We’ve had two watershed moments this year. The first is the Fed acknowledging inflation in March. The second is the Fed acknowledging the potential for a recession in May.
Thornburg Income Builder Opportunities Trust – 3rd Quarter Update
Greetings and welcome to the Thornburg Income Builder Opportunities Trust Quarterly Update.
At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should operator assistance during the conference, please press “*”, “0” on your telephone keypad.
As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Adam Sparkman, Client Portfolio Manager for Thornburg. Thank you. You may begin.
Good afternoon, everyone, and thank you for joining the call, today. Again, my name is Adam Sparkman, Client Portfolio Manager at Thornburg Investment Management.
I’d like to remind you that today’s presentation may contain forward-looking statements, which are based on management’s current expectations and are subject to uncertainty and changes in circumstances.
Actual results may differ, materially, from these statements, due to a variety of factors, including those described in our SEC filings.
Slides from today’s presentation can be found on our website at Thornburg.com/webcast.
I’d like to quickly introduce to you our speaker today, Christian Hoffmann, Managing Director and Portfolio Manager on the Income Builder Opportunities Trust, as well as several other fixed income strategies, here at Thornburg.
A point of housekeeping, before we get started. There’s going to be three different ways to ask a question, this afternoon. First, you can submit them email at firstname.lastname@example.org– that’s email@example.com.
Second, you can type your questions directly into the webcast, online. And lastly, the operator will pull for questions for those of you on the telephone, when we reach the end of the prepared remarks.
For those of you on the call today who may be less familiar with Thornburg, we are an investment manager based in Santa Fe, New Mexico, overseeing approximately $40 billion of assets across a suite of actively managed equity fixed income and multi-asset solutions.
In the midst of celebrating our 40th year anniversary as a firm, we are also celebrating the recent one-year performance anniversary of This Fund, which closed its initial public offering during the third quarter of 2021.
Whether the Thornburg Investment Opportunities Trust has been your introduction to our firm or an extension of a long partnership, on behalf of everybody here, we’d like to say, “thank you.”
Amid a backdrop of elevated volatility and challenging levels of global uncertainty, the aim of Income Builder Opportunities Trust remains the same, to provide investors with an attractive level of income today and into the future.
Despite the headwinds of 2022, by the end of this call, we hope you’ll have a sense of how positive we are for the prospects of both this fund in the near and long term.
So with that said, let me turn it over to Christian, who will kick off the presentation.
Thanks, Adam. And let’s jump to Slide 2. Again, we completed our initial public offering for Thornburg Income Builder Opportunities Trust, over a year ago. And through an extremely challenging market, we continue to earn and pay a meaningful distribution to shareholders.
As of yesterday’s close, over an effective 9.5% distribution which, again, is paid on a monthly basis. And that is with a fund that remains unlevered.
I want to thank everyone on the call for your continued interest and for your ongoing support of the fund.
To refresh on the strategy, our objectives continue to be to pay an attractive monthly distribution with a secondary goal for capital appreciation, over time.
And really, we’re using three levers to pull to generate that distribution: global dividend paying stocks, fixed income, and the options overlay.
TBLD is designed to be a diversified income producing portfolio, a multi-asset vehicle of global stock and bonds focused on our firm’s ability and willingness to pay.
The ability to pay is shorthand for good companies. It’s companies with strong balance sheets, consistent cash generation, durable competitive advantages in all of their fields.
Willingness to pay, we can think of as shorthand for good shareholder-friendly governance. So, companies didn’t force capital discipline on the management teams by not allowing them to invest every last penny, every year, but instead, sharing a portion of the profits with the shareholders.
The interception of those two concepts, good companies and good governance, is really at the heart of what we’re doing in TBLD.
Jumping to Slide 3, a quick snapshot of macroeconomic themes. We’re well into the fourth quarter, at this point. This year has kind of felt like five years jammed into one.
And I think, as we go back and look at this year and we think about it through time, I think there are, clearly, two watershed moments.
The first one is the Fed acknowledging inflation in March, 2022. And the second one is the Fed acknowledging the potential for a recession in May.
