July 01, 2016

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Brexit Volatility Creates Opportunities

Brexit’s Ramifications

Last week's referendum in the U.K. sent risk-asset markets into a tailspin, as investors wonder what "Brexit"—the U.K.'s exit from the European Union—means for the U.K., the E.U. and, by extension, global markets. The political, economic and market implications are significant for both sides of the English Channel, and beyond. It's critical, however, to understand how the process is slated to play out near term and farther down the road and to recognize the many questions and uncertainties regarding its repercussions while keeping them in perspective. As always, the key to successful investing in an uncertain world is carefully considering future prospects relative to current prices.

What Happened: Although the leaders of the U.K.'s establishment Tory and Labour parties campaigned for Britain to remain in the E.U. fold, 52% of British voters elected to leave the 28-member common market, amid high voter turnout of 72%. Tory Prime Minister David Cameron, who is credited with pushing economic reforms that helped make the U.K. Europe's most dynamic large economy, has resigned in the wake of the vote. Opposition Labour Party leader Jeremy Corbyn, meanwhile, has lost a no confidence vote by a wide margin after a slew of resignations from his shadow administration. New leaders of both parties will be selected.
What's the Political Worry: Concerns of political contagion have grown dramatically, as calls for similar referenda among other E.U. members, and most importantly from those that use the common euro currency, spread in the wake of the vote. It's important to note, however, that the nationalist, populist parties pushing for similar "exit" votes aren't in power where their voices are loudest: France, Italy and the Netherlands. That said, there is a risk that Scotland, which in last week's Brexit balloting, voted to stay in the E.U., could hold another referendum on its continued presence in the U.K., after electing to remain a part of Great Britain two years ago. Northern Ireland also voted to stay in the E.U., and would no doubt like to keep its borders open with its cousins to the South, E.U.-member Ireland.
What's the Economic Concern: Economists generally expect the U.K. to fall into a near-term recession, as investment projects get put on hold; housing, commercial & industrial real estate cools amid expectations of lower prices and fears grow that London's crucial financial services economy may not have as much access in a future outside the E.U. as it currently enjoys. As for continental Europe, it's losing the world's fifth-biggest economy and the fastest-growing of Europe's large economies, not to mention its biggest military.

The degree to which Brexit and the associated economic and political risks in the U.K. and continental Europe affect the day-to-day operations of a company or a sovereign issuer must be evaluated against its current business or economic fundamentals and future prospects. The volatility in asset prices, after all, may well not reflect meaningful changes in those fundamentals. For long-term investors, such price dislocations can present excellent entry points to world-class, overseas companies or sovereign debt that, however the Brexit process plays out, continue to have excellent prospects.

Important Information

The views expressed are those of Thornburg Investment Management. These views are subject to change at any time in response to changing circumstances in the markets and are not intended to predict or guarantee the future performance of any individual security or the markets generally, nor are they intended to predict the future performance of any Thornburg Investment Management account, strategy or fund.

Additional risks may be associated with investments outside the United States, especially in emerging markets, including currency fluctuations, illiquidity, volatility, and political and economic risks.

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 thornburg.com . Read them carefully before investing.

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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 Investment Management, Inc. does not offer personalized investment advice. Thornburg Securities Corporation (TSC) does not act as broker of record for investors.

Not FDIC Insured, May Lose Value, No Bank Guarantee.

JUNE 2016

Beyond the economic loss of the U.K.,

which also boasts Europe’s most robust

armed forces, the potential political impli

cations are significant. The fear is Brexit

will encourage more exit votes in other

E.U. member states, particularly among

the 19 members who joined the eurozone,

in which monetary union was created

without fiscal union. That created funda

mental contradictions in economic policy

that have festered since the euro’s 1999

deadline for the first round of adoption

by participating states. Britain, of course,

doesn’t participate in the eurozone or the

26-member Schengen Area accord, which

allows for the passport-free movement of

people between states. But given its access

to the E.U. common market, it was obli

gated to allow citizens of other E.U. states

to work and reside in the U.K.

Economic Contradictions

As with “Grexit” a few years ago, the

monetary and fiscal contradictions have

weighed heavily on various members.

The biggest, though, wasn’t Greece,

which adopted the euro in 2001. It was

Italy, where the anti-establishment,

euro-sceptic 5-Star Movement swept lo

cal elections just over a week ago. As the

lira was replaced by the euro at too high

a rate, it badly undercut the competi

tiveness of Italy’s storied manufacturing

sector, hurting its employment, income,

and broad economic growth ever since,

and leaving its total debt load an increas

ingly onerous burden to bear. Technically,

there’s no euro exit mechanism. But were

a eurozone member’s electorate to vote for

an exit, it might ultimately precipitate the

euro’s demise. In the wake of the Brexit

vote, populist, nationalist parties have

called for similar votes in France and the

Netherlands.

