1. finance
2. investing
3. stocks

JANUARY 2015
4th Quarter 2014 Portfolio Manager Market Commentary
Thornburg Value Fund
Value Fund ­Performance
A shares, as of December 31, 2014
1-YR
3-YR
5-YR
10-YR
SINCE
INCEP
Without sales charge
11.50% 19.84% 10.21%
6.94% 10.00%
With sales charge
6.48% 18.01%
9.20%
6.45%
9.74%
13.69% 20.41% 15.45%
7.67%
8.80%
S&P 500 Index
Periods over one year are annualized. Inception of the A
shares is 10/2/95.
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
­thornburg.com or call 877-215-1330. The
maximum sales charge for the Fund’s A
shares is 4.50%. The total annual fund operating expense for A shares is 1.40%.
Connor Browne, cfa
Portfolio Manager
Two quarters ago, we wrote about how boring a time it was in U.S. equity markets.
Last quarter, things grew a l­ ittle more interesting. In the most recent quarter, markets
turned much more ­e xciting—and volatile.
Crude prices continued their decline from $98 earlier in the year to $54 late in the
quarter. Foreign exchange markets suffered tremendous volatility, with the dollar
strengthening against almost ­every major global currency. Russia suffered dire geopolitical consequences for its i­ntervention in Ukraine, and was quickly hit with a plummeting ruble—a reflection of that economy’s overdependence upon oil-export revenues
and thus crude prices. Combine all this with mixed messages from the Fed about the
rate at which it will remove monetary stimulus. The recent October market bottom,
for example, seems to have coincided with unexpected comments from St. Louis Fed
President James Bullard on delaying the end of quantitative easing.
No wonder the quarter was volatile.
Performance for the Quarter
The Thornburg Value Fund rose 4.28% (for the A shares without sales charge), modestly trailing the benchmark S&P 500 Index’s return of 4.93%. For the year, the fund rose
11.50% (A shares without sales charge), versus the index’s 13.69% climb.
We remain excited about our overall progress since mid-2012, when we began to bolster the consistent earning characteristics of the portfolio. Since the end of June 2012
we’ve ­a nnualized at 23.92% versus the S&P 500 at 20.49% with improved risk and
downside capture characteristics.
That said, the lag in performance for the quarter and the year brings us to a debate that
rages periodically within the investment world: the merits of active versus passive management styles. Active managers, such as Thornburg, favor individual stock picking and
tend to care little about emulating performance benchmarks. Passive “management” is
essentially investing in the benchmark itself (or some proxy thereof). After we touch on
the a­ ctive/passive debate, we’ll look at performance drivers for the fund.
2 | Value Fund
Time for A Turn? Active Management
Takes A Beating
On the first Monday back following the
New Year’s holiday, the Wall Street Journal
seemed to say to active portfolio managers, “I hope you had a nice holiday because
your industry is dying!” After noting
Vanguard Group’s massive inflows during
2014, the article observed: “Through Dec.
29, about 74% of active stock funds in the
U.S. were underperforming their category
benchmarks, according to Morningstar.”
The last several years have been quite
tough for active managers, not just 2014.
No wonder passive styles have been garnering huge flows of investor dollars and
the financial press are reading the last
rites over individual stock pickers.
This debate is not new. Thirty years ago,
Warren Buffet gave a speech at Columbia
University focused on what he called “The
Superinvestors of Graham-and-Doddsville,” (http://www8.gsb.columbia.edu/
rtfiles/cbs/hermes/Buffett1984.pdf). He
was responding to the preponderance of
academics who, at the time, were certain
that their efficient market hypothesis
(EMH) was correct, and that all information that is knowable about publicly
traded securities is always reflected in
their prices. The EMH leaves little room
for active managers to outperform over
time in aggregate, and suggests that those
that have are simply lucky coin flippers.
Buffett steered attention towards “an
­
­e xtraordinary concentration of success” in
this purported coin-tossing contest made
up of a group of pre-identified investors
that came from a common “intellectual village,” in this case, disciples of Ben
Graham. There seem to be too many successful investors in this village for it all to
be just chance, Buffett argued.
A quick caveat: keep in mind that we
are active managers whose livelihood
­depends on our ability to outperform over
time. We would ask you to focus on two
further intellectual villages. First, high
active-share managers. Those managers
who run diversified portfolios with high
active share, or difference from their index, have, on average, outperformed over
time, according to “Active Share and Mutual Fund Performance,” by Antti Pettajisto.1 There aren’t many of us left that
don’t “closet benchmark,” but those of us
that remain have shown a much higher
rate of outperformance, net of fees, relative to our benchmarks.
Finally, take a look at one even smaller
“intellectual village,” this one even corresponding with a particular geography:
Santa Fe, New Mexico, of all places.
All seven of the equity funds launched
by Thornburg Investment Management,
beginning with the Thornburg Value
­
Fund in early October 1995, have performed competitively compared to their
respective benchmarks, net of fees, since
inception.
Either we are a group of incredibly talented coin flippers, or there is something to
our philosophy and approach, our culture,
and our location, that has allowed each
strategy to prevail over the long term in
a contest that some believe is impossible.
