3rd Quarter 2018

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Strong market performance in the U.S. continued in the third quarter of 2018, with the S&P 500 Index up 7.7% and broad indices hitting several new records. International indices were up more modestly but turned in their first positive quarter of the year with the MSCI EAFE Index gaining 1.35% and the MSCI ACWI ex-U.S. Index advancing 0.71% as some of the concerns that dominated the first two quarters (global trade war, Italian political uncertainties, emerging market contagion) subsided a bit. For the first three quarters of the calendar year, the MSCI EAFE Index and MSCI ACWI ex-U.S. Index, which includes an emerging market component, were down 1.43% and 3.09%, respectively.

During the quarter, concerns over a global trade war lessened somewhat with the U.S. reaching a new trade deal with Mexico and Canada and expressing optimism about eventually reaching deals with Europe and Japan. That moves the focus to China, with 10% tariffs on $200 billion in additional Chinese goods going into effect during the quarter, raising the total amount of goods subject to tariffs to $250 billion—nearly half of Chinese imports into the U.S. The MSCI China Index and the Shanghai Composite Index in U.S. dollars fell 7.4% and 3.3%, respectively, during the quarter, bringing year-to-date losses to 9.1% and 17.2%.

At quarter end, our allocation to greater China was 17%. Despite the decline in China’s equity market, which has been driven mostly by trade war concerns, we remain comfortable with the companies we hold for several reasons. First, from a bottom-up basis, the already announced and upcoming trade tariffs have limited impact on their underlying earnings growth trajectory. Second, the Chinese government has a number of policy actions it can take to stimulate the domestic economy and lessen the effect of trade tariffs. Since most of our holdings are exposed to domestic consumption, those measures would likely benefit them. Finally, in the event that both the U.S. and China were to reach a mutually beneficial trade agreement, China equity markets, along with our holdings, would see valuation re- rating reflecting reduced political risks.

Markets in developed Europe also turned in their first positive quarter of the year with the MSCI Europe Index up 0.81% in dollar terms, paring its year-to-date loss to 2.1%. Concerns over an Italian exit from the European Union eased, although late in the quarter the new coalition government announced budget deficit targets over the next three years that surprised investors on the negative side. Italian markets, particularly Italian banks, sold off on concern about the impact of the projected deficit on Italy’s fiscal position and debt burden. European banks declined, based on the expectation that an interest-rate hiking cycle will be further pushed out, given Italian policy uncertainties. We expect market volatility to continue as the Italian government and the European commission negotiate the Italian budget in the fourth quarter.

At quarter end, we held 20% of the portfolio in financials, with 16% in Europe the course of the last six months, those positions have come under pressure over economic and trade-war concerns, jitters in Italy, and as the ECB (European Central Bank) has delayed the onset of tightening, as higher interest rates generally benefit banks.

As in China, we like our financials holdings on a bottom-up basis for a number of reasons. Some banks are benefiting from “self-help” measures—selling non-performing loans, cutting costs, and making divestitures to improve profitability and capital positioning. Some banks hold excess capital and should be ready to return a portion to shareholders. Some are sensitive to interest rate movements and their earnings will benefit when the ECB eventually begins to tighten. In addition, valuations of our bank holdings are attractive and don’t yet reflect, in our view, the positive fundamentals.

For the quarter ended September 30, 2018, Thornburg International ADR Strategy returned negative 1.72% (net of fees), compared to the MSCI EAFE and MSCI ACWI-ex U.S. Indices’ returns of 1.35% and 0.71%, respectively. Aside from individual company issues, which are noted below, the three largest topdown factors that have impacted performance over the last three to six months are pressures on European banks, the potential of a trade war between the U.S. and China, and the continuing underperformance of stocks categorized as value versus those tagged as growth. The valuation gap between the two also intensified. The MSCI EAFE Growth Index price-to-earnings multiple (P/E) based on estimated 2019 earnings expanded to 16.5x as of September 30, compared to a MSCI EAFE Value Index forward P/E multiple of 10.9x. The MSCI EAFE Value Index is now trading more than one standard deviation below its long-term average relative to the MSCI EAFE Growth Index based on forward P/E.

