, we experienced three more recent events which pressured the following investments: 1) the failure of a bridge in Italy that was operated by our investee, Atlantia SpA, 2) a surprise jury verdict against the pharmaceutical/ag science group Bayer AG, and 3) a fire at an Australian property owned by Peabody Energy.

Beyond these idiosyncratic events, share price declines for many portfolio holdings reflected sensitivity to the valuation de-rate in their respective geographies. Our overweight positioning outside the U.S. has been particularly detrimental to fund performance given the 1,000 basis points (10%) differential in 2018 returns noted in Chart 4. We believe we’ve found quality companies at attractive valuations outside the U.S., but over the past year these international investments burdened our relative returns.

In 2018, U.S. Relative Outperformance Was Substantially
Higher Than in Recent Year

In the fourth quarter the largest detractors from fund performance were a diverse group. Netherlands-domiciled OCI NV, the chemicals concern that was a strong contributor earlier in the year, was our biggest decliner as its shares reversed course in November and December. A November U.S. cold snap caused an unusual coincidence of spiking natural gas prices while oil prices were falling, with the price moves amplified by margin calls on financial speculators in these commodities. A higher natural gas price reduces OCI’s near-term profitability. We believe the longer-term outlook for OCI’s profits remains attractive. Agricultural demand for OCI’s fertilizer remains steady as a shrinking supply of arable land works to feed a growing global population of more than 7 billion people.

 

  Top 5 Contributors Top 5 Detractors
  Atlantia SpA Baidu, Inc.
  Galaxy Entertainment Group Ltd. Capital One Financial Corp.
  Helmerich & Payne, Inc. Citigroup, Inc.
  MGM China Holdings Ltd. OCI NV
  New World Development Co. Ltd. Zayo Group Holdings

Source: Bloomberg

 

U.S. telecom infrastructure provider Zayo declined when its earnings result and guidance were softer than expected. Zayo partially rebounded after reports that a private equity manager was considering a bid for the company. Chinese internet leader Baidu disappointed investors with conservative guidance for the fourth quarter, citing a slowing domestic economy and regulatory changes to discourage certain online activities, including gaming. Nevertheless, Baidu’s core business continues to grow at a healthy rate and provide funding for investment in emerging businesses, including artificial intelligence and autonomous driving.

U.S. banks, including Citigroup and Capital One, fell during the quarter as long-term interest rates fell back, the yield curve flattened, and investor concerns about an imminent recession increased. In an example of the derating noted above, Capital One’s multiple to 2019 expected earnings decreased from 10.1x to 6.6x during the year, even as expectations for its 2018 and 2019 earnings per share increased by approximately 29% and 14%, respectively.

To varying degrees, we experienced similar developments across most of Thornburg Global Opportunities Fund portfolio. Consensus expectations for per share earnings published by analysts tracking our 31 portfolio holdings as of year-end 2018 increased over the course of calendar 2018 for both the 2018 (+12% versus prior earnings-per-share, or EPS, growth expectations) and 2019 (+3.5% versus prior EPS growth expectations) fiscal years on a portfolio weighted average basis, even as the stock prices of most of these declined. In summary, these stocks became cheaper, particularly in the December quarter.

For 2019, analyst consensus expectations for weighted average EPS growth of Thornburg Global Opportunities Fund portfolio currently exceed 30% on a year-over-year basis. Of course these expectations will be revised during the year, as is typical. Nevertheless, we view the current weighted average P/E multiple for the fund portfolio, approximately 13.6x expected 2019 earnings, as representing very good value for this group of businesses.

Regarding the better fourth quarter 2018 performers in the fund portfolio, our patience was rewarded when several Asian holdings resisted the broader market selloff. Hong Kong conglomerate New World Development and Macau casino operators MGM China and Galaxy Entertainment Group each delivered positive returns. New World Development’s recent results showed substantial progress made in leasing its flagship property, “Victoria Dockside,” on the Hong Kong waterfront. MGM investors also gained comfort from an in-line quarterly earnings result and consistent levels of tourist visitation to Macau. The new MGM Macau–Cotai resort continues to mature and may allow the company to gain market share in 2019.

