Thornburg Investment Income Builder Fund – 1st Quarter Update 2023

Thornburg Investment Income Builder Fund – 1st Quarter Update 2023

Adam Sparkman:        Good afternoon, and welcome to the Thornburg Investment Income Builder quarterly update call. My name is Adam Sparkman and I’m a client portfolio manager with Thornburg Investment Management. A few housekeeping items before we get started. This time, all participants are in a listen only mode. However, you can ask questions at any time by submitting them through Webex or emailing us at questions@thornburg.com. This webcast is being recorded and a replay will be available in a few days. Slides from today’s presentation can be found on our website in the events and webcasts section. Just to remind you, today’s presentation may contain forward looking statements based on management’s current expectations and are subject to uncertainty in changes and circumstances. Actual results may differ materially from these statements due to various factors, including those described in our SEC filings. For those on the call today who may be less familiar with Thornburg, we are an investment manager based in Santa Fe, New Mexico overseeing approximately $40 billion of assets across a suite of actively managed equity, fixed income and multi asset solutions. I would also like to highlight that we are celebrating the recent 20^th year performance anniversary of the Investment Income Builder Fund, which launched December 24^th, 2002. Congratulations to the team and thank you to all of you who have invested alongside of us. I’d like to quickly introduce our speakers today. McMahon, Portfolio Manager, Vice Chairman and Chief Investment Strategist for Thornburg, along with Portfolio Manager Matt Burdett, as well as Christian Hoffmann, who is a Portfolio Manager for many of our fixed income strategies and will be standing in today for Jason Brady. So, with that, let me turn it over to McMahon, who will kick us off.

