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Following the Principles of Islamic Finance

Quarterly Commentary

Q2 2011 · June 30, 2011


Following the run-up in equity prices in the first quarter, equity markets suffered as investors weighed the impact of a spate of natural disasters (the Japanese earthquake/tsunami, flooding in Australia, etc.), the turmoil of the Arab Spring, the anticipation of the end of the Federal Reserve's long-term asset purchases, and the lingering European sovereign debt crisis. These events conspired to erode investor confidence leading to a meager quarterly gain of 0.10% on the S&P 500 Index, a loss of -0.03% on the tech heavy NASDAQ and -1.61% on the small cap focused Russell 2000 Index. Not surprisingly, an investor flight to safety caused bonds to outperform in the quarter with the Barclay's Aggregate Bond Index returning 2.29% (2.72% for the year-to-June 30).

While the sell-off has been noticeable, it follows a 5.92% gain in the S&P 500 Index in Q1 2011. On net, equities have still provided investors with a reasonable 6.02% total return for the six months to June 30, 2011.

The European debt crisis has been a particular burden for the market in recent weeks, and the news has been very influential in the daily movement in the market. In some ways, it is both amusing and puzzling, as Greece's dire straits have long been known. Yet, as that country moves closer to the reality of a possible default, the market becomes increasingly sensitive. Be it with every protest or dire prediction, or any time a European official makes assurances of a Greek bailout package, the market moves to the beat of the loudest drum on any particular day.

For equities, the second quarter saw investors favor defensive stocks, with large caps outperforming small caps. Consistent with this defensive posture, sectors such as Health Care and Utilities outperformed while investors sold off cyclical sectors such as Mining and Steels and Technology. That being said, Deep Cyclicals and Technology saw the largest increases in revenues, with Utilities seeing revenues decline modestly (for the Q1 earnings season). The rise in stock prices for some of the defensive sectors such as Utilities was driven primarily by multiple expansions, with P/E ratios rising 5% for Utilities. In contrast, the Technology sector saw P/E ratios decline 4% in spite of stronger sales and earnings growth. Overall, for the Q1 earnings season, the S&P 500 Index saw sales increase 9.15% and earnings per share increase 19.62%.


As with our prior report, we once again highlight the Federal Reserve's continuing commitment to an accommodative monetary policy. All things equal, this is supportive of equity prices. The difference now is that the Federal Reserve has come to the end of its long-term asset purchases (known euphemistically as QE2). Going forward, it will be interesting to see how markets react to the absence of this overt monetary stimulus. Recent performance suggests that some of these risks are already being discounted into asset prices.

With fundamentals showing signs of continued (but modest) growth we believe stock prices should follow earnings up. The wild card, however, remains the prospect of significant exogenous risks such as those detailed above. As we have recently witnessed, they have the potential to separate stock prices from their underlying fundamentals. We add to this the investment community's very legitimate concerns on national debts, both here and abroad. In the case of the United States, the fiscal path the country is on is not sustainable. What the investment community needs is evidence that there is a credible plan to address the national debt issue. The lack of one creates a huge amount of uncertainty, and that is exactly what investors do not like. In the absence of certitude, we may witness investors continue to demand compensation in the form of lower asset prices, in spite of fundamentals.

While current and future portfolio holdings of the Amana Funds are subject to market risks, we note that the funds lack of direct exposure to Financials lessens the risk of a deleterious impact on the funds in the event of a sovereign debt crisis.



For the calendar quarter ended June 30, 2011, the Amana Income Fund had a total return of 2.16% as compared with 0.10% for its S&P 500 Index benchmark. The Amana Income Fund underperformed the S&P 500 Index by 1.09% for the one-year period. For three years ending June 30, 2011, the Fund outperformed the S&P 500 Index by 7.65%.

Portfolio Highlights

In the second quarter, Amana Income made additions to existing holdings in a broad range of sectors. Of some note was an increase in the Fund's position in McGraw-Hill (Consumer Discretionary), Microchip Technology (Information Technology), as well as the continued buildout of the McCormick (Consumer Staples) position initiated in Q1 2011. Of the $36 million in capital deployed in the quarter, 42.4% was allocated to stocks in the Information Technology sector and 20.0% was allocated to stocks in the Consumer Staples sector.

Despite the investment in Information Technology, the Fund remains underweight relative to the S&P 500 Index. Significant overweights include Industrials and Materials. The Fund also has significant exposure to the Consumer Staples and Health Care sectors, which are somewhat over benchmark weights.

Given the performance of the defensive sectors, it is not surprising that the Chilean utility Enersis SA was among the best performing stocks, lagging only Nike and BASF. Following closely behind was Johnson & Johnson and seven other health care names. Telecom companies Chunghwa Telecom, Telstra, and Telus also provided support as their strong cash-flowing, defensive, utility-like business models were rewarded by investors. Materials and Energy companies dominated stocks lagging in performance.

The only new addition to the portfolio during the second quarter was the purchase of a Malaysian government sukuk with a yield of 2.55%. Sukuk are negotiable, equity instruments with strong fixed income attributes, structured to provide income distributions in conformity with the prohibition of interest under Islamic principles. Sukuk make regular distributions of pass-through income, similar to a REIT, and are like equities in that investors own proportional interest in the trust in which the assets are held.



