4th Quarter 2017

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A Decade of Success

We are excited that the small fund we launched so that clients could take advantage of the growing breadth of the global bond market, combined with our broad investment perspective, has reached its 10-year anniversary. Late 2007 was an interesting time, but while we believed that the coming years and decades would provide interesting opportunities for investing, the scale of that “opportunity” just one year later was both overwhelming and valuable. Around the holidays in that year we began the portfolio with just $3 million of seed money from various partners at Thornburg, and as we began to invest, the added pressure of putting the personal money of our colleagues to work was a tangible reminder that the job we do is really for those who entrust us with their savings. It’s a lesson that we keep at the front of our minds every day, even as the portfolio has grown to over $1 billion.

The last 10 years have been, like most 10-year periods, episodic with regard to opportunity. While we initially believed there would be tremendous expansion in bond markets outside of the U.S., ultimately the expansion has occurred in U.S. dollars, but to a size and breadth that significantly exceeded our expectations. As such, the investment idea, innovative at the time, that global bond markets were changing and the role of fixed income in investors’ portfolios was also changing is even more relevant today than 10 years ago. With rates off of their historical (2000 years of history!) lows recently, but remaining for the time being fairly uninteresting, we are drawn to the flexibility that this strategy represents—not to make exotic bets, but to construct a portfolio that provides significant value across many macroeconomic outcomes. Heading into 2018, there has been a reasonably consistent bull market in bonds for most investors’ working lifetimes. If that is about to change, we all need to re-examine the role of bonds in a broader portfolio. Happily, the diversity of the market continues to be of huge benefit.

Overall, we are proud of our record over the past decade and through several different market episodes. Today, we are more defensive due to the current state of rate and credit markets, but we still have been able to generate significant value for shareholders. Because we are uniquely structured with a different investment process, we believe we are well positioned to provide a differentiated set of outcomes. Ten years in, it’s working pretty well.

Markets Perspective

Near the end of 2016, interest rates jumped significantly following the election of President Trump. Higher yields were fueled by expectations of faster economic growth and rising inflation as a result of policies projected to be put in place by the new administration. Many expected yields to continue to rise throughout 2017. Interestingly, the yield on the 10-year U.S. Treasury remained below 2017 starting levels for most of the year, and ended the year roughly unchanged from where it started. Markets remained sanguine with regards to risk in the fourth quarter of 2017 with renewed optimism inspired by developments surrounding tax reform.

In our view, U.S. fiscal stimulus (e.g. the tax bill)—while short-term positive—could potentially result in inflation. But perhaps more important in the long run is the fact that the tax bill immediately increases the U.S. fiscal deficit. If growth doesn’t pick up on a sustainable basis, then that deficit increase will become long-lasting. In previous commentaries, we mentioned government balance sheets as an area of concern going forward. While we generally believe a simpler, more efficient tax structure would lead to improved growth, we are not yet certain that is what we will see. Indeed, though lower tax rates will provide short-term stimulus, we have not been convinced that our current system was significantly improved.

In our view, the largest risk to markets in general is the removal of policy accommodation by most major central banks around the world. The Federal Reserve Board (Fed) is shrinking its balance sheet and raising its policy rates, the European Central Bank is tapering its purchases, and even the Bank of Japan has signaled that 0% interest rates won’t last forever. Despite central banks taking punch out of the punchbowl, general macroeconomic and market indicators point towards loose financial conditions. This may embolden central bankers and allow them to potentially remove stimulus at an increased pace. No one on Earth has a road map for what is to come, but it is certainly reasonable to suggest that at some point this will be a headwind to asset performance, even if the global economy strengthens further from here.

Fed chair Janet Yellen raised rates one final time while at the helm during the fourth quarter. Now, markets look toward the transition to incoming Chair Jerome Powell. We expect the transition to go smoothly and the Powell-led Fed to be a potentially more hawkish continuation of the Yellen regime. With New York Fed President William Dudley and board member Stanley Fischer also departing, there are multiple posts in transition within the Fed. While the large number of new members mostly appear benign, it remains another potential source of volatility in 2018.

