22 Jul 2011 Thornburg Value Fund - Q2 2011 Commentary ( Portfolio )
During the quarter, the S&P 500 Index declined steadily beginning in May, but rallied sharply at quarter end. Investors continued to be concerned about rising consumer prices, unemployment, home prices, and any exposure to Greece’s sovereign debt crisis. Also weighing on markets are the potential consequences of the end of the second round of quantitative easing (QE2) and the ongoing debate over the U.S. federal debt ceiling. Concerns about weaker global demand and increases in U.S. fuel supplies and the announcement of the release of millions of barrels of oil from the strategic reserve helped push fuel prices lower. We decreased the overweight position in the energy sector during the quarter. Financials have been pressured by fears of ongoing European debt concerns, especially in Greece, and a harsher regulatory climate with the Federal Reserve possibly raising capital requirements. We added to our financial holdings during the quarter and increased our overweighting to this sector.

Two of the largest contributors to results in the quarter were telecommunication services companies Level 3 Communications and Global Crossing Ltd. During the quarter, Global Crossing agreed to be acquired by Level 3 Communications in an all-stock transaction. Bermuda-based Global Crossing, a leading provider of advanced communications services to multinational companies in Latin America, the United Kingdom, and the United States, appears to be a good strategic fit with Level 3. The new combination should benefit from across-the-board improvements in financial performance. In addition to greater access to capital, the new company may boost operating results in each of its three geographic regions. The Latin America region continues to be a particularly bright spot; internet usage there is in its early stages. We liked the deal so much that we added Global Crossing to the portfolio after the deal was announced. Even with price increases in anticipation of the deal, and prior to our purchase, it was one of our top performers during the period. Another telecom company, Japan-based KDDI Corp. had a good fiscal year 2010 earnings report and fiscal year 2011 guidance was above expectations. Expenses and losses associated with the March earthquake were minimal. Valuations are supportive. Smart phones are underpenetrated in Japan which provides growth opportunity.

Purchases during the quarter included Goldman Sachs, which is a leading investment bank in the United States and globally. Goldman Sachs has strong franchises in investment banking, trading, asset management, and principal investing. We also purchased Staples Inc., a leading supplier of office products in the United States and around the world. High unemployment has weakened the demand for office products, creating a supply-demand imbalance in the industry. Profitability should improve with job growth and reductions in industry supply, either through store closures or possible consolidation.

Sales activity during the quarter included Eli Lilly, which was sold due to deteriorating fundamentals and disappointing news regarding product approval delays by the FDA. Rite Aid Corp. was sold due to deteriorating fundamentals caused by a drop in sales due to the economic crisis, exacerbated by heightened competition in pharmaceutical sales from discount stores such as Wal-Mart. Rite Aid’s stock was up from recent lows, and we took the opportunity to exit the position. Monsanto Co. was sold to make room for other investments. DISH Network Corp., Conoco Phillips, Ansys Inc., NCR Corp, and ING Groep were all sold after reaching their price targets.

We are optimistic on the global growth outlook. In the United States, equity valuations as a multiple of earnings are compelling. Corporate balance sheets and free cash flow yields are unusually strong. The outlook for increased dividends, share repurchases, and mergers and acquisition activity appears favorable. We expect monetary and fiscal policy to be neutral going forward. Given the stimulus that has already occurred and where we are in the economic cycle, a neutral policy should be supportive of rising equity values. In our opinion, raising taxes or cutting government spending while economic growth is tepid would be a major policy error. The possibility of this type of policy error is one of the greatest risks facing investors. If the economy were to weaken substantially, we believe a third round of quantitative easing would be likely.