4th Quarter 2017

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Looking back, 2017 was a good year for Thornburg Long/Short Equity Fund. The fund gained 16.87% vs. 21.83% for the benchmark S&P 500 Index, and with just 32% average net exposure. For the fourth quarter, the fund gained 4.79% vs. 6.64% for the index—also with just 32% average net exposure for the period.

As we write this, the market is staging a relief rally on news that members of the U.S. Senate were able to come together and agree to end a brief federal government shutdown. We wondered whether the market had traded off in response to the failed negotiations just the week before that threatened the shutdown in the first place. It sure didn't. And we saw new highs for the S&P 500 Index on both that Friday and the following Monday. This is exactly how the market has seemed to us for some time: Bad news—no worries; good news—let's take her higher.

Further, 2017 marked nine consecutive years of market appreciation for the S&P 500 Index. This has happened only once before. And that prior streak ended in 1999. Further spiking the punchbowl is the fact that, before 2017, the S&P 500 Index had never gone up in every month of a calendar year. While it lasts, we suppose we should all party like it's 1999.

As in past rallies, investors are just following the pack. For example, have you heard of blockchain? Good for you, if you haven't. We noticed that Kodak is creating its own image rights management service and cryptocurrency, based on blockchain technology. That news was enough to take Kodak stock from $3 to over $10 per share in a matter of days. Maybe that's the correct reaction. But count us skeptical. Amidst this herd mentality, we wonder what sort of interest we might garner in this fund if we were to alter its name to something like Thornburg Long/Short and Blockchain Fund? Are you suddenly, viscerally, more interested in our investment product? If so, maybe we should go buy some tulips?

To be clear, our strength is not calling the next market move. Rather, we are in the business of evaluating individual securities. We choose 30 to 40 stocks to hold long and 30 to 40 to sell short, with selections on both sides of the book based on our calculation of each company's intrinsic value. And we believe having some downside protection is always prudent in any portfolio, especially before the next, inevitable pullback. When the correction eventually rears, it will be hard for anyone to say there weren't any warning signs.

The fund has been sitting close to 30% net exposure for some time (at the low end of our 30% to 50% limit). Historically, our net exposure has been a good indicator of our realized beta to the S&P 500 Index. That is, a 30% net exposure should mean around a 0.3 beta to the market. Generally, stock market exposure is the biggest risk exposure in a client's portfolio (as it should be—the market has a long history of consistently going up, especially over the long term). Usually, bonds and cash represent the counterbalance to this equity exposure. And Thornburg Long/ Short Equity Fund provides a “bridge” between stocks and bonds. Our goal is to generate broad equity index-like returns, over the full market cycle, while minimizing the bumps along the way (i.e., provide lower equity market exposure and, ideally, less volatility). Especially in a world that may look different in the future, where perhaps stocks decline while interest rates continue to march higher (and bond prices, therefore, fall), Thornburg Long/Short Equity Fund should provide the opportunity for compelling relative returns as compared to both stocks and bonds, while reducing market exposure (and potential volatility) in client portfolios.

2017 Results

Growth investments led the market in 2017. We tend to invest in growthy companies on both sides of the long/short book. Happily, our growthy long investments well outpaced our growthy short investments. Our long holdings were up 34.8%, while our short positions were up 18.2% for the period. (We lost money on our shorts, but not as much as we would have had we shorted the S&P 500 Index). We generated alpha on both sides of the book in 2017 vs. the S&P 500 Index.

This marks the fourth consecutive year of alpha generation for the short book. We are particularly proud of our work on the short side for two reasons. First, we've done well shorting these last few years in what has been an especially difficult environment for many of our competitors. Second, because Thornburg is known as a strong equity and fixed income “long only” investment shop, it's particularly rewarding to see our investment culture and the research platform we've built yield strong results the other way too. For the year, we generated more than 75% of the S&P 500 Index total return with just 32% net exposure. Initial public offerings (IPOs) positively contributed to 2017 performance as well.

Top 5 Contributors (2017)

Long Book

  • Grand Canyon Education, Inc.
    This was a great investment for the fund over the last few years, and it reached our price target and was sold in 2017. Grand Canyon offers lowcost, high-quality on-campus undergraduate and graduate degrees. The company's investment in their ground campus brand has allowed their online enrollment growth to well outpace competitors.
  • Activision Blizzard, Inc.
    Activision was a standout during the year with its shares up significantly. Better in-game monetization and the formation of a new E-sports league based on their game Overwatch helped propel the stock.
  • Facebook, Inc.
    During 2017, Facebook grew users, engagement, and monetization across its social media properties.
  • Walmart Inc.
    Walmart's re-investment in its business (both in stores and online) continues to pay off. In particular, traffic in Walmart's U.S.-based stores grew solidly throughout 2017.
  • KOSÉ Corp.
    This Japanese cosmetics company benefited from strength in its North American brand (Tarte Cosmetics), Chinese inbound tourist demand, and Japanese domestic consumption.

Top 5 Detractors (2017)

Long Book

  • Carvana Co.
    We participated in the botched IPO of used car seller Carvana during 2017. While we sold some of our initial stake at our price target (much higher than the IPO price); early, significant trims at prices below the IPO made this one a significant loser for the year.
  • General Electric Co.
    Following our investment in early 2017, GE cut its dividend and future earnings expectations. Its Power business has been the largest source of disappointment, with heightened competition and softening end-demand.