We haven’t outperformed every year in
every strategy. And high-active-share
managers can provide return streams that
are lumpy at times relative to their benchmarks. But our philosophy and approach
to active management has worked in the
long run.
Further, we have attempted to position
the portfolio today so that it performs
better in a difficult equity environment.
It will be interesting to follow whether
­active managers broadly can provide more
protection when we get the ­
inevitable
downturn in U.S. equities.
With regard to fund flows, the move from
active to passive may continue for some
time. This could further impact relative
performance of securities in the markets
in which we invest. But, the worm has
turned in the past, and active managers
have often started to outperform just as
the multitudes of articles declaring their
death reached their peak.
Following this period of significant flows
into passive strategies, we like our odds.
Back to Buffett:
“In any sort of a contest—financial, mental or physical—it’s an enormous advantage to have opponents who have been
taught it’s useless to even try.” 2
The Best House in a Bad Neighborhood
U.S. large-cap active managers have
more exposure, on average, to mid- and
small-cap companies than does the S&P
500 Index. Large-cap performance walloped small-cap performance in 2014.
But i­nterestingly, if we think critically
about the current economic environment, the United States looks very good
right now, relative to everywhere else in
the world. Europe is a mess. Russia is a
mess. Emerging markets are weak. China
may suffer a severe downturn. Relatively speaking, the United States seems in
great shape.
Which U.S. companies have the most
business exposure to the United States?
Small and mid-cap firms! Which U.S.
companies have the most exposure to
markets outside the United States? The
large-cap multinationals! So, what’s
going on? We think the rush of flows
into passive index funds in the United
States has pushed up valuations of many
large-caps.
In the Value Fund, we are finding compelling value in mid- and small-cap
stocks in the United States. We’re being
mindful about how much exposure we
carry to them, but over the course of the
year, we’ve grown our exposure to smalland mid-caps somewhat. In an environment in which the U.S. economic backdrop looks much better than anywhere
else in the world, we’ve increased our
exposure to firms that do more business
here. Granted, this exposure dragged on
our relative performance in 2014.
Delving into Performance
For the quarter, the fund trailed a bit in
a strong U.S. stock market. Positioning
weighed on fund performance with our
high average cash balance (8.1%) not
doing much for us. Other than our cash
position, sector positioning contributed
3 | Value Fund
TOP 10 HOLDINGS AS OF 11/30/14
Thermo Fisher Scientific, Inc.
4.0%
Express Scripts Holding Company
3.7%
Gilead Sciences, Inc.
3.4%
JPMorgan Chase & Co.
3.2%
Zoetis, Inc.
2.8%
Phibro Animal Health Corp.
2.6%
Mead Johnson Nutrition Co.
2.4%
Target Corp.
2.3%
Mondelez International, Inc.
2.3%
IMS Health Holdings, Inc.
2.3%
slightly positively, with our overweights
in consumer discretionary and health
care both helping, and our underweights
in consumer staples and utilities both
hurting.
Stock selection was about neutral for the
quarter overall, though we saw material
variances versus the benchmark in two
sectors in particular, telecommunication
services and energy. Within telecom, new
holding Zayo Group was a big winner.
Zayo, a Colorado-based global provider
of internet bandwidth services, had its
initial public offering (IPO) in October.
We felt at the time that Zayo’s higher exposure to dark fiber (a more predictable
business) and lower valuation than Level
Three Communications made it a good
swap candidate. Strong performance of
this holding helped lift the performance
of our telecom exposure 22% versus a
negative 4% total return for the S&P’s
exposure. Zayo is too new to be included
yet in the S&P 500; the 61% total return
that we captured in Zayo shares during
the quarter wasn’t available to passive
S&P 500 investors. The index was stuck
mostly with AT&T and V
­ erizon, which
both traded lower.
Within the energy sector, we used our
flexibility to do some harm, u
­ nfortunately.
While our average energy exposure
(7.9%) was lower than the index (8.9%),
because we have a mix of riskier invest-
ments within the space, our performance
was much worse. Our energy holdings
were down just over 20% versus the index’s energy exposure (with a big weight
in Exxon) down only half as much. After
the crash in oil prices, we’ve been investigating the carcasses, but so far have a­ dded
only to current holding Weatherford.
Weatherford is a compelling self-help
story—management has divested noncore assets and is focusing on operating
their key businesses better. We like their
oligopoly position in tubular services.
While business might slow, given much
lower oil prices, this is a good business
with a strong competitive position.
Leading individual contributors included
Phibro Animal Health, Zayo, Express
Scripts, Target, and Alibaba Group.
­Phibro was what we would call a “cold
IPO.” It is a family-run, NJ-headquartered
animal-health business. When ­
Phibro
shares came to market in early 2014, investors were not interested. ­Phibro’s largest competitor, Zoetis, s­tarted the year
on a down note, disappointing the street
with slower-than-expected revenue and
earnings growth. In a busy IPO market
at the time, Phibro, a small cap, was overlooked. We participated in the deal (at a
lower-than-anticipated price, mind you)
and bought additional shares close to deal
price once it began trading. Since then,
Phibro management has done a good job
of executing and growing their business,
and the space has garnered more interest from investors (not in the least due to
Pershing Square’s activist stake in Zoetis)
and both stocks have a­ ppreciated materially. Though Phibro shares are higher, we
see further upside, especially if a strategic
buyer shows interest.
