Thornburg International Value: Opportunity In Japan

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Thornburg International Value Second Quarter 2014 Letter To Investors

For the second quarter of 2014, the Thornburg International Value Fund returned 2.14% (for the A Shares without sales charge), versus 5.25% for the MSCI ACWI ex-U.S. Index and 4.09% for the MSCI EAFE Index. Despite concerns about political stability in places such as the Ukraine and Iraq — and over the deceleration of monetary easing — equity markets resumed their upward trajectory. Global markets were led higher by continued strength in the U.S. market and a reversal of negative trends in Japan and several emerging markets.

Among the top contributors to the fund’s performance for the quarter ending June 30, Schlumberger delivered positive performance following strong quarterly results and recently announced encouraging long-term targets for returns and earnings per share. For Hong Kong Exchanges & Clearing, a cash and derivative trading bourse in Hong Kong, performance was driven by positive prospects from an announced trading partnership with the Shanghai Stock Exchange. Higher trading volumes are expected from incremental transactions in and out of China. Shares of Baidu, a detractor highlighted in our last commentary, performed well, driven by strong earnings momentum due to better than expected mobile monetization and margin profile.

Portfolio laggards in the second quarter were largely driven by security and sector-specific catalysts. In the cases of both UBS and Deutsche Bank, ongoing litigation and regulatory issues, combined with low trading volumes in fixed income, currency, and commodities, weighed on investor sentiment. Lululemon, the athletic apparel manufacturer, declined as the company lowered annual guidance after delays in seasonal product reduced conversion to sales of in-store traffic.

Recent portfolio activity has been sensitive to geographic and sector diversification as well as the three categories of stock classifications we use (basic values, consistent earners, and emerging franchises). Representative recent buys include BT Group (a U.K. telecom), NXP Semiconductor (a global semiconductor company), Rio Tinto (a global miner), and Perrigo (a private label OTC drug manufacturer).

BT enjoys pricing power on fiber broadband because it is the sole owner of the fiber network in the United Kingdom. BT generates strong cash flow under a variety of economic scenarios and has supportive dividend yield and low expectations. NXP Semiconductors is poised to grow faster than the industry due to its leading market shares in high-growth end-markets, such as security, automotive electronics, and infrastructure. NXP is a direct beneficiary of increasing Europay, MasterCard, and Visa (EMV) mobile payment adoption in China and the United States, starting this year. Rio Tinto is a leading global iron ore miner currently focused on cost cuts, capital expenditure reductions, and free cash flow generation. Despite falling prices for commodities they produce, management is creating value for shareholders with increasing returns of capital. Another recent purchase, Perrigo, exemplifies our efforts to be opportunistic when valuation dislocations arise. The core business benefits from both consumers’ and retailers’, such as Walgreens, increasing demand for cheaper store-brand alternatives to branded basic medicines. Recent weak quarterly results are related to low sales during a mild cold and flu season and we believe them temporary. The stock was available at historically low valuations. We believe Perrigo’s scale, record of regulatory compliance, and supply chain advantages are durable competitive advantages.

Recent sales include WPP, SAP, Sinopharm, HSBC, Sina, and Yandex, most of which were sold to make room for what we judge to be better opportunities. In the case of Sina, earnings power is perceived to be diminished by the suspension of its online video license by its Chinese regulator. While we believe the suspension is temporary in nature, we don’t have a good gauge on when the license will be reissued. The sale of Yandex was related to the Ukraine/Russia conflict and the uncertainty surrounding it.

As we enter the sixth year from the market bottom, equity markets have continued to move higher, fueled by a steady dose of monetary stimulus from the three major developed-market economies (United States, Europe, and Japan). While we appear to be entering the late innings of the Federal Reserve’s monetary intervention, attempts to spur growth through monetary stimulus outside of the United States appear to be just getting started. Japan shows little sign of backing down from their current rate of government bond purchases, though they have held off from moving aggressively into other types of asset purchases as economic data has largely continued to come in better than expected. Europe has been reluctant to embark on true quantitative easing, focused first on improving capital flow with targeted measures designed to transmit low credit costs from the core economies to the periphery. Judging from peripheral sovereign spreads, they appear to have achieved some success. The next step will be spurring more robust demand in Europe, which may require the addition of unconventional monetary policy — a prospect that is proving difficult for Germany to support without further fiscal restraint from the periphery.

A key area of focus in the near term remains the evolving nature of U.S. monetary policy and its impact on both U.S. and global growth, as well as enthusiasm for dollar-funded foreign investments. Expectations call for U.S. interest rates to begin to rise as early as 2015, which is likely to pressure various currencies around the world. Lower exchange rates are likely to be welcomed in regions fighting deflation, such as Europe and Japan, but may prove to be an unwanted headwind for some emerging markets. While there is no way to immunize our portfolio from the influence of these macro developments, our focus will continue to emphasize the merit of individual stocks, their risk/reward trade-offs, and how they fit our three-basket approach to diversification.

Thank you for investing alongside us in the Thornburg International Value Fund.

For a print friendly version of the International Value Fund market commentary click HERE.

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