2nd Quarter 2018

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The second quarter of 2018 saw several geopolitical events hit news headlines —and global equity markets—to varying degrees. Though spells of volatility returned, some developed market indices posted point-to-point gains, despite the noisy environment. In the U.S., the S&P 500 Index returned 3.43%. Internationally, the developed market MSCI EAFE Index declined 1.24%. Emerging markets bore the brunt of investor concern, with the MSCI EM Index plunging 7.96%. The inclusion of emerging markets in the MSCI ACWI ex-U.S. Index, coupled with the exclusion of the U.S., impacted that index's performance, which shed 2.61% in the period.

Following the Italian general election, the Five-Star Movement and the League surprised the market and agreed to form a coalition government. Though the parties have opposite beliefs in fiscal and some political policies, they are unified in their anti-establishment posture. Thus, dormant fears of a potential euroexit were reinvigorated, initially causing a sell-off in Italian sovereign bonds and bank stocks. We broadly see these fears, and their effects, to be overestimated and do not expect Italy to attempt an exit from the eurozone. Nonetheless, we closely monitor the market volatility they generate.

In addition to the Italian election, ongoing concerns over a global trade war escalated during the quarter due to a series of tit-for-tat tariff moves between the U.S. and its trading partners, most notably China, the E.U., and Canada and Mexico within the North America Free Trade Agreement framework. The net effect of these actions will not be fully known for some time, but what is likely in the meantime is episodic market volatility. Through it all, however, we remain sanguine about the ability of our investments to thrive over a reasonable time horizon. For instance, should the current rhetoric evolve into more severe tariffs on U.S. imports from China, the Chinese government would have several policy levers to pull to offset the negative effects of declining exports: it could inject liquidity into the system, depreciate the relative value of renminbi, or increase state-led domestic investment, to name but a few. These countermeasures would likely stimulate Chinese domestic consumption, which could provide a tailwind to domestic-facing companies.

For the quarter ended 30 June 2018, Thornburg Global Equity Ex-U.S. Fund returned negative 5.43%, compared to the MSCI EAFE and MSCI ACWI-ex U.S. Indices' returns of negative 1.24% and negative 2.61%, respectively.

Top Contributors

  • SAP SE
    SAP is an international software company based in Walldorf, Germany. The company is the market leader in enterprise resource planning (ERP) software and a major competitor in other complementary areas, such as customer relationship management and human resources management. Recent investments have fueled SAP's expansion into cloud services, which have driven significant growth. The company's new S/4HANA platform is positioned to become the next generation of ERP software and is quickly changing the way that companies operate on a day-to-day basis. This past quarter has seen an uptick in adoption of S/4HANA as corporations such as Walmart, Nestle, and Royal Dutch Shell have made the jump over to the new platform and we anticipate an acceleration in this trend as competitors realize the need to make the shift to remain operationally relevant.
  • Teva Pharmaceutical Industries Ltd.
    Teva is a global pharmaceutical company operating in generic and specialty medicines, mainly in the U.S. and Europe. Teva has more than 1,700 generic products in its pre-approved pipeline. It secures most of its active pharmaceutical ingredients from its own 18 manufacturing facilities. The stock started to underperform a year ago due to lower-than-expected U.S. generic drug pricing, leverage, and lack of a management team. While still early in its turnaround initiatives, investors started to gain confidence in new CEO Kare Schultz' aggressive cost-cutting objectives and potential for de-leveraging. As a result, the stock rebounded during the second quarter.
  • Sinopec
    China Petroleum & Chemical Group (Sinopec) is China's largest oil refiner, petrochemical producer, and distributor. China's maturing economy and growing urbanization drive strong demand for fuels and petrochemical products. Sinopec benefits from an upgraded product mix and volume growth that is also displacing imports. Rising oil prices and upstream asset quality have also helped profitability. Strong free cash flow is supported by relatively limited spending requirements, positioning the company to continue sustaining its dividend payout at a relatively high level.
  • Royal Dutch Shell plc
    We expect oil major Royal Dutch Shell to deliver growth in free cash flow and to raise cash returns to shareholders. The stock performed well in the quarter given higher oil prices and a potential share buyback announcement.
  • Reliance Industries Ltd.
    Reliance Industries rose on continued strong performance in its petrochemical and refining business. Its emerging mobile telecom business continues to exceed expectations in terms of subscriber acquisition and market share gains. We expect improving cash flow generation as network spending requirements fall and it reduces price promotion over time.

