Thornburg Investment Income Builder Fund

2nd Quarter 2019

Jason Brady, CFA
Jason Brady, CFA
President and CEO
Matt Burdett
Matt Burdett
Portfolio Manager and Managing Director
Ben Kirby, CFA
Ben Kirby, CFA
Portfolio Manager and Managing Director
Brian McMahon
Brian McMahon
Chief Investment Officer and Managing Director
Portfolio managers are supported by the entire Thornburg investment team.
July 1, 2019

The Thornburg Investment Income Builder Fund paid an ordinary quarterly dividend of $0.229 per I share in the quarter ending June 30, 2019. This compares to a dividend of $0.216 for the comparable quarter of 2018. The fund paid $0.985 per I share in the 12-month period ending June 30, 2019, down 2.5% from $1.01 in the comparable prior year period. The dividend per share was lower for A and C shares, to account for varying class specific expenses.

The fund’s net asset value increased by $0.31 per share ($21.42 to $21.73) during the June quarter. For the trailing 12 months ending June 30, 2019, the fund’s net asset value increased by $0.40 per share ($21.33 to $21.73).

Investment Income Builder’s I share returns of 2.53% for the June quarter trailed its blended benchmark (75% MSCI World Index and 25% Bloomberg Barclays U.S. Aggregate Bond Index), which returned 3.87% for the quarter. The fund’s 6.69% total return for the year ending June 30, 2019, trailed the blended benchmark return of 7.02% for the 12-month period. Performance comparisons of Investment Income Builder to its blended benchmark over various periods are shown on the fund performance page. We are optimistic about the return potential of the Investment Income Builder portfolio and encourage you to read on for more details.

The quarter ending June 30, 2019, was the 66th full calendar quarter since the inception of Thornburg Investment Income Builder Fund in December 2002. In 49 of these quarters the fund delivered a positive total return. The fund has delivered positive total returns in 13 of its 16 calendar years of existence. As of June 30, 2019, Thornburg Investment Income Builder Fund has delivered tax efficient average annual total returns of more than 9% since its inception.

Dividend increases from a majority of your fund’s equity portfolio holdings did not quite offset the headwinds of (i) a stronger currency that reduced the year over year U.S. dollar value of dividends paid in foreign currencies and (ii) The fourth quarter 2018 special dividend paid by top holding CME Group was lower than CME’s fourth quarter 2017 special dividend. We cannot predict how currency fluctuations will impact your fund’s 2019 dividend, but we do expect annual dividend growth in local currencies this year for a majority of your fund’s equity investments.

In assessing the second-quarter 2019 performance of Thornburg Investment Income Builder, it is constructive to consider the performance in U.S. dollars of the sector components of the MSCI World Index over the three-month period. The MSCI World Index comprises 75%, and the entire equity portion, of the fund’s global performance benchmark:

  1. Ten of 11 Index sectors showed positive total returns during the second quarter, with sector results ranging from approximately 6.2% (financials) to negative 1.6% (energy). Stocks of firms in the information technology, consumer discretionary, communication services, materials and industrials sectors joined financial stocks in generally outperforming the strong returns of the index for the June quarter. Stocks of firms in the health care, consumer staples, utilities and real estate sectors joined energy sector stocks in underperforming the index. In general, stocks of firms in sectors that are most sensitive to fluctuations in economic activity performed better, while stocks of firms in sectors less sensitive to changes in economic growth lagged in the June quarter.
  2. Relative to the MSCI index, Thornburg Investment Income Builder’s portfolio was significantly overweight the higher dividend–paying telecommunications, financial and energy sectors, as it has been for most of its history.
  3. Income Builder Fund investments in firms in the following sectors comprised the largest average sector weightings in the fund portfolio during the second quarter:
    • Financial sector (25% average weighting in the fund’s equity portfolio, plus 2% weighting over the quarter)
    • Communication services sector (16% weighting in the fund’s equity portfolio, unchanged weighting over the quarter)
    • Energy sector (11% weighting in the fund’s equity portfolio, minus 1% weighting over the quarter)
    • Information technology sector (9% weighting in the fund’s equity portfolio, plus 1% weighting over the quarter)
    • Health care sector (7% weighting in the fund’s equity portfolio, minus 1% weighting over the quarter)
    • Industrials sector (6% weighting in the fund’s equity portfolio, minus 2% over the quarter)
    • Consumer discretionary sector (5% weighting in the fund’s equity portfolio, plus 1% weighting over the quarter)
    • Utilities sector (5% weighting in the fund’s equity portfolio, unchanged over the quarter)
  4. In the Income Builder portfolio, 26 equity investments contributed positive returns of at least 0.05% (five basis points) to the portfolio during the second quarter. Eleven of the fund’s equity investments contributed returns of negative 0.05% or worse in the quarter.

Investment Income Builder’s bond holdings delivered positive returns during the June quarter. Both U.S. government bond prices and corporate bond prices rose, as we detail later in this note.

