The market environment continued to be difficult in the quarter ending June 30. Total returns for the quarter were -2.73% for the S&P 500 Index, -6.85% for the Dow Jones Industrial Average and a plus 0.82% for the NASDAQ Composite Index. A market lift in April and May was more than erased by the downdraft in June. With oil passing $140 per barrel, energy stocks were standout performers while financials, housing, telecommunications and consumer discretionary stocks led the market decline. Interestingly, stocks normally associated with “value” underperformed stocks identified with “growth” by a wide margin, not the usual relationship in down markets.

The Thornburg Value Fund A shares (without sales charge) performed in-line with the benchmark S&P 500 Index during the second quarter of 2008 posting a return of -2.74%. Areas of strength in the portfolio included hard assets—the energy, materials, and utilities sectors—along with more traditionally defensive areas of the market such as healthcare and telecommunications. Our investments in technology also performed well during the quarter. Energy holdings Apache (APA) and ConocoPhillips (COP) benefited from higher oil/gas prices while diversified metals holding Freeport-McMoRan Copper & Gold (FCX) benefited from strength in copper prices during the period. Entergy (ETR), a Louisiana-based regulated utility with merchant assets in the Northeast, appreciated as higher natural gas prices highlighted the attractiveness of their Northeast nuclear base-load power generation assets. Healthcare holdings, Gilead Sciences (GILD) and Varian Medical Systems (VAR) continued steady performance with Gilead’s position as the treatment of choice for HIV/Aids further solidified during the quarter. Varian recently reported good results that allayed fears regarding regional hospital financing for upgrades to oncology/radiation equipment. In telecom, global generation of data traffic is expanding rapidly in both broadband and wireless venues. Portfolio holdings such as Level 3 Communications (LVLT), AT&T (T) and Crown Castle (CCI) are benefiting from this secular trend. Technology holdings Apple (AAPL) and Dell (DELL) are reflecting incremental growth opportunities coming largely from non-U.S. markets.

Areas of weakness include holdings in cyclical sectors such as consumer discretionary, financial services, and industrials as well as our stock selection in consumer staples. In consumer discretionary, the main culprit was our position in Las Vegas Sands (LVS). Our conviction that management will deliver superior results as projects come on stream in Macau, Las Vegas and later in Singapore, is being tested as recent results have been disappointing. In financials, we experienced poor performance in stocks such as American International Group (AIG) and CIT Group (CIT) as balance sheet exposure continues to be of significant concern in the industry. We received good news on an asset sale at CIT on the first day of July, one of a number of ways we believe the company can address liquidity concerns (this was a recent purchase, already at a 52-week low). Our holding in CME Group (CME) also performed poorly as volume growth in derivatives contracts has slowed dramatically in the short-term. However, our long-term outlook for growth and volumes remains favorable as CME remains primarily a securities exchange with little apparent credit risk. CME is in the process of acquiring the NYMEX (NMX) for greater access to commodities markets. In industrials, we sold General Electric (GE) after it became evident that GE’s robust international businesses were no longer enough to offset the material slowdown in the broadly diversified U.S. businesses, especially financial services. Our consumer transportation related holdings such as Hertz (HTZ) and JetBlue (JBLU) are being hurt by slowing travel demand and higher energy prices. In consumer staples, Rite Aid (RAD) has continued to under-perform despite some indication of improvement in pharmaceuticals and front-end sales mix at acquired entities. The company’s operating cash flow appears sufficient to cover their working capital, debt obligations as well as meet their programmed capital expenditure plans.

During the quarter we added to our energy and consumer discretionary exposures with the purchases of ExxonMobil (XOM) and LifeTime Fitness (LTM). Exxon is expected to deliver on its non-conventional fossil fuel projects (oil sands, LNG, GTL) and modestly lift its production growth over the next several years. LifeTime Fitness continues to expand square footage, take market share from competitors, and appears to have the flexibility on membership fees to manage traffic and revenues during an economic slowdown. We have added to our insurance exposure where companies like Hartford Financial Services (HIG) are trading at below their 10-year average price to book value with a less exposed business model than many other financial institutions (leveraged only 5-7x equity versus 15x equity at banks and brokers). Also added was market share gainer U.S. Bancorp (USB) that is actually taking on more clients in this hostile banking environment.

Inflation at a time of economic contraction seems to be the bad dream that we are experiencing in the equity markets today. Our financial system is in asset contraction mode. Some of the financial instruments created over the past several years will likely disappear from lack of end market buyers. Out of necessity, capital will flow in a different direction, in part attracted and in part directed. The invisible hand of government will play a role, hopefully constructive. Society is adjusting to a new set of realities and markets will adjust too. We are in such a transition now. For equity investors it is not that the play is over, it is that the script is different and the cast will have some new stars. In stock market parlance leadership is changing. The best stocks of the next decade will not likely be the best stocks of the last decade. Our mantra remains to buy promising companies at a discount to intrinsic value. Diversification among Basic Value, Consistent Earners and Emerging Franchise stocks provides the opportunity to invest where value is being created by motivated sellers, such as we have in today’s market.

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

Click here to see the top 10 holdings and performance of the Thornburg Value Fund

Important Information

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.

Securities, countries and sectors mentioned are presented for the general information of Fund shareholders. Portfolio holdings are subject to change daily. Under no circumstances does the information contained within represent a recommendation to buy or sell securities.

The S&P 500 Index, an unmanaged broad measure of the U.S. stock market, does not reflect sales charges.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded “blue chip” stocks, primarily industrials, but includes financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

The NASDAQ Composite Index is a market value-weighted, technology-oriented index comprised of approximately 5,000 domestic and non-US-based securities.

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.

Second Quarter 2008

The second quarter of 2008 was a difficult period for the international equity markets. This is mostly attributable to a combination of increasing anxiety regarding inflation, continued troubles in the financial industry, and deteriorating consumer sentiment in some major economies. In general, natural resource-rich economies such as Australia, Brazil, Canada, and Russia performed well, while more consumer and financial-centric economies such as Spain and Switzerland performed poorly. Areas of strength in the portfolio mainly involved energy, materials, and utilities. Areas of weakness included more cyclical sectors such as consumer discretionary, financial services, and industrials. Telecommunications also continued to experience weakness despite compelling valuations and the defensive characteristics of their business models.

The Thornburg International Value Fund A shares (without sales charge) trailed its respective benchmark during the 2nd quarter with a total return of -2.59% (A shares without sales charge) versus -2.25% for the MSCI EAFE Index. We are not satisfied with either relative or absolute performance during this challenging period, and constantly question how we can improve upon the portfolio and its returns.

