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Following the Principles of Islamic Finance

Quarterly Commentary

Q4 2010 · December 31, 2010


In 2010 we saw a close race between Growth and Value, with Value out ahead in the first half of the year, and Growth coming back in the second half. During the fourth quarter, the Russell 1000 Growth Index continued its modest momentum, outperforming the Russell 1000 Value Index by 1.29%. The increased investor appetite for risk also helped Small Caps outperform Large Caps. Equity investors also signaled optimism on the back of modest increases in leading economic indicators and the eleventh hour extension of the Bush tax cuts. As a result, consensus GDP estimates for 2011 have been increased from 2.5% to 2.6%, with many forecasting growth much higher than 3%. Indeed, expectations are such that our domestic markets outperformed both the MSCI EAFE and the MSCI Emerging Markets Indices in Q4.

The fourth quarter also witnessed an acceleration of the long expected rise in interest rates. However, the Federal Reserve remained committed to its near-zero Federal Funds Rate, and the yield curve rose largely at the intermediate to long end. Ironically, the Federal Reserve's "QE2" program (whereby Treasurys would be purchased in the hopes of lowering interest rates) was the likely catalyst for the rate bump. An obvious consequence of rising fixed income yields was the poor performance of fixed income securities relative to equities. The BarCap Aggregate U.S. Bond Index lost 1.30% and lagged the S&P 500 Index by 12.06%.

As for sector performance, Capital Goods, Machinery, Electrical Equipment, and Building Products all posted strong double-digit gains in Q4 concurrent with rising corporate capital expenditures and higher than expected economic growth. As for other sectors, performance was diverse with gains in Transports (Air Freight up 10.88%, Railroads up 13.32%, and Trucks up 16.87%), Materials (Metals & Mining up 22.59%, Steels up 22.02%, Fertilizers up 42.03%, and Forestry up 19.74%), and Energy up 21.48%.


With industrial output finding solid footing and an economic recovery gaining modest strength, we view upcoming quarters as positive for earnings growth. Yet, we hesitate to "swing for the fences" when European sovereign risks remain elevated, state and federal budgets are a mess, unemployment remains above 9% (and will be for some time), and corporate input costs are expected to rise. Typically markets price in these unknowns through higher volatility and lower valuation multiples. But with the Chicago Board Options Exchange Volatility Index (VIX) at 17.75* and the estimated 2010 P/E ratio for the S&P 500 Index at 14.7x, it appears that much of this uncertainty may not be discounted by the market.

We expect that capital expenditures will support demand as corporations continue to reinvest in operational efficiencies. With the savings rate of U.S. consumers stabilizing at 5.7% and a less volatile economic environment, retail spending may also find some support. Recent reports indicate that U.S. exports have steadily risen, thereby lending credibility to the view that the economic recovery is coming into its own. In an environment where inflation appears well contained and the Federal Reserve remains committed to a near-zero policy rate, we continue to have a positive bias toward equity markets in general, and U.S. markets in particular.



For the calendar fourth quarter, the Amana Income Fund slightly underperformed its Russell 1000 Value Index benchmark by 1.54%. The Fund produced a total return of 9.00% as compared with a total return of 10.54% for the benchmark, and 10.21% for the Morningstar Large Cap Value peer index. For the calendar year, the Amana Income Fund returned a healthy 12.21% as compared with 15.51% for the Russell 1000 Value Index and 13.65% for the Morningstar Large Cap Value peer group.

Portfolio Highlights

In the fourth quarter, there were no new names added to the portfolio. Purchases were sparse with modest increases in existing positions in Microsoft, Stanley Black & Decker, Bristol-Meyers Squibb and the French oil company Total. The fund sold its positions in Piedmont Natural Gas and Plum Creek Timber.

For the quarter, an underweighting in Energy detracted from relative performance, as did the portfolio's overweighting of the Health Care sector, which had lower than benchmark returns. However, performance was well supported by overweight positions in Industrials and Materials. This is reflected in the total return of the 20 topperforming stocks of which six were Industrials and seven were Materials companies.

For the calendar year, the overweighting in Health Care stocks was again the drag on relative performance, and the Energy sector takes much of remaining blame. BP, Total and Encana all suffered company specific events that acted to impair the performance of the portfolio. The Fund's investment managers continue to hold favorable views toward Total and Encana, however, and believe their long-term economics should provide investors satisfactory gains in the future. The Fund's position in BP was sold earlier in the year. Telecommunications are the Fund's bright spot, where relative overweighting provided investors with a 6.25% comparative annual return.



