3rd Quarter 2018

    Portfolio managers are supported by the entire Thornburg investment team.

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Thornburg Strategic Income Fund returned 1.04% (I shares) in the quarter ended September 30, 2018, outperforming the Bloomberg Barclays U.S. Aggregate Bond Index’s 0.02% gain and the Bloomberg Barclays U.S. Universal Index benchmark return of 0.27%. That brought the fund’s year-to-date return to 1.07%, versus a Bloomberg Barclays U.S. Aggregate Bond Index loss of 1.6% and a Bloomberg Barclays U.S. Universal Bond Index decline of 1.41%.

A Message from Portfolio Manager and Thornburg President and CEO Jason Brady

As we move past the 10-year anniversary of the Strategic Income portfolio, it’s worth reflecting on why the team is constructed the way it is, such that we can continue to deliver significant benefits to our clients.

While many are comfortable with the idea that a relatively small number of equity investors can cover the universe of available investments, we at Thornburg have often run into skepticism that our “right-sized” team can cover the global bond universe. Certainly, there are plenty of possible offerings, both in the new issue and secondary markets, that can vie for our attention. Many other asset managers have tackled the problem by deciding to silo their teams: each analyst is an acknowledged field expert while portfolio managers are asset allocators. This, in our minds, forms the traditional siloed basis for fixed income analysis.

Formed over the course of our long history managing fixed income, we believe that due to the siloed nature of fixed income analysis, debt markets are inefficient with respect to the assessment of risk and reward. Moreover, fixed income allocations driven by market-capitalization-weighted benchmarks are also inefficient in assessing compensation for assumed risks. These inherent inefficiencies provide a robust environment for benchmark-agnostic active management.

Importantly, however, to take advantage of such inefficiencies, an investor must marry both a deep expertise and robust fundamental analysis of individual situations and asset classes with the ability to survey risk and reward across the full spectrum of available investment opportunities. We believe this is best done within a relatively small team with diverse skill sets and expertise, in which individual opportunities and portfolios are discussed broadly on the merits of relative risk and reward. The ultimate result of our philosophy is, in our experience and judgment, a diversified portfolio of the best relative-value investments designed to perform across many macro outcomes.

When I arrived at Thornburg in October of 2006, I took over a set of portfolios that were not very large, but that were informed by the way that the firm has managed assets since 1982. We have always been focused on our clients’ outcomes, versus hewing to a benchmark allocation. Hence, as the fixed income market has become somewhat distorted by central bank intervention, our process arrived at different investments than those dominating any typical benchmark, which is usually laden with lowor negatively yielding sovereign debt. We have always looked at a broad array of varied securities, and as issuance in global fixed income has exploded in size and diversity, we’ve been ready to incorporate new sub-asset classes into our portfolio. We’ve always believed fixed income exists in the context of a global market for assets, and so we’ve continued to benefit from close contact with all investors here at Thornburg.

We have found that our ability to have timely, detailed discussions around the relative merits of occasionally significantly different investments is a primary driver of long-term value. Where we differ is in our ability to get that detailed work into portfolio construction, as opposed to abdicating those sorts of decisions to a benchmark. In short, it’s about our philosophy and the way in which we’ve designed our team to fit with that philosophy.

For the last 12 years, I’ve been fortunate to be joined by a number of talented individuals who not only are good at analyzing individual securities, but who are comfortable uttering the unthinkable phrase in asset management: “I don’t know.” Because the questions we ask around this team tend to be difficult, even impossible ones, we maintain our perspective and keep our confidence in check. While each one of us comes from a particular background (both personally and professionally), the team’s diversity of opinion has led to consistently better outcomes. This is deliberate.

Our eight-person team is, as we see it today, a sweet spot. The way we look at the world requires a lot of collaboration, and while everyone in the business speaks of collaboration, in practice things turn out quite differently. In academic literature the problem is called the Ringelmann effect, and at its basic level, it describes how, as the size of any team grows, each member becomes marginally less productive. Ultimately, it makes intuitive sense. As the size of your team grows, it becomes increasingly difficult to tease out the individual contributions of each team member, which discourages true collaboration. There’s a real scientific reason that elite military groups with a focused mission remain small. For us, when our entire philosophy and process is built around delivering returns via a relative value framework, a small team with true collaboration is necessary to find value between the sectors and segments available. We’ve built a strong track record—not despite our small team size, but because of it.