During the quarter, our largest detractors included technology (Nokia-NOK1V FH), consumer staples (Groupe Danone-BN FP), financials (Swiss Re-RUKN VX, Standard Chartered-STAN LN, AXA-CS FP), and consumer discretionary (Porsche-POR3 GR, Carnival-CCL LN). Nokia reacted to fears of a consumer slow-down impacting handset sales in some of its key markets, particularly those in the developing world, as well as heightened competition in the high-end arena. Concerns about higher input costs at Groupe Danone caused a retraction in the stock. Although some of our holdings in financial services have suffered from a slowdown in business volumes and fears of continuing write downs, there is little doubt that risk aversion played a role in the price declines. Swiss Re’s exposure to the equity and fixed income markets coupled with further write-downs has weighed on the stock. Standard Chartered Bank, which is focused on fast-growth emerging economies, suffered from increasing risk aversion regarding financial names and broad exposure to those markets. AXA experienced declining annuity product sales mainly attributable to weaker global equity markets.

Porsche, another detractor, was a new purchase during the quarter. Volkswagen is an important development partner for Porsche, and Porsche has options to acquire up to 50% of Volkswagen, which are substantially in the money today. This should ensure Porsche’s capacity to grow as well as to reduce R&D expense as the companies share future costs (i.e. hybrid development projects) and garner improved synergies in platform engineering. In the near term we may continue to experience headwinds given general concerns regarding the automotive industry in this high oil price environment. Finally, while Carnival continued to execute well on its business model (higher yields, more berths, better demand in the Caribbean vs. year-ago levels), bunker fuel prices continue to rise with the price of oil dampening improving margin potential.

Our top performing stocks included basic materials (Potash-POT), energy, Canadian Natural Resources-CNQ CN, Schlumberger-SLB) and utilities (E.ON-EOA GR, Fortum-FUM1V-FH). Potash continues to exhibit strong pricing power due to the robust global agricultural and fertilizer market.  Canadian Natural Resources’ Horizon oil sands project is coming on-line during a period of strong oil prices and should enhance their production profile for the next several years. Higher fuel prices and increased electricity demand in Northern Europe is leading to price convergence between Nordic and European electricity markets and causing upward revisions to Fortum’s profitability. Like Fortum, E.ON has benefited from higher energy prices. Schlumberger has similarly been a beneficiary of higher oil prices, which typically leads to higher spending by exploration and production companies, and a greater emphasis on deep drilling opportunities. We believe that certain commodity subsectors will continue to experience robust pricing, as additional supply is challenged to match rising global demand.

Geographic diversification changed only slightly during the most recent quarter with the addition of holdings in Australia, Sweden and Turkey. Exposure to China, Japan, Switzerland and the U.K. declined, reflecting activity and stock price movements.

Just how far along global markets are in adjusting to $140 dollar oil and the impact on global capital markets is yet to be determined. With declines in financial stocks far beyond what might have been imagined a year ago, it may be that the recent transition to a more sober investment environment is near an end. We are mindful of the current environment with regard to slowing economies and inflationary cost pressures as we consider new investments as well as monitor existing holdings.

While the extent to which markets have adjusted to $140 dollar oil will only become obvious at a later date, it is clear that global shocks reverberate faster and more powerfully now than in the past. Coordination among global central banks to address inflation would offer some relief which we believe may not be far away. However, current global inflationary pressures and the broad contraction of the financial system have become all the more pervasive. Perhaps what appears cheap on the surface might not be in the final analysis, and we suspect some of the best opportunities may lie in higher-quality companies with earnings and business model stability. To this point, while the valuation parameters of the Thornburg International Value Fund reflect improved value in absolute terms, they remain slightly above those of the broader international market indices. New purchases reflect this positioning, as values have emerged in high-quality companies including Standard Chartered (STAN.L), SAP (SAP) and H&M (HMB SS). Indeed, the silver lining of the current investment environment is the potential for improved long run portfolio attributes with regard to value and profitability. Ultimately, such improvements should serve to protect the portfolio in the event of further market dislocation while preparing it for a better market environment at some point in the future.

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

Click here to see the top 10 holdings and performance of the Thornburg International Value Fund

Important Information

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.

Securities, countries and sectors mentioned are presented for the general information of Fund shareholders. Portfolio holdings are subject to change daily. Under no circumstances does the information contained within represent a recommendation to buy or sell securities.

The Morgan Stanley Capital International (MSCI) Europe, Australasia, Far East Index (EAFE) is an unmanaged index of over 900 companies, and is a generally accepted benchmark for major overseas markets. Index weightings represent the relative capitalizations of the major overseas markets included in the index on a U.S. dollar adjusted basis. The index is calculated separately; without dividends, with gross dividends reinvested and estimated tax withheld, and with gross dividends reinvested, in both U.S. Dollars and local currency.

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.

Established in 1988, the Morningstar Fund Manager of the Year Award recognizes portfolio managers who demonstrate excellent investment skill and the courage to differ from the consensus. To qualify for the award, managers must have not only a great year, but also must have a record of delivering outstanding long-term performance and of aligning their interests with shareholders’. The Fund Manager of the Year Award winners are chosen based upon Morningstar’s proprietary research and in-depth evaluation by its senior analysts.

Second Quarter 2008

The second quarter was a rocky one for the Thornburg Core Growth Fund, capping a tough first half of 2008. The Fund (A shares without sales charge) was down 3.26% for the quarter vs. a positive return of 1.51% for the Russell 3000 Growth Index.  Overall, underperformance can be traced to individual security selection as well as a lack of exposure to the high-flying energy sector.

Security selection within IT, where the Fund has its largest weighting, was positive as a number of stocks performed well (6 of the top 10 contributors to performance came from IT). In a couple of cases - ON Semiconductor (ONNN) and Equinix (EQIX) - our conviction was tested in the first quarter when the market punished both stocks. Both ON and Equinix carry debt on their balance sheets and during the first quarter most stocks with material debt levels were driven down regardless of the timing of debt expiration or the level of interest coverage. In both cases we found the business models to be attractive and cash flows more than adequate to cover interest payments. Both rebounded as the market recognized what we saw, and ONNN and Equinix were the top two contributors to performance during the second quarter. Google’s share price (GOOG) bounced back as questions brought on by their first quarter earnings report faded. Western Union (WU) rose as the company provided analysts with a higher long-term growth forecast. Visa (V), a stock we purchased at the Initial Public Offering, rose sharply and we exited the position at a significant profit. Long-time holding Amdocs (DOX) also posted gains. Beyond IT, Alexion Pharmaceuticals (ALXN) and Illumina (ILMN, healthcare), as well as ATP Oil & Gas (ATPG) and Alpha Natural Resources (ANR, energy) contributed to performance.

Unfortunately the success we had in selecting IT, Healthcare, and Energy stocks did not carry over to other sectors. Some of our holdings with ties to the consumer hurt performance as a global economic slowdown provided headwinds. Las Vegas Sands (LVS) was the largest detractor during the quarter. The number of visitors to Las Vegas, by air and by auto, came under pressure as consumers tightened their purse strings. Our investment thesis, centered on attractive future cash flows from their Las Vegas and Asian properties, thus far remains intact. America Movil (AMX) fell on concerns of a slowdown in consumer spending in Latin America, which was compounded by potentially higher cross-border tariffs. Cosmetics maker Bare Escentuals (BARE) declined amidst questions about US same stores sales. While sales at some chains are down, overall volumes are higher and we think that attractive opportunities are opening up for BARE in overseas markets. As such, we remain invested. Hansen Natural (HANS) declined as an increase in raw materials costs caused volatility in quarter-to-quarter sales volumes. New addition Porsche (POR3 GR) detracted, partially based on concerns over US auto sales as well as a slowdown brought on by the pending roll-out of a new design. Our view is that overall global demand for its cars remains high. If US sales do decline, inventory can be shifted to other markets. Furthermore, answers to questions about Porsche’s potential acquisition of Volkswagen could provide a catalyst for the stock. Comcast (CMCSK) fell on concerns that increased competition for subscribers could result in market-share loss and drive overall industry pricing down. We believe that its overall competitive position and current valuation remain interesting.

