2nd Quarter 2018

    Portfolio managers are supported by the entire Thornburg investment team.

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Thornburg Long/Short Equity Fund returned 1.33% (I shares) during the second quarter of 2018, compared with a 3.43% advance for the S&P 500 Index and the Morningstar category's average gain of 0.14%. The fund generated 39% of the index return with a 32% average net long exposure, which amounted to less than half the category's average net long exposure.

For the first half of the year, our 0.97% return represented 37% of the S&P 500's 2.65% rise over the first two quarters, and also outpaced our steady 32% net long exposure for the six-month period.

In both the second quarter and first half, both our longs and our shorts have total returns much greater than the return of the S&P 500. This is good news in the case of our longs, and bad news in the case of our shorts, implying more losses. Growth stocks outperformed in both periods, and both sides of our book tend to be growthy, so some of this is to be expected. In both cases, however, our shorts outpaced our longs. This created a decent risk-adjusted result, given our larger gross exposure to our longs. But our goal is to generate alpha on both sides of the book. We have only accomplished our goal on the long side so far this year.

Contribution

Growth Stocks

Recent growth outperformance is nothing new for this market. Growth stocks have outperformed value stocks six quarters in a row, and in 15 of the last 20 quarters. Surely, less expensive stocks are due for a comeback.

At the risk of sounding too much like John Kerry, it's more complicated than that.

For example, let's take a quick look at the telecommunications sector. In the age of the internet, with mobile data usage growing rapidly and an integral part our daily lives, the telecommunications companies that provide those services in the U.S. must be hugely important to our economy, one would think. Well, not so, based on their combined market caps. In fact, telecom stocks are near historic lows as a percentage of the S&P 500 Index. For this exercise we are using S&P's Global Industry Classification Standard (GICS).

 

Telecom Sector weigh in S&P 500 Index over Time

So, is the telecom sector due for a huge comeback? Will the sector be much larger as a percentage of the index in five years than it is today? While we generally shy away from bold predictions in these commentaries, this one we feel confident about: no, definitively not. In fact, the telecom sector, as we know it, is going away at the end of September. It will be replaced by the new “Communication Services Sector” and add currently designated consumer discretionary names, such as Netflix and Comcast, as well as some presently tagged information technology names, including Facebook, Google, and Activision, to the traditional telecom stocks.

Why does this matter? We think it underlines the fact that the world is changing. And perhaps at an accelerating pace. Our flexible perspective works really well in this sort of environment, which makes confident, big picture predictions hard. Will value stocks come back? What's a value stock? The telecommunications sector would certainly qualify today. But that sector won't even exist come September.

We understand the world is changing, and we do see more opportunity in relatively cheaper stocks today. That's beginning to show in portfolio positioning. Still, we try to avoid factor bets or portfolio exposures based on macro themes over which we have no control. But we have always had the flexibility to go where we see discrete opportunities. And recently, the fastest-growing, tech-related growth companies look too expensive to us. We remain growth-oriented investors on both sides of the book, but have more interest today in companies that represent growth at a reasonable price rather than aggressive growth businesses.

Likewise, on the short side, some of our higher-valuation, more momentum-oriented investments have moved against us, but we continue to consider them compelling short investment opportunities.

Growth company management teams, by the way, seem to agree with us, if the rate at which they are issuing convertible securities is any indication.

Tech Company Issuance of Bonds that can Convert to Stock

To be sure, we fight the urge to move too far toward greater net exposure to cheaper, out-of-favor companies because they can stay out of favor for long periods of time. But, in the context of a balanced portfolio, we will certainly let our stock picking drive incremental moves in portfolio long and short stock selection. In Chart 3, you can see long and short book factor decile exposure to the valuation factor—this is a reasonable measure of growth vs. value exposures on each side of the book.

Growth/Value Factor Deciles for Long and Short Books

Since the beginning, our commitment to disciplined net exposure and a focus on returns driven through idiosyncratic elements rather than broad-based market factors have benefited our clients. We would like to think the combination has been responsible for our ability to generate market-like returns with less volatility since inception. But, regardless of the causality, we do believe that it forms a core tenet of our strategy and one which we will safeguard—no matter which direction the current wind may blow.

