3rd Quarter 2018

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Thornburg Long/Short Equity Fund returned 0.96% (I shares) during the third quarter of 2018, compared with a 7.71% advance for the S&P 500 Index and the Morningstar Long-Short Equity category’s average gain of 2.77%. For the first three quarters of the year, our 1.94% return represented 18.37% of the S&P 500’s 10.56% rise over the same period. Thus, our net-exposure-adjusted return did not keep pace given our average 31.94% net long exposure for the nine-month period. Though the thrust of this commentary is centered around a short-term period, we remain focused on longer- term outcomes, driven by a repeatable process. Nonetheless, we do strive to outperform our net exposure, regardless of the time frame.

As a reminder, we seek to manage the risks of the portfolio through both qualitative and quantitative risk management. We strive to allow our stock selection to tell the story; that is, we work to have similar sector, market cap, geographic, and risk-factor exposures on each side of the book. We employ a six-basket approach to portfolio construction. We believe this framework can immunize the portfolio from the extremes, facilitating good risk-managed outcomes measured by through-cycle returns.

Our goal is to generate equity-index-like returns over the cycle through long and short investing, minimizing the bumps along the way with lower equity market exposure and volatility.

However, in short- to medium-term periods, market leadership can run for what feels like an eternity. That has been the case in recent years with growth outpacing value, and it was certainly the case again during the quarter. Not surprisingly, our more growth-oriented baskets outperformed our less growth-oriented baskets on the long side, and the converse was true on the short side. But, we avoid the temptation to chase the trends and instead remain committed to our investment process. Decades of investment experience has taught us that a repeatable process and methodology endure, whereas emotions are erratic. We will continue to allocate some of the fund’s capital to out-of-favor corners of the market to build a portfolio for all seasons. John Maynard Keynes purportedly exclaimed: “The market can remain irrational longer than you can remain solvent.” The follow-up, were there ever an occasion for it to be delivered, may have been, “but it can reverse course more quickly than you can react.”

We work hard to build balance within the portfolio, primarily utilizing our basket structure. If we are successful, our relative returns will usually be driven by good or bad stock picks. That said, it feels strange out there to us. No doubt, active managers have been sailing into a headwind over the last 10 years.

We can’t help but wonder at the impact that passive and machine-driven investing are having on the overall markets. Our best guess is that, over-time, this will tend to lead to greater dislocations between where a company’s stock trades and the intrinsic value of its business, and perhaps more violent corrections from time to time as these differences are corrected. JPMorgan recently suggested that only about 10% of U.S. equity investment is now done by traditional, discretionary traders. Charts 1 and 2 provide a couple looks at flows since the financial crisis.

Further, industry luminaries have weighed in, including, recently, one of the all-time greats, Stan Druckenmiller: “These algos have taken all the rhythm out of the market and have become extremely confusing to me.” Value investors, as a group, appear to have become a bit dense. But we worry some about how long valuations will take to correct, given that any of the buyers that you would usually expect to force the adjustment are likely facing redemptions. But, we don’t doubt that, over the long-term, stock prices ultimately reflect fundamentals. As we’ve said for some time, the proliferation of indices and index flows may make short-term dislocations more severe, but ultimately create more opportunity for fundamentals-based, bottom-up investors.

Another Depressing Chart

In Chart 3, you can see some sobering statistics related to the opioid crisis. We bring this up simply to remind investors that one of our weaker holdings recently, Alkermes, sells a drug that we believe is part of the solution. While Vivitrol isn’t the answer for every patient seeking treatment for opioid addiction, over the next few years we think it has the opportunity to be used by many more of those suffering. Vivitrol blocks the opioid receptor in the brain for 30 days after treatment; i.e., you can’t get high from opioids while you’re on Vivitrol.