Brian McMahon:        Hello everyone. Brian McMahon, and let’s dive into the call, to review the first quarter and our outlook for the Thornburg Investment Income Builder. we have a slide deck available on our website, www.thornburg.com and I’d like to start with slide 2, where we list some key, ac, macroeconomic issues at the moment. I won’t read all of these, but what I will point out is a, is a couple of things, number one of course, inflation rates remain well above central bank targets even as, this inflation, rate increases are moderating, and I expect further moderation in the next few months. alongside that, labor compensation continues to grow, the Atlanta Fed Wage Growth tracker is up mid‑single digits, latest observation of 6 percent. a word on, on, the banking situation. and I’ll just go back to, 3 years ago at this time, the onset of the, the COVID, epidemic. Deposits of the US commercial banks in March of 2020 were, $13.3 trillion. And over the next 2 years, they increased to $18.4 trillion. So almost a 40 percent increase in, deposits at US commercial banks in about 2 years. During most of this period, the effective Feds funds rate was 8 basis points. So, it is, and one way of looking at it is, the Feds more or less set a trap, because there wasn’t really much to buy, but, there were a lot of deposits pouring into commercial banks and, and trap also, snared some individual investors who, who, maybe bought things that they wouldn’t have bought if interest rates had been more regularized. But lacking, accretive short maturity investment opportunities, too many banks invested their deposit inflows in longer duration securities and these fell sharply in value as the Feds funds rate increased by 4 ¾ percent over 53 weeks. So, unable to sell these securities, the fund deposit outflows, while also maintain solvent capital issues, some banks have failed. And others are stressed, maybe what matters going forward, is the ability of some small and mid‑size US banks to provide loans, while also remaining liquid enough to fund deposit outflows, is probably going to lead to a degree of credit crunch in the US economy, and it just remains to be seen to what extent, the Federal Reserve’s decision makers will factor that bank stress and tie their credit conditions into their decision making on rates, for whether they remain only focused on how far inflation is above their 2 percent target. So, that’s, maybe the most important thing that markets will be watching for, in the, in the coming weeks and months. just to review, Income Builder slide 3, we haven’t changed. Our objective for more than 20 years has been to pay an attractive yield today, grow the dividend over time, and we believe we should be, getting long term capital appreciation if we have a collection of a growing dividend payors. Our investable universe is all over the world. global dividend paying stocks, also global bonds and hybrid securities. And we remain focused on the firm’s ability and willingness to pay good dividends and, of bond obligors, ability and willingness to, to pay their bond obligation. Slide number 4 in the deck, gives you an overview of, equity portfolio allocation shifts, in recent quarters, in fact, going back 2 years, and what you see is, some increase in energy, although that came off the peak levels of more than 10 percent, but, but an increase in energy year over year, an increase in, allocation to, utilities year over year, and here we’re pretty focused on utilities with a high renewables businesses. Also, some modest increase in industrials and we paid for those, allocation increases with, modest, step downs in, allocations to information technology, health care, and a larger decrease in, allocation to communication services stocks, and that’s mostly the, the Chinese Telcos that we had on, in prior years that we were forced to sell, in the spring of 2022. The next page has, some significant information on it facts. If you look under Equity characteristics, what you see is our trailing PE, for looking back 1‑year in the portfolio is, is just 10.1 time, which is down a couple of multiple points from what we reported a year ago at this time, and that’s due to a combination of earnings growth, and some price declines in the, in many of the, the equities that we own. Notice that the forward P/E estimate is 9.6 times, so we’re looking for at the moment, I would say, consensus estimates are looking for about half, 5 percent, increase in earnings this year, from our portfolio on weighted average base, is buy to books to 1 ½ times, return on equity between 13 and 14 percent and dividend, you’ll over 5 percent. the, the regional composition of our portfolio had, evolved a bit further, in favor of, foreign equity and some of that is just us, looking at valuations and yields and some of it is appreciation, because for four consecutive quarters, we’ve seen, foreign equities outperform the S&P 500, just on, on sheer cheapness and on, foreign markets doing a bit better, basically, foreign economies doing a bit better than they were expected to do. we’ve got 26 percent of the portfolio and domestic equities and the, the remaining 14 percent is in, bonds and cash. going to the next slide, we list our top 10 equity holdings that accounted for 34 percent of portfolio assets as of March 31, and you see there are four columns there. The first column is Q1 March quarter price changes in US dollars. The second column is last year, the 2022 price changes in US dollars, the third column is dividend yield, as of, February 28^th, and the last column is the 5‑year dividend growth rate. And these are all important, little facts about each of these, top 10 holding, and I think what you’ll notice is, some of the things that were down last year, have bounced back this year, and, and furthermore, we have, a set of really a very attractive yielding, equity investments in the Income Builder, most of which have increased their dividend. in fact, of our top 25 holdings, there’s only one that hasn’t increased its dividend, over the last 5 years. It’s, compound average growth rate. So, I think, and, and that one is a special situation, Vodafone, which I, I think, we can comment on further, but it, they, they’ve got the dividend, but there’s maybe some interesting break up possibilities going on there and the current yield is 8.6 percent. So, I think this kind of speaks for itself. The next slide is, number 7, which has then, the next 10 equity holdings. Though, these account for 21 percent of the portfolio as of March 31, though between slides 6 and 7, you have, 55 percent of our, portfolio assets there, again with, Q1, last year, current dividend yield and the 5‑year dividend growth rate. one thing you’ll notice is some of the ones that have lower yields, have had faster, growth rates on the dividends, so, for example, Broadcom on the prior slide would be an example, where the, the dividend yield is 2.7 percent, but it’s been growing in over 30 percent per year for the last 5 years, and others that have higher dividends and lower, dividend growth rates, but most of these names will be familiar to, those who have, monitored, the Income Builder in recent quarters. none of them are, are brand new names in the portfolio. The next, 10 slides, 8 through 17, just give you some information, stock by stock, on these top 10 holdings in the Income Builder portfolio, we are, quite comfortable, as having our constituents, advisors and shareholders know, what we own in the portfolio. So, there are a few facts about each of those. I’m not going to go through them, one by one, but if anybody has a specific question, I’d be happy to come back to them. maybe one thing that I would point out with respect to all of these, is, that the prices have been probably more volatile than they should be, given the fact that, these are, are pretty solid businesses, most of them, not at all cyclical, with, a large number of paying customers that generate a lot of cash. but they are, somewhat volatile and that gives us an opportunity to, to buy them when they’re down. and we track these businesses pretty closely. next I’ll go to slide number 18, which, highlights the, the potential for us to grow our distribution over time, and that’s, that’s rooted mostly in the equities being able to grow, their distributions, over time, and if we look back last year, more than three out of four of our equity holdings grew their dividend, last year, in local currency, and, that’s actually better than,  most years we aim for around 70 percent, growing the dividend. most of the remaining, equities that we, paid a flat dividend last year, with an average, calendar 2022 yield among those of more than 5 percent. and a small percentage, paid lower dividends. Some of those, because of the special dividend and a couple of, of non‑bank financials that, cut their dividends. because their liability costs went up. So, with that, I’d like to hand over to, Matt Burdett, to, cover the rest of the slide deck. Matt?