Two other names rounded out the quarter’s top performers. Atlantia SpA shares were roughly flat following a September quarter price decline after the August bridge collapse in Genoa. Helmerich & Payne, a new addition in the quarter, was a modest contributor.

We have adapted and noted certain lessons from our 2018 experiences, most notably regarding the detractors. While we saw some idiosyncratic forces impact the portfolio, we also acknowledge that in some cases our initial thesis was less sound, or the investment circumstances changed. We have acted accordingly. For example, in the case of Atlantia, we reassessed the risk after the Morandi bridge failure and eventually increased our holding at what we deem to have been an appealing price. In the case of Bayer, while the adverse court ruling could be discounted as a “one-off,” it served to highlight that the Monsanto acquisition may have brought more “tail risk” uncertainty into the business than we originally anticipated. As a result, we have substantially reduced our exposure to Bayer.

We are neither reinvesting indiscriminately nor pulling back from all our underperformers. Instead, we are increasing exposures where we see significant opportunity and mispricing while cutting investments in firms which have not maintained or improved their competitive positions or shown adequate potential to do so.

We added three new positions in the quarter, each tied to some aspect of the evolving energy supply industry—French electric utility EDF (French exports of electricity increased more than 50% in 2018 as neighboring countries reduced dirty coal-fired generation and curtailed nuclear powered generation), Danish wind turbine manufacturer Vestas Wind Systems (increasing demand for more efficient latest generation wind turbines and associated service contracts), and Helmerich & Payne, a U.S.-based drilling services company.

Relative to the index, Thornburg Global Opportunities Fund exited the quarter particularly overweight the consumer services and industrials sectors, moderately overweight energy sector investments, and underweight information technology and health-care investments. Geographically, the fund has above-benchmark exposure to Europe and Asia ex-Japan, but no direct exposure to Japan. Firms headquartered in emerging markets comprise 9% of the portfolio. We will continue to monitor revenue and earnings progress closely since we believe these are key determinants of value creation over time.

This past year was one of transition in market, macro-economic, and political trends. We expect to see continued debate around valuation levels for equities and the durability of global economic growth. The U.S. Federal Reserve has moved the upper bound of its target from 0.75% to 2.50% over the last eight quarters, but most major central banks continue to pursue very easy monetary conditions that should help support the prices of financial assets. In 2019, it is likely that investor attention will remain focused on the interplay between expected economic growth, inflation, capacity investment in various industries, technological change, government regulation, and the inevitable monetary tightening that accompanies a transition from government-administered real interest rates and quantitative easing, to more market-determined prices for financial assets.

With our focus on earnings progress and the absolute and relative intrinsic values of the businesses in Thornburg Global Opportunities portfolio, we remain constructive about the long-term prospects for the fund. We believe the dispersion in equity returns across regions and sectors—or generally lower asset prices—could present opportunities for our investment framework in the years ahead. Patience and a long-term investment orientation have served Thornburg Global Opportunities Fund well since its inception in 2006.

Thank you for investing alongside us in Thornburg Global Opportunities Fund.

 

1. Clifford Asness, Roni Israelov, and John M. Liew, “International Diversification Works (in the Long Run)” by (Working Paper, 2010).

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
Before investing, carefully consider the Fund’s investment goals, risks, charges, and expenses. For a prospectus or summary prospectus containing this and other information, contact your financial advisor or visit thornburg.com. Read them carefully before investing.

Unless otherwise noted, the source of all data, charts, tables and graphs is Thornburg Investment Management, Inc., as of 12/31/18.

Investments carry risks, including possible loss of principal. 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 small- and mid-capitalization companies may increase the risk of greater price fluctuations. 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.

Any securities, sectors, or countries mentioned are for illustration purposes only. Holdings are subject to change. Under no circumstances does the information contained within represent a recommendation to buy or sell any security.

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Funds invested in a limited number of holdings may expose an investor to greater volatility.

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