Other stocks which hurt performance included Vistaprint (VPRT, IT), PNOC Energy Development (EDC PM, Utilities), CME Group (CME, Financials) and AT&T (T, Telecommunications).

While we pride ourselves on our bottom-up research, it is noticeable how our lack of exposure to certain “hot” sectors (energy, and to a lesser extent materials) hurt performance. The Energy sector was far-and-away the best performer within the Russell 3000 Growth Index during the quarter, and 11 of the top 20 performing stocks were energy-related, despite a modest 10% weight in the benchmark.

We are currently well underweight energy (on average we had about 3% invested during the quarter) as we have been typically underweight over the past five years. Our investment process is geared towards identifying secular growth stories as opposed to cyclical ones, which rightly or wrongly, leads us away from these names. In the current environment, where the energy sector is driving returns for the benchmark, we will trail the index, all other things being equal. Ironically, we generated positive selection effect within the sector (our energy names performed better in aggregate than the sector as a whole) however our low weight to energy stocks held back performance.

Our approach to investing is predicated on a divergence from consensus. In many cases, our view of the value of a company differs substantially from what the “Street” is seeing. Unfortunately, we have often seen the market’s view of our holdings be more pessimistic than ours. We do however remain confident in our team and process. If our investment thesis for a company remains intact we will remain invested. If our view has changed we will not hesitate to exit a position. We do make small changes to improve efficiencies and take advantage of individual talents on our team, however our overall process and philosophy remain unchanged from what has made us successful over the long-run.

It is very important to realize how investment horizons affect stock prices. We are currently operating in an environment with a high level of uncertainty about the future. The issues are manifest: strength of the dollar, global growth, real estate weakness, credit writedowns, election uncertainty, and inflation – food, materials, and energy. At times like this investors get fearful and their investment horizons shrink dramatically. They are not looking for the best stock to own over the next 5 years, they are looking for the best stock to own over the next 5 days.

Warren Buffett has the luxury of investing in a similar fashion to a private investor. His horizon can be quite long and he is not driven to produce results over any near-term time period. Since he is both patient and brilliant, he takes full advantage of this longer term perspective. Mutual fund investors are generally less patient. Their horizon (retirement, asset purchases, wealth building over their life time) is generally shorter and therefore they prefer to give their money managers less latitude. Because of this, we try to structure our portfolio in such a way that we own stocks with different performance horizons: stocks that will generate performance in the near-term as well as stocks with strong intermediate term or longer term outlooks. There is usually a balance between these different horizons because we believe each period is important and relevant to our shareholders.

If we want performance today, we look to energy or materials stocks. It has historically been our approach to not “chase” areas of the market where the primary driver of performance is performance. There are strong fundamentals underlying the moves of many of these stocks, but the large price moves reflect this. There are areas and stocks which look very attractive. However, if we are willing to set aside the desire to balance the horizons within the fund, the big opportunity appears to be in the stocks where the underlying business continues to develop but the stock prices have declined considerably. This represents the best risk/reward in the market and we feel it so skewed in this direction that we feel comfortable owning more of these “distant horizon” stocks than usual.

Hansen Natural is a good example of what’s happening in the current market environment. Hansen makes energy drinks, which comprise about 90% of their sales. Their lead brand is Monster, with additional contributions from Lost, Rhumba, etc. Monster is growing sales at 40% or more, according to most recent Nielsen data. The original Monster beverages are still growing well and the Java (coffee based) Monster beverages are growing at an accelerated rate. Monster is the only brand taking market in the US (even Red Bull is slightly negative).

Hansen also has gross margins around 50%, an ebitda margin above 25%, and a return on equity which exceeds 35%. If you believe First Call earnings estimates, HANS will grow earnings per share 29% this year, and 21% next year. Our internal numbers are more optimistic. What would you expect to pay for this company?

The stock trades at about 12x 2008 earnings and 10x 2009 earnings (consensus). HANS is extending their distribution into Canada, the UK, and Mexico with strong partners such as Cadbury Schweppes and Pepsi. We don’t know when value will be realized in HANS or in the other stocks we hold in our portfolio, but we do know that it will eventually happen. Some stocks will suffer fundamental deterioration and fail to achieve our future projections – for example, Hansen could develop issues internationally or health issues could surface relating to energy drinks – but we have rarely had opportunities this decade to buy such strong companies at such attractive multiples.

It will be continued business execution in a difficult environment which will eventually shift investor focus from commodities to great brands with strong secular growth opportunities. We hope to profit when that shift occurs.

For a print friendly version of Alex's market commentary click HERE.

Click here for the top 10 holdings of the Thornburg Core Growth Fund

Important Information

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.

Securities, countries and sectors mentioned are presented for the general information of Fund shareholders. Portfolio holdings are subject to change daily. Under no circumstances does the information contained within represent a recommendation to buy or sell securities.

The Russell 3000 Growth Index is an unmanaged index comprised of those Russell 3000 companies with higher price-to-book ratios and higher forecasted growth values.

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.

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.

Lipper Fund Awards are granted annually to the fund in each Lipper classification that consistently delivered the strongest risk-adjusted performance (calculated with dividends reinvested and without sales charges). Awards are given for three-year, five-year, and ten-year periods. The fund did not win the award for other time periods. Past performance does not guarantee future results.

Second Quarter 2008

Recall that the primary investment objective of Thornburg Investment Income Builder is to provide income dividends at a level which exceeds the average yield on U.S. stocks, and which will generally grow over time, subject to periodic fluctuations.  The fund’s secondary objective is long term capital appreciation.  Results respecting these objectives have been more mixed than usual in the first half of 2008.  In the following paragraphs, we consider some of the highlights of this period. 