The interesting thing about both of those is that well over a year ago, in 2021, we were already seeing signs of runaway inflation. And with such a long policy of having quantitative easing and, effectively, zero interest rate policy, it shouldn’t have been a surprise to anyone that when that reverses, that would have a negative impact on the economy and would, eventually, create inflation.
But timing remains incredibly hard and also, not necessarily subject to rationale or reason. And it was really those two watershed moments that have defined this year. They’re both tied to Central Bank policy, and they both react to each other, really, in an inverse way.
So, we may tame inflation, but it may come at the cost to a severe hard landing in the economy.
We work very hard to engineer a soft landing and debating which outcome we’re going to have has really been what the market is grappling with from a day-to-day basis. And that’s why we’re seeing such tremendous volatility in fixed income markets, which are bleeding through to equity markets and really global asset prices, through the world.
This is also something that is not going to be known on any day. Any data point illuminates where we think we’re going but does not provide the ultimate answer.
And really, we’re talking about a long-term trend of inflation and how it trends down, over time. If you think about it, whether that’s nine or seven or five or three percent and how long of a duration that that is maintained for.
Look, fundamentals matter, again. Valuation matters, again. You could argue they didn’t in 2020 and parts of 2021. But if you think about really investing basics, discounted cash flow and what your discount rate should be, and inflation is the key driver of that. And that’s why we see this continued volatility from day to day.
And that’s why it’s likely to persist because, again, none of these things are going to be answered, overnight. And we’re going to continue to grapple with it, really, for the persistent future.
Let’s jump to the next slide, which is select world market returns. Obviously, it’s been a tough year for nearly every asset class. Besides some commodities and cash, there really weren’t many safe places to be. And even with cash, your dollar was eroded with inflation, which remains persistently high.
All this came on the back of incredibly strong 2021 results, which really set up this environment to become challenging. But it’s also created a lot more opportunities and mispricings in the market, especially, as you have liquidity issues, both in equity and fixed income markets.
It’s creating more irregularities, and it’s really creating more opportunities for us to step in and identify mispriced assets.
So, it’s really a tail of two cities. No one likes to see markets sell off. No one likes volatility. But it also really creates the most attractive opportunity for deploying capital, reinvesting capital and generating alpha.
Even in a market that moves sideways, TBLD can perform very strongly in that type of market, owing to the distributions which are paid, again, monthly.
Jumping to Slide 5, again, I want to highlight a portfolio that we believe is very well diversified across country, sector, style and asset class.
And because it’s a diversified portfolio, it’s really designed for investors who have a long-term time horizon and want to be able to put this in their back pocket, put the distribution, and again, hold and invest for a very long period of time.
Yes, component is 70%-75%, in general, fixed income of 25% to 30%. We can see that the equity in credit components themselves are diversified by types of investment with the option overlay, which is running at 15% to 25% of the portfolio.
That’s a program where we’re writing covered calls and, in some cases, also writing puts on the portfolio.
Jumping to Slide 6, quick overview of our current allocations. This remains a concentrated portfolio of 59 equity holdings and 116 bonds. Just talk very high level on sector allocation and diversification, cross sectors.
You will see us having higher exposure to sectors with higher distribution yields. Some have lower; we de-emphasize those. But again, this portfolio allows us to have exposure to those sectors and generate income via the option’s overlay which, again, provides more ballast and really more factor exposure than traditional income-producing portfolio.
It also allows us to have, really, an all-weather character by splitting it across those different sectors.
Continue to remain significant exposure outside of the U.S. That’s no surprise, as that’s really where you go to look to find dividend yields. Part of that is for historic reasons. Some of it is for industry—industry sectors which tend to be distributed, across various countries and certainly taxation and historic policies, as well, generate that.
So, if you’re hunting for income, you really have to do so, around the globe. We don’t see that changing, any time soon.
Jumping to Slide 7, another snapshot of sector diversification. Again, not trying to make any specific country or sector bet. We have large exposures to IT, just again, combination of software, semiconductors and payments.
Some of those are more cyclical, but many are going to be very resilient, especially, if you think about mission critical software that should be very persistent, through the business cycle.
