Helping Clients Face Today’s Markets
Thornburg Investment Income Builder Fund – 2nd Quarter Update
Greetings, everyone, and welcome to the Thornburg Investment Income Builder Fund Quarterly Update Conference Call. 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 require operator assistance during the conference, please press star, zero, on your telephone keypad. And as a reminder, this conference call is being recorded.
It is now my pleasure to introduce your host, Michael Ordonez, Director of Client Portfolio Management for Thornburg. Thank you, Mr. Ordonez, you may begin.
Thank you, operator and welcome, everyone. Thank you for participating in this afternoon’s call. Hope everyone is doing well. It’s a beautiful, rainy day here in New Mexico, in what has been an unusually wet June and July. Today, you’re going to be hearing from the portfolio management team of the Investment Income Builder’s Strategy on recent performance, current positioning and our market outlook.
I’d like to remind you today that today’s presentation, which slides can be found on our website, thornburgh.com/webcast, 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.
I’d like to quickly introduce our speakers today, Brian McMahon, Portfolio Manager, Vice Chairman and Chief Investment Strategist for Thornburg; along with Christian Hoffmann, Portfolio Manager for many of our fixed income strategies, who will be standing in for Jason Brady today. One housekeeping point to make before we get started, there are three ways to ask questions to the portfolio management team this afternoon. First, you can send us an email at firstname.lastname@example.org. That’s email@example.com. Second, you can type your question 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.
As we celebrate our 40th anniversary at Thornburg this year, the quarter ending June 30th was the 78 full calendar quarter since the inception of the Income Builder in December of 2002. Now in its 19th year, we continue to follow the same principles and philosophies that we set out with. Income Builder aims to provide a differentiated level of income with companies that have the potential to grow those dividends over time. We also believe that as our companies grow their earnings and dividends, investors should also be able to benefit from capital appreciation over a whole market cycle. So whether it’s to help meet short term funding needs, such as retirement income or foundation distributions, or contribute significant significantly to long term growth to help make your income sustainable and long lasting, we look forward to helping you do that for another 19 years.
So with that, let me turn it over to Brian McMahon, Portfolio Manager, Vice Chairman and Chief Investment Strategist.
Okay. Thank you, Michael, and thank you to everybody listening. We’re going to roll through these slides today that are on the website, as Michael described. If you’re not in front of a screen where you can look at the slides, I’ll try to animate the discussion. So you can follow along without, but it’s richer if you do have access to the slides.
We start off with a few macroeconomic issues, key issues, on slide number two, and I will not read through those. I would just like to maybe highlight a couple of things. Firstly, I expect that you’ll see headlines in the coming weeks about the fact that the United States has slipped into a technical recession, reflecting two consecutive quarters of negative real GDP growth. And I would say that that’s probably going to happen, so don’t be shocked. But I’ll also say that it’s an unusual set of national income accounting statistics to get us to that place.
Back in the Q4 of 2021, GDP was reported at plus 6.9%, but 5% of the 6.9% was a positive contribution from trade and inventories. And basically, we’ve given that back, that trade and inventories part, and the rest of GDP actually is growing. And the other thing that I’ll say is that back in the fourth quarter of 2021, the unemployment rate in the United States averaged 4.2%. And as we know from the data we saw last week, it’s currently 3.6%. So are very unusual to have the unemployment rate go down, and yet have a technical recession, but it’s kind of due to these trade and inventory, data washing through the national accounts statistics.
The other thing that I’ll mention that probably doesn’t need to be mentioned, is volatility of financial asset prices is increased a lot in the first half of 2022, and that’s true for both stocks and bonds. Frankly, it’s also true for many hard assets and commodities. We believe that this presents really interesting opportunities for disciplined and analytical investors. So it may be scary to to those who aren’t doing analysis and are undisciplined but, but we think it’s an exciting time.
And so with that, I’ll skip to slide number three. And just to remind our listeners, that the Investment Income Builder is a solution that consistently seeks to provide attractive income to to our shareholders. Our objective is to pay an attractive yield today and to grow it over time. And we believe that if we have assets that are growing income over time, that we’ll also get some long term capital appreciation. And that, in fact, has been the case as we’ll illustrate later on with some numbers. Our investable universe is a global dividend paying stocks, and also global bonds and hybrid securities. And the pillar of our analysis is we focus on firms’ ability and willingness to pay interesting dividends today, and hopefully to grow them over time.