We have enough firepower to see the world, especially in concert with the broader Thornburg investment team. At the same time, we can be nimble in difficult times, communicate easily amongst ourselves, and have the portfolio’s goals always in the minds of everyone doing the analytical work. We believe our process, people, and products are designed to work together to give our clients great outcomes that differ from those offered by more conventional teams. I hope you agree.

The Third Quarter

The third quarter of 2018 began with more-dovish-than-expected minutes from the previous U.S. Federal Reserve monetary policy committee meeting and ended with less-hawkish-than-expected Federal Open Market Committee (FOMC) projections. As central banks move away from ultra-accommodative monetary policies, dependence on forward guidance as a market influence has grown increasingly important. While the Fed has eliminated some forward guidance, Chairman Jerome Powell continues to guide markets through the “normalization” process in post-meeting press conferences, which, in a new development, will be held at every FOMC meeting beginning in 2019. The European Central Bank and Bank of Japan, meanwhile, have increased their communications as well.

U.S. 10-year Treasuries traded in a narrow range around 2.90% through the first two thirds of the quarter before spiking to 2.97% on rumors Japan was about to change its quantitative easing (QE) program, highlighting the importance of global central bank actions and market reaction functions. As we have mentioned in previous communications, an important feature in today’s marketplace is a changing landscape for global central bank accommodation and the resultant market gyrations that follow.

The U.S.’s 4.2% annualized second-quarter economic growth appeared to have had little immediate effect on the market, as it was widely anticipated. Other economic data during the third quarter appeared mixed, but generally suggested continued above-trend growth. Perhaps most notably, despite trade war rhetoric and an ongoing negative political environment, both business and consumer confidence remain strong. Wages continue to increase, albeit at a moderate pace, causing no major impact to inflation. The biggest question facing the economy is if the acceleration in ecoour doubts.

Tax reform has certainly given a boost to after-tax consumer and business income. Consumer spending has jumped and even corporate investment has picked up in 2018. That said, future growth will now be measured relative to a higher base, creating a more difficult hurdle. Meanwhile, leverage in all three major sectors (government, corporate, and consumer) is becoming more expensive to service with higher rates. Going forward, it will be challenging to find additional spending power in an already indebted economy to fuel future growth. In the meantime, growth tailwinds from increased capital expenditures and deregulation will have to suffice.

Corporate leverage remains at elevated levels across the credit spectrum, despite some improvement in recent quarters thanks to strong revenue and cash flow growth. Bids across corporate sectors remain strong but considering our questions around the path of growth going forward, credit selectivity is of utmost importance. Flows into high-yield (HY) were not broadly supportive, but generally had a good July and August, which combined with lower new HY issuance has been very supportive of the market this year. Bank loans continue to attract new money, funds, and CLO (collateralized loan obligation) creation. As such, ongoing demand has led to increasing amounts of issuance with quality of issuance deteriorating in terms of fundamentals and covenants. We remain vigilant in this area.

We continue to favor investing in securities backed by the cash flows of the U.S. consumer. That said, consumers are re-leveraging their balance sheet largely via unsecured borrowing (student, personal, and auto loans) and via autos. Spreads in many of the asset-backed securities (ABS) sectors that we’ve found attractive have gotten tighter. In turn, we’ve become even more selective with consumer ABS. We’re finding value in non-agency mortgage-backed securities. Essentially, we are moving more into secured consumer loans (i.e., secured by houses). In our view, our place in the capital structure reduces our credit risk and the underlying borrowers’ incentives/ ability to refinance controls prepayment activity, making for an attractive opportunity, given the limited convexity risk.

Thank you for investing with us in Thornburg Strategic Income 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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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

Investments carry risks, including possible loss of principal. Portfolios investing in bonds have the same interest rate, inflation, and credit risks that are associated with the underlying bonds. The value of bonds will fluctuate relative to changes in interest rates, decreasing when interest rates rise. This effect is more pronounced for longer-term bonds. Unlike bonds, bond funds have ongoing fees and expenses. Investments in lower rated and unrated bonds may be more sensitive to default, downgrades, and market volatility; these investments may also be less liquid than higher rated bonds. 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. Investments in equity securities are subject to additional risks, such as greater market fluctuations. 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 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.

U.S. Treasury securities, such as bills, notes and bonds, are negotiable debt obligations of the U.S. government. These debt obligations are backed by the “full faith and credit” of the government and issued at various schedules and maturities. Income from Treasury securities is exempt from state and local, but not federal, taxes.

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High yield bonds may offer higher yields in return for more risk exposure.

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