Also, inflation has really been driving negative returns, across asset classes. But in some ways, we can participate in an inflationary environment by exposure to materials, which is just 9% of the portfolio and energy, which is at 7 which, again, you can think about persistent inflation should be positive tailwinds for those sectors.
And if we do see some reduction and if inflationary pressures, that should boost both valuations, as well as some evaluations within the fixed income portion of the portfolio.
I’m going to turn it over to Adam to talk about performance.
Thanks, Christian. So, as we flip to Slide 8, you’ll see the performance of the portfolio, as well as our benchmark, which is a blend of the MSCI world and the Bloomberg U.S. aggregate index.
As a starting point, I think it’s really important to point out that the first three quarters of 2022 have actually been the most challenging nine-month period for a 75/25 multi-asset portfolio, since the 2008 financial crisis.
And during the financial crisis, during the global equity selloff in 2008, bonds really bolstered a multi-asset allocation. But in 2022, stocks and bonds have really sold off in tandem, during this current drawdown and while also painful for equities, I think the -15% return for the U.S. AG has actually been the worst rolling nine-month period, over the index’s 40-year history.
Specific to Income Builder, when looking at the performance, I think it’s really constructive to consider both in terms of the current market price, as well as on the actual NAV.
On a price basis, the portfolio is down, roughly, 27%, annualized since inception. But a substantial portion of that negative return has actually been driven by the 15% discount to the current NAV.
On a NAV basis, year to date and since inception performance has generally been in line with our broader index.
Importantly, assets and goods is helpful to consider that the press to NAV dislocation that we’ve seen this year hasn’t been specific to TBLD, but is broadly reflective of the closed end fund market becoming oversold, during a period that’s obviously had heightened volatility and a lot of market pullbacks.
Moving on to Slide 9, there’s really a similar message here as to the previous slide. It’s been a persistently challenging environment, over the past year. But to me, two months really stick out, and that’s November of 2021, as well as this past September.
In both cases, actual NAV performance in those months was, roughly, 6% more than the market price. So, in aggregate, those two months represent the majority of the discounts of NAV that I mentioned, previously.
While we’re definitely not making excuses for performance, I do think it’s important to note the driving forces this year have broadly been exogenous in nature and, largely, macro driven.
While non-fundamental events like COVID, the crisis in Ukraine and the Chinese shutdown have obviously had short-term impacts on the portfolio, we really are remained focused on the longer-term fundamentals that the businesses that we own that may have been masked by some of these recent headlines.
Flipping to Slide 10, in these two charts you can see the price NAV premium and discount history. Price in NAV traded in line through much of the end of 2021, but as liquidity in the marketplace became challenged, the fund has traded away from intrinsic value.
At the end of 2018, as well as in early 2020, we had a similar dynamic where the broader closed end market had dislocations across global equity and multi-assets, funds in particular, similar to what we’ve seen in 2022. And I think the encouraging thing is that those gaps for the market really closed pretty quickly, as market sentiment improved.
At some point, I think we’re going to see a similar recovery. When that is, no one knows. But we do believe that the funds’ current discount, right now, that 15% discount to NAV provides a very attractive entry point for would be buyers.
We certainly what this fund to trade near NAV, and we hope that by earning and paying a substantial distribution, as we’ve done over the past 14 months, as well as engaging in client calls like this, that we can really help to reassure current and prospective shareholders, through tough periods.
Moving on to Slide 11, one of the things that we can control is the distribution. And we have paid, we just paid a monthly distribution actually, yesterday, of a little bit more than $.10, per share. Since inception, you’ll see that TBLD has now paid 14 distributions of that same 10.4 cents a share, totaling nearly $1.46, per share.
When we declared that initial distribution, last August, it was at an annual distribution rate of 6.25% on the ITO price. But for investors buying today, that same 10.4 cents represents a yield on cost, as I think Christian mentioned, of being as called of 9.5%.
Again, we think that’s a really attractive proposition for would be buyers. And it’s also important to note that our current distribution, none of it has been a return of capital, and we remain very confident in the durability of our distribution, moving forward.
Turning now to Slide 12, this table highlights the importance of dividend income, over time. Looking back over the past 150 years and segmenting the S&P into 10-year periods, you can see that, over time, dividends have accounted for, roughly, half of your total return.
