3rd Quarter 2017

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The fund gained 2.39% during the third quarter of 2017, compared to a 4.48% increase for the S&P 500 Index while the Morningstar Long/Short Category returned 2.55%. As of September 30, 2017, on a year-to-date basis, the fund is up 11.5% with the S&P 500 Index rising 14.2% and the peer group with a 6.9% gain. Our net exposure has averaged around 32%, both for the quarter and year to date.

"Owner's Manual"

While new to the mutual fund world, Thornburg Long/Short Equity Fund has been around much longer than just these last 10 months. In fact, the original LP structure hedge fund was started in early 2008 and was converted to a mutual fund on December 30, 2016. We will celebrate the strategy's 10th anniversary in February of 2018. In our 2013 partner letter, we provided a brief Owner's Manual of sorts, and we would like to include a similar disclosure here for the mutual fund. While this manual will look a little bit different than what we wrote then, it's heartening how little has changed. So, here goes.

Thornburg Long/Short Equity Fund is an opportunistic strategy that will generally own a focused portfolio of long investments (30 to 40 stocks), against a focused portfolio of short investments (also 30 to 40 stocks).

We limit the net market exposure of the fund to 30% to 50%. You should think of our net exposure as our expected beta against the S&P 500 Index. If we add or subtract no value through stock selection, you could expect the fund to return 30% to 50% of the S&P 500 return in any given year (less fees). Our current net exposure is lower (by a lot) than our average peer in the Morningstar Long/Short Equity category. Our net exposure range is also more limited (and therefore more predictable). While we have tremendous flexibility to buy, or short, the investments that we are most excited about, we don't give ourselves the flexibility to whip around our net exposure to compound our risks. (We don't believe in market timing, holding to heart economist John Kenneth Galbraith's saying: "There are two kinds of forecasters: those who don't know, and those who don't know they don't know.")

Geographically, we can invest anywhere in the world, though our history and our expectation is that we will tend to do more investing in the U.S. than elsewhere. We are multi-cap and growth oriented investors on both sides of the book.

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. Our basket approach, as well as our risk reporting and monthly risk meetings, aid us in this endeavor.

Our goal is that through long and short investing we will be able to generate broad equity index-like returns over the cycle, while minimizing the bumps along the way (i.e., provide lower equity market exposure and volatility).

Fund Long-Term Results

What's most important in the previous sentence is the term "over the cycle." We are in a historically long drought between bear markets. If the S&P 500 Index finishes positive for 2017 (which seems likely, given the 14% return year-to-date as of September 30, 2017—though stranger things have happened), it will mark nine consecutive years of positive total returns. The only other time this has happened since the founding of the original Composite Index in 1923 (which later became the S&P 500 Index) was in the nine years ending in 1999 (Let's party like it's 1999!). Given the long bull run, we think a risk-adjusted return measure is a reasonable way to examine our results. In Charts 1 and 2, you can see the annualized alpha generated over the last five years and since inception for the fund against the S&P 500, as well as how our peer group has fared.

We are excited to have provided good up-market participation for the fund during the long rally, despite our low net exposure. We are also excited that our investment process has contributed to fund alpha on both sides of the book. Our alpha generation on the short side seems particularly distinctive over the last five years. Keep in mind trailing returns would look better if we excluded the 20% incentive fee we previously charged when the fund was a private vehicle. Excluding our incentive fee, we've annualized at 8.54% since the fund's February 1, 2008, inception vs. a return of 8.78% for the S&P 500 Index over the same period.

Finally, we think it's important (especially after this long bull run) to keep our net exposure consistent. We recently came across Chart 3 showing average equity beta of equity long/short hedge funds.

The hedge funds depicted have lower equity beta than the mutual funds in our Morningstar peer group (currently around 60% net exposed). We run our mutual fund just as it was run as an LP structure hedge fund, so this makes sense. That said, our 32% net exposure at quarter end is lower than the hedge funds in the chart. A good market timer (in a parallel universe where they exist) would have shown high equity beta at the beginning of the chart, lowest at the peak in 2007, then again high in March 2009, and would have carried the high beta exposure through today. That is not the average hedge fund investor experience. We believe it's just much easier to keep a consistent net exposure of between 30% and 50% and let our stock selection tell the story. But that's just us...our competitors can have at it.

Quarterly Results

During the quarter, the fund's long book contributed to absolute return, while the short book detracted. Our long positions didn't keep pace with the broad market, though they were close. Our shorts, however, were alpha generative during the period, up (which means we lost money), but only about half as much as the S&P 500. This produced an overall satisfactory result for the quarter, as our 2.39% return was about half of the market return, though we carried only around a third of the equity market exposure (our net exposure). For the year-to-date period, we are very satisfied with our results, capturing 80% of the market return with, again, only around a third of the equity market exposure.