Encouraging signs in the relative performance of growthoriented stocks emerged during the six months to December 31, and during the fourth quarter in particular. For the quarter ended December 31, 2010, the Amana Growth Fund provided investors with a total return of 8.92%, and the Fund ended the year with a total return of 15.92%. These results are comparable to the Morningstar Large Cap Growth peer category, which returned 11.63% in the fourth quarter, and 15.53% for the calendar year. Relative to the Russell 1000 Growth Index, the Amana Growth Fund trailed by 2.91% in the quarter, and trailed a modest 0.79% for the year.

Portfolio Highlights

Urban Outfitters and ASML Holding were the only new names added to the portfolio in the fourth quarter. In keeping with its traditional overweighting in Information Technology, the Fund added to existing positions in Hewlett-Packard, Adobe Systems, and IBM (in addition to the new position in ASML Holding). Other additions to existing positions included American Eagle Outfitters and Canon. Relative to the Russell 1000 Growth Index, the Fund remains overweight in Health Care and in Information Technology. Relative to the benchmark, some notable sector underweights include Financials (no exposure due to policy constraints), Industrials, and Energy.

From a relative performance perspective, sector allocations were positive for Information Technology, Telecommunications, and Materials, but negative for Industrials and Energy. Materials was the best performing sector with Teck Resources, Anglo-American, and Rio Tinto all producing excellent returns. A fair number of Technology companies also had outstanding results, including Cree, Sandisk, Taiwan Semiconductor and Oracle. Securities that detracted from shareholder value in the quarter included: Best Buy, Cisco, and Rogers Communications.

For the year, the Amana Growth Fund modestly lagged the performance of the Russell 1000 Growth Index by 0.79% largely as a result of the Fund's performance in the fourth quarter. We note that selection bias within the Energy sector was a significant contributing factor, with well performing oil service stocks absent from the Fund's portfolio. BP also detracted from performance as a result of its Macondo oil spill. On the opposite side of the ledger, positions contributing positively to performance included a number of Information Technology companies such as Akamai, Gartner, Sandisk, and Intuit as well as Industrials such as LAN Airlines, Gentex, and Trimble Navigation.



Consistent with its large cash holdings, the Amana Developing World Fund's returns paled in comparison to the other Amana Funds. In the fourth quarter, the Amana Developing World Fund had a total return of 1.78%. This compares unfavorably to the MSCI Emerging Markets Index, which returned 7.37%, and the Morningstar Emerging Market peer group, which returned 7.10%. For the calendar year, the Amana Developing World Fund delivered a total return of 5.63% versus a total return of 19.04% for the MSCI Emerging Markets Index and 19.23% for the Morningstar Emerging Market peer group. The Fund's cash level remains well above industry average, and this adversely impacted relative performance as equity markets rose.

Portfolio Highlights

New positions added to the portfolio in the fourth quarter include Kalbe Farma, one of the largest regional pharmaceutical firms in Southeast Asia; Gedeon Richter, an Eastern European pharmaceutical firm focused on generics; and Freeport-McMoran Copper and Gold. Management also added to several existing positions including: Genpact, Impala Platinum Holdings, Southern Copper, Colgate-Palmolive, Enersis, Vale, Anglo-American, Telekomunikasi Indonesia, Millicom International Cellular, China Mobile, Tenaris and Cia de Concessoes Rodoviaria. The Fund disposed of its positions in China Education Alliance and China Natural Gas.

For the quarter, performance was blemished by the Fund's overweighting in the Telecommunication Services and Information Technology sectors. Both sectors posted sub-benchmark returns. The Fund's slight underweighting in Consumer Discretionary names also detracted from performance, though this was partly offset by well performing stock selections in this sector. Nevertheless, the Amana Developing World Fund benefited from an overweight position in Materials, strong security selection in Consumer Staples and support from Industrials. This can be seen in the performance of Dr. Reddy's, Mead Johnson Nutrition, and Colgate-Palmolive.

The calendar year told a similar story, with the Amana Developing World Fund's 5.63% total return supported primarily by overweighting in Materials and adept selection of Information Technology and Industrials shares.