Matt Burdett:  Great, thank you, Brian. so, turning to slide 19, just talking about some of the characteristics, of, of the portfolio and riding the rate environments, so this is the, the historic, behavior of the investment and can build a fund. and generally, what you can see here, what we did is we looked at, 34 periods where the US 10 year treasury yield rose by 40 basis points or more, and then we compared the Income Builders relatives, performance versus various other income, portfolios, including the US Corporate Bond Index, the AG US high yield and that, and then our blended benchmark, which is of course, 75 percent, MSCI world and 25 percent US Aggregate Bond Index. And what you can see over there on the far, far right, is the frequency, with which we have, have outperformed, these various other income, oriented portfolios, with frequencies, of as low as 71 percent up to 82 percent for the respective indices. a lot of this has to do with just the fact that we, we run our assets in, or asset allocation in a dynamic fashion, and I’ll highlight that a little bit later on a later slide. Slide 20, gives you a little more detail, a little specifics on how we have behaved in various rising rate environments. I would note that, throughout this period, the Income Builder, has averaged, a dividend yield of 250 basis points higher than our blended benchmark, so and what you’re seeing on the slide here, is a lot of numbers, but, if you look at the bottom, on the, the little gray arrow, looking shapes, you can see the, the intra period peak to trough rising yield. Okay? And then, and so that’s, that’s starting at 149 back in ’03 and going all the way up to 138, last, last third quarter, roughly. and what you see in the bars is, in the light blue, is, is the Thornburg Investment Income Builder total return versus our blended index in the dark blue and the Bloomberg US Corporate, index in the, the gold, the gold color. And I think the takeaway of all of this is that in, in, almost all cases, we have had better upside and better downside compared to, those respective benchmarks. And, and I think that really, is just a function of us being flexible in our, in our asset allocation as well as, having a diverse set of companies and not anchoring too close to bomb proxies on the equity side of the portfolio. Slide 21, is just highlighting the equity returns for various global portfolios here. I won’t spend a lot of time on this, other than to say, you know, after a pretty rough, 2022, we’ve seen the markets come back, pretty, pretty strongly in Q1 of ’23, with the best performance coming from, from growth as you can see in the Russell 2000 growth index. and also coming from, Europe in the Euro stock index here. a lot of this, is, is likely, just driven by the fact that I think rates, rates have come down and there is, there is some, some, read through into the markets that, that maybe we, we are, are hitting peak rates. But that, that remains to be seen, yet. Moving to slide 22, this is the, investment performance. You can look at these numbers at your, at your leisure, here. I would just highlight, so, for that first quarter of ’23, we, we delivered 555, basis points, a positive, return, which is about, almost, almost a percentage point below, below our benchmark. this is after having a couple, strong out performance years, for the Investment Income Builder fund and, looking at the inception total return, of near 9 percent per annum for 20 years, that’s probably the more, more important, number to look at there. Slide 23 is showing the, the quarterly total returns for, for the Investment Income Builder fund. 81 quarters completed, 59 of those have delivered positive returns and we have delivered positive returns in 15 of the 20 calendar years, that the fund has been in existence. Slide 24, I think, I, I touched on this earlier. This is the flexibility of, of our asset allocation, we are not married to a static equity bond allocation and we take advantage of bonds when those, those yields, we feel like those yields are compensating us for doing so. what you can, can see on this slide is the dark blue, is the Income Builder cash, and fixed income allocation. and it basically overlaps the US high yield to worst yield level which is what the, right hand axis is showing. Also in light blue, you have the, or sorry, in orange you have the European high yield to worst. So basically, what you can see here is, is that we’re tracking, our asset allocation tracks where yields are going. and that helps us to be less sensitive, less negatively sensitive, when interest rates are rising. Moving to slide 25, this is the quarterly distributions, for the fund. We, distributed for the first quarter of ’22, and at, and .03 cents, that was roughly 5.7 percent higher year on year for that quarter and traveling dividend is about 120. you know, as you know, we try and generate as much income as we can, in a sensible way, by, you know, not taking too much risk doing so, but as a result, you can see dividend fluctuate a bit over time, but generally that direction is, is, is positively upward, and on slide 26 you can kind of see, the history of the fund with the yield level, for the In, Income Builder yield in the gray bars, and then you have the yields of our blended, blended index in, in light blue. and in orange is the Bloomberg US Corporate Bond index, and then in dark blue is, is CPI. which has, of course, shot up quite a bit, in 2022 and, and is tracking down. so over the history, the dividend has grown at a, at a 4.9 percent CAGR for 20 years and the entity has grown at about a 4 percent CAGR, over that period. Moving to slide 27, this is kind of, you know, a report card, so to speak of how we’ve done. this is, the hypothetical $100,000.00 investment, at inception of the A shares of the Thornburg Investment Income Builder fund, and in this instance, this individual, collected the dividends along the way and sent them, they were not reinvested and over this period, the growth and incomes total dividends was $166,726.00, on the original $100,000.00 investment and that $100,000.00 of capital appreciated,  near doubling, to, close to $200,000.00 and, and I would highlight the power of this kind of investing, where you have a growing dividend, so, in the, in year one, you’re, you’re yield is roughly 4.2 percent, right? You collected 4.2, $4,200.00 for your original $100,000.00 investment. If you fast forward, to the end of ’22, you collected $10,000.00 on your $100,000.00 investment for a 10 percent yield on original cost, which is, is a pretty powerful concept. moving to slide 28, we highlight this concept a little bit more here, with the same $100,000,00 investment, however, with reinvestment of the dividend along the way. So, this is, this is an individual who is, you know, saving for retirement, but they don’t need the, they don’t need the income now, so they just reinvest it and so they reinvested for 20 years, and the cumulative dividends they received over that time, which was over $287,000.00, you know, it, it took their share count from 8,375 to 23,583 over this period. So, so, a massive growth in the number of shares that you owned, and the capital appreciated, 135,221, giving your total return over, over half a million dollars, and so, when you think about it, you, you’ve now moved through a yield on original cost of 25 percent, which is simply the $25,000.00 received in 2022 divided by the $100,000.00 original investment. The last slide I’ll talk to you here is one we show quite a bit which is, on slide 29, just showing the importance of dividends over time. this is the S&P 500. We break down the price and income component here, and what you can see on the far right is income as a percentage of total return, is, roughly 50 percent over this period, which goes back to 1871, all the way through Q1, of 2023. And, the key takeaways are again, it’s roughly half of your total return, however, if you look in the column on the far right, what you see is that that percentage dividend as a percent of your total return varies wildly. Right, it can be as low as 14.9 percent during the dotcom era, or as high as 233 percent. So, you know, we’ll see what’s in store, excuse me, for markets, going forward, but starting yield of 5.3 percent is probably not a bad place to start. for total returns from here, which is what the Income Builder is yielding today. and with that, I will turn it back to Adam for the Q&A.

