3rd Quarter 2018

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Strong market performance in the U.S. continued in the third quarter of 2018, with the S&P 500 Index up 7.7% and broad indices hitting several new records. International indices were up more modestly but turned in their first positive quarter of the year with the MSCI EAFE Index gaining 1.35% and the MSCI ACWI ex-U.S. Index advancing 0.71% as some of the concerns that dominated the first two quarters (global trade war, Italian political uncertainties, emerging market contagion) subsided a bit. For the first three quarters of the calendar year, the MSCI EAFE Index and MSCI ACWI ex-U.S. Index, which includes an emerging market component, were down 1.43% and 3.09%, respectively.

During the quarter concerns over a global trade war lessened somewhat with the U.S. reaching a new trade deal with Mexico and Canada and expressing optimism about eventually reaching deals with Europe and Japan. That moves the focus to China, with 10% tariffs on $200 billion in additional Chinese goods going into effect during the quarter, raising the total amount of goods subject to tariffs to $250 billion—nearly half of Chinese imports into the U.S. The MSCI China Index and the Shanghai Composite Index in U.S. dollars fell 7.4% and 3.3%, respectively, during the quarter, bringing year-to-date losses to 9.1% and 17.2%.

At quarter end, our allocation to greater China was 17%. Despite the decline in China’s equity market, which has been driven mostly by trade war concerns, we remain comfortable with the companies we hold for several reasons. First, from a bottom-up basis, the already announced and upcoming trade tariffs have limited impact on their underlying earnings growth trajectory. Second, the Chinese government has a number of policy actions it can take to stimulate the domestic economy and lessen the effect of trade tariffs. Since most of our holdings are exposed to domestic consumption, those measures would likely benefit them. Finally, in the event that both the U.S. and China were to reach a mutually beneficial trade agreement, China equity markets, along with our holdings, would see valuation re- rating reflecting reduced political risks.

Markets in developed Europe also turned in their first positive quarter of the year with the MSCI Europe Index up 0.81% in dollar terms, paring its year-to-date loss to 2.1%. Concerns over an Italian exit from the European Union eased, although late in the quarter the new coalition government announced budget deficit targets over the next three years that surprised investors on the negative side. Italian markets, particularly Italian banks, sold off on concern about the impact of the projected deficit on Italy’s fiscal position and debt burden. European banks declined, based on the expectation that an interest-rate hiking cycle will be further pushed out, given Italian policy uncertainties. We expect market volatility to continue as the Italian government and the European commission negotiate the Italian budget in the fourth quarter.

At quarter end, we held just under 22% of the portfolio in financials, with 17% in Europe and 12% of it in European banks, including UniCredit, Commerzbank, and Credit Suisse. Over the course of the last six months, those positions have come under pressure over economic and trade-war concerns, jitters in Italy, and as the ECB (European Central Bank) has delayed the onset of tightening, as higher interest rates generally benefit banks.

As in China, we like our financials holdings on a bottom-up basis for a number of reasons. Some banks are benefiting from “self-help” measures—selling non-performing loans, cutting costs, and making divestitures to improve profitability and capital positioning. Some banks hold excess capital and should be ready to return a portion to shareholders. Some are sensitive to interest rate movements and their earnings will benefit when the ECB eventually begins to tighten. In addition, valuations of our bank holdings are attractive and don’t yet reflect, in our view, the positive fundamentals.

For the quarter ended September 30, 2018, Thornburg International Value Fund returned negative 0.38% (I Shares), compared to the MSCI EAFE and MSCI ACWI-ex U.S. Indices’ returns of 1.35% and 0.71%, respectively. Aside from individual company issues, which are noted below, the three largest top-down factors that have impacted performance over the last three to six months are pressures on European banks, the potential of a trade war between the U.S. and China, and the continuing underperformance of stocks categorized as value versus those tagged as growth. The valuation gap between the two also intensified. The MSCI EAFE Growth Index price-to-earnings multiple (P/E) based on estimated 2019 earnings expanded to 16.5x as of September 30, compared to a MSCI EAFE Value Index forward P/E multiple of 10.9x. The MSCI EAFE Value Index is now trading more than one standard deviation below its long-term average relative to the MSCI EAFE Growth Index based on forward P/E.

Top Contributors

  • Électricité de France
    Électricité de France (EDF) produces, transmits, distributes, imports, and exports electricity. EDF owns the largest nuclear power generation capacity in France and is vital for the reliability of electricity across Europe. Given its generation mix, EDF benefited from higher carbon prices and higher power prices, driven by higher fossil fuel prices during the quarter. Even with its recent re-rating, we believe EDF’s assets have still been considerably undervalued.
  • SoftBank Group
    Softbank invests in companies from mobile telecommunication operators to e-commerce, technology services, and content, etc. Softbank has also been engaging in venture capital investing in technology-related areas globally via the Softbank Vision Fund. Our investment thesis is that Softbank owns valuable assets, a number of which are priced at a significant discount to our sum-of-the-parts valuation. The stock performed well in the third quarter as the company is on track to unlock value by listing its Japan wireless operator, Softbank KK, and as investors gain more confidence in the Sprint/T-Mobile merger in the U.S.
  • Reliance Industries
    Reliance Industries is India’s largest petrochemical and second-largest refining company. It has also diversified into retail, media, and most recently telecom businesses. Reliance’s performance in refining and petrochemicals has been strong, benefiting from its scale and integration advantages. Its telecom business, JIO, already accounts for 20% of India’s wireless subscribers within two years of its launch and is now the most profitable telco in India. The option to list JIO and/or Reliance’s new retail businesses could further unlock value for shareholders in the coming years.
  • Canadian Pacific Railway
    Canadian Pacific Railway provides rail and intermodal freight transport services throughout North America. We believe that Canadian Pacific is one of the best managed and most efficient railroads in the world following an impressive turnaround led by railroad legend Hunter Harrison. The stock performed well during the quarter as it benefited from strong demand for commodities, such as oil. In addition, Canadian Pacific has been taking market share from trucking companies. We continue to see the macro environment as supportive for railways and expect CP to deliver high returns from volume-driven operating leverage.
  • Ping An Insurance Group
    Ping An Insurance is a leading Chinese financial conglomerate involved in insurance, pensions, banking, brokerage, trust, and other financial services businesses. Currently Ping An is the second-largest life insurer and the second-largest P&C insurer in China in terms of premiums. The stock’s performance was driven by better premium growth and an improving earnings outlook during the quarter. Going forward, we continue to expect positive business momentum and the potential to list and unlock the value in its fintech businesses (such as Lufax).