* The VIX 20-year high of 89.53 occurred in 2008, and the 20-year average is 20. Shaw, Richard. Seeking Alpha. February 16, 2010. http://seekingalpha.com/article/188846-price-probability-at-historic-high-and-low-vix

Q4 2010 Performance

Average Annual Total Returns (Before Taxes) 1 Year 3 Year 5 Year 10 Year
As of December 31, 2010
Amana Income 12.21% 1.98% 7.97% 6.66%
S&P 500 Index 15.06% -2.85% 2.29% 1.41%
Amana Growth 15.92% 2.58% 6.94% 5.86%
Russell 2000 Index 26.86% 2.22% 4.48% 6.37%
Russell 1000 Index 16.13% -2.36% 2.62% 1.86%
Amana Developing World Fund¹ 5.63% N/A N/A N/A
MSCI Emerging Markets Index 19.04% -0.16% 12.90% 15.58%

As of the Funds' most recent Prospectus dated September 3, 2010, the expense ratios were 1.26% for Amana Income, 1.21% for Amana Growth, and 1.59% for Amana Developing World.

Please consider an investment's objectives, risks, charges and expenses carefully before investing. For this and other important information about the Amana Funds, please obtain and carefully read a free prospectus from www.amanafunds.com or by calling toll-free 888/73-AMANA.

Distributor Saturna Brokerage Services, a wholly-owned subsidiary of Saturna Capital Corporation, investment adviser to the Amana Funds and Member FINRA / SIPC.

Performance data quoted herein represents past performance and does not guarantee future results. The investment return and principal value will fluctuate. Shares of the fund, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than performance data quoted herein. Returns do not reflect the potential deduction of a 2% redemption fee on shares held less than 90 calendar days which if applied would have lowered quoted returns. The Funds cannot guarantee that their investment objectives will be met. Securities of the Fund may only be sold by offering the Fund's prospectus. The Russell, S&P 500, and Morgan Stanley ("MSCI") indices are widely recognized indices of common stock prices which reflect no deductions for fees, expenses or taxes. Investors cannot invest directly in the indices.

¹ The Amana Developing World Fund began operations September 28, 2009.

A Fund's performance depends primarily on what happens in the stock market. The market's behavior is often volatile, particularly in the short-term and in periods of unusual market occurrences. Because of this, the value of your investment will rise and fall, and you could lose money. For performance current to the most recent month-end, please ask your representative, visit our Average Annual Returns Page or call us toll-free at 888/73-AMANA (888-732-6262).

A Few Words About Risk

By diversifying its investments, each Fund seeks to reduce the risk of owning only a few securities. Diversification does not assure a profit or protect against a loss in a declining market. The Growth Fund typically invests in smaller and less seasoned companies than the Income Fund, which may lead to greater variability in the Growth Fund's returns. Growth stocks, which can be priced on future expectations rather than current results, may decline substantially when expectations are not met or general market conditions weaken.

The Funds may invest in non-U.S. companies and in foreign markets. Investing in foreign securities involves risks not typically associated directly with investing in U.S. securities. These risks include fluctuations in exchange rates of foreign currencies; less public information with respect to issuers of securities; less governmental supervision of exchanges, issuers, and brokers; and lack of uniform accounting, auditing, and financial reporting standards. There is also a risk of adverse political, social or diplomatic developments that affect investment in foreign countries.

Islamic principles restrict the Funds' ability to invest in certain stocks and market sectors, such as financial companies and fixed-income securities. This limits opportunities and may increase risk.

Important Disclaimers and Disclosure

This report is intended only for the information of the reader, and is not to be used for or considered as an offer or the solicitation of an offer to sell or buy any securities or other financial instruments of any kind, including without limitation, any mutual fund or other product offered, sponsored, created, or managed by Saturna Capital Corporation or its subsidiaries or affiliates ("Saturna"). This report is not intended for distribution to, or use by, any person or entity who is a citizen or resident of, or located in, any locality, state, country, or other jurisdiction in which such distribution, publication, availability, or use would be contrary to law or regulation or which would subject Saturna to any registration or licensing requirement within such jurisdiction.

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Past performance does not imply or guarantee future performance, and no representation or warranty, express or implied is made regarding future performance. The price, and value of, and income from, any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of foreign securities and financial instruments is subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities or financial instruments. Investors in securities such as ADRs — the values of which are influenced by currency volatility — effectively assume this risk.