Value Fund - Commentary

3rd Quarter 2020

Robert MacDonald, CFA
Robert MacDonald, CFA
Portfolio Manager and Managing Director
Portfolio managers are supported by the entire Thornburg investment team.
October 1, 2020
Market Review

Following a sharp recovery in the second quarter, U.S. equity markets continued to bounce back in the third quarter, supported by optimism surrounding a COVID vaccine and reopening of the economy. The S&P 500 and the NASDAQ Composite indices set new record highs last quarter as investors continued to focus on beneficiaries of the shelter-at-home economy. Growth stocks again outperformed their value counterparts despite temporary bouts of underperformance that had many believing the rotation into value names was finally upon us. The massive fiscal stimulus from the federal government paved the way for the market rebound but has also created a K-shaped recovery by increasing wealth disparities.

Even with the Congressional Budget Office projecting a record deficit of $3.3 trillion for 2020, negotiations continued with lawmakers on a second round of stimulus that will provide much needed aid to troubled sectors as well as state and local municipalities. The U.S. economy continued recovering jobs, and leading economic indicators improved, creating hope for the economy as nearly half a dozen major drug companies are conducting phase trials on a vaccine. While sentiment was positive for much of the quarter, a second wave of COVID infections in Europe and a sharp rise in cases in parts of the U.S. stoked fears that more challenges lie ahead.

Third-Quarter 2020 Performance Highlights
  • The Thornburg Value Fund outperformed its index as purchases made during the market dislocation paid off handsomely for shareholders. Stock selection was the large driver of returns while sector weightings were a slight detractor.
  • Health care was the best-performing sector during the quarter. Our slight underweight to the sector, as well as stock selection within the sector, were both positive contributors during the quarter.
  • Financials was the worst-performing sector during the quarter. Performance suffered from both our overweight to the sector as well as stock selection within the sector.

Current Positioning and Outlook

The recovery in the equity markets from the March low has been incredible. Indices have returned to record levels with unprecedented swiftness. The monetary and fiscal stimulus has provided a springboard for valuations with risk assets benefiting from a zero-interest rate policy that has pushed real yields into negative territory. The liquidity injection from the U.S. Federal Reserve has created what many investors interpret as a price floor and credit backstop for large swaths of the fixed income market. The Fed’s $4 trillion increase in its balance sheet this year includes purchases of not only Treasuries and mortgage-backed securities, but even investment grade corporate and high yield paper. While the impact of rates on bonds is obvious, areas of the equity market have benefited as well.

In a low rate environment, future earnings become more valuable because the opportunity cost of a future return prospect, or yield, diminishes. In other words, the “time value of money” in an environment of rock-bottom rates means a dollar earned tomorrow is being valued as highly as a dollar earned today. That makes it easier to invest in speculative stocks in hopes of out-sized future earnings when the alternative is investing in bonds at historically low yields. Zero-bound rates push investors out the risk spectrum, benefiting equities of companies that in many cases are free-cash-flow negative.

Market returns during the quarter were driven meaningfully by investor willingness to pay up for future earnings as high-growth names came back in vogue. The popularity of growth stocks was reinforced by flows into “momentum” factor strategies, lifting high-growth stocks even further and sharply expanding their valuation multiples. While relatively few high-growth stocks pay dividends, those that do saw their dividend yields swoon, while the dividend yields of out-of-favor value stocks soared.

The bifurcation has created a somewhat challenging environment for fundamental, valuation-sensitive investors. The goal of running a high-quality, balanced portfolio without bets on factors, such as growth, value or momentum has become more difficult. The thematic nature of the rally has led momentum and growth factors to significantly outperform, and like a snowball rolling down a hill, their market caps and valuations have surged. As humans we are susceptible to cognitive biases and this seems to be a classic case of recency bias. Greater importance is being placed on the most recent events, which may explain why higher multiple stocks have performed so well and why higher dividend yield stocks have performed so poorly.

We are very happy with the way the portfolio performed during the quarter and how the investments made during the market dislocation have served our shareholders. The long-term fallout remains unclear, as the possibility of a second wave of COVID cases may erase the economic gains made thus far and create volatility in the markets. As we have seen in the past, market dislocations can be a driver of disruption and innovation and a provider of great opportunities to invest. We stand ready to take advantage of whatever the market provides.
Thank you for investing alongside us in the Thornburg Value 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%.

Important Information

Unless otherwise noted, the source of all data, charts, tables and graphs is Thornburg Investment Management, Inc., as of 9/30/20.

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