On June 26, Income Builder paid its highest ever 2nd calendar quarter dividend, 21.75¢ per A share.  This quarterly dividend was 17.5% higher than the 2nd quarter of 2007, while the trailing 4-quarter dividend, 97.9¢ per A share, was up 15.3% over the prior year’s trailing 4-quarter dividend.  The following table shows quarterly income dividend paid by Income Builder for varying time periods.  For a longer term perspective, we also show dividends paid for the four quarters ended June, 2004:

Thornburg Investment Income Builder – A Share Dividends Paid (¢ per share):
Calendar Quarter Ended	2008	(vs. prior year % change)	2007	2004
June	21.75	(up 17.5%)	18.50	12.5
March	17.85		14.20	10.2
December	36.80		33.0	17.5
September	21.50		19.2	12.4
Trailing 4-Quarter Total	97.9¢	(up 15.3%)	84.9¢	52.6¢

The compound average annual growth rate for the trailing 4-quarter dividends shown above was +16.8% between 2004 and 2008, a better outcome than we would have expected.  As we have stated several times in recent years, we do not expect to be able to continue to increase dividends at this annual rate.  In the June 2008 quarter, our better than expected dividend increase was powered by median year-over-year dividend increases from our portfolio companies of approximately +14%, plus higher yields on corporate bonds and a slightly higher portfolio weighting for bonds.  The dividend increases from our portfolio holdings generally have been supported by year-over-year increases in revenues and earnings.  In short, our pursuit of the primary investment objective of Thornburg Investment Income Builder is on track. 

So why is the Income Builder share price down by 14.7% in the first half of calendar 2008? 

We don’t know all of the reasons.  We do know that “Mr. Market”…… the total of all investor opinions as expressed by buying and selling of shares……has been in a bad mood with respect to many Income Builder companies.  This is despite the fact that revenues, earnings, and dividends have been developing reasonably well in a challenging environment.  Consider the following:

1. There have been few places to hide. U.S. equity market indices are down for H1 2008.  Most major equity indices outside the U.S. are down even more:

Equity Portfolio Index Name	Performance YTD 2008 through June 30th (local currency)
S&P 500 Index (USA)	-12.8%
Dow Jones Industrial Ave. (USA)	-14.4%
Dow Jones Euro Stoxx 50 Index (Europe)	-23.8%
Nikkei 225 Index (Japan)	-11.9%
Shanghai Composite Index (China)	-48.0%
MSCI All Country World Index	-14.2%
MSCI All Country Asia Pacific Index	-15.8%
MSCI All Country Europe Index	-19.1%

The magnitude of price declines around the world have been great enough to trigger forced selling by “weak hands” investors, and emotion-driven selling by investors whose investment stamina collapses in the presence of downward volatility.  8 of 10 sectors in the MSCI All Country World Index delivered negative returns in the first half of 2008, and 3 of these delivered returns below -10% (Financials, Telecommunications Services, Consumer Discretionary).  Only 2 sectors (Energy and Materials) delivered positive total returns.

2. Considering the performance of the Income Builder portfolio as a whole during H1 2008, 11 stocks delivered price increases, 60 had price declines, our bond portfolio delivered a small positive total return, and our currency hedges had a modest net cost.   Yields available on bonds with credit risk generally increased, as prices of those bonds declined.  We increased our cash and bond weighting by approximately 5 percentage points, to 22% of portfolio assets, between January 1 and June 30. 

3. Of the 64 stocks owned in the Income Builder portfolio as of the beginning of 2008, 11 declined in price by 30% or more in the first 6 months of the year.  These stocks, which had a combined average portfolio weighting of 11.1%, have the following attributes:  (“expected” earnings are tabulated by Bloomberg)

1. 2007 average earnings/share change: +21% (low: -29%; high +144%; 2 negatives)
2. 2008 avg. expected earnings/share change:  +5% (low: -51%; high +67%; 4 negatives)
3. Latest dividend % change:  +5% (low 0%; high +212%; none negative)

A smallish position in the one firm (Huntsman Chemical (HUN)) had declining earnings in 2007, the worst expected earnings decline in 2008, and no increase in the latest dividend.  It is no longer in the portfolio, nor is another stock that we purchased during 2008 that would also have fallen into this category, and where our expectations have changed for the worse.  We are monitoring developments for the other firms in this group (Macquarie Airports (MAP AU), Mediaset (MS IM), Intesa SanPaolo (ISP IM), AXA (CS FP), Bolsas y Mercados (BME SM), Reddy Ice (FRZ), Hong Kong Exchange (388 HK), EFG Eurobank (EUROB GA), GMP Capital Trust (GMP-U CN), and Fuji Food & Catering (1175 HK)) which we continue to own as of the date this note is written.  We may buy or sell shares in the future.   Reasons for the price declines of these businesses range from general anxiety about economic activity (5 of the firms are European, 3 Asian….geographies where the economies are generally considered to be better than the U.S., but where equity investors are extremely temperamental) to a Department of Justice investigation (and follow-on civil lawsuits) about possible collusion to limit competition in the bag ice industry in the U.S.  By comparing the average expected changes in earnings (+5%) of this subset for 2008 to the observed increases in earnings from 2007 (+21%), it is clear that momentum is slowing for this group. 

4. Of the 64 stocks owned in the Income Builder portfolio as of the beginning of 2008, 11 stocks declined in price by between 20% and 30% in the first 6 months of the year.  These stocks, which had a combined average portfolio weighting of 18.2%, have the following attributes:

1. 2007 average earnings/share change: +13% (low: 2%; high +47%; none negative)
2. 2008 avg. expected earnings/share change:  +12% (low: -12%; high +32%; 2 negatives)
3. Latest dividend % change:  +13% (low -20%; high +33%; 3 negative)

Five of these eleven stocks are large telecom service firms:  France Telecom (FTE FP), Telefonica (TEF SM), Vodafone (VOD), AT&T (T), and China Mobile (941 HK).  We own these firms for their attractive dividends, which in turn are supported by excellent cash flow characteristics, modest cyclicality, resistance to input cost inflation, and relatively solid capital structures.  It may surprise you that telecom services was the second worst performing sector in the MSCI World equity universe, trailed only by the financial sector.  Among the other stocks in the group, four of the eleven were financials (investment manager Alliance Bernstein (AB), debt investor KKR Financial (KFN), global bank BBVA (BBVA SM), and Liechtenstein Landesbank (LLB SW)).  The final two were Chinese port operator Chiwan Wharf and Italian-based electric utility Enel (ENEL IM).  In general, we consider these to be good businesses with attractive valuations.  Obviously, motivated sellers of these businesses in the first half of 2008 disagreed with our viewpoint, or they needed the sale proceeds for some other reason.

5. Inflation is back as a global phenomenon, with dozens of countries reporting year-over-year inflation above 10%. China and India report high single digit percentage year-over-year inflation, with core components running higher.   With good reason, investors are concerned.  As input costs rise, companies are challenged to pass through the costs to their customers.  Airlines and auto manufacturers are two visible examples of industries that are not able to raise prices high enough against existing capacity; therefore, they must shrink capacity and sell to a smaller population of customers who can afford to pay high enough prices to cover costs.  We have attempted to keep in mind the degree of resistance of various businesses to cost inflation when constructing the Income Builder portfolio.  With $140/barrel oil, record metals prices, and near record agricultural commodities prices, investors are pummeled each day with news of inflation.  In an increasing number of markets, labor cost inflation and rising inflationary expectations are observable.
6. Economic growth has slowed perceptibly.  In the U.S., our economy is struggling to re-channel capital and labor away from residential housing and related areas and into other productive activities.  This is painful, but necessary.  There is much to do to make the U.S. economy function better, with somewhat less focus on pure consumption.  Hopefully, by this time next year it will be more apparent to all that a constructive transition is well underway.