Your fund’s average return from its investments in the financial sector was positive in second quarter 2019 and outperformed the equities in the finance sector of the MSCI World Index for the quarter. CME Group was one of the strongest performers in the portfolio, recovering from a weak March quarter even as expectations for future interest rate volatility and consequent need for hedging activity receded. JPMorgan Chase, Apollo Investment Corporation, Ares Capital Corporation, and Axa Equitable Holdings were strong performers in the quarter. Most of your fund’s other holdings in the financial sector were positive for the quarter, other than Italy’s Intesa Sanpaolo. In general, earnings and portfolio credit quality for these firms are holding up better than feared late last year.

Your fund’s significant holdings in the communications services sector delivered mixed performances, lagging the performance of the equities in this sector of the MSCI World Index. England’s BT Group, multi-national network operator Vodafone and China Mobile each delivered negative June quarter returns. Deutsche Telekom, African multi- national MTN Group, and U.S. network operator AT&T each made positive contributions to Income Builder performance in the June quarter. Deutsche Telekom is the controlling shareholder of the third-largest U.S. mobile network operator, T-Mobile, which contributes approximately half of Group operating profit. T-Mobile has made frequent headlines in recent quarters as a result of its pending merger with Sprint, the fourth largest U.S. mobile communications network operator.

The entire energy sector was influenced down by the 35% drop in the Brent oil price to $53.80 during the December 2018 quarter. While the Brent oil price rallied 25% in the first quarter of 2019, it dropped another 5% in the June quarter. Royal Dutch Shell and Total each delivered significant contributions to portfolio performance, while Spanish refiner Repsol and Chinese refining and marketing giant Sinopec each detracted from performance. For perspective on the June 30, 2019, benchmark oil price of $64.74/barrel, the average Brent oil price fell from approximately $115/barrel in June 2014 to a January 2016 low of $28/barrel. We expect volatile oil prices to persist. Demand fundamentals appear positive for the sector, following a global consumption increase of more than one million barrels per day in 2018 that shows signs of repeating this year. Our investments in this sector are focused on resilient dividend payors with strong balance sheets. Business prospects for these firms appear sound within recent ranges for oil and gas prices.

Income Builder’s investments in the technology sector delivered positive returns in the June quarter, led by a strong contribution from Qualcomm following a favorable settlement of its long running litigation with Apple. Trade tensions, patent disputes and evolving consumer preferences created uncertainty around the near-term outlook for device sales and optimizing the geographic spread of component manufacturing networks. Among Income Builder portfolio holdings, diversified semiconductor designer Broadcom appears caught in the trade dispute crossfire. We expect most of your fund’s technology sector firms to benefit from the ongoing proliferation of “connected” digital devices and associated data flows since these firms hold important positions in the value chain for producing the devices as well as data transmission and storage capability.

Investment Income Builder’s second quarter 2019 returns from its holdings in the health care sector significantly outperformed the return of this sector within the MSCI index. Novartis, and its spinoff of U.S. eyecare specialist Alcon, drove a strong positive contribution to portfolio performance. There were no significant negative contributors to June quarter portfolio performance from the health care sector.

Income Builder’s investments in the Industrials sector delivered strongly positive returns in the June quarter, further reversing late 2018 weakness from this group. European toll-road operators Atlantia and Vinci, Spanish airport operator AENA, and German conglomerate Siemens each made significant positive contributions to portfolio performance. There were no significant negative contributors to June quarter portfolio performance from the industrials sector.

Among other portfolio holdings, notable contributors to June quarter portfolio performance included U.S. outdoor advertiser Outfront Media, Home Depot, mine operator Norilsk Nickel and Italy-based multi-national electric utility Enel SpA. Detractors from portfolio performance included Électricité de France, diversified miner and commodities trader Glencore, Korea Tobacco & Ginseng and Walgreens Boots Alliance. Walgreen’s share price has been much more volatile than its business result in recent quarters, as speculation about a changing competitive landscape and regulatory intervention in the pharmaceutical value chain periodically overwhelms the positives of a greater-than 9% 2018 dividend increase and a share count that is down more than 13% over the last four years.

A stronger U.S. dollar decreased the year-over-year dollar value of our non- U.S. assets during the quarter by an overall average of approximately minus 5%. This trend reversed modestly in the second quarter, as the trade-weighted U.S. dollar declined in value quarter-to-quarter by just over 1%. We hedged a majority of the currency exposure of our asset positions denominated in the Australian dollar, the British pound, the euro, the Chinese yuan and the Swiss franc. These hedges subtracted modestly from the relative performance of Thornburg Investment Income Builder during the quarter, since benchmark indices are not hedged, and the U.S. dollar weakened slightly. We are more focused on risk control than on reaping possible currency gains from exposure to assets denominated in these currencies, however, we believe increasing U.S. government fiscal and trade deficits could create conditions that would lead us to reduce hedges if these deficits persist.

Bond prices appreciated significantly again in the second quarter. The U.S. Federal Reserve guided down forward interest rate expectations, and inflation measures around the world were low enough to give other central banks room to continue easy money policies.