Top Five Contributors

  • Électricité de France
    Électricité de France (EDF) produces, transmits, distributes, imports, and exports electricity. EDF owns the largest nuclear power generation capacity in France and is vital for the reliability of electricity across Europe. Given its generation mix, EDF benefited from higher carbon prices and higher power prices, driven by higher fossil fuel prices during the quarter. Even with its recent re-rating, we believe EDF’s assets have still been considerably undervalued.
  • SoftBank Group
    SoftBank invests in companies from mobile telecommunication operators to e-commerce, technology services, and content, etc. SoftBank has also been engaging in venture capital investing in technology-related areas globally via the SoftBank Vision Fund. Our investment thesis is that SoftBank owns valuable assets, a number of which are priced at a significant discount to our sum-of-the-parts valuation. The stock performed well in the third quarter as the company is on track to unlock value by listing its Japan wireless operator, SoftBank KK, and as investors gain more confidence in the Sprint/ T-Mobile merger in the U.S.
  • Canadian Pacific Railway
    Canadian Pacific Railway provides rail and intermodal freight transport services throughout North America. We believe that Canadian Pacific is one of the best managed and most efficient railroads in the world, following an impressive turnaround led by railroad legend Hunter Harrison. The stock performed well during the quarter as it benefited from strong demand for commodities, such as oil. In addition, Canadian Pacific has been taking market share from trucking companies. We continue to see the macro environment as supportive for railways and expect CP to deliver high returns from volume- driven operating leverage.
  • China Petroleum & Chemical Corp. (Sinopec)
    China Petroleum & Chemical Corp. (Sinopec) is China’s largest oil refiner and petrochemical producer and distributor. China’s maturing economy and urbanization drives strong demand growth for fuels and petrochemical products. Sinopec benefited from upgraded product mix and volume growth from displacing imports. On the back of rising oil prices, upstream asset quality and profitability have improved. Strong free cash flow is supported by relatively limited spending requirements, positioning the company to continue to sustain dividend payout at a relatively high level.
  • Ping An Insurance Group
    Ping An Insurance is a leading Chinese financial conglomerate involved in insurance, pensions, banking, brokerage, trust, and other financial services businesses. Currently Ping An is the second-largest life insurer and the second-largest P&C insurer in China in terms of premiums. The stock’s performance was driven by better premium growth and an improving earnings outlook during the quarter. Going forward, we continue to expect positive business momentum and the potential to list and unlock the value in its fintech businesses (such as Lufax).

Bottom Five Contributors

  • TAL Education Group
    TAL Education Group provides after-school tutoring services in China. Its services cover core academic subjects such as mathematics, English, Chinese, physics, chemistry, political science, history, etc. Policy uncertainties related to after-school tutoring regulation in China have negatively impacted the entire industry. While it could temporarily slow TAL’s capacity expansion plan, we see limited impact on TAL’s business from a fundamental perspective. With rising urbanization, favorable demographics, and intense competition for admission into top schools in China, TAL benefits from a supply- demand imbalance, coupled with a growing market share resulting from favorable brand recognition.
  • Ctrip.com International
    Ctrip.com, the premier online travel agency in China, offers a broad set of travel-related services such as air tickets, train tickets, hotel, car rental, travel insurance, etc. As discretionary income in China grows, we see experience- based consumption, such as travel, continuing to gain consumers’ wallet share. With a dominant market share, Ctrip is best positioned to benefit from increasing travel online penetration over the long term. During the quarter, investors were concerned that the slowdown of Chinese economic growth and currency depreciation may negatively impact Ctrip’s near term earnings.
  • Infineon Technologies
    Infineon Technologies designs, manufactures, and markets semiconductors. The company’s products include power semiconductors, microcontrollers, security controllers, radio frequency products, and sensors. Secular demand drivers for power semiconductors include electrification in automotive (content increase in ICE vehicles and mix shift from ICE to BEV) and growth in renewable power plants. Infineon has a structural advantage over its competitors given its superior technology, better manufacturing know-how, and unique manufacturing scale with 300mm wafer fab to take advantage of this secular growth. During the third quarter, investors become more bearish on global automotive sales volume. With 45% revenue exposed to automotive industry, Infineon stock was also punished.
  • ams AG Austrian Micro System
    AG (ams AG) designs and manufactures sensing technology for consumer electronics and communication device manufacturers. Products include optical parts for 3D sensing (one of the key drivers of ams’ revenue growth), light sensors, near field communication solutions, active noise-cancelling integrated circuits, low power solutions, and other sensing components. ams serves the industrial, medical, and automotive markets with global headquarters in Unterpremstatten, Austria. ams is a supplier of optical parts for the 3D sensing module in the iPhone and has increasing opportunities to supply Android handset manufacturers with a broad range of 3D sensing solutions. As a result of slowing high-end smartphone sales globally, in addition to the redesign of the 3D sensing module in the iPhone, the company experienced volatility in its second quarter 2018 results and lowered margin guidance for third quarter 2018. While ams continues to possess scalable technology for burgeoning 3D sensing solutions, the shares have been pressured (negative 43% YTD and negative 30% in third quarter 2018) by uncertainty around the growth trajectory of 3D sensing.
  • UniCredit SpA
    UniCredit is the second-largest bank in Italy, the third-largest in Germany, and the leading bank in Austria and in Central Eastern Europe. UniCredit was one of the best-performing stocks in 2017. However, in 2018 it has underperformed as the market has discounted the lower earnings growth resulting from delayed ECB rate hikes. Political uncertainties in Italy, particularly with the budget debate, widened the Italian sovereign spread during the quarter, which negatively impacted all Italian bank stocks. Our investment thesis on UniCredit is a self-help story. As Uni-Credit executes on portfolio restructuring, cost discipline, and faster non-core rundown, we expect it to deliver higher returns and unlock the path to higher dividends/capital redeployment in the medium term.