Investors' moves to de-risk did not favor growth oriented stocks. As a consequence, the Amana Growth Fund had a total return of 0.00% in the quarter. The Fund performed roughly in line with the S&P 500 Index,lagging only by 0.10% for the quarter. Year-to-date, the Amana Growth Fund returned 3.28%, while the S&P 500 Index returned 6.02%.

For the trailing twelve-month and three-year periods, the Amana Growth Fund had total returns of 26.85% and 17.68% as compared with 30.69% and 10.35%, respectively, for the S&P 500 Index. For the trailing five-year period, the Amana Growth Fund outperformed the S&P 500 Index by 24.13%.

Portfolio Highlights

No new positions were added to the Amana Growth Fund in the second quarter. Nevertheless, the Fund deployed nearly $100 million in capital (net of sales of securities) in existing names, with the Information Technology sector seeing the biggest additions. Positions were increased in SAP AG, Corning, Adobe, Qualcomm, Cisco Systems, Taiwan Semiconductor, and ASML Holdings. Health Care also saw significant increases as the Fund added to positions in Stryker, Johnson & Johnson, and Eli Lilly. Other additions included Canadian oil sands producer Cenovus Energy, consumer staples company Church & Dwight, Teck Resources, car parts maker Gentex, rail operator Norfolk Southern, and Regal Beloit. The firm greatly reduced its position in Turkcell Iletisim and closed its positions in Seagate Technology (poor results amid increasing competition) and Ritchie Brothers Auctioneers.

Relative to the S&P 500 Index, the best performing sector was Consumer Staples which supported positive relative return differentials. Other sectors performing well relative to the benchmark were Financials (underweight relative to benchmark), and Consumer Discretionary (Best Buy, Bed Bath & Beyond, and Coach). The Fund's large overweight in Information Technology proved to be a significant drag on relative returns in the quarter. Other laggards included, Materials (Teck Resources), and Energy (underweight relative to benchmark). Despite the performance, we remain true to our core beliefs about value investing and believe these firms have franchise values that will reward investors in the future.



As many emerging market countries grapple with inflation in the face of resilient consumption, moves to tighten monetary policy became increasingly noticeable, particularly in China. As a result, these markets have been characterized by the same defensive qualities as have been evident in developed countries. In the quarter, domestic markets outperformed emerging markets by 1.20% and outperformed by 5.20% year-to-date.

In the case of the Amana Developing World Fund, it outperformed in the quarter by 1.47% relative to the MSCI Emerging Markets Index as the Fund maintained its defensive position in cash. For the three months ended June 30, the Amana Developing World Fund had a total return of 0.37% as compared with to the MSCI Emerging Market Index which had a total return of -1.10%. Relative to the Morningstar Emerging Market peer universe having a -0.86% total return, the Fund outperformed by 1.23%.

Portfolio Highlights

New positions added to the portfolio in the second quarter included apparel manufacturer VF Corp, and engineering and motor manufacturer Nidec, both of whom source the majority of their production in emerging markets. The fund also added energy exploration and production company Pacific Rubiales (having its major asset base in Columbia), and Chinese internet travel company Ctrip.com. Aside from these, positions were increased in diverse sectors, including Brazilian homebuilder MRV Engenharia, Telecomunicacoes de Sao Paulo, potash miner Quimica y Minera de Chile, Malaysian health services provider KPJ Health Care, diversified miner Anglo American, pediatric victuals company Mead Johnson Nutrition, Chinese medical device manufacturer Mindray Medical, South African energy company Sasol, and palm oil company IOI Corp. The Fund disposed of its position in Mexican homebuilder Desarrolladora Homex over concerns on the state of the Mexican housing market.

As with domestic U.S. markets, investors in emerging markets sought out safer havens in the quarter. Though, in the case of the developing world, investors were slightly less risk averse as Financials significantly outperformed Utilities. As for the Amana Developing World Fund, its best relative performance was in the Industrials sector as strong stock selection offset poor performance within the sector (Nidec, Semen Gresik, LAN Airlines, and MRV Engenharia). The Fund also had good relative performance in the Consumer Staples (overweight) and Utilities sectors. With regard to the latter, Enersis SA was the primary driver of performance.

As for lagging sectors, Telecommunications added to shareholder return but lagged very strong returns in the MSCI Emerging Markets Index benchmark. Certainly, this suggests stock selection weighed on relative performance, but we are comfortable with the long-term performance potential of the existing portfolio assets. These include China Mobile, Millicom International, America Movil and MTN Group. Consumer Discretionary stocks also weighed on short-term performance. However, the biggest drain on quarterly performance was the Fund's underweight in the Financials sector. Financials had the strongest returns of all sectors within the MSCI Emerging Market Index, yet the Fund has difficulty investing in the sector due to investment policy restrictions relating to the Fund's religious mandate.