  • 10-year U.S. Treasury bond yields ended the June quarter at 2.01%, down from 2.41% at March 31, 2019, and 2.69% at December 31, 2018. As recently as September 30, 2018, the 10-year U.S. Treasury bond yield stood at 3.05%.
  • Corporate bond prices outperformed U.S. government bonds in the quarter as credit spreads narrowed, and the FINRA-Bloomberg Active Investment Grade U.S. Corporate Bond Index dropped from 3.63% to 3.16% during the quarter.
  • The yield drop for sub-investment grade bonds was even more severe, with the FINRA-Bloomberg Active High Yield U.S. Corporate Bond Index declining to 5.87% from 6.43% over the June quarter. As recently as December 31, 2018 this index showed a yield of 7.95%.

Readers of this commentary who are long-time shareholders of Income Builder will recall that the interest-bearing debt portion of the fund’s portfolio has varied over time, ranging from less than 9% in 2015 to 45% at June 30, 2009.

Interest Bearing Investments as a Percentage of Total Portfolio

The table below compares the dividend yields for the equities of the 10 largest investments held in the Income Builder portfolio with the current marketable debt yields of specific bonds issued by the same firms as of June 30. Nine of the 10 firms shown below have issued marketable debt. For eight of these nine debt issuers, the dividend yields on their stocks exceed their debt yields by differentials ranging from 5.45% (Royal Dutch Shell) to 0.19% (JPMorgan Chase).

Interest Bearing Investments as a Percentage of Total Portfolio

As of June 30, the fund portfolio included more than 85 bonds and hybrid securities. In recent years, the reduced yields available from bond investments have posed a meaningful headwind to delivering year-over-year dividend increases on Investment Income Builder shares.

Today, investors debate the future direction of the economies of China, Europe, various emerging markets and the U.S. They consider potential policy actions by the U.S. Federal Reserve, Congress, the Trump administration and foreign government regulatory and policy actions. Concerns about tariffs and trade policy changes continue to impact share price movements of global producers of tradeable goods, which are volatile day-to-day. Most economic data tracking business expectations of manufacturers around the world are indicating slowing growth. We expect the volatility to continue until new trade policies are established.

We believe that people around the world will continue to buy goods and services and trade with each other. Importantly, overall global consumer spending grew in 2018 and appears poised to grow in 2019, along with global population, industrial production, and digital communications. Despite uncertainty around macro- economic policies and expectations for slowing economic growth in 2019 and beyond, employment and wage growth trends remain positive, consumer debt is under control, and many governments around the world, other than the U.S., have room to implement expansionary fiscal policies.

Most firms held in Thornburg Investment Income Builder’s portfolio delivered positive year-over-year earnings in 2018, even as the U.S. Federal Reserve hiked the Federal funds target rate to 2.50%, roughly in line with year-over-year average consumer price inflation measures last year. Most major central banks around the world continue to pursue very easy monetary conditions, which artificially suppress interest rates and support prices of financial assets.

While low interest rates are good news for borrowers, they have negative consequences for conservative savers. Interest income as a percentage of the aggregate adjusted gross income of U.S. households fell from 4% in 2007 to less than 2% in 2016, according to Statistics of Income published by the Internal Revenue Service.

Investors must consider other options. Banks in the U.S. offer below-inflation yields on most deposits. A very large pool of investor dollars is looking for better returns elsewhere, but in sensible investments. We are optimistic that the types of income-producing investments owned by the Thornburg Investment Income Builder Fund will experience sustainable popularity among investors as their intrinsic values for income production are recognized. A high percentage of investor funds belong to people over the age of 55, for whom income is an increasingly necessary and desirable attribute.

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%.

30-day SEC Yield as of 6/31/19 – A Shares: 3.01%; I Shares: 3.40%.

Important Information

Unless otherwise noted, the source of all data, charts, tables and graphs is Thornburg Investment Management, Inc., as of 6/30/19.

Prior to inception of class I shares, performance is calculated from actual returns of the class A shares adjusted for the lower Institutional expenses.

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. 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.

Any securities, sectors, or countries mentioned are for illustration purposes only. Holdings are subject to change. Under no circumstances does the information contained within represent a recommendation to buy or sell any security.

Neither the payment of, or increase in, dividends is guaranteed.

The performance of any index is not indicative of the performance of any particular investment. Unless otherwise noted, index returns reflect the reinvestment of income dividends and capital gains, if any, but do not reflect fees, brokerage commissions or other expenses of investing. Investors may not make direct investments into any index.

There is no guarantee that the Fund will meet its investment objectives.

Please see our glossary for a definition of terms.

Thornburg mutual funds are distributed by Thornburg Securities Corporation.

Thornburg Investment Management, Inc. mutual funds are sold through investment professionals including investment advisors, brokerage firms, bank trust departments, trust companies and certain other financial intermediaries. Thornburg Securities Corporation (TSC) does not act as broker of record for investors.