In periods where price appreciation has been high, dividends have obviously accounted for less. But you can see, also, that in periods like 2001 to 2010, dividends have actually occasionally accounted for more than 100% of your total return because price appreciation was negative.
Over the past decade, dividends only accounted for, roughly, 16% of that total return but depending on your outlook over the next decade, price returns are not as strong as we’ve seen, recently. We expect that then, again, dividends are going to account for a really meaningful portion of your total return percentage.
Flipping finally to Slide 13, you’ll see here our top 10 equity holdings in order, by weight.
The reason we include this as the last slide is because we believe that the underlying ingredients of the portfolio really matter, and these 10 holdings here represent close to 25% of the portfolio.
If you focus on the middle column, you’ll see that the prices in many of these businesses are down pretty substantially, over this year. These price changes certainly reflect what we feel are broader worries about inflation, rising rates in a slower economy.
But we also want to mention that many of these businesses have continued to perform very strongly, through 2022.
The portfolio’s largest holding, Total, which is a large multinational energy company, has seen substantial EBITDA expansion this year and continues to grow their dividend. It’s obviously been a net beneficiary of the energy situation, resulting from the Ukraine crisis.
And I think its systemic importance to the global economy is probably more obvious now, than ever. Nonetheless, it’s trading at, roughly, 4x forward-looking earnings. And in this environment, with the tailwinds that we’ve seen, I think that’s a really compelling valuation for a company like Total.
Similar to Total, the other names on this list are not trivial businesses. These are well capitalized companies that occupy important positions in their respective markets and are well-positioned to weather periods of extreme market volatility.
With that, I think we’ll pivot to Q&A. But first, I do want to reiterate that while environments like today are obviously challenging for investors, as well as you as shareholders, as Christian mentioned in the beginning of the call, it does present really attractive opportunities for active managers, like ourselves.
And we believe this fund has a lot of flexibility to pursue opportunities in a variety of ways, moving forward.
So, as I stated at the beginning of the call, we hope you sense how constructive we are for the prospects of this fund, over the longer-term.
With that, we’ll turn to Q&A. Operator, could you please pull for questions.
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One moment please, while we pull for questions.
Okay, well while we wait for questions from the operator, maybe I’ll start with one that I think is interesting.
As you mentioned, indicated toward the beginning of the call, if investor pessimism is at levels that really I don’t think we’ve seen since the financial crisis, often when sentiment gets this out of balance, I think the market is likely presenting attractive opportunities.
Christian, what are some areas where you’ve been able to take advantage of opportunities in the current environment, within the portfolio?
For one thing, I want to highlight that when everyone is so one-sided on any trade, generally, that’s actually a recipe for the opposite happening.
I can’t remember a time when everyone was so one-sided and so symmetrically bearish. To extend the animal analogy a bit further, bears go into a feeding frenzy, at the end of summer. They do that, before hibernation.
And that’s really where seeing in the market. People are just trying to outdo each other by being more and more bearish and more and more draconian, in terms of what they are seeing in the world and in their projections and in their outlook and in their positioning.
But when everyone is sure, and when everyone is at max cash position—I’m not saying we’re there yet but it doesn’t feel like we’re that far off.
When that flips, that can flip very hard and the spring back can be pretty severe, as people look to readjust their positioning.
And that’s really what it feels like, right now. So, I would caution people on being too conservative, being too much in cash, especially, if you’re a longer-term investor and thinking about opportunities, through the cycle.
I think we saw a good example of this the other day when we had what I think anyone would have interpreted as a very bad economic print, bad for the market because it suggested continued hawkishness by, especially the Fed, but by global central banks.
And the initial algo reaction was incredibly negative. We ended up, actually up very much on the day. It was almost like there was no one left to sell. And at that point, buyers stepped in, and the covering was pretty severe.
I trade fixed income, every day. And I can’t remember when liquidity has been this bad. And really, broadly, when you see markets up several points to down several points, you’re really alternating from day-to-day, again, it shows that people are confused, people are lost, people are looking for direction.
But if you zoom out and think about your long-term goals, think about the true fundamentals in valuation and getting paid to take risk, it’s really the type of environment that active managers should live for and should seek to outperform in and be excited about.