Earlier this year, we wrote on this page that an ever expanding list of financial players….broker dealers, closed-end mutual funds, hedge funds and “alternative” asset managers of varying descriptions…..have employed (formerly) low cost and readily available borrowings to transform low yielding debt assets into respectable returns on equity.  In some cases, these players employed debt to purchase dividend paying equities.  That game is finished for the foreseeable future.  For investors with real money to invest, the great unwinding in progress is presenting an attractive buffet of higher yields and lower prices on virtually all financial assets except U.S. Treasury securities and the highest quality plain vanilla money market instruments.    (It is interesting that in recent months we actually hear traders bragging that “real money investors” have purchased financial assets when they want to assure market participants that the assets are well placed.  While this is a throwback to earlier decades, for most of the last decade Wall Street was content to flip stocks and debt instruments back and forth among “play money investors”).

The process of securing stable homes for financial assets with real money investors can be unnerving for investors who carefully watch daily price fluctuations, and are comforted more by rising prices than by rising income yields.   As James Grant points out in the June 26 issue of Grant’s Interest Rate Observer, “If the (U.S.) savings rate returned to just half its level in 1992, it would reach 3.9% of disposable income, up from 0.6% at present.  Savings shuttled between 7% and 12% (of disposable income) in the decades of the 1960s, 1970s, and 1980s.  An increase in savings of 3.3 percentage points would amount to $346.5 billion…..”  We believe today’s combination of lower prices and higher yields present a great opportunity for unleveraged, traditional saver-investors.   The U.S. savings rate will increase.  The best bargains likely will be obtained by those savers who buy financial assets from forced sellers during a period like the present, not by those who pile in after the prices of financial assets stabilize as the savings rate approaches historical norms. 

You can read more about individual firms in the Income Builder portfolio under the “Holdings Commentary” section of this web site.

For a print friendly version of the Investment Income Builder Fund market commentary click HERE.

Click here for the top 10 holdings of the Thornburg Investment Income Builder Fund

Important Information

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.

Securities, countries and sectors mentioned are presented for the general information of Fund shareholders. Portfolio holdings are subject to change daily. Under no circumstances does the information contained within represent a recommendation to buy or sell securities.

The Blended Index is comprised of 25% Lehman Brothers Aggregate Bond Index and 75% MSCI World Equity Index. The Lehman Brothers Aggregate Bond Index is composed of approximately 6,000 publicly traded bonds including U.S. government, mortgage-backed, corporate and Yankee bonds with an average maturity of approximately 10 years. The index is weighted by the market value of the bonds included in the index. The Morgan Stanley Capital International World Equity Index is a total return index, reported in U.S. dollars, based on share prices and reinvested gross dividends of approximately 1,600 companies from 22 countries, including the U.S.

The S&P 500 Index, an unmanaged broad measure of the U.S. stock market, does not reflect sales charges.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded “blue chip” stocks, primarily industrials, but includes financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

The Dow Jones STOXX 50 (Price) Index is a capitalization-weighted index of 50 European blue-chip stocks. The equities use free float shares in the index calculation. The index was developed with a base value of 1000 as of December 31,1991.

The Nikkei Stock Average is an index of 225 leading stocks traded on the Tokyo Stock Exchange. Similar to the Dow Jones Industrial Average, it is composed of representative “blue chip” companies (termed first-section companies in Japan) and is a price-weighted index, whereby the movement of each stock, in yen or dollars respectively, is weighed equally regardless of its market capitalization.

The Shanghai Stock Exchange Composite Index is a capitalization-weighted index. The index tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange.

The Morgan Stanley Capital International All Country World Index (MSCI AC World Index) is a market capitalization weighted index composed of over 2,000 companies, and is representative of the market structure of 48 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.

The Morgan Stanley Capital International (“MSCI”) All Country Asia Pacific Index is a market capitalization weighted index composed of companies representative of the market structure of 15 developed and emerging market countries in the Asia Pacific regions including Australia, China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, New Zealand, Pakistan, Philippines, Singapore, Sri Lanka, Taiwan and Thailand. The index is calculated separately; without dividends, with gross dividends reinvested and estimated tax withheld, and with gross dividends reinvested, in both U.S. Dollars and local currency. The index excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners.

The Morgan Stanley Capital International (“MSCI”) All Country Europe Index is a market capitalization weighted index composed of companies representative of the market structure of 21 developed and emerging market countries in Europe including Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Norway, Poland, Portugal, Russia, Spain, Sweden, Switzerland, Turkey, and United Kingdom. The index is calculated separately; without dividends, with gross dividends reinvested and estimated tax withheld, and with gross dividends reinvested, in both U.S. Dollars and local currency. The index excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners.

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.

U.S. Treasury securities, such as bills, notes and bonds, are negotiable debt obligations of the US 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.

Lipper Fund Awards are granted annually to the fund in each Lipper classification that consistently delivered the strongest risk-adjusted performance (calculated with dividends reinvested and without sales charges). Awards are given for three-year, five-year, and ten-year periods. The fund did not win the award for other time periods. Past performance does not guarantee future results.

The Thornburg Global Opportunities Fund declined 1.06% during the second quarter of 2008. While this was 0.51% better than the MSCI AC World Index, the overall result for the Fund in the first half of this year (down 11.47%) has been unsatisfying. You can find historic return data elsewhere on this web site, or by using the symbol “THOAX” (A shares) with various data services.

A number of factors have led to the recent broad selloff in equities, and the price declines themselves have in turn confirmed many investors’ fears. Foremost among these are concerns regarding inflation, recession, and credit contraction. These issues touch many areas of the global economy. Thus eight of ten industry sectors in the MSCI All Country World Index delivered negative returns in the first half of 2008, and three of these delivered returns below -10% (Financials, Telecommunications Services, Consumer Discretionary). Only two sectors, Energy and Materials, delivered positive returns.

As shown below, US equity markets are down materially for the first half of 2008, and many international markets are down even more:

Inflation is back as a global phenomenon, with dozens of countries reporting annual inflation above 10%. Reported inflation rates in China and India are approaching 10%. With good reason, investors are concerned. As input costs rise, companies are challenged to pass through the costs to their customers. Airlines and auto manufacturers are two visible examples of industries that are not able to raise prices enough against existing capacity; therefore, they must shrink capacity and sell to a smaller population of customers who can afford to pay high enough prices to cover costs. We have considered this in managing the Fund. With $140/barrel oil, record metals prices, and near record agricultural commodities prices, investors see abundant news of inflation. Labor cost inflation and rising inflationary expectations are also observable.

Global economic growth has slowed this year, particularly in countries which have become too dependent on housing and construction (e.g. Ireland, Spain, and the United States). In the U.S., our economy is struggling to re-channel capital and labor away from these areas and into other productive activities. This is painful, but necessary. There is much to do to make the U.S. economy function better, with somewhat less focus on pure consumption. Hopefully, by this time next year it will be more apparent that a healthy transition is well underway.

