1st Quarter 2018

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The last three months were a tale of two halves in global equity markets. The period started with a grind higher that culminated in an almost euphoric turn upward during the month of January. The euphoria quickly wore off and in late January markets began to swoon, with many of the major indices giving back half or more of the gains. A recovery began in February but failed to hold, losing steam again into the end of March.

Every pundit has a different narrative about the increase in volatility and atrophying prices after such strong performance in 2017, when volatility was near-zero. From our perspective, there's no sole reason, and we think it's most likely a combination of various headwinds, including higher interest rates, lofty valuations, burgeoning trade conflicts, and weaker economic data. The good news for long-term investors is that, in our opinion, the market became more attractively valued after the recent pull back.

Thornburg Developing World Fund shed 0.41% in the March quarter, trailing the index return of 1.42%. The majority of the underperformance occurred during the final few weeks of the period, as several stock-specific issues took a toll, but they have not impacted our view of fundamental value for those holdings.

Major contributors for the period include Alibaba Group Holding Ltd., Sunny Optical Technology Group Co., Ltd., Sberbank Russia OJSC, Itau Unibanco Holding S.A., and Yandex NV.

Alibaba shares benefited from continued strong revenue growth on its core e-commerce platform, driven by higher monetization of its ad inventory and strong purchase volume growth. Alibaba continues to be one of our highest conviction ideas driven by its "New Retail" strategy, which promises to digitize existing retail infrastructure in China through Alibaba's supply chain, customer relationship tools, payments platform, and logistics.

Sberbank, the leading banking franchise in Russia, reported robust results during the third and fourth quarters of 2017. Accelerating loan growth, combined with falling provisions for doubtful accounts, is driving strong earnings growth. The company's investor day also shed light on Sberbank's technology leadership. Lastly, with strong returns on equity and high capital levels, Sberbank communicated to shareholders its commitment to a higher dividend payout ratio. We remain constructive on the long-term prospects for the bank.

With the Brazilian economy showing early signs of improvement, investors have become more constructive on the prospects of Itau Unibanco, a leading private sector bank. Better economic growth in an environment of falling inflation and lower interest rates should boost loan demand in Brazil. Itau Unibanco should also recover some of the market share lost to public-sector banks in the last five years. Better economic prospects have led to banks taking less loan loss provisions for potentially troubled credits. Like Sberbank, Itau recently made an effort to clarify its capital return policy, which is important as its provision expenses are expected to fall. We are optimistic about the potential that Itau will pay an attractive and growing dividend over the next several years.

Sunny Optical, a leading provider of lenses and camera modules for smartphones, saw their shares rebound nicely from recent lows after they delivered strong revenue growth, despite weakness in overall smartphone demand growth. The strong demand for Sunny products is driven by market share gains in mid-to-high-level handsets sold primarily in China and by the adoption of dual cameras in Chinese smartphones. Sunny has several long-term drivers for the business, including ongoing market share gains, continued penetration of dual cameras, adoption of 3-D sensing by Android smartphone makers, and the adoption of camera modules in vehicle applications.

Finally, Yandex shares reacted strongly to the news that the company has continued to gain market share on mobile platforms from Google after Google was forced to cease several anti-competitive practices. In addition, there is increasing optimism for Yandex earnings growth, based on the expectation that discounting in their Yandex.Taxi business will decline following its recent merger with Uber in Russia.

Major detractors for the period include BRF S.A., ICICI Bank Ltd., Qualcomm, Inc., British American Tobacco plc, and Kroton Educacional S.A.

Shares of BRF, a leading global poultry producer domiciled in Brazil, declined in the first quarter following the announcement of a Federal Police investigation focused on the company's quality-control procedures. With allegations that the company had possibly altered samples sent to regulators, investors anticipated potential food bans from several importing countries and became concerned about the prospects. During this period, it also came to light that several of the major shareholders had lost confidence in the chairman after years of difficulty. We felt the combination of a leadership struggle combined with an already difficult operational turnaround and a new investigation created too much uncertainty about the outcome of our investment and we exited the shares.

ICICI Bank, a leading private sector bank in India, has seen its shares come under pressure as investors anticipate weak near-term results. The Reserve Bank of India has taken a more assertive approach toward recognition of troubled loan exposures at a system level. With many corporate-loan exposures having been non-performing for several years, the regulator wants banks to take the necessary provisions to unclog the system. Higher loan loss provisions will likely impact results in the coming quarters, but should help ICICI complete the process of cleaning up its balance sheet. We remain constructive on the long-term opportunity for ICICI Bank's franchise, driven by continued market share gains from troubled public sector banks. Growing financial inclusion in the Indian market should also drive more demand for its services. ICICI Bank continues to be one of our highest conviction investments, and we have added to our position during the weakness.

Qualcomm shares fell in response to the Trump Administration's decision to block Broadcom's acquisition of Qualcomm due to concerns about national security. The shares have fallen back to just above the level where we began accumulating them. While this outcome was disappointing, it was not part of our original thesis. We still think Qualcomm's stock is undervalued as normalized earnings potential is realized.

British American Tobacco shares have been weak recently due to ongoing investigations into the role of nicotine in cigarette sales and production. While changes in nicotine content could impact volumes, we still think the earnings power of the business is undervalued at the current multiple, which is one of the lowest in the world for a consumer staples business and near an all-time low for the company outside the great financial crisis.

Kroton Educacional is one of the leading private education companies in Brazil. The shares were strong during the middle of 2017 thanks to delivery of an internal cost-cutting program, which helped the firm maintain profitability despite sluggish demand. During that period, we significantly reduced our position. Unfortunately, stubbornly high unemployment during the still-nascent economic recovery in Brazil has made it difficult for many students who attend school part time while working to continue their studies. The recent reports have shown higher-than-normal dropouts and weak student intake, which have weighed on the shares. We believe that sellers are confusing cyclical and structural pressures, and that enrollment trends will improve.

Looking forward, volatility is higher but valuations are more attractive after the recent pull back. The economic data has improved over the last few years but softened a bit in the last few months. At this point it's pretty easy to take the view of either a bear or a bull at a high level. We instead turn our focus on company fundamentals, where we have high conviction in our portfolio and believe that despite recent setbacks, our holdings remain undervalued with a path to success.

Thank you for investing in Thornburg Developing World 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, visit the Prices & Performance page.
Important Information

Source of data: Factset, BBH, Confluence, Bloomberg—unless otherwise stated.
Date of data: 31 March 2018—unless otherwise stated.

Investments carry risks, including possible loss of principal. Additional risks may be associated with investments 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 insured, nor are they bank deposits or guaranteed by a bank or any other entity.

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