Intra-quarter, we were ahead of the S&P 500 in a rising market through September 8, 2017. From there, the market went higher, and we traded sideways. Small-cap stocks dramatically outperformed large-caps during the period. With much talk of tax reform, the end of September felt like last year's post-election environment. As recently as early 2016, fund alpha was positively correlated with small-cap vs. large-cap returns. We worked hard to reduce our fund exposure to more volatile small-caps over the course of 2016. It seems safe to say that we've overcorrected. At year end 2016 and through 2017 so far, fund alpha has been negatively correlated with small-cap vs. large-cap performance. We're monitoring and mindful of this exposure, though it may remain for some time.

Best Performers

Long Book

  • Gilead Sciences, Inc.
    Earlier this year, we added significantly to our long-held Gilead investment. For the first time in two years, it is again the largest holding in the fund. So far, the add seems well timed as the stock has rallied following their acquisition of Kite Pharmaceuticals.
  • Pure Storage, Inc.
    Pure Storage is a purpose-built flash storage provider serving the enterprise and cloud markets. In the second quarter of 2017, it reaccelerated its revenue growth rate ahead of new product ramps and looks poised to become the first stand-alone enterprise IT company in 20 years to reach $1 billion in annual revenues.
  • Facebook, Inc.
    Despite intensifying political pressure surrounding Russian interference in the U.S. election, Facebook remains a high return on investment venue for advertising dollars globally. We expect recent strong business trends to continue.

Short Book

  • Ellie Mae, Inc.
    Ellie Mae is a mortgage origination software company. We believe the company's revenues are inherently cyclical vs. management's claim that it can consistently grow top-line at 25%. A recent deceleration in user growth has led to weakness in the shares.
  • Electronics for Imaging, Inc.
    Our short position in Electronics for Imaging (EFII), a high-end industrial printer manufacturer, was initiated due to a stretched valuation and accounting red flags, including masking the lack of organic growth through acquisitions, increasing days sales outstanding through extended payment terms, and rising inventory levels. EFII delayed its quarterly results after discovering accounting irregularities around revenue recognition, and we took this opportunity to cover half of our position. It has since rallied and we have added again to our short.

Worst Performers

Long Book

  • Alkermes plc
    Alkermes de-rated after investors learned that a phase-3 drug for major depressive disorder will need to pass a higher hurdle before Food & Drug Administration approval. Although the company's drug pipeline has the potential for significant financial opportunity, our investment case has been based on two commercial products—Aristada and Vivitrol—which are performing in line with expectations.
  • Medtronic plc
    Medtronic underperformed in the quarter after reporting disappointing growth. While quarterly variance based on new product launches can affect short-term volatility, the company continues to grow steadily.

Short Book

  • Myriad Genetics, Inc.
    Myriad Genetics showed stability in its core hereditary cancer–testing business after many quarters of declines. Myriad will face new contract renewals in this increasingly competitive space in the coming years.
  • Cogent Communications Holdings Inc.
    We believe that Cogent Communications, an internet service provider, will have difficulty achieving its financial goals of growing revenues and EBITDA (earnings before interest, taxes, depreciation, and amortization) margins on a consistent basis. In our opinion, the stock's expensive valuation is supported by the dividend, which is partially funded through new debt issuance.
  • BofI Holding, Inc.
    We believe BofI Holding, Inc. operates with a weak balance sheet as neither its deposits nor loans are relationship based. When credit and deposit costs for the banking industry normalizes, we expect BofI's earnings to deteriorate considerably.

Selected Fund Activity

Long Book New Positions

  • General Electric Co.
    General Electric Co. is a global industrial company. The company's products and services range from aircraft engines, power generation, and oil-and-gas production equipment to medical imaging, financing, and industrial products.
  • Echostar Corp.
    Echostar Corp. is a holding company. The company is a provider of satellite operations, video delivery solutions, digital set-top boxes, and broadband satellite technologies and services for home and office, delivering network technologies, managed services, and solutions for enterprises and governments.
  • O'Reilly Automotive Inc.
    O'Reilly Automotive Inc. is a specialty retailer of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States. The company sells its products to both do-it-yourself and professional service provider customers.

Thank you for your continued trust in us.

Contributors to Performance
Contrib % Avg Wgt %
Gilead Sciences, Inc. 0.95 6.47
Pure Storage, Inc. Class A 0.79 3.08
Ellie Mae, Inc. 0.61 -2.06
Electronics For Imaging, Inc. 0.57 -0.82
Facebook, Inc. Class A 0.52 4.03
Detractors from Performance
Contrib % Avg Wgt %
Myriad Genetics, Inc. -0.76 -2.47
Alkermes plc -0.58 4.29
Medtronic plc -0.47 3.74
Cogent Communications Holdings, Inc. -0.44 -2.07
BofI Holding, Inc. -0.42 -2.11


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 our literature center. Read them carefully before investing.

Unless otherwise noted, the source of all data, charts, tables and graphs is Thornburg Investment Management, Inc., as of 9/30/17.

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

Thornburg adjusts the characteristics of certain derivatives to, in our investment team’s opinion, more accurately reflect their market exposure.

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