A broad source of underperformance for the Fund in the first half of this year has been our China-related holdings. Several of these were among our better performers in 2007. This year, despite continued strong economic growth, six of the Fund’s ten worst performers have been China-related. While two of these stocks were sold earlier this year (Soho and Sinopec), our remaining quarter-end holdings in China Mobile (941 HK), Hong Kong Exchanges (388 HK), Country Garden Holdings (2007 HK), and Chiwan Wharf (200022 CH) declined in price by an average of -35% in H1’08. The fundamental outlooks for these companies are reasonably good, though each has challenges. Combined, they comprised less than 13% of the June 30, 2008 Global Opportunities portfolio.

Aside from our China-related investments, performance of our other holdings has been diverse. Top performers in 2008 thus far include Canadian Natural Resources (CNQ CN), Quadra Realty Trust (QRR) (acquired in Q1), Freeport McMoRan Copper & Gold (FCX), Mercator Minerals Ltd. (ML CN), Huron Consulting (HURN), and Apache Corp. (APA).

Prices of more Global Opportunities Fund portfolio stocks declined than rose in H1 2008. The share prices of five non-Chinese portfolio stocks declined by more than 20% in the period. These included: healthcare technology provider Eclypsis Corp. (ECLP), specialized lenders Babcock & Brown Air (FLY) and KKR Financial LLC (KFN), Brazilian financial exchange operator Bovespa (BOVH3 BZ), and geothermal electricity provider PNOC (EDC PM). Given the changes in equity prices and the economic backdrop this year, we have been adjusting our weightings in individual stocks to manage expected risks and returns. The success of these changes will only be apparent over time.

During the second quarter we sold Apache Corp, Crown Castle International (CCI), and Shinhan Financial Group (055550 KS) to make room for other opportunities.

The process of securing stable homes for financial assets with “real money investors” can be unnerving for those who watch daily price fluctuations, and are comforted more by rising prices than by rising income yields. As James Grant points out in the June 26 issue of Grant’s Interest Rate Observer, “If the (U.S.) savings rate returned to just half its level in 1992, it would reach 3.9% of disposable income, up from 0.6% at present. Savings shuttled between 7% and 12% (of disposable income) in the decades of the 1960s, 1970s, and 1980s. An increase in savings of 3.3 percentage points would amount to $346.5 billion…..” We believe today’s combination of lower prices and higher yields present a good opportunity for unleveraged, traditional saver-investors. We believe the U.S. savings rate will increase. The best bargains likely will be obtained by those savers who buy financial assets during a period like the present, not by those who pile in after the prices of financial assets stabilize as the savings rate approaches historical norms.

When will the performance of equities improve? For some firms, reported results in the coming quarters will relieve analysts and investors who have embedded negative expectations into current share prices. For others that disappoint vis-à-vis current expectations or that are not well capitalized, there may be no improvement. It’s worth remembering that equity prices are a discounting mechanism, reflecting anticipated fundamental developments. Investor expectations have already been significantly reduced for businesses in most sectors. It remains to be seen whether further reductions lie ahead and whether observed business results will meet the reduced expectations. Gross national product data are reported on a lagging basis: consider that the last two recessions in the United States (1990 and 2001) ended shortly after they were officially declared by the National Bureau of Economic Research. Despite the widely recognized macroeconomic challenges, we think that owning good businesses at attractive prices will continue to form a sensible long term investment program.

You can review descriptive comments about the portfolio holdings under the “Holdings Commentary” section of this web site.

For a print friendly version of the Global Opportunities Fund market commentary click HERE.

Click here for the top 10 holdings of the Thornburg Global Opportunities Fund

Important Information

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.

Securities, countries and sectors mentioned are presented for the general information of Fund shareholders. Portfolio holdings are subject to change daily. Under no circumstances does the information contained within represent a recommendation to buy or sell securities.

The S&P 500 Index, an unmanaged broad measure of the U.S. stock market, does not reflect sales charges.

The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded “blue chip” stocks, primarily industrials, but includes financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

The Dow Jones STOXX 50 (Price) Index is a capitalization-weighted index of 50 European blue-chip stocks. The equities use free float shares in the index calculation. The index was developed with a base value of 1000 as of December 31, 1991.

The Nikkei Stock Average is an index of 225 leading stocks traded on the Tokyo Stock Exchange. Similar to the Dow Jones Industrial Average, it is composed of representative “blue chip” companies (termed first-section companies in Japan) and is a price-weighted index, whereby the movement of each stock, in yen or dollars respectively, is weighed equally regardless of its market capitalization.

The Shanghai Stock Exchange Composite Index is a capitalization-weighted index. The index tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange.

The Morgan Stanley Capital International All Country World Index (MSCI AC World Index) is a market capitalization weighted index composed of over 2,000 companies, and is representative of the market structure of 48 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.

The Morgan Stanley Capital International (“MSCI”) All Country Europe Index is a market capitalization weighted index composed of companies representative of the market structure of 21 developed and emerging market countries in Europe including Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Norway, Poland, Portugal, Russia, Spain, Sweden, Switzerland, Turkey, and United Kingdom. The index is calculated separately; without dividends, with gross dividends reinvested and estimated tax withheld, and with gross dividends reinvested, in both U.S. Dollars and local currency. The index excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners.

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.

Price/Earnings ratio (P/E ratio) is the price of a share of stock divided by earnings per share, usually calculated using the latest year’s earnings.

Second Quarter 2008

Amidst soaring energy and commodity prices, continuing turmoil in the financial industry and weakening consumer sentiment, international markets posted somewhat mixed results during the second quarter. The MSCI EAFE Index declined 2.25% for the quarter, while the benchmark for the Thornburg International Growth — the MSCI All-Country World ex-US Index — eked out a gain of .98%. The International Growth Fund unfortunately trailed both, returning -5.88%. Much of the decline occurred during the tough environment seen in June.

The investment philosophy of the International Growth Fund is predicated on finding promising international growth companies trading at attractive valuations. Our process is geared towards identifying secular growth companies, which can deliver higher earnings through solid business models and sound execution. This tends to lead us, rightly or wrongly away from cyclical growth companies, like those in the energy and materials sectors, where the investment thesis is often predicated on the price of the underlying commodity. Unfortunately for us and our investors, energy was the top performing sector of the benchmark, in aggregate posting a return in excess of 20% during the quarter. Materials was the second best performing sector, also posting double digit returns. In fact, 15 of the top 20 performing stocks in the benchmark came from either the energy or materials sectors. Based on our process and philosophy, we held no energy stocks and our exposure to materials was less than a quarter that of the Index.

While our allocation effect was substantially negative (i.e. we were not in the “right” sectors), our security selection further hindered our results. Of-note was the performance of our consumer discretionary stocks. Las Vegas Sands (LVS) was the top detractor as a slowdown in consumer spending could impact traffic to U.S. properties. However, we remain invested as of the date of this note, as much of the investment thesis is centered on future cash flows from U.S. and Asian properties currently coming on-line. Porsche (POR GR) was also a top detractor to performance. Weak U.S. sales, confusion over tax-related accounting and a lack of clarity surrounding a potential acquisition of Volkswagen caused a slump in the shares of the automaker. Indian-based Zee Entertainment (Z IN) fell in concert with many other Indian stocks. While not in the consumer discretionary sector, wireless provider America Movil (AMX) traded lower on concerns of a slowdown in consumer spending in Latin America as well as potential cross-border tariff disagreements.