Even though international equity markets have delivered lower returns for investors than the U.S. equity market, there are benefits for maintaining a strategic allocation to international equity markets.

  1. Valuation in international equity markets is attractive. The MSCI EAFE Index is trading at a 20% discount to the S&P 500 Index on forward P/E multiple. It is more than one standard deviation below its long-term relative valuation average.
  2. International equity markets give investors access to a diverse set of companies and different sources of alpha.
  3. Strategic allocation to international markets has also proven to reduce risk at the portfolio level.

While volatility and bouts of unsatisfying performance are top of mind in the short term, it is our long-term lens and bottom-up, fundamental analysis that have led to our long-run outperformance. We maintain conviction in our philosophy, process, and three-basket portfolio construction process, all of which have combined to create positive outcomes for long-term clients. Having been through many of these environments in the past, we believe that our patience and diligence can be rewarded when volatility creates valuation opportunities.

Thank you for investing in Thornburg International ADR Strategy.

Contributors to Performance1
(Representative Account)
Name Contrib % Avg Wgt %
Électricité de France S.A. 0.97 4.30
SoftBank Group Corp. 0.77 2.42
Canadian Pacific Railway Ltd. 0.49 3.54
China Petroleum & Chemical Corp. 0.35 2.59
Ping An Insurance Group
Co. of China Ltd.
0.32 2.93
Detractors from Performance1
(Representative Account)
Name Contrib % Avg Wgt %
TAL Education Group -0.96 2.77
Ctrip.com International Ltd. -0.65 2.54
Infineon Technologies AG -0.36 3.04
ams AG -0.35 1.34
UniCredit SpA -0.34 3.30

1. Past performance does not guarantee future results. To obtain the calculation methodology and a list showing the contribution of each holding in the representative account to the overall account's performance during the reporting period, please email a request to bdg@thornburg.com. The holdings identified do not represent all of the securities purchased, sold or recommended for advisory clients.

Important Information

Performance data for the International ADR Strategy is from the International ADR Composite, inception date of August 1, 2003. The International ADR Composite includes discretionary institutional and high net worth accounts that are not part of a broker-sponsored or wrap program. Effective January 1, 2014, the composite includes separately managed institutional and high net worth accounts. Prior to January 1, 2014, the composite also included broker-sponsored accounts that paid transaction costs. The composite was redefined to include broker-sponsored accounts in the same composite. Returns are calculated using a time-weighted and asset-weighted calculation including reinvestment of dividends and income. Periods less than one year are not annualized. Individual account performance will vary. The performance data quoted represents past performance; it does not guarantee future results. Gross of fee returns are net of transaction costs. Net of fee returns are net of transaction costs and investment advisory fees. Thornburg Investment Management Inc.’s fee schedule is detailed in Part 2A of its ADV brochure. Performance results of the firm's clients will be reduced by the firm's management fees. For example, an account with a compounded annual total return of 10% would have increased by 159% over ten years. Assuming an annual management fee of .75%, this increase would be 142%.

As of 9/30/18 1 Year 3 Year 5 Year 10 Year Inception
International ADR Composite (NET)    -6.94% 4.15% 1.38% 4.12% 7.27%
International ADR Composite (GROSS)    -6.46% 4.69% 1.95% 4.75% 7.94%
MSCI AC World ex-U.S. Index    1.76% 9.97% 4.12% 5.18% 7.52%
MSCI EAFE Index  2.74% 9.23% 4.42% 5.38% 7.10%

Unless otherwise noted, the source of all data, charts, tables and graphs is Thornburg Investment Management, Inc., as of 9/30/18.

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.

The Strategy 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 Strategy will have continued access to profitable IPOs. As Strategy assets grow, the impact of IPO investments on performance may decline.

The information provided in this report should not be considered a recommendation to purchase or sell any particular security. There is no assurance that any securities discussed herein will remain in an account's portfolio at the time you receive this report or that securities sold have not been repurchased. The securities discussed may not represent an account's entire portfolio and in the aggregate may represent only a small percentage of an account's portfolio holdings. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein.

Portfolio holdings and characteristics shown herein are from a representative account managed within the investment composite. The representative account is selected based on account characteristics that Thornburg believes accurately represent the investment strategy as a whole. Should these characteristics change materially, Thornburg may select a different representative account. Holdings may change daily and may vary among accounts, which may contribute to different investment results. The representative account information is supplemental to the strategy’s composite and GIPS compliant presentation.

Holdings may change daily and may vary among accounts.

Portfolio construction will have significant differences from that of a benchmark index in terms of security holdings, industry weightings, asset allocations and number of positions held, all of which may contribute to performance, characteristics and volatility differences. Investors may not make direct investments into any index.

Please see our glossary for a definition of terms.