I think that’s exactly where we are.
Thanks, Christian. I think that’s really good insight and a reminder for investors on the call.
We do have a question here has come in from the webcast audience. Can you please remind us if TBLD engages in any currency hedging, as well as kind of the level of exposure that you all have to the UK?
There was a big announcement, this morning out of the UK, and do you expect to have any material changes to your exposure in the UK, as a result?
We have the ability to hedge in this portfolio but, broadly, we have diversified currency risk.
I think, very much to the prior question, when things reverse, they can reverse, quite hard. I think that’s actually exposure you want to have on, at this point. And I imagine most of our investors are dollar-based investors.
And when the dollar has been such a phenomenal trade and a one-way street, over time, it’s easy to lose track of the value and ballast that having some foreign denominated currency can actually add to your portfolio, especially, over time.
I feel like we’re in the final innings of dollar strength. And really, that’s going to be tied into the final innings of peak Fed hawkishness, in my opinion.
But again, when that reverses, I think you’re going to see a significant snapback, as people look to reverse that trade to put on a more balanced portfolio view, in terms of currency exposure and see some of that reverse.
In terms of the UK, I think it’s the shortest tenure of any PM. I think there were lessons learned there. I think, very much, that’s an oversold market. And I think we’ve seen peak pain and actually look for some improvement and a more sober balanced tone, I think, from that government, going forward.
And I think that should provide some opportunities.
All right, thanks, Christian. Another question in from the webcast. Central banks have obviously been top of mind for market participants, all year, and they’re clearly on a mission to curb prices.
With the rapid rate rising that we’ve seen out of the U.S. and other global venture banks, how worried are you about the pressure that this puts on the broader global economy?
I think the reason you’re seeing central banks and, particularly, the Fed talk so tough is because, right now, it doesn’t cost them anything.
There’s extreme political pressure on fighting inflation. And that remains what everyone is laser focused on.
At some point, it’s going to be more of a tough choice, as people start to lose jobs, as people start to feel the consequences of what is really a very different type of central bank activity than we’ve seen, really, for 15, plus, years.
A lot of investors in this marketplace have never lived through that, have never invested in it. And again, it’s easy to talk tough when all people care about is fighting inflation. When it becomes that challenge of fighting inflation or putting another 500,000 people out of work, then there becomes a more balanced political pressure.
I think that’s when you see the Fed blink. And I think they might be willing to tolerate higher inflation to try to thread the needle between keeping the economy from not totally falling off the cliff and having inflation that doesn’t feel so challenging to operate businesses, to maintain margins at normal historical levels.
But right now, the Fed does not want the market to outflank them, to front run them. So, they’re going to keep talking tough, I think, especially through the end of the year, especially through this election cycle.
But again, I caution folks, when that pivot happens, when the market flips, not only I think you’re going to see a strong fixed income rally but that’s also going to be where you’re going to see a lot of currency reversals.
And that’s going to be, I think, hard and fast.
Okay, thanks, Christian. Sticking with inflation here for a minute, US CPI has fallen, modestly, from the high print that we saw in June. But core inflation, as you mentioned, has continued to tick up a bit.
How sanguine are you on inflation rolling over, during 2023? What’s kind of your base case and how high does the–how much gas do central banks keep drawing on that?
I think there’s three big things that we’re paying attention to. One of the key drivers of inflation right now is owners’ equivalent rent, which is clearly a lagging indicator and is lagging housing.
Now, for someone that monitors the housing market extremely closely, we’re not seeing further housing inflation. We’re seeing the opposite. You’re seeing price cuts; you’re seeing softness in the market and seven-plus mortgage rates are going to do that to the marketplace.
That is going to take a while to feed through into the rental market, which probably has 6 to 12 months of lag. But you’re already seeing that correction.
Two other big ones are energy and food. A lot of that is driven by the tragic situation between the Ukraine and Russia.
But those are things that, as a humanity, we actually have the ability to correct, over time. We can plant more seeds, we can grow more food, we can drill for more energy assets.
It takes time for that to filter through, but there are actually things that have solutions that you can manufacture that are actually quite far removed from central bank policy.
