4th Quarter 2018

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For the fourth quarter of 2018, Thornburg Developing World Fund returned negative 6.72% (Class I shares), ahead of the MSCI Emerging Markets Index, which returned negative 7.47% during the period. Since its inception, Developing World Fund has returned an annualized negative 0.53% compared with the MSCI Emerging Markets Index return of 3.04% over the same period.

Equity markets posted a negative quarter as tensions surrounding the U.S.– China trade dispute continued, the future growth rate of China came into question, and additional increases in U.S. short-term rates along with hawkish comments from the Federal Reserve strained equity markets. U.S. equities plummeted 13.52% during the quarter, as measured by the S&P 500 Index, and the MSCI EAFE Index ended the quarter down 12.54%. Emerging markets fared relatively well, having already corrected throughout the year.

Performance Discussion

The Fund employs a basket approach, allocating to “Basic Value,” “Consistent Earners,” and “Emerging Franchises” stocks. This additional layer of diversification is unique to Thornburg, and for Developing World is intended to provide exposure to a wide range of companies with varied cash flow and market cycle characteristics.

Companies within the Consistent Earners basket normally exhibit steady earnings growth and cash-flow characteristics. These types of companies are expected to participate in up markets and also provide downside protection for the portfolio. Stocks within this basket outperformed during the quarter as expected.

Basic Value companies are financially sound with well-established businesses selling at low valuations relative to net assets or potential earnings power. These stocks tend to do well during more compressed periods of the business cycle. For the quarter, this basket also outperformed.

Emerging Franchise companies are those in the process of establishing a leading position in a product, service, or market with the potential to grow at an above-average rate. Stocks within this basket tend to perform well during growth-led markets. As expected, these stocks trailed the index for the quarter.

Among the larger emerging market countries, Brazil and India were the only positive performers within the MSCI Emerging Markets Index. China, Korea, and Taiwan each shed more the 10% during the quarter, while Russia held up slightly better on a relative basis.

Top contributors to performance for the quarter included Azul S.A., ICICI Bank Ltd., Itau Unibanco, B3 Brazil Bolsa Balcao, and PT Bank Central Asia Tbk.

Azul S.A. is a Brazil-based airline operator. Azul rose during the quarter, benefiting from declining oil prices. In addition, passenger traffic and capacity expansion were favorable.

ICICI Bank Ltd. rebounded following selloffs in the third quarter over the stability of the non-bank financial sector and how that might impact the broader economy. India, broadly, is a beneficiary of lower oil prices, which drove enthusiasm for the shares.

Itau Unibanco and B3 Brazil Bolsa Balcao both rebounded as it became clear the market-friendly presidential candidate won the election. While controversial, President Jair Bolsonaro has adopted a market-friendly policy agenda focused on fiscal reform and privatization of public sector assets.

Bank Central Asia (BCA) reported strong profit growth, beating expectations. The beat was driven by the liquidity franchise of the bank, which has led to market share gains. BCA is gaining share of private sector corporate and retail loans in an environment where state-owned enterprise banks are increasingly focused on directed lending. Smaller banks are being held up due to cost and availability of liquidity.

Major detractors for the period included Grupo Financiero Banorte, Alibaba Group Holding Ltd., Haliburton Co., Ctrip.com International, and Baidu, Inc.

Banorte shares sold off following comments made by incoming Mexican president Andrés Manuel López Obrador regarding the completion of a new but partially built airport for Mexico City. While Banorte’s exposure to the airport is small, there was concern that the incoming president was tacking harder to the left and that he might burden the private sector with increased regulation and taxation. As the leading bank in Mexico, economic growth is a key driver for Banorte.

Alibaba and Baidu shares fell due to concerns over slowing Chinese economic growth, which may impact demand for their services in the short term.

Haliburton provides energy and engineering and construction services, and manufactures products for the energy industry. Shares fell due to ongoing delays of North American onshore capex and in sympathy with weaker oil prices. Weaker oil prices usually drive weaker cash flows and ultimately production spending in the near term.

Ctrip.com is China’s largest online travel agency. Despite the Chinese travel industry growing nicely, Ctrip.com surprised the market by guiding investors to flattish adjusted operating margins (when market expectations were for mid-teens adjusted operating margins) for fourth quarter 2018. The reasoning behind the big downward guidance was puzzling to us and lowered our confidence in the medium-term prospects for the company. We sold our position in the quarter.

Year in Review and Year Ahead Outlook

In 2018, January started out with investors exhibiting high hopes that emerging market equities could sustain the momentum seen in 2017. Although their ascent briefly accelerated into January 2018, performance sputtered and developing world stocks fell back to earth. The asset class ended 2018 down 15%, plummeting 24% from the first-quarter peak. That brought returns so far this decade to an anemic annualized 2.4%.

Investors are asking if they should be more optimistic from here. After all, from its early 1988 inception through the end of last year, the MSCI Emerging Markets Index has returned an annualized 9.7%, just ahead of the MSCI USA Index’s 9.3% and about double the MSCI EAFE Index’s 4.9% gains in the period. Both short-term overhangs as well as the current catalysts are worth consideration, as the entry point now provides a good margin of safety for those with longer investment horizons.

If the trade dispute and stronger dollar kicked off the correction in emerging market equities, the question facing many investors is how those factors will be reversed. Low multiples, low expectations, and growing earnings typically make for a good investment climate in emerging market equities. Expectations are now at a more realistic starting point. At the index level, the forward 12-month price/earnings multiple has compressed significantly. The de-rate was broad based, with lower multiples seen across all sectors. The hardest hit sectors were consumer discretionary, health care, technology, and materials.

Looking forward, emerging market earnings are expected to grow close to 10% this year and next year. Given the low starting point, positive revisions, and faster growth in many sectors are likely. These favorable conditions, combined with a near-term catalyst, either an end to the tariff dispute and/or renewed growth in China, should send emerging markets higher.

Our approach to emerging market investing is through a focused, yet diversified portfolio of attractively-priced, free-cash-flow generative stocks. Our flexible and balanced process has benefited the Fund as the market shifted from growth-led stocks in 2017 to value- led names in 2018. Although macroeconomic conditions have been challenging within many emerging market countries, we believe great companies can still rise to the challenge and distinguish themselves over the long term.

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 December 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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