We would note, however, that no such

anti-E.U. or eurozone-sceptic party has

ascended to national power in a mem

ber state, and, depending on how things

evolve for the U.K., none may. Spain’s

ruling market-friendly Partido Popular

gained legislative seats in general elections

Sunday, while the center-left, establish

ment PSOE also came out better than ex

pected against the leftist Podemos party.

Nonetheless, the euro’s deflationary im

pact on several eurozone countries (mainly

in the southern periphery) continues to

animate anti-establishment sentiment

among electorates, particularly among

lesser-educated, native-born segments

that, fairly or unfairly, blame the E.U. and

Brexit Roils Markets, Creating Risks and

Opportunities

Charles Roth |

Global Markets Editor

thornburg.com | 8 7 7. 2 15 .13 3 0

The British voted in a June 23 referendum to leave the 28-member European Union, the biggest common market in the

world. Markets have been volatile, rising in the prelude to the “Brexit” vote on expectations that the “remain” campaign

would win and then going into a tailspin as the “leave” camp definitively won with 52% of a vote in which a high 72% of

the electorate participated. Risk markets fell sharply and safe-haven sovereign yields dropped to multi-year or record lows as

questions about the economic and political repercussions of the vote gripped investors. The United Kingdom is the world’s

fifth-largest economy and the second-biggest in Europe after Germany. It’s also Europe’s fastest growing major economy,

averaging 2.1% annual growth over the last five years, easily outpacing Germany’s 1.6% growth in the period as well as the

eurozone’s anemic 0.14% rate.

the “dirigiste” bureaucrats in Brussels for

years of, in many cases, marginal employ

ment and wage growth.

Immigration and Desired Limits

on Freedom of Movement

The other factor driving growing seg

ments of national electorates in Europe

is immigration across the E.U. and espe

cially the refugee crisis, which is putting

the Schengen Area accord increasingly at

risk. Nigel Farage, the leader of the far-

right U.K. Independence Party and one of

the most vocal Brexit proponents, made

limiting immigration one of his top cam

paign points. While migrants from the

Middle East might help offset the chal

lenges facing Europe’s aging demograph

ics, they generally haven’t been easily

assimilated, and terrorist attacks, most re

cently in Paris and Brussels, clearly don’t

help. Coupled with the lack of economic

growth, the populist, nationalist par

ties have been gaining electoral ground

across Europe. Barring a shift in current

economic, social, and political trends, the

euro’s longer-term viability may well be

at risk. That’s the underlying fear driving

market volatility.

Why Brexit?

As a member of the E.U. customs union,

Britain has been subject to myriad regu

lations promulgated by unelected com

missions in Brussels, while E.U. courts

can overrule the British Parliament. Over

the decades, the E.U. “harmonization”

push has given rise to massive bureaucracy

that, those who favor “Brexit” argued,

runs roughshod over local political, eco

nomic, and social decision-making. That

can involve highly impactful issues such

as taxation and labor regulation, as well

as silly ones, such as the spelling of words

or the required shape of fruits and vege

tables. E.U. defenders contend that some

national sovereignty must be sacrificed

for the greater good derived from the free

movement of goods, services, and people.

They add that Britain does have more lee

way to influence domestic policies than is

generally thought and point to Germany’s

welfare and labor market reforms in 2003

and 2004, and Spain’s more recently un

der the Partido Popular.

Nonetheless, Brexit supporters argued

there’s not enough leeway, and charge

that the supranational E.U. has stifled

innovation and economic growth. They

point to the E.U.’s poor economic record

in recent times. In today’s digital world,

why has nothing on the order of Apple,

Amazon, Facebook, Google, Netflix, etc.,

been born in Europe? Brexit advocates

also note that while the E.U. has allowed

for free trade within the block, it’s been

quite protectionist in promoting free

trade agreements (FTA) with countries

and customs unions outside Europe, and

doesn’t allow the U.K., which has a long

history of foreign trade, to unilaterally ne

gotiate its own FTAs. Instead, the E.U.’s

FTAs often involve small countries—such

as Chile, Colombia, and Singapore—that

don’t really impact member states’ pro

ducers and often exclude services, which

comprise the bulk of the U.K.’s economy.

Next Steps

Initially, nothing happens on the legisla

tive front. Given that Tory Prime Minis

ter David Cameron argued vigorously for

the U.K. to remain in the E.U., he has re

signed. Meanwhile, Labour leader Jeremy

Corbyn has lost a no-confidence vote by a

wide margin after a slew of resignations

from his shadow administration. New

leaders of both parties will be selected.

Cameron has insisted the next conserva

tive party leader, who will be appointed in

October, should be the one to invoke Ar

ticle 50 of the Lisbon Treaty, which will

formally start the separation process. E.U.

officials, on the other hand, are pushing

to have the process, which once initiated

will run on a two-year clock, start im

mediately to avoid “a prolonged period of

uncertainty,” as E.U. Commission Pres

ident Jean-Claude Junker said Tuesday,

while German Chancellor Angela Merkel

warned that the U.K. won’t be allowed

to “cherry pick” the most advantageous

elements of E.U. membership during the

negotiations.