Other areas of detraction included financial holdings. German stock exchange operator Deutsche Boerse (DB1 GR) fell, as economic uncertainty impacted trading volumes. EFG International (EFGN SW) and EFG Eurobank Ergasias (EUROB GA) both declined amidst a weak environment for European financials overall. Outside financials, Telekomunikasi Indonesia (TLKM IJ) declined. As competition for telecommunication services in Indonesia increases, industry pricing power is adversely impacted. Smartrac N.V. (SM7 GR) fell after issuing weaker guidance.

Some success stories were found, and given our broad mandate, they often came from unconventional places for a growth manager. A case-in-point was utilities which were a source of strength overall. Verbund (VER AV), RWE AG (RWE GR) and Cez (CEZ CP) all posted gains on higher wholesale energy pricing in Europe. MTN Group (MTN SJ) rose on talks of a possible merger with Reliance Communications. Turkish bottler Coca-Cola Icecek (CCOLA TI) saw its share price rise after a solid earnings report and completion of its acquisition of Pakistan’s Coca-Cola bottling franchise. Aldar Properties (B28QGD8) gained amidst a booming real estate market in Abu Dhabi. South African media company Naspers (NPN SJ) rose after a strong semi-annual earnings report.

Five stocks were added during the quarter and another five were sold. At quarter-end, the Portfolio held 40 stocks in total, fairly evenly spread among our Growth Industry Leader, Consistent Growth and Emerging Growth baskets.

We are not satisfied with results on either an absolute or relative basis. To-date, the market has taken an extremely short-term view of the world, which has not boded well for many of our holdings. We believe the market will eventually return its focus to attractively priced companies with solid business models and strong long-term growth prospects. Our goal is to be invested in these companies when this occurs.

For a print friendly version of this market commentary click HERE.

Click here for the top 10 holdings of the Thornburg International Growth Fund

Important Information

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.

Securities, countries and sectors mentioned are presented for the general information of Fund shareholders. Portfolio holdings are subject to change daily. Under no circumstances does the information contained within represent a recommendation to buy or sell securities.

The Morgan Stanley Capital International (MSCI) Europe, Australasia, Far East Index (EAFE) is an unmanaged index of over 900 companies, and is a generally accepted benchmark for major overseas markets. Index weightings represent the relative capitalizations of the major overseas markets included in the index on a U.S. dollar adjusted basis. The index is calculated separately; without dividends, with gross dividends reinvested and estimated tax withheld, and with gross dividends reinvested, in both U.S. Dollars and local currency.

The Morgan Stanley Capital International All Country World ex-U.S. Growth Index (MSCI AC World ex-U.S. Growth Index) Index is a market capitalization weighted index which includes growth companies in developed and emerging markets throughout the world, excluding the United States.

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.

Second Quarter 2008

To quote an old Bronx-born colleague of mine, “Just when you think you are out of the woods, you go right back into the soup.” Malapropism aside, that is something of the story of the market over the 2nd quarter. While the recovery from lows post-Bear Stearns rescue lasted through May, June brought on a resumption of concern about housing, employment, and the overall economy. Writing in mid-July, I have seen this second downtrade deepen to the point where major stock indexes are lower than the March lows while U.S. Treasuries have pared back some of their losses.

The specter of inflation, however, has kept the U.S. Treasury curve from revisiting the March low yields. Though currently the 10-year Treasury sits at 3.96, we are far from both the low yield in mid-panic of 3.30 and the high yield a few weeks ago of 4.30. In fact, total returns on most fixed income asset classes year-to-date in 2008 have been fairly poor. Though the status of fixed income as a safe haven certainly has kept most returns positive, and bonds are certainly outperforming equities in 2008, many fixed income securities have trended lower in price.

Credit has been a poor performer through the first half of 2008 as corporate bonds continue to widen on the expectation that the still low default rate will tick dramatically higher. Indeed concerns around financials have heightened of late. Investors no longer believe that Bear Stearns is an isolated case. Add the woes of the auto industry and weaker consumer-oriented names to this picture and the possibility of significant defaults in the reasonably near future is high.

Mortgages also have been widening in spread. The status of Fannie Mae and Freddie Mac continues to be uncertain, with the possibility of significant U.S. government intervention on the table. Non-agency mortgages have fared worse than their agency counterparts, as delinquencies continue to rise and almost no one forecasts a return to a house price appreciation environment any time soon.

In this environment, what the heck is anyone doing in anything other than U.S. Treasuries? It’s a good question, but one with a good answer. The fact of the matter is that U.S. Treasuries over the past year and a half have outperformed most U.S. dollar assets. Only inflation protected securities and commodities have been significantly better. Stocks, high-yield corporates, high-grade corporates, all types of mortgages, convertibles, asset-backed securities, agencies, and municipals have all significantly under-performed. Treasuries, meanwhile, have gained much more than their already low coupons on an annual basis. In other words, a 4% coupon U.S. Treasury which has a total annualized return of 7% over a year and a half eventually must have a lower return than the 4% coupon to average down the higher return years. This means that an investor looking to invest money today could receive a much better return on all of their non-Treasury debt and a much worse return on their Treasury securities, even adjusting for the significant probability of continued poor economic performance. Particularly in an inflationary environment, the low yields on offer from U.S. government securities seem to me to be inadequate. As a result, we have changed the portfolios to take advantage of the wider spreads and higher potential returns from non-Treasury securities.

One way to think about portfolio risk is to understand that most investors are inclined to take risk when there aren’t too many clouds on the horizon. Unfortunately, it is those times when prices are such that risk is not correctly valued. At the same time, it is hard to buy or hold on to risk when it seems as though the hurricane of downgrades and down trades will never end. At these times, risk is perhaps also incorrectly valued, but at the other extreme. I do not want to sound like a Pollyanna and tell you that everything is fine. Clearly it is not. However, to be continually bearish on all risk assets, even quality assets such as agency-backed mortgages and highly (and correctly) rated corporates will not be a winning strategy over the long term.

In all of Thornburg Investment Management’s funds, we try to achieve an appropriate risk-reward tradeoff. In the Limited Term U.S. Government Fund and the Limited Term Income Fund, for example, we are careful to keep that balance skewed more toward lower risk given their status as core bond holdings and our desire to continue to be uncorrelated with equities. However even in these conservatively run bond funds we are seeing the opportunity to increase our return with a very small increase in additional risk. Though there is no such thing as a free lunch, at least we can buy lunches when they are on sale.