Inside the Portfolio

High-yield spreads were flat to a little tighter over the quarter. This was not without some volatility as option-adjusted spreads ranged from 326 basis points to 378 basis points, due to a combination of bad news in telecom and health care amid fairly heavy supply. As with most periods of volatility these days, markets quickly moved on and spreads tightened once again. Yield-to-worst in the high-yield sector moved higher over the quarter and stayed higher, even as spreads tightened and U.S. Treasuries moved higher. Of course, we’ll have to wait and see how this tug-of-war between relatively high yield-to-worst metrics and relatively low spreads plays out as investors look to put money to work in the new year. Currently, we are not seeing great value in the sector and remain defensively positioned for the time being.

Although we’ve noticed some deterioration in some consumer loan markets, we remain constructive on the state of the consumer. Furthermore, we continue to view favorably the structural enhancements provided by many of the ABS (asset-backed securities) we’ve purchased recently. We’ve also increased exposure to mortgages. Given the type of mortgages we have purchased, we perceive the credit risk to be minimal and are focused on the convexity profile of purchases with a close eye on structural enhancements and the incentive profile of underlying borrowers.

Generally, compensation for risk continues to grind tighter, whether in high yield, ABS, or investment-grade corporates. We will be watching to see if spread tightening can continue in the face of reduced liquidity from the world’s central banks. As opportunities present themselves across sectors and classes, we remain ready to deploy capital if adequately compensated. However, for now, cash levels in the fund remain elevated. Notably, the return on cash has increased markedly over the past 12 months and will likely increase further with the market currently expecting two Fed hikes in 2018 and some economists forecasting as many as four. Because short commercial paper, U.S. Treasury bills, and agency notes rates quickly reflect Fed rate changes, holding some cash (i.e., dry powder) is akin to investing in floating rate bonds, without the one- or three-month delay associated with LIBOR (London Interbank Offered Rate) resets. Furthermore, with an extremely flat yield curve, the opportunity cost to holding cash is low.

We are thankful for your interest in the fund, and for your trust in Thornburg. The next decade will likely see periods of up and down markets, as well as an increase in volatility, and we believe the further validation of this portfolio’s style. Ugly market moments in 2008, 2011, 2013, and 2015/16 were balanced by ebullient markets in 2009, 2010, 2012, 2014, and 2017. We will continue to do our best to navigate these choppy waters and deliver value to you.

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
Before investing, carefully consider the Fund’s investment goals, risks, charges, and expenses. For a prospectus or summary prospectus containing this and other information, contact your financial advisor or visit our literature center. Read them carefully before investing.

Unless otherwise noted, the source of all data, charts, tables and graphs is Thornburg Investment Management, Inc., as of 12/31/17

Investments carry risks, including possible loss of principal. Portfolios investing in bonds have the same interest rate, inflation, and credit risks that are associated with the underlying bonds. The value of bonds will fluctuate relative to changes in interest rates, decreasing when interest rates rise. This effect is more pronounced for longer-term bonds. Unlike bonds, bond funds have ongoing fees and expenses. Investments in lower rated and unrated bonds may be more sensitive to default, downgrades, and market volatility; these investments may also be less liquid than higher rated bonds. Investments in derivatives are subject to the risks associated with the securities or other assets underlying the pool of securities, including illiquidity and difficulty in valuation. Investments in equity securities are subject to additional risks, such as greater market fluctuations. 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 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.

U.S. Treasury securities, such as bills, notes and bonds, are negotiable debt obligations of the U.S. government. These debt obligations are backed by the “full faith and credit” of the government and issued at various schedules and maturities. Income from Treasury securities is exempt from state and local, but not federal, taxes.

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.

High yield bonds may offer higher yields in return for more risk exposure.

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.