Slide number four gives you an overview of the portfolio allocation shifts by sector. There are 11 sectors shown, and this goes back two years, quarter by quarter. And maybe I’ll just focus on what the key changes have been between June of 2021 and June of 2022. So we’ve lightened up in financials by 1%, in communication services by 4%, and by Infotech, so technology by 3%. And we’ve increased our allocation to healthcare, energy, utilities and materials businesses over the last year. And I’ll just point out that the reduction in allocation to communication services, think telecoms, is mostly due to our divestment of investment that we had in China Telecom and China Mobile over the last year.
Slide number five gives you some characteristics of the portfolio. These are sourced from Bloomberg and facts that and reflect the consensus opinions of analysts of sell side analysts. And I think the key is, if you look at the PE of our portfolio, weighted average PE, it’s now under 10 times. We do expect earnings growth over the next year, which is why the forward PE is 8.3 times. That indicates what we would expect to be interesting earnings growth, earnings per share growth. Price to book, 1.3 times. Price to cash flow, modest. Return on equity, interesting, in the mid-teens at 16.6%. And weighted average dividend yield on the portfolio of 5.3%.
So the yield is better than benchmark portfolio, the PE is cheaper. The price to book is cheaper than than benchmark averages. You can see there, a breakdown of equities, foreign, domestic and bonds. The allocation to interest bearing debt is creeping up, and we’ll get some comments from Christian Hoffmann in a moment on that, and the menu that he’s looking at these days, which is increasingly interesting.
Slide number six gives our top 10 equity holdings in the Income Builder Portfolio, along with some information that I hope you find interesting. So what we see is the year to date 2022 price change, through June 30th, the 2021 year price change and then the dividend yield. And for some of these, you see kind of a mixed picture where the price maybe went up a lot last year, and they’ve given back some this year, or vice versa. What I find especially interesting about this is most of these businesses are having a pretty good 2022. We haven’t heard official earnings reports from most of them, but we have for a couple already. For example, Taiwan Semiconductor, we see the price down 28% in the first half of 2022. They just reported last night, and their revenue was up 36% year over year for the June quarter, and their operating income was up 67% year over year for the June quarter.
So what’s happened? It’s just gotten a whole lot cheaper. And the reason that their revenue is up by more than 30% and their operating income is up by more than 60%, is this is a really important business, very foundational for kind of almost everything technology. So we feel pretty good about it. We regret that the share price is down 28%, but it just means it’s that much cheaper. And it’s so much a better buy than it was six months ago or 12 months ago. And I feel that way about many of these companies.
Right above Taiwan Semi, you see CME Group. Their volumes were up almost 21% in the first half of this year. So the share price is down 10%, but their trading volumes are up quite a bit, and I think they’ll continue to comp well versus last year. And so the share price may be anticipated some of that last year, but it’s given back a lot this year, and that’s now our largest financial holding.
On the next slide, number seven, you see the second 10, so the next 10 equity holdings that we have. And here, again, some of them that were strong last year gave a lot of it back this year, and a little bit vice versa. But notice the dividend yields, they’re they’re attractive, and these businesses are by and large, they’re doing pretty darn well. Most of them, we expect to grow earnings this year.
The next slide, number eight, is the next 35 equity holdings. So here on these three slides, you see the names of everything that we owned, as of June 30 in the equity department. We also want some 200 Bond (INAUDIBLE) in the portfolio, and Christian could talk a bit about those. But we want you to just know that we’re pretty proud of these ingredients. We feel that they’re good high quality ingredients that comprise this portfolio, and it’s a mix. It’s an interesting mix, but they all contribute to our income.
Actually, the next 10 slides, which I won’t talk about in detail, give us some summary statistics and pictures of share price developments, really over the last nine quarters for our top 10 holdings, one by one. So Total (SP) through Tesco, and maybe the most interesting thing is to see how volatile some of the share prices have been relative to the businesses, which are relatively smooth. And the other thing is just a snapshot of maybe some important summary valuation characteristics.