The No Jerks Rule

We’ve long said our collegial culture, built on Bill Fries’ belief that to collaborate effectively, we must first respect each other, is a key to the cultural alchemy that has led to long-term success across our investment strategies at Thornburg. It’s good to see this soft cultural tone find a wider audience. And, hopefully, wider adoption could lead to broadly improved outcomes across the industry (and, more happy people at work!).1

Best Performers (Top 5)

  • Assured Guaranty Ltd. (Long) Assured Guaranty continues to get better pricing on new municipal issuance while it manages exposure to Puerto Rico insured bonds. The company continues to buy back over 10% of its shares annually at a meaningful discount to book value.
  • O’Reilly Automotive, Inc. (Long) Auto parts retailers broadly rebounded from cyclical lows in same store sales. O’Reilly’s same store sales have continued to outpace peers on the back of a best-in-class distribution network. The stock has responded by re-rating to the upside on higher earnings estimates.
  • ITT, Inc. (Long) ITT continues to experience secular growth in its Motion Technologies business and has been aided by the early stages of a cyclical rebound in its other businesses. In addition, operations and margin structure have improved and legacy liabilities have been reduced, allowing the stock to re-rate closer to peer levels on improved earnings power.
  • Thermo Fisher Scientific, Inc. (Long) As a leading supplier of research products and services, Thermo Fisher is well positioned to capitalize on the secular growth in research. The stock responded to strong revenues and continued margin improvement.
  • Medtronic plc (Long) The shares rallied after quarterly revenue and earnings, plus newly raised forward guidance, beat estimates for this medical device manufacturer. The firm saw strength across several of its product divisions, including across relatively new products within its diabetes franchise.

Worst Performers (Bottom 5)

  • Sonic Corp. (Short) We believed that earnings growth of Sonic, a quick-service restaurant operator, was challenged due to lack of store growth and heightened promotional intensity in the industry. However, during the quarter Sonic was acquired by a private equity–backed company and thus we closed this position.
  • Shionogi & Co. Ltd. (Short) So far, Shionogi’s joint venture (Shionogi- ViiV Healthcare LLC) sales have held up better in HIV than we would have anticipated, but we expect this to change. We believe their royalty income to be at risk due to the launch of a competing product by Gilead Sciences.
  • TRI Pointe Group, Inc. (Long) TRI Pointe Group underperformed as rising mortgage rates, higher home prices, and concerns about a slowdown in home building caused sentiment to shift. Additionally, orders were softer than expected in the short term.
  • US Foods Holding Corp. (Long) Shares came under pressure when the company pre-announced light quarterly earnings on execution issues and announced a large strategic acquisition of another distributor at a higher valuation than they’ve typically paid.
  • Square, Inc. (Short) Square provides integrated, mobile payment solutions to small- and medium- sized businesses. We believe it’s temporarily benefiting from investor willingness to pay a higher price per unit of earnings for some growth companies than has been the case historically. But, we believe this phenomenon will be temporary.

Looking forward, we are focused on navigating an uncertain landscape through our time-tested, fundamental, bottom-up investment process and six-basket portfolio construction framework. Our goal is to deliver compelling investment returns over the course of a cycle, while managing the volatility and investor experience along the way.

Thank you for investing alongside us in Thornburg Long/Short Equity Fund.

1. Chris Schelling, “The ‘No Jerks’ Rule of Investing,” September 2018, https://www.institutionalinvestor. com/article/b19y8b1zzmx8kx/The-No-Jerks-Rule-of- Investing.

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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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 9/30/18.

Data prior to 12/30/16 is from the predecessor fund.

Notable purchases and sales includes material transactions other than recently purchased securities, which may be excluded for best execution purposes.

The Fund may invest in shares of companies through initial public offerings (IPOs). IPOs have the potential to produce substantial gains and there is no assurance that the Fund will have continued access to profitable IPOs. As Fund assets grow, the impact of IPO investments on performance may decline.

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. A short position will lose value as the security's price increases. Theoretically, the loss on a short sale can be unlimited. 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. Non-diversified funds can be more volatile than diversified funds. Investments in the Fund are not FDIC insured, nor are they bank deposits or guaranteed by a bank or any other entity.

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Morningstar Long/Short Equity Category – Long/short portfolios hold sizeable stakes in both long and short positions in equities, exchange traded funds, and related derivatives. At least 75% of the assets are in equity securities or derivatives, and funds in the category will typically have beta values to relevant benchmarks of between 0.3 and 0.8 over a three-year period.

Adjusted S&P 500 Index – Reflects returns of S&P 500 Index multiplied by the percentage of the Fund’s exposure to the index on a monthly basis. Source: Kiski Group.

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