Short Book

  • PetMed Express, Inc.
    Shares of PetMed Express rallied during 2017 as revenue and margin growth inflected due to newer generation medications. The company's effective tax rate will also go down due to tax reform.
  • Myriad Genetics, Inc.
    Myriad Genetics benefited from signs of stabilization in their hereditary cancer business.
  • Arista Networks, Inc.
    During 2017, Arista's business benefited due to strong demand for its switching products from data-center clients.
Contributors to Performance (2017)
Contrib % Avg Wgt %
Grand Canyon Education, Inc. 2.53 4.43
Activision Blizzard, Inc. 2.42 3.39
Facebook, Inc. 1.93 4.15
Walmart Inc. 1.86 5.00
KOSÉ Corp. 1.64 2.67
Detractors from Performance (2017)
Contrib % Avg Wgt %
PetMed Express, Inc. -1.89 -2.23
Myriad Genetics, Inc. -1.72 -2.25
Artista Networks, Inc. -1.37 -2.10
Carvana Co. -1.35 2.27
General Electric Co. -1.17 3.22

Fourth Quarter 2017 Results

The fund had a good fourth quarter. Our long holdings were up more than the market, and our short positions were up less. We were able to generate almost 75% of the market return on just 32% net exposure. IPOs had an outsized impact to our long book performance during the fourth quarter. Our long book total return, excluding IPOs, was positive for the period and ahead of our short book total return, though it trailed the S&P 500 Index.

Top 5 Contributors
(fourth quarter, 2017)

Long Book

  • Walmart Inc.
    See above.
  • TRI Pointe Homes, Inc.
    Strength in the construction and sale of single-family attached and detached homes continues.
  • Switch, Inc.
    We participated in the successful IPO of this data-center operator.
  • KOSÉ Corp.
    See above.
  • US Foods Holding Corp.
    Continued market share gains with independent restaurant customers, improved margins from higher sales of private-label products and an intentional shift in customer mix towards higher-value independent customers allowed the company to grow operating income at a high single-digit rate.

Top 5 Detractors
(fourth quarter, 2017)

Long Book

    General Electric Co.
    See above.

Short Book

  • Hello Fresh SE
    HelloFresh sells meal kits over the internet. We have serious doubts about the long-term growth and margin profile of this company. In the short term, however, the stock has re-rated due to positive sentiment.
  • Petmed Express Inc.
    See above.
  • W.W. Grainger, Inc.
    Our longer-term thesis on Grainger, an industrial supplies distributor, is that company's margins are secularly challenged due to increased price transparency brought by e-commerce. Grainger is a beneficiary of the tax reform which got reflected in the stock price during the quarter.
  • Haemonetics Corp.
    Haemonetics is a medical devices company whose revenues are structurally challenged due to price cuts and increased competition. Strength in the company's shares during the quarter can be attributed to bullish expectations on product launches as well as on tax-reform benefits.
Contributors to Performance
(Fourth Quarter 2017)
Contrib % Avg Wgt %
Walmart Inc. 1.08 4.42
TRI Pointe Homes, Inc. 0.98 3.67
Switch, Inc. 0.96 2.59
KOSÉ Corp. 0.82 2.70
US Foods Holding Corp. 0.75 3.94
Detractors from Performance
(Fourth Quarter 2017)
Contrib % Avg Wgt %
General Electric Co. -1.01 3.16
HelloFresh SE -0.75 -2.03
PetMed Express, Inc. -0.66 -2.04
W.W. Grainger, Inc. -0.63 -2.24
Haemonetics Corp. -0.60 -2.31

Select Fund Activity

Long Book / New Positions

  • Evolent Health, Inc.
    Evolent is a software and services company originally spun out of the University of Pittsburgh Medical Center (UPMC). UPMC successfully started a health-insurance company to pair with its strong provider (hospital) network. We believe that integrated health systems (which combine insurance, hospitals, surgery centers, doctor's groups and other operations) are likely to be a part of the solution to providing better care at a lower cost in the U.S. Evolent works with providers who are looking to move towards riskbased payments or to start integrated health systems.
  • ITT, Inc.
    ITT is an industrial company that operates in three divisions: Motion Technologies (brake systems), Industrial Process (pumps for industrial end markets), and Connect & Control Technologies (connectors and other industrial components). ITT is a secular market share gainer in brake systems (especially in China), while their pumps business seems to be setting up for a cyclical rebound.

On a final note, February 1, 2018, marked 10 years of long/short investing in this strategy for Thornburg. We are proud of our results so far, and we are optimistic about the next decade.

Thank you for your continued trust in us.

2017 Year to Date
Total Return % Avg Wgt %
Long 34.8 106.7
Short 18.2 -74.3
Fund 16.9 32.3
S&P 500 Index 21.8 -
Russell 2000 Index 14.7 -
Fourth Quarter 2017
Total Return % Avg Wgt %
Long 7.5 105.6
Short 3.5 -73.7
Fund 4.8 31.9
S&P 500 Index 6.6 -
Russell 2000 Index 3.3 -


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