For example, here on slide nine, Total, $131 billion market cap, $33 billion of net debt, so $164 billion economic value of the firm. Annual EBITDA for Total over the last 10 years has been between $16.5 and $45.5 billion. This year it’s expected to be around $60 billion. So $60 billion versus $131 billion market cap with a 5.3% yield, and really some very interesting initiatives in green energy for Total, plus a huge gas trading and gas transport business. And if you read any headlines at all, you know that LNG is very, very important. So this is, we think, a bargain in a box right now, and we’re happy to, to own a bunch of it. And that’s why it’s our number one holding.
Our telecoms, and you see Orange and Vodafone, have performed relatively better than the market as a whole year to date. And the two Chinese ones that we sold back in the spring, both gave us positive returns year to date in the months before we sold them. And why are telecoms resilient? Well, if you look at Orange here, the second one, they’ve had 231 million mobile customers, and almost 24 million broadband customers in 27 countries. They don’t have to ship a box. They get paid every month, and they have, really, a wide range of customers, and they provide a very, very necessary service. And it’s not so easy to compete, because there’s so much invested in their networks, in their spectrum holdings, in their towers, and, frankly, in these customer bases.
So it makes sense to us that these are beginning to perform, but we think they have more performance ahead, because most of our telecoms are valued somewhere between four and a half and six times EV to EBITDA, and the dividend yields range between 4% and more than 6% for these holdings. So I won’t dwell on all of them, but maybe I’ll just skip ahead to one other holding. It’s a domestic company that I think you all know, and that’s Pfizer, which is our ninth largest holding, and it’s been creeping up in the portfolio. We’ve been buying more of it.
So here they have about a 3.1% dividend yield. The interesting thing about Pfizer is after years of their revenue, being annual revenue, being between $40 and $50 billion, last year was up 94% year over year to $81 billion. And this year, it looks like it may approach $100 billion in revenue, so Pfizer’s in a very different orbit than it used to be in the preceding decade. This is mostly due to their COVID vaccine that they developed with the small German company, BioNTech, and really manufactured billions of doses and distributed them and got them through the FDA and other government FDAs all around the world in pretty much record time. They do have other therapies. They’re using a bunch of the cash that they’ve been generating from their COVID related businesses to buy other businesses. And here’s a company that sells at roughly eight times earnings, with better than 3% dividend yield, and some pretty exciting growth.
So with that, I will skip ahead to slide number 19 in the deck, which shows, as we have for several years now, the comparative stock and bond yields from our top 10 holdings, our top 10 equity holdings. And as of this quarter, this slide looks a whole lot different. So for Total Energies, for example, the trailing 12 months dividend yields 5.3%. Their current debt yield for their 2.83% through 2030 is 4.15%. But I’ll point out that a year ago, last year, when we were doing this presentation, we also owned the Total equity, and their comparable majority debt issue was had a yield of 34 basis points. So we’ve gone from 34 basis points to 4.15%.
If I would just look at Vodafone, their debt due in November of 2032 has a market yield now of 5.01%. A year ago was 1.68%, and on and on down the list, we have these kinds of comps. The takeaway is, bonds are a lot more interesting, a lot more interesting, in and of themselves, and relative to equities. And so our bond allocation is creeping higher, and probably will continue to creep higher. So get ready with questions for Christian on that.
Slide number 20 is a snapshot of what we think, and I’ll point out, it’s just what we think will be the dividend dynamic for our portfolio holdings this year. We’re only halfway through the year. Some of these companies are done with their dividends for 2022, but most are not, and dividends are not contractual obligations. So I just caution you that these aren’t contractual obligations. But we do expect 76% by weight of our holdings to grow their dividends in local currencies this year. And for those companies that we expect to be growing their dividends, their estimated yield is 4.9% as a group, their weighted yield.
We expect about 7% to have a flat dividend, and they’re at 5.9%, and about 17% to pay a lower dividend this year. And more than half of those paid some kind of special dividend last year, which is why they’re paying a lower dividend this year. Maybe it was a ketchup dividend, because some companies withheld dividends in calendar 2020 at the height of the COVID onset. So those we think will have an estimated yield of about 5.3%. The potential to grow the dividend over time is hugely important to our program because that’s how we’ve really been able to escalate our dividend from $0.53 a share back in 2003, to more than $1 a share last year.