Top Ten Holdings

Amana Income Fund
Exxon Mobil 2.1%
Illinois Tool Works 2.0%
Rockwell Automation 2.0%
PepsiCo 2.0%
Canadian National Railway 2.0%
Nike 2.0%
Novartis ADR 2.0%
Carlisle 2.0%
Honeywell International 1.9%
Intel 1.9%
Total 19.9%
Other Securities Mentioned
McGraw-HIll 1.7%
Microchip Technology 1.6%
Johnson & Johnson 1.5%
Chungwha Telecom 1.4%
McCormick 1.1%
BASF 1.0%
Telus 0.4%
1Malaysia Sukuk 0.4%
Enersis 0.3%
Telstra 0.2%
Amana Growth Fund
Apple 3.1%
Coach 2.5%
Humana 2.4%
Potash Corp. of Saskatchewan 2.2%
Intuit 2.2%
Agilent Technologies 2.1%
Qualcomm 2.1%
International Business Machines 2.0%
PepsiCo 2.0%
Amazon.com 1.9%
Total 22.5%
Other Securities Mentioned
Johnson & Johnson 1.9%
Norfolk Southern 1.7%
Adobe 1.6%
Cisco 1.5%
Teck Resources 1.4%
Best Buy 1.2%
SAP 1.1%
Eli Lilly 1.1%
Cenovus Energy 1.1%
Church & Dwight 1.1%
Stryker 0.8%
Taiwan Semiconductor 0.7%
ASML Holdings 0.7%
Bed, Bath & Beyond 0.7%
Gentex 0.6%
Regal Beloit 0.6%
Corning 0.3%
Turkcell Iletisim 0.1%
Positions Closed
Ritchie Brothers Auctioneers 0.0%
Seagate Technology 0.0%
Amana Developing World Fund
KPJ Healthcare 2.1%
LAN Airlines ADS 2.0%
Mead Johnson Nutrition 1.9%
IOI Corporation 1.8%
Baidu.com ADR 1.8%
Colgate-Palmolive 1.7%
Dr. Reddy's Laboratories ADR 1.7%
Danone ADS 1.7%
Sasol ADS 1.7%
Millicom 1.6%
Total 18.0%
Other Securities Mentioned
MRV Engenharia 1.6%
Quimica y Minera de Chile ADS 1.6%
Anglo American ADR 1.6%
Telecomunicacoes de Sao Paulo ADR 1.5%
China Mobile ADS 1.5%
VF Corp. 1.4%
Semen Gresik 1.4%
Enersis ADS 1.4%
Pacific Rubiales 1.3%
MTN Group 1.3%
America Movil ADS 1.3%
Nidec ADR 0.7%
Mindray Medical 0.7%
Ctrip.com ADR 0.6%
Positions Closed
Desarrolladora Homex 0.0%

Q2 2011 Performance

Average Annual Total Returns (Before Taxes) 10 Year 5 Year 3 Year 1 Year
As of June 30, 2011
Amana Income 8.07% 7.37% 5.67% 29.60%
S&P 500 Index 2.72% 2.94% 3.34% 30.69%
Russell 1000 Value Index 3.99% 1.16% 2.28% 28.94%
Amana Growth 7.66% 6.92% 5.58% 26.85%
Russell 2000 Index 6.31% 4.08% 7.77% 37.41%
Russell 1000 Growth Index 2.14% 5.33% 5.01% 35.01%
Amana Developing World Fund¹ N/A N/A N/A 6.90%
MSCI Emerging Markets Index 16.07% 11.56% 4.40% 27.85%

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 or summary 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.

ยน 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.

This document should not be considered as providing investment advice or services, or any service offered by Saturna. Saturna may not have taken any steps to ensure that the securities referred to in this report are suitable for any particular investor. Saturna will not treat recipients as its customers by virtue of their reading or receiving the report.

Nothing in this report constitutes investment, legal, accounting or tax advice or a representation that any investment or strategy is suitable or appropriate to a particular investor's circumstances or otherwise constitutes a personal recommendation to any investor. Saturna does not offer advice on the tax consequences of any investment.

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The information in this report was obtained from sources Saturna believes to be reliable and Saturna believes the information and opinions in the material are accurate and complete as of the date of this material. However, information and opinions contained herein will change over time and without notice. Saturna has no obligation to update or amend any information or opinions at any time. Saturna makes no representations as to the accuracy or completeness of this material, nor does it have any responsibility to ensure that any other materials, including any containing materially different information, are brought to the attention of any recipient of this report.

Under no circumstances shall Saturna, its employees, or any affiliate, be responsible for any investment decision by any recipient. This material is distributed on condition that it will not form the sole basis for any investment decision by any recipient. Any recipient who is not a market professional or institutional investor should seek the advice of an independent financial advisor prior to taking any investment based on this report or for any necessary explanation of its contents.

Saturna does not provide tax, legal or accounting advice. Investors should consult their own tax, legal and accounting advisers before engaging in any transaction. In compliance with IRS requirements, recipients are notified that any discussion of U.S. federal tax issues contained or referred to herein is not intended or written to be used for the purpose of (A) avoiding penalties that may be imposed under the Internal Revenue Code; nor (B) promoting, marketing or recommending to another party any transaction or matter discussed herein.

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.