Adam Sparkman:        Brian, Matt, thanks for the, the great update, on the fund. turning to Q&A, and I think I’ll kick it off with, Christian here, on a question around commercial real estate, the, audience member asks, as highlighted in a recent Bloomberg article, there’s risks looming, around commercial real estate with roughly $1.5 trillion of commercial real estate debt, coming due between now and 2025. Christian, do you have any thoughts on the potential impacts that might have on banks, and then maybe more specific, more generally on the market as a whole?

Christian Hoffmann:   Yeah, let me just start by saying that, the good news is, you know, in this fund, and actually our fixed income funds broadly, have avoided the trouble spots for a very long time, so we’re, we’re starting, you know, the start of this, so called crisis, you know, in a very good position. I think we will see, you know, a significant pull back in, in lending to that space. I also believe that you’ll see some median transactions. You’ve already seen, you know, some equity owners hand over the keys to lenders when they’re just clearly out of the money, and , you know, properties are, you know, bleeding cash, but you’ll also see a lot of, you know, what we call a man, extend and pretend, which is to say, you kick the can down the road, ’cause actually, you know, dealing with the work out of restructure is too painful. so, you kind of hide the losses, you know, over time and kick the can down the road by extending terms, and, you know perhaps getting haircut, you know, in the interest burden. you know, we, we had hoped to take advantage of opportunities in the future. I’d say they’re not here yet; you know, things have gotten cheaper. and will likely continue to get cheaper. our strategy would be to, you know, catch the babies that are getting thrown out with the bath water. So, property is where it’s, you know, not a question of, you know, what does the future of, of work look like, or, you know, will this tenant renew, you know, really focusing on things where, it might be painted with an offish or commercial real estate brush, but actually has underlying fundamentals, which, you know, don’t share those risk characteristics. That’s, that’s high level philosophically speaking, you know, what we might do, but, you know, we haven’t had those opportunities so far. on the bank level, again, I think, you know, we’re going to see the impact at the regional level, really flat over time and, you know, along with, you know, some of the hangovers and the excess, you know, the past, past 5 to 10 years.

Adam Sparkman:        Great, thanks, Christian. Matt let’s turn to you, for this next one. Are there any emerging themes and or catalysts, that the investment team is currently focused on within this portfolio?