The next slide number, 21 and number 22, next two slides, look at how we’ve performed in rising interest rate environments, relative to some other benchmarks. And the reason we put these in is just interesting comparison of other historical periods where the 10 year treasury has risen at least 40 basis points during the lifetime of the Income Builder. And there have been 31 of those periods, and in a majority, but not all of those periods, but more than 70% of those periods, we’ve outperformed the U.S. corporate bond index, the U.S. aggregate bond index, the U.S. high yield bond index or the blended index, with significantly higher total returns.
The next slide, number 22, just looks at it a little bit differently. Now, we’ve got some slightly different comps, and the blue bar shows the return to Thornburg Investment Income builder, iShares, during the periods that are defined down below these bars. And what you see is the into a period trough to peak rise in yields, in 10 year treasury yields during these periods. And we have tended to outperform our blended index, and also the Bloomberg U.S. corporate index during those periods. Not all, but most of those periods.
And so this addresses a question that we are asked all the time. How do you perform in a rising rate environment? We like rising rates. Christian especially loves rising rates. It makes things way more interesting. And so we have a yield rally going on right now, and it gives us a whole lot more interesting stuff to do.
Slide number 23 is just a snapshot of selected index portfolio returns during the second quarter and then prior years back to 2015. And I think it’ll be no surprise to anybody that pretty much all of these asset classes had negative returns in the second quarter of 2022. Slide number 24 just highlights the investment performance of the income builder over various period, the quarter, year to date, one year, three, five, 10, and since inception. I think our relative performance has been mixed over those periods. We feel pretty good that over the trailing year, for example, at negative 370, we’ve been a lot more durable than our blended benchmark index, which is negative 13.18%.
The next slide, number 25, just shows quarterly total returns in a visual way. And about three quarters of the quarters since we started this fund, now 78 quarters ago, we’ve delivered a positive total return. And about one out of four quarters, it’s been negative. There haven’t been very many quarters where we’ve had two consecutive negative quarters, but that’s been the case in the first half of this year, which I find quite interesting because the performance of our underlying companies is pretty good.
Slide number 26 is a slide that shows how flexible we are with respect to our allocation to interest bearing debt versus equities. And if you look at the bold Line, the dark line, it shows the allocation scaled off to the left of cash and bond investments, and you see that turning up in the first half of 2022. And the reason that it’s turning up, is really those two dotted lines, because the available yields for us to invest in have also turned up significantly. And so we expect that our allocation to fixed income will continue to creep higher. And if there’s a big upset, maybe it’ll gap higher. So far, the the retreat of bond prices has been somewhat orderly.
The next slide, number 27, just shows our quarterly distributions. If I look at the trailing four quarters, through June of 2022, we were up 13% over the prior year, four quarters, and in the second quarter of 2022, we were down 8.3% year over year versus our June quarter ’21 dividend. The next slide, number 26 or 28, I’m sorry, we’ve consistently delivered dividend yields pretty much higher than 4% since our inception. And I have no reason to believe that we’ll wake that tradition this year, but this shows kind of what the yields have been based on our NAV at the time in each of those years.
And the dividend has grown at a compound annual growth rate of 4.9% over the last 19 years, and our NAV has grown at a compound annual growth rate of 3.9% over these 19 years. So that’s a nice mix of capital appreciation plus income that is interesting to start with, and that has grown over time. So back to what I was remarking on at the beginning, and we could see some further detail on that, on the next two slides, 29 and 30.
Slide 29 considers a hypothetical $100,000 investment that would have been made at the inception of Thornburg Investment Income Builder back in 2002. And to summarize it, we’ve paid cumulative dividends for somebody who took their dividends in cash for the entire period of $176,943. And in the meantime, their $100,000 investment has appreciated by $91,026. It’s now worth $191,026. So good income and growth of the corpus that is producing that income.
The next slide considers the case of somebody who’s reinvesting the dividends, rather than taking them in cash. And in their case, the cumulative dividends total, on the $100,000 initial investment, total $267,000. So they started out with 8,375 shares, they now own 22,624 shares. And I just remind you back in 2003, those 8,375 shares paid $0.53 cents a share, and last year, we were up over $1 a share. In fact, $1.24 a share last year, so you can kind of do the math in your head, I believe, what the income production is on those 22,624 shares relative to your initial $100,000 investment. The capital appreciation along with that is $116,000. So total account at June 30, is worth $483,000. This is just another way of looking at a compound average annual return of 8.77% that we have delivered point to point and it’s one thing to say 0.77%, but it’s maybe another thing and maybe more illustrative to some people to look at the breakdown between income and capital appreciation that gets us there, and what the income potential is at the moment. And we have no reason to believe that we can’t continue to deliver a good result and hopefully, a tree that continues to grow.