A Quick Note on Our Flexible Perspective

From a recent read, The Power of Habit by Charles Duhigg:

“When people are asked to do something that takes self-control, if they think they are doing it for personal reasons, if they feel like it's a choice, or something they enjoy because it helps someone else, it's much less taxing. If they feel like they have no autonomy. If they're just following orders, their willpower muscles get tired much faster.”

We believe our flexible approach to team organization, allowing the pursuit of investment ideas across sector and geography, keeps the work exciting.

Notable Purchases and Sales

Best Performers (Top Five)

Long Book

  • iQiyi, Inc.
    iQiyi contributed strongly to performance in the second quarter. iQiyi is the leading online video streaming service in China and is often compared to Netflix. China is an appealing market for an online video service like iQiyi, given high broadband penetration, relatively weak competing content on broadcast TV, and an underdeveloped content production industry. We have followed iQiyi for many years through its development as a private company. We were excited for the chance to own iQiyi when it went public in late March at what we had considered an attractive valuation. iQiyi's share price fell immediately after its initial public offering, and we used that opportunity to buy more shares. The price subsequently rebounded handsomely as the market came to appreciate iQiyi's growth prospects.
  • Evolent Health, Inc.
    The continued move toward value-based payment methods from fee-for-service payment for health care services has kept demand for Evolent's core consulting offering strong. Growth continued against muted expectations and further the market received more clarity from Washington, DC, that value-based care outcomes are less likely to get caught up in health care reform.
  • Devon Energy Corp.
    Higher oil prices and expense reductions should result in better margins and earnings, especially when combined with substantial non-core asset sales that are expected to lead to significant company share buy backs and debt paydowns. The company's continued portfolio transformation and streamlining should highlight what we believe is a sharp divergence between its share price and the value of its remaining assets.
  • Facebook, Inc.
    Following a first-quarter pullback in Facebook shares in the wake of the Cambridge Analytica fallout, strong revenue and profits helped drive a share price recovery during the second quarter. While we worry about potential new privacy regulation, we believe continued strong advertising revenue gains are likely to be the primary driver of stock price performance in the coming quarters.
  • Start Today Co. Ltd.
    The fund recently purchased Start Today shares, Japan's apparel e-commerce leader. Start Today offers better economics for brands than retail sales, and is benefiting from local scale benefits. We are particularly excited about upside optionality potential from their Zozosuit, a bodysuit that, along with a smartphone, allows custom sizing of private label apparel. Brian Burrell and Sean Sun on the Thornburg investment team have each already ordered theirs. Recent results have been strong.
  • Worst Performers (Bottom Five)

    Long Book

    • Alkermes plc
      Alkermes has also shown surprising volatility since our investment. We trimmed our position on strength during the first quarter and added back to the stock after a pullback recently. Sales results for one of their most important early launch drugs, Vivitrol, have been somewhat disappointing, though we expect them to pick up in coming quarters.

    Short Book

    • DiaSorin SpA
      A medical devices company that focuses on diagnostic testing for infectious disease. While we believe this company faces earnings headwinds due to regulatory changes and payor pushback, the shares outperformed during the quarter thanks to multiple expansion of small- and mid-cap devices companies.
    • Cogent Communications Holdings, Inc.
      An internet service provider mainly to small/mid-sized corporate customers and to video content providers. We believe the growth and margin expansion goals of this company are unachievable and thus the company doesn't deserve the growth multiple at which it trades.
    • Financial Engines, Inc.
      A financial advisory firm whose core robo-advisory business has been facing secular growth challenges from target-date funds and increased competition. Nonetheless, the company was acquired by a private equity firm during the quarter, and, thus, we exited our position.
    • Chegg, Inc.
      An education services company that is heavily reliant on a single product for sustainability of growth. We believe that valuation is disconnected from sustainability of earnings growth for this company.

    Thank you for your continued trust in us.

    Contributors to Performance
    Contrib % Avg Wgt %
    iQIYI, Inc. 1.63 1.59
    Evolent Health, Inc. 1.02 2.12
    Devon Energy Corp. 0.84 2.58
    Facebook, Inc. 0.73 3.62
    Start Today Co., Ltd. 0.68 2.71
    Detractors from Performance
    Contrib % Avg Wgt %
    Alkermes plc -1.16 4.19
    Chegg, Inc. -0.62 -2.12
    Financial Engines, Inc. -0.59 -2.09
    Cogent Communications Holdings, Inc. -0.48 -2.22
    DiaSorin SpA -0.47 -1.87

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 6/30/18.

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.

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