Thornburg Investment Management
November 02, 2016
Thornburg is a global investment firm delivering on strategy for institutions, financial professionals and investors worldwide.

3rd Quarter 2016 Income and U.S. Government Bonds Commentary

By Jason Brady, CFA; Lon Erickson, CFA and Jeff Klingelhofer, CFA of Thornburg Investment Management

Over the past couple of years, we added some high-quality floating-rate securities to the portfolios, believing the Federal Reserve would increase short-end rates at some point as both real gross domestic product (GDP) growth and inflation were low but notably positive. We'll concede that the recovery hasn't been robust, so the Fed funds rate shouldn't be around 5%, like at the peak of the last cycle, but it shouldn't still be about 0.50% right now either. The Taylor Rule (a formulaic guide to interest rate policy suggested by Stanford economist John Taylor) suggests the Fed funds rate should be 1.25% or greater using assumptions offered by various Federal Open Market Committee (FOMC) members.

Furthermore, a cursory review of current real GDP growth and core Personal Consumption Expenditures inflation rate of 1.4 to 1.7% in historical context suggests the Fed funds rate should be higher. However, given its propensity to quiver at the sight of its own shadow, the FOMC's move to increase rates 0.25% last December would perhaps best be viewed as a divine gift for which we should be grateful (i.e., "Please sir, can I have some more?"). This action moved the three-month London Interbank Offered Rate (LIBOR), the interest rate for the vast majority of the funds' floating rate securities, from 0.31% to 0.55% and then ranged from 0.55% to 0.65% through June 30, 2016. Then, the market received another gift, at least from our vantage point, but not from the FOMC this time.

In 2014, the Securities & Exchange Commission (SEC) adopted new money-market reform rules in an attempt to limit the potential of another post-Lehman-like run on money market assets, as well as any subsequent damages. Many institutional prime funds decided to convert to government-only money market funds, which means they will no longer buy Commercial Paper (CP). The effective date of the new SEC reforms is October 14, 2016, as such these funds stopped buying 90-day CP in early July 2016, so all non-government securities would mature before the effective date. Well, large banks were significant issuers of CP, including 90-day maturities, but now as a result of these money-market fund conversions, the CP buyer base, and the liquidity it provided, declined significantly. Banks turned to alternative sources of liquidity, which drove up their cost. Meanwhile, the three-month LIBOR increased from 0.65% to around 0.87%, as of this writing. This rise not only increased the yield of our existing floating-rate holdings but also made adding additional short-term floating-rate securities even more attractive. For example, at 0.87%, the yield on the three-month LIBOR is essentially identical to the yield on the two-year U.S. Treasury, but with much less duration.

In Thornburg Limited Term Income and Thornburg Low Duration Income funds, we've added some additional short maturity (0.5-year to two-year) corporate floating-rate bonds and floating-rate tranches of asset-backed securities (ABS). We've focused on high-quality securities where we've assessed the credit risk as low. This is because, while the securities offer interesting relative value in this market, at 1% to 1.25%, the absolute yield does not contemplate a lot of adverse scenarios (nor perhaps should it as a short-term, high-quality investment). Even in Thornburg Limited Term U.S. Government Fund, we have added some floating-rate paper when it became available, although opportunities for this portfolio are very limited. These investments exemplify a core principle of how we think about managing the portfolios: when our shareholders are not paid appropriately to take a risk, we don't take it. As risk-free rates fell over the last few years we decreased duration. While credit spreads declined, we decreased credit risk in the funds by moving up the quality spectrum within corporates and swapping some corporate exposure for senior tranches of ABS. This shorter duration and high-credit-quality positioning has hurt the funds' performance somewhat on a relative basis this year, but we believe it's appropriate for medium/ long-term returns.

Looking forward, we continue to see a low-growth world. Global economic data, including inflation, has been just OK. Corporate earnings have been disappointing, even declining in the U.S. for several quarters. Corporate credit metrics continue to deteriorate. Continued central bank accommodation seems to be the only major pillar on which quite lofty asset valuations rest.

In May 2013, then Fed Chairman Ben Bernanke told the market that U.S. quantitative easing was coming to an end, and the result was the so-called "taper tantrum." It's uncertain what would happen if the European Central Bank and Bank of Japan were to pull back the reins of their quantitative easing programs while the Fed continues ahead with a rate-hike cycle, albeit a shallow one. The world, and markets, will also have to endure a U.S. election, an Italian referendum, French and German elections next year, and "Brexit" negotiations in the near term. Furthermore, with 10-year U.S. Treasury real rates at around 0%, the market doesn't seem to be concerned about inflation at all despite the economy being at or near full employment and average hourly wages growing about 2.5%. It seems to be a time to be defensive rather than offensive when it comes to taking risk of all types. As part of the defensive posturing, the funds continue to hold significant cash and/or short, highly liquid U.S. Treasuries. While we cannot predict exactly when the markets will sell off and offer us more attractive buying opportunities, we can be ready for it, and believe the funds are well positioned.

Thank you for investing with us in Thornburg core bond funds.

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 1.50%.

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 is Thornburg Investment Management, Inc., as of 9/30/16.

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. Unlike bonds, bond funds have ongoing fees and expenses. Investments in mortgage backed securities (MBS) may bear additional risk. 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 by the portfolio managers reflect their professional opinions and are subject to change. Under no circumstances does the information contained within represent a recommendation to buy or sell any security.

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.

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.



Loading PDF

Disclaimers & Disclosureskeyboard_arrow_up

To learn more, please visit www.thornburg.com

The views expressed by the portfolio managers reflect their professional opinions and are subject to change. Under no circumstances does the information contained within represent a recommendation to buy or sell any security. Investments carry risks, including possible loss of principal. 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. Unlike bonds, bond funds have ongoing fees and expenses. Investments in the Funds are not FDIC insured, nor are they bank deposits or guaranteed by a bank or any other entity. Please see our glossary for a definition of terms: http://www.thornburg.com/legal/glossary.aspx 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.

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: https://www.thornburg.com/forms-literature/product-literature/mutual-funds/index.aspx



More from Thornburg Investment Management
The most important insight of the day
Get the Harvest Daily Digest newsletter.