In the context of the Strategic Income Fund, we have more latitude and a mandate for higher yield securities. While on one hand buying high yielding bank debt, preferred stocks, or even common equity could be very attractive (and in certain cases those types of purchases are quite interesting), we are looking beyond those investments to a broader array of income producing securities with a focus on keeping volatility under control. The fund continues to receive income from a wide variety of sources with a wide array of risks. The lack of concentration in one asset or one sector has served us well thus far in this challenging period, and we hope to continue to deliver an attractive sustainable yield.

I hope you are pleased with our performance this year. Though these times can be extremely trying, we believe our market discipline and fund strategies have served us well for many years and should continue to do so through these difficult periods. Thank you for your investment in Thornburg Investment Management.

For a print friendly version of Jason's market commentary click HERE.

Important Information

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.

Treasuries are negotiable debt obligations of the U.S. government 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.  Treasury Bills are short-term instruments with maturities of no more than one year. Treasury bills function like zero-coupon bonds. Investors buy bills at a discount from the par, or face value and then receive the full amount when the bill matures. Treasury Notes are intermediate to long term investments typically issued in maturities of two, five and ten years. Interest is paid semi-annually. Treasury Bonds cover terms of more than and are currently issued only in maturities of 30 years. Interest is paid semi-annually.

The Fed Funds Rate is the interest rate at which point a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight.

Basis Point (BPS) - a unit for measuring a bond yield that is equal to 1/100th of a 1% yield. A 1% change = 100 basis points (bps).

Lipper’s large firm universe is comprised of fund families with more than $28 billion in total net assets. Only fund families with at least five bond funds were eligible. Risk-adjusted returns are calculated with dividends reinvested and without sales charges. Past performance does not guarantee future results. The individual funds may not have ranked number one in their categories.

Second Quarter 2008

In the first quarter of 2008, the bond market anticipated continued easing by the Federal Reserve, taking the yield on 2-year Treasury notes down to 1.35%. However, consumer price pressures did not moderate as expected (by some) in the second quarter, and economic growth has not yet dipped into negative territory. Consequently, the bond market has started to anticipate a higher Fed Funds target rate by the end of the year. This has led to higher bond yields and a flatter yield curve. The yield on a 2-year Treasury note rose by 1% in the second quarter, while the yield on a 30-year bond rose only 0.23%.

Municipal bonds followed the Treasury market lead, as yields generally rose in the second quarter of 2008. This led to somewhat lower bond prices, particularly for bonds inside of 10 years where yields rose the most. Despite outperforming the Treasury bond market recently, municipal bonds continue to trade at historically inexpensive valuations relative to other bonds. This is because of a combination of factors.

We have seen a very heavy supply of new issue and secondary market bonds for sale. New issue supply of $228 billion is just below last year’s elevated pace. The deal flow has been lumpy and much of the supply has been driven by the restructuring of auction rate bonds that fell out of style. Typically, these deals have been rushed to market and priced attractively, to our benefit.

In the secondary market, supply continues to be driven by the deleveraging and restructuring of hedge funds, arbitrage accounts and closed-end funds, among others. These sellers are confronting reduced liquidity. Bear Stearns and UBS, both major players, have mostly disappeared, and other firms have cut back on capital commitments to the municipal market place. This has led to somewhat greater inefficiency in the market, and helped us with our search for good bonds at inexpensive prices.

Many investors have been worried about the plight of the bond insurers and what their troubles mean to the market. As was widely expected by nearly everybody, Moody’s and Standard and Poor’s recently downgraded bond insurers MBIA and AMBAC. We believe that more downgrades are likely and insolvency for these insurers is not out of the question. However, for the most part, bond insurance simply is not needed. Defaults are extremely rare for investment grade municipal bonds. We believe a well diversified, carefully managed portfolio of investment grade municipal bonds provides significantly more protection than an insurance policy from a highly levered bond insurer. Most bonds insured by MBIA and AMBAC are currently trading based upon the underlying credit quality of the issuer, as if the insurance didn’t exist. This is as it should be, and is a sign that the municipal market is adjusting to the new paradigm.

Separate from the bond insurers, municipal credit quality is holding up well, but there are pockets of weakness. State tax revenues rose only 1.7% over the one year period ending in March, 2008. That was the slowest pace since 2003. Certain states, particularly ones that recently enjoyed the benefits of housing fueled economies, are currently grappling with large budget deficits. Principal among these are California, Arizona, Nevada, and Florida. The Jefferson County, Alabama Sewer Authority is feeling the heat of some bad derivative bets and balance sheet choices which may ultimately result in a bankruptcy filing. These are significant credit problems in a municipal market that mostly includes stable, solid credits. As always, we will select bonds carefully and monitor these issues as they unfold.

The other significant threat to bond returns today is the prospect of elevated inflation going forward. Currently, a 10-year Treasury note yields less than 4%, while inflation, as measured by the all-items CPI is running 4.2%. Core (ex food and energy) inflation is fairly contained, but core measures seem to be losing their legitimacy in the face of an unfaltering bull market for commodities and rising global prices. There are some signs that inflation might moderate: rising unemployment and falling capacity utilization usually help the cause, but the battle is far from won. If inflation does not moderate, then Treasury bond yields will probably rise fairly significantly, leading to lower bond prices.

However, the municipal bond market holds a couple of wild cards that should help returns going forward. Moody’s recently complied with political pressure and announced that they would move toward rating municipal bonds on an even scale with corporate and other bonds. This should result in significant widespread upgrades of many municipal bonds as their low default rates and high recovery levels get factored into the rating process. Standard and Poor’s has not made a similar announcement, but we would be surprised if they don’t follow suit.

The second wild card for municipal bonds is the looming prospect of higher marginal income tax breaks. We believe that a reversion to the pre-2001 maximum tax bracket of 39.6% is nearly inevitable, no matter who wins the White House. This is because the tax cuts enacted in George W. Bush’s first term will expire soon, so Congress and the Administration can let taxes go up without passing a tax increase. Furthermore, deficit hawks will argue that it is necessary to help balance a spending deficit that will probably surge to $500 billion this year.

So our expectation of higher taxes and the potential for widespread upgrades of municipal bonds could provide a nice little tail wind for municipal bonds to outperform the Treasury bond market going forward.

For a print friendly version of the municipal bond portfolio manager market commentary, click HERE

Important Information

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.

Securities, countries and sectors mentioned are presented for the general information of Fund shareholders. Portfolio holdings are subject to change daily. Under no circumstances does the information contained within represent a recommendation to buy or sell securities.

Treasuries are negotiable debt obligations of the U.S. government 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. Treasury Bills are short-term instruments with maturities of no more than one year. Treasury bills function like zero-coupon bonds. Investors buy bills at a discount from the par, or face value and then receive the full amount when the bill matures. Treasury Notes are intermediate to long term investments typically issued in maturities of two, five and ten years. Interest is paid semi-annually. Treasury Bonds cover terms of more than and are currently issued only in maturities of 30 years. Interest is paid semi-annually.

Lipper’s large firm universe is comprised of fund families with more than $28 billion in total net assets. Only fund families with at least five bond funds were eligible. Risk-adjusted returns are calculated with dividends reinvested and without sales charges. Past performance does not guarantee future results. The individual funds may not have ranked number one in their categories.