Once the clock starts ticking, the U.K.

will seek to cut its current E.U. ties and

reestablish trade, investment, and immi

gration links with the E.U. on its own

terms, perhaps similar to those enjoyed

by Norway. The E.U., on the other hand,

is expected to punish the U.K. in setting

harsher terms for those links to dissuade

other members of the E.U., and especially

the eurozone, from leaving. Markets fear

that the U.K. won’t fare as well outside the

E.U. as it has inside. It should be noted

that trade accords can take many years to

hammer out, given their complexity. The

E.U.–Canada trade agreement has taken

seven years to reach, yet it doesn’t include

fully liberalized trade in financial services

and still hasn’t been ratified. That’s a big

drawback for the U.K., as services com

prise four-fifths of its economy, and its ra

tio of financial services exports to GDP is

the highest in the Group of Seven indus

trialized nations at about one-third.

But as Britain renegotiates its economic

ties with the E.U. over the next couple

years, businesses are unlikely to invest,

and there may even be an exodus of expats

who currently live in the U.K. under E.U.

“passporting rights” (an estimated three

million people). It’s also reasonable to as

sume foreign direct investment may de

cline as global businesses no longer view

the U.K. as the ideal place to set up shop.

Markets Fall Out, Then Find Their

Footing

These expectations caused U.K. risk as

set prices to swoon in the two trading

sessions subsequent to the vote, with the

pound weakening to a 31-year low before

stabilizing Tuesday, while U.K. stocks

also took a beating before finding their

footing, and the 10-year U.K. government

bond yield dropped below 1% for the first

time ever. Continental European stocks

and the euro also came under significant

selling pressure, and in some equity mar

kets even more than in the U.K., before

recovering somewhat Tuesday.

Markets will likely continue to experience

tremendous volatility as the U.K. seeks

to define its future relationship with the

E.U., and the E.U. tries to keep its re

maining members, especially in the euro

zone, on board. Investors should keep in

mind that, while the U.K. faces an uphill

climb near-term, as time passes, cooler

heads at both sides of the negotiating

table may prevail, hammering out trade,

investment, and labor migration terms

acceptable to all. Indeed, there’s a chance

that under articles 46 and 47 of the pend

ing “Markets in Financial Instruments

Regulation,” many rights now extended

to E.U. passport holders can be extended

to non-E.U. countries and their financial

services providers. The U.K. may be able

to advance similar accords with the U.S.,

and Commonwealth countries, such as

Canada and Australia, at a quicker clip

than has customarily been the case.

Meanwhile, the Brexit vote may prompt

the European Commission to reevaluate

its own “harmonization” efforts, perhaps

facilitating greater federalism within the

common market. To keep their populist,

nationalist parties on the fringe and not in

power, more member state governments

may also decide to undertake the pro-

growth structural reforms that Germany

and Spain have already undertaken.

Our Take

We believe the way to manage “event

risks” such as Brexit is to stay rational

and look for opportunities as they arise,

around the globe. Investors should re

member that nearly 50% of global market

capitalization is outside the U.S., based on

country weights of the MSCI All-Coun

try World Index, with Europe and the

U.K. together representing almost a quar

ter of that. Moreover, European Union

GDP rivals in size that of the U.S.

Many of our portfolios were positioned

with higher-than-normal cash positions

ahead of the vote, and have taken ad

vantage of the volatility to add to current

positions or initiate new ones from their

wish lists, many of which included com

panies that they previously held but had

become too richly valued.

Our fundamental research at the indi

vidual and portfolio levels gives us deep

knowledge of each of our positions, their

operating contexts and end markets. This

is invaluable during times of significant

price dislocations, when relative value

bargains can be obtained. For long-term

investors, short-term volatility affecting

asset prices of companies and countries

with sound fundamentals and promising

prospects can ultimately prove very prof

itable.

For more articles and information about our

active approach visit www.thornburg.com.

We believe the way to manage “event risks” such as

Brexit is to stay rational and look for opportunities

as they arise, around the globe. Investors should

remember that nearly 50% of global market

capitalization is outside the U.S.

The views expressed by Mr. Roth reflect his professional opinions and are subject to change. Under no circumstances does the information contained within represent a recom

mendation to buy or sell any security.

Investments carry risks, including possible loss of principal. Additional risks may be associated with investments outside the United States, especially 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 FDIC insured, nor are they bank deposits or guaranteed by a bank or any other entity.

The MSCI All Country (AC) World Index is a market capitalization weighted index that is representative of the market structure of 46 developed and emerging market countries in

North and South America, Europe, Africa, and the Pacific Rim. The index is calculated with net dividends reinvested in U.S. dollars.

Gross Domestic Product (GDP) – A country’s income minus foreign investments: the total value of all goods and services produced within a country in a year, minus net income

from investments in other countries.

Sovereign debt – Government debt that has been issued in a foreign currency.

Thornburg mutual funds are distributed by Thornburg Securities Corporation.

Past performance does not guarantee future results.

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.

6/29/16

TH3681

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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

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