Central bank policy is certainly working, both in the direct method and an indirect method. There’s obviously been a tremendous amount of wealth destruction. I think freezing the housing market has severe consequences, through the economy.
And really, some of these issues with supply chains and manufacturing, again, I don’t think you want to be short human ingenuity. You don’t want to discount the fact that people will figure this out.
It’s easy to be very shortsighted in a sale. These things will continue, forever. But human nature is quite productive and innovative. And I believe we’ll figure these things out and already have been.
Thanks, Christian. Why don’t we pause here for a second and check in with the operator to see if any questions have come in, over the phone.
We have no questions, at this time.
Okay, there’s a couple more here from the webcast.
Christian, to your point about things potentially flipping over and going the other direction, this year, we’ve seen fixed income and equity both plunge, in tandem.
Do you think that, if we get a reversal, that equity and fixed income remain correlated but to the upside, or do we get a more normalized environment where fixed income is defensive in certain environments, equity is more risk on?
What is your outlook for the correlation to equity and fixed income, moving forward?
Yeah, it’s a fascinating question. I think, if you jump back to 2020 and 2021, both were extreme and unusual environments, both for investors but, particularly, asset allocators.
Look, 60/40 didn’t work. Nothing worked, unless you had an oil derrick in your backyard and you had, basically, all your money in some kind of inflation protected vehicle.
But I think actually both things could happen. Again, we talked about this bearish feeding frenzy, which is happening right now.
I think, when that flips, you could really see all boats rise and broadly, assets and risk premia decrease and asset prices rise, globally.
But we’re kind of resetting something that looks a lot more normal. And by normal, I mean the world, before 15 years of crazy, unprecedented central bank intervention.
And really, that’s where 60/40 works. That’s where these correlations, historically, have made more sense, where they’ve lived and where they’ve worked.
I also think, at this point, it’s hard to say with the tenure moving 10 basis points, a day. But at this point, if stocks go down a lot from here, it’s probably because of a pretty pessimistic view of the world, a pretty steadfast view of a recessionary world.
And in that world, it’s very hard to have inflation. You could see that fixed income could and should provide the ballast portfolio that, historically, it has. When you’re starting at 4% to 4.5% treasuries and 10% high yield, certainly has more of an ability to do that than when you’re at 0% treasuries and 3% high yield.
Thank you, Christian. We spent a lot of time, obviously, talking about the larger macro environment, here during the Q&A. But maybe one final question that I’ll throw at you, kind of take it a little bit more back to the portfolio.
Third quarter earnings are starting to trickle in. What are you seeing, so far, out of third quarter earnings, and are there any particular sectors, geographies or asset classes that look, particularly, attractive?
Yeah, it’s a very interesting earnings season; 2Q, people were very worried about it. I think it broadly came out a lot better than people expected.
But we kind of push that forward to 3Q. People again, worried about earnings downgrades from companies and that putting pressure, broadly, from sell side analysts which, broadly, may have been too slow to take down earnings and that really feeding through to a revised valuation outlook for equity markets.
I think maybe 20-odd percent of the S&P 500 is reported, at this point.
The early reads are actually better than expected. I think, over the last couple days, it’s been more of a mixed bag. Certainly, you’ve had some standouts and staples and luxury goods. But life is more than sugary snacks and silk scarves.
And I think the core report really should be sobering and give caution to folks about the central bank policies are reverberating, through the world. They’re causing demand destruction, which they’re designed to do. But that is not costless. That is not unsettled by both the market and individuals.
So, we’re watching earnings incredibly closely. And I think, between that and inflationary data points, that’s really going to be what’s driving the market, over the next weeks and months.
All right. Well, Christian, we’re at roughly 40 past the hour. I think that’s the majority of the questions have that we’ve gotten to from the webcast.
Thank you so much for your time, today. And with that, we will wrap it up.
This concludes today’s teleconference. You may disconnect your lines, at this time. Thank you for your participation.
With an aging global population, the demand for retirement income will only increase. TBLD seeks to deliver income now from diversified income sources.
Hear from the portfolio managers of Thornburg Income Builder Opportunities Trust as they share their thoughts about income opportunities during a review of past performance, current positioning, and market outlook.