Bottom Contributors

  • TAL Education Group
    TAL Education Group provides afterschool tutoring services in China. Its services cover core academic subjects such as mathematics, English, Chinese, physics, chemistry, political science, history, etc. Policy uncertainties related to after-school tutoring regulation in China have negatively impacted the entire industry. While it could temporarily slow TAL’s capacity expansion plan, we see limited impact on TAL’s business from a fundamental perspective. With rising urbanization, favorable demographics, and intense competition for admission into top schools in China, TAL benefits from a supply-demand imbalance, coupled with a growing market share resulting from favorable brand recognition.
  • Yunnan Baiyao Group
    Yunnan Baiyao is the largest Traditional Chinese Medicine (TCM) company in China. It has three business segments. The pharmaceuticals segment produces Yunnan Baiyao branded coagulant drugs. The drug is considered as one of the “national secrets” in China, so its patent will never expire. The pharmaceuticals segment is the cash cow of the company. The company has leveraged its strong Yunnan Baiyao brand awareness and has entered into the consumer product business. Its toothpaste products have been very successful and are the growth driver for the company. Yunnan Baiyao is also the largest pharmaceuticals distributor in Yunnan Province with over a 60% market share. Its first-half results missed expectations as the pharmaceuticals segment’s sales volume was lower than expected due to price increases in the period. The stock is currently halted from trading while it is going through a re-organization merging the parent company with the listed company.
  • Halliburton
    Halliburton provides energy and engineering and construction services, as well as manufacturing products for the energy industry. Although oil prices continue to move higher, Halliburton’s North America pressure-pumping segment and the industry have been experiencing challenges. Crude oil pipeline constraints in the Permian Basin, an increased supply of pressure- pumping services and materials, capacity additions, and efficiency gains are noticeable headwinds. While the North America market is becoming more competitive, we maintain confidence in Halliburton’s ability to evolve and industrialize its operations to drive operating efficiency and lower costs.
  • Tencent Holdings
    Tencent Holdings Limited is the largest social and gaming platform in China. The company offers gaming, social networking, cloud solutions, payments, and other value-added services to consumers and merchants. Tencent continues to have the largest share of mobile user time in China through its WeChat (Weixin) platform, which remains early in its monetization cycle and has demonstrated increasing nodes of opportunity. Growth on Tencent’s gaming platform has slowed as Chinese regulators have temporarily halted the granting of licenses to monetize new games. In particular, because Tencent’s popular survival shooter games have taken share from monetizing games, revenue growth has slowed. Meanwhile, Tencent continues to garner user engagement on its gaming titles (particularly its survival shooter games), demonstrating Tencent’s capabilities as a toptier game designer and publisher. The shares were down negative 28% yearto- date and negative 27% during the third quarter, pressured by uncertainty around the timing of monetization approvals from Chinese regulators.
  • UniCredit SpA
    UniCredit is the second-largest bank in Italy, the third-largest in Germany, and the leading bank in Austria and in Central Eastern Europe. Uni- Credit was one of the best-performing stocks in 2017. However, in 2018 it has underperformed as the market has discounted the lower earnings growth resulting from delayed ECB rate hikes. Political uncertainties in Italy, particularly with the budget debate, widened the Italian sovereign spread during the quarter, which negatively impacted all Italian bank stocks. Our investment thesis on UniCredit is a self-help story. As UniCredit executes on portfolio restructuring, cost discipline, and faster non-core rundown, we expect it to deliver higher returns and unlock the path to higher dividends/capital redeployment in the medium term.

Even though international equity markets have delivered lower returns for investors than the U.S. equity market, there are benefits for maintaining a strategic allocation to international equity markets.

  1. Valuation in international equity markets is attractive. The MSCI EAFE Index is trading at a 20% discount to the S&P 500 Index on forward P/E multiple. It is more than one standard deviation below its long-term relative valuation average.
  2. International equity markets give investors access to a diverse set of companies and different sources of alpha.
  3. Strategic allocation to international markets has also proven to reduce risk at the portfolio level.

While volatility and bouts of unsatisfying performance are top of mind in the short term, it is our long-term lens and bottom-up, fundamental analysis that have led to our long-run outperformance. We maintain conviction in our philosophy, process, and three-basket portfolio construction process, all of which have combined to create positive outcomes for long-term clients. Having been through many of these environments in the past, we believe that our patience and diligence can be rewarded when volatility creates valuation opportunities.

Thank you for investing alongside us in Thornburg International Value 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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Unless otherwise noted, the source of all data, charts, tables and graphs is Thornburg Investment Management, Inc., as of 9/30/18.

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.

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