Express Scripts asserted its role as a force
for cost containment in the U.S. healthcare distribution chain at the end of the
quarter. Unfortunately, it did so at the
expense of another holding in the fund,
Gilead Sciences. Express announced that
it would exclusively cover a new drug
from Abbvie for the treatment of hepatitis C for a portion of its covered lives.
This caused some weakness into yearend in Gilead shares, though we contin-
ue to believe Gilead will get more than
its fair share of this large market. We’d
prefer that the kids play nicer with each
other in the sandbox, but that said, if
there is a risk to pharma/biotech pricing
over the long term (which would be bad
for ­Gilead), some of the savings should
accrue to the Pharmacy Benefit Managers
(good for Express).
Target’s turnaround seems to be progressing. During the quarter we visited
a Canadian Target store in Calgary and
collected many on the ground accounts
that support the idea that this holiday
season in Canada was likely to be much
better than last year’s disaster. For example, in Calgary it starts snowing as early as September each year. For the 2013
holiday season, Target’s Canadian inventory management system was only able to
deliver snow shovels to the stores in late
November. This past holiday season, the
store manager in Calgary had more of
what he needed when he needed it.
We’ve written much in the past about
Alibaba Group. Alibaba stock strength
continued into the fourth quarter after
the company’s successful third-quarter
IPO. We continue to like the opportunity
for the company, though we sold our direct ownership at price target during the
quarter and remain exposed through our
Yahoo holding. While promise remains,
the discount was much greater when
­A libaba was misunderstood and hidden
as a private company owned mainly by
Yahoo and Softbank.
Top detractors were Weatherford International, Inpex, MasTec, Gilead Sciences, and Netflix. Weatherford and Inpex
have direct exposure to the price of oil.
If oil prices stay at or below current levels forever, these will likely be poor investments for us. We find that scenario unlikely. MasTec, while less directly
exposed to the crude oil price, performs
installation services for energy infrastructure projects in the United States, which
may be weaker than anticipated. MasTec also does cellular-tower installation
work for AT&T, who has recently lowered their capital expenditure expecta-
4 | Value Fund
tions in the United States. We think some
of this may be bluster, given FCC threats
to regulate broadband more aggressively.
We like MasTec’s competitive position in
a relatively fragmented market. They are
market share gainers, both organically and
through acquisition. Generally speaking, a
healthy U.S. economy should be good for
MasTec business levels.
Netflix performed well following our initial investment in May of 2014, though
following a disappointing third quarter
earnings report, retraced its gains and sits
today at about the price where we initially
invested. We think the recent results are
a bump in the road and believe Netflix is
strongly positioned in a world where inter-
net TV is likely to grow at the expense of a
fraying cable/satellite bundle.
Thank you for investing alongside us in the
Thornburg Value Fund. n
1. “Active Share and Mutual Fund Performance,” by
Antti Pettajisto, Financial Analyst’s Journal, Volume 69,
Number 4.
2. Berkshire Hathaway annual letter to shareholders, 1988.
Important Information
Investments in the Fund carry risks, including possible loss of principal. Special risks may be associated with investments outside the United States, especially in emerging markets,
including currency fluctuations, illiquidity and volatility, and political and economic risk. Investments in small capitalization companies may increase the risk of greater price fluctuations.
Investments in the Fund are not FDIC insured, nor are they deposits of or guaranteed by a bank or any other entity.
The views expressed by the portfolio managers reflect their professional opinions and should not be considered buy or sell recommendations. These views are subject to change.
There is no guarantee the Fund will meet its objectives.
Any securities, countries, and sectors mentioned are for informational purposes only. Portfolio holdings are subject to change daily. Under no circumstances does the information contained
within represent a recommendation to buy or sell securities. Notable purchases and sales include material transactions other than recently purchased securities, which may be excluded
for best execution purposes.
Diversification does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
The Fund may invest in shares of companies through initial public offerings (IPOs). IPOs have the potential to produce substantial gains and there is no assurance that the Fund will have
continued access to profitable IPOs. As Fund assets grow, the impact of IPO investments on performance may decline.
Active Share is a measure of the percentage of stock holdings in a manager’s portfolio that differ from the benchmark index.
The S&P 500 Index, an unmanaged broad measure of the U.S. stock market, does not reflect sales charges.
The performance of any index is not indicative of the performance of any particular investment. Keep in mind that indices do not take into account any fees and expenses of the
individual investments that they track. You cannot make an investment in any index.
Quantitative Easing is the Federal Reserve’s monetary policy used to stimulate the U.S. economy following the recession that began in 2007/08.
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 thornburg.com. Read them carefully before investing.
Thornburg Securities Corporation, Distributor | 2300 North Ridgetop Road | Santa Fe, New Mexico 87506 | 877.215.1330 1/9/15
TH1758