Considering the market right now, on slide 31, I think it’s important for some perspective. And this happens to be 150 years of perspective, going back decade by decade. And if we look at the bottom, we see that total returns to the S&P 500 Index, or its proxy in those early decades, was averaging a return of 9.1%, almost evenly divided between price appreciation and income, dividend income, over that whole 150 year period. If you look decade by decade by decade, some years it’s more price appreciation, some years income is more important. We can look for example, between 2011 and 2020, price appreciation was the king. But the prior decade in the wake of the.com bust, the income was very, very important, and in fact, there was no price appreciation.
We’re not sure what this decade will look like, but so far, it looks a little bit more like the decade following the.com bust. Income appears to be more important, and with that, I will close just noting that we feel pretty good about our income production that we have in the Investment Income Builders. So we think we’re well suited for the times and well suited for this decade. And with that, Christian, and I would like to take your questions, and I hope you have plenty of questions about the bond market.
Well, I can tell you, there already are Brian. So Christian, the first one is in fact for you, and it’s a simple question, but is it time to buy credit?
Fixed income broadly has become much more interesting. Let’s talk about the high yield market for a second just because I think it illustrates the concept pretty clearly and explicitly. You know, if we were having this conversation one year ago, and you bought the entire high yield market, you would be buying and underwriting, basically a three and a half percent yield to worse. That’s not spread, that’s 3.5% yield to worst, and inflation was notably higher at that point in time, just as a reference.
Today, if you by the market, you’re getting closer to 8.5% to 9%. So if you think about that in terms of total return, in terms of income, that’s a market change, and certainly something that should exceed inflation over time. Now, in Brian’s comments, he alluded to the macro-economic slowdown, which we’re currently in the middle of and likely to see further. Default rates will rise broadly in fixed income markets, but at this point, you’re talking about high yield spreads and the load of the high five hundreds, depending on the day, which is kind of at or through average levels. You can actually sustain a pretty elevated number of defaults and still post a reasonable return.
So not only were spreads and core rates quite low or historically low last year, but we’ve actually, again, reversed on both of those. So now you’re getting actually an interesting level of spread and an interesting level on the base rate on the core rate, again, providing for a high potential total return. So it’s much more interesting. We’ve been sharpening our pencils for a while. We have a list of things that we believe are interesting, and I’ve started executing on that.
Now, again, the overall allocation remains quite low, again, going back, especially to 2008 time and that as the perspective. But it’s time to start nibbling, it’s time to start sharpening our pencils, which we have been doing. And also, as Brian alluded to, sometimes things break quite quickly, and we got to ramp our speed up if and when that happens.
And maybe a follow up to that, Christian, how does liquidity look in the market right now?
Liquidity is terrible, but unfortunately, it’s not terrible in the way that we really like. We like to be a liquidity provider to the market when it doesn’t have liquidity, but really, what you’re seeing is a lot of ETF, and algo-driven days where it’s just quite wimpy, and the non-fundamental buyer, seller, is all looking to buy or sell at the same time and it’s creating a lot of market imbalance. What we want to see is when people really need liquidity, and we can provide them with a terrible bid, terrible bid for them and amazing level for us, and get execution on that.
We have had some days like that, but we’d like to see a lot more. But broadly, when liquidity is terrible, like it is today, again, it can go two ways, right? It’s very delicate, and you can tip into that scenario that we’re talking about, which becomes very opportunistic for us, or it can heal. It can certainly go either way, but again, I think we’re more likely to go into the former than the latter.
When searching for income, investors tend to focus solely on current yield, which has some limitations. TIBIX seeks to provide an attractive yield today, but also aims to increase the cash dividend to investors over time.
Hear the portfolio managers of Thornburg Investment Income Builder Fund share their thoughts about income opportunities during a review of past performance, current positioning, and market outlook.