Bottom Contributors

Financial services was the worst performing sector within the MSCI EAFE Index during the second quarter. Banks were the worst performing industry group within the financial services sector, and European banks were the worst performing regionally in U.S. dollar terms. The challenges come from a combination of rising geopolitical risk in Italy, and European Central Bank statements indicating the outlook for rates and rate hikes is down and out, respectively. As a result, European banks re-rated and contributed negatively to performance during the period. An increase in bond yields and steeper yield curves would clearly be positive for banks. However, we continue to focus on self-help stories and proven business models in this environment.

  • UniCredit SpA
    UniCredit is the second-largest bank in Italy, third largest in Germany and the leading bank in Austria and in Central Eastern Europe. The stock underperformed as the market discounted the lower earnings growth due to delayed rate hikes and higher political risk premiums. We believe the self-help initiatives are a more meaningful driver of the stock. As UniCredit 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.
  • Commerzbank AG
    Commerzbank is Germany's second- largest bank. The bank serves over 18 million private and small business clients and over 60,000 corporate and institutional clients. A sharp decline in the German 10-year bund yield and a flattening of European yield curves due to risk aversion and softening macro data are the drivers of Commerzbank's underperformance during the quarter. Our investment thesis for its underlying restructuring story has not changed. We expect to see a significant improvement in operating profit, driven by lower loan losses and lower restructuring costs. We believe a sustainable improvement in return on equity will lead to a re-rating in its valuation.
  • Barclays plc
    Barclays is a U.K. universal bank offering retail, commercial, and investment banking services. Its main markets are the U.K., where it has a leading credit card franchise, and the U.S., where it has a significant investment bank. We see positive momentum on revenue over the coming few years from risk-weighted asset recycling; growth in U.S. cards and U.K. mortgages; lower liability costs and normalization of non-core businesses.
  • AMS AG
    AMS AG is an Austrian producer of highly technical sensors and related equipment. The company's solutions are used in consumer applications, such as cellular handsets, and its 3D and light sensing solutions have been particularly important for AMS' growing opportunity in this segment. AMS also produces sensors for the automotive, industrial, and medical markets. As the computational abilities of the average smartphone continues to grow exponentially, and as consumers globally use handsets for increasingly more applications, 3D technology has now become possible and promises to solve numerous pain points for the customer. Virtual reality/ augmented reality, remote health care services, and apparel are some of the areas that appear ripe for disruption by 3D technology. Through a series of acquisitions and organic growth, AMS now has capabilities across some of the most important parts of the 3D sensor, including the vertical cavity surface emitting laser (VCSEL), wafer level optics, and infrared sensors. The stock has been challenged recently due to unexpected changes in the design of the 3D sensor developed by AMS' main customer, and uncertainty surrounding the selling price of the new parts that AMS will provide. It has partnered with other key members of the 3D sensor supply chain to provide a "one-stop shop" to smaller handset makers that do not have the capabilities to develop their own solutions, and, as a result, AMS remains well positioned to democratize what we believe will be a game-changing technology.
  • Alkermes plc
    Alkermes saw its shares fall sharply as the U.S. Food & Drug Administration sent a Refusal to File (RTF) letter to the company regarding its pipeline depression drug ALKS 5461. Although the FDA rescinded the RTF letter just two weeks later and accepted the drug for review, the stock has yet to fully recover.

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 Global Equity Ex-U.S. Fund.

 



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Source of data: Factset, BBH, Confluence, Bloomberg—unless otherwise stated.
Date of data: 30 June 2018—unless otherwise stated.

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