Other Speaker:            Yeah, thanks, Adam. I don’t know if I would say they’re emerging, emerging themes or, or catalysts, more specifically. I would say there’s certain areas that we think are, where growth is probably under appreciated by the market. and some of that was highlighted by, the comments Brian made when he showed, kinda the sector weight changes at the beginning of the presentation. So, one, one, I would highlight here, which I think is very broad, is just energy transition, opportunities, so, we, we’ve, you know, increased our holdings into some European utilities, which most of them are large, integrated across the energy value chain. and will be very necessary companies for the energy transition to happen. Both, both in Europe and in other parts of the world, and there’s a lot of political support and capital, being made available to these companies to be able to invest, right? And, it’s really all about getting, getting, greener energy system. but as you, as you make your, your energy system more and more renewable, which is the goal in most places, you ought to bring more volatility into the energy, to the generation mix, right, because the sun, obviously, doesn’t shine at night, so there’s no solar production; wind speeds can vary, and sometimes they, they go wrong at the same time. So what that means is you need more flexible, what they call flexible generation. and some of the companies that, that, that we own, and Enel, would be one, AnG is another one, that have assets that can take advantage of this. and, and on the other side of it, it also actually benefits the traditional energy producers, like a Total Energies, that produces oil and gas. Shell, you know, these Total energies in particular, has an energy transition strategy that we think is, is a very sensible one. and they’ll benefit from this transition, which will take, more likely, will take decades than, than years, so, it’s, it’s pretty long duration; the relative values are very, are very good for these types of businesses. So that’s, that’s something, I think is probably under, under appreciated. back to you, Adam.

Adam Sparkman:        Thanks, Matt. Yeah, that’ll be interesting to watch over the next, the next several years. That, Christian, shifting back to you for, Fed question. kind of in the light of, of what we’ve seen, over the past month with banks, what’s your view on the likeliest path forward for the Fed from here, and how has your, your expectations changed, given the bank liquidity stress?

Christian Hoffmann:   Yeah, the bank stress, clearly has shown that there is, there’s poison in the system. you know, we had the, the Fed minutes come out yesterday. And it was pretty clear that they might have gone 50, and we would have seen very different dot plot had it not been, you know, for bank failures, and, you know, at least the start of a, a miniature banking crisis that may or may not, you know, extend into something more severe. the good thing about this Fed is they’ve been loathe to surprise us. So, I think it’s pretty reasonable to say that if they had their meeting today, they would hike another 25 basis points. we have a couple more weeks of that before the next meeting. I think if things feel pretty bad, they won’t, but that’s actually probably less interesting at this point. I think, again, we’re probably, you know, almost to the end of the hiking cycle in whether we do 0 or 25 isn’t going to really move the needle. The more interesting debate, I think, at this point, is going to focus on the duration of hikes, and the cognitive dissonance between the Fed and the market right now is, you know, much more pronounced, as you look forward with the market. Just in we get to the low 4 percent range by the end of this year, and the Feds saying, no, we’re going to hold rates, and you know, actually be closer to, you know, the high 4 percent area. so, I, I think that’s where we are over the last 2 weeks, we’re finally seeing some softening in the labor market, which remains, you know, incredibly robust, but I think the turn there is, is very important, and you know, something new, that’s showing up in the economic data. but, yeah, I, I think, I think the trajectory is what we should focus on at this point.

Adam Sparkman:        Thanks, Chris, thanks, Christian. Brian, I’m going to shift back to you, for, for a little geopolitics. regarding, the position, in Taiwan’s semiconductor, the, the holding in the portfolio, and the saber rattling that we’ve seen, between Taiwan and, and, China, how does that, kind of affect your outlook on, on TSMC?

McMahon:      Well, there’s really not a big change, in the degree of saber rattling versus recent years, and I think maybe what’s most important Taiwan’s semiconductor is the, is the, largest, and, most profitable, foundry, for manufacturer’s sophisticated semiconductor chips in the world. and what, the saber rattling has done, is it’s, caused TSMC to, to begin to diversify geographically outside of Taiwan. including a, a very large facility that’s under construction in Arizona, in the United States, but also, planning facilities in Europe, and, possibly even in Japan. So, it is moving them to , to diversify geographically, which, I’d be, positively, but, the saber rattling, on, from China, is probably holding down the PE multiple on TSMC by one or two turns, possibly more, though it’s good that they are, diversifying their production geographically at some cost, but, TSMC is pretty indispensable to, to the global economy. So, I’ll, I’ll leave it at that.

Adam Sparkman:        Great. Well, thank you, thank you, Brian. And, and why don’t we, why don’t we wrap up and, and leave it there for today. I’d like to thank everybody for being on the call today and, and making it as interactive as it was. As always, please feel free to reach out to us with any follow up questions you have. We love to make ourselves available and love talking about the portfolio and why we’re so constructive on the future return potentials. So, please reach out with any questions, and thanks so much for joining us today.