Q3 2011 · September 30, 2011
The equity market rallied strongly into the end of the second quarter of 2011, and this trend initially continued into the current quarter. The S&P 500 quickly posted a 2.5% gain, going from 1,320 to 1,353, and then remained in a relatively calm and tight trading range.
This changed, however, as the market gave away to heavy selling pressure heading into the month of August. A steady flow of negative news out of Europe added to the shock of Standard & Poor's downgrade of U.S. debt from AAA to AA+ and was the main cause of much of the selling. At the outset selling pressure was quick and volatile, often accompanied by heavy volume. At its trough, the S&P 500 closed down -14.38% before retracing some of its losses, finally closing down -5.43% for the month of August.
September did not fare any better as the market continued to whip around headline news coming out of Europe and the lack of policy action by the Federal Reserve. However, it was encouraging, despite the volatility, that three of the major U.S. indices — S&P 500, Dow Jones Industrials, and NASDAQ Composite — all held their respective August lows.
Among the major equity sectors, Technology fared much better than one would expect during a market correction. The bounce from the August low saw Technology retrace much of its losses, and it lagged only two other sectors — Consumer Staples and Utilities — which are often thought of as defensive sectors.
The worst performing sector was Materials, down -24.52% for the quarter. This was followed closely by Financials (-22.79%), Industrials (-21.02%), and Energy (-20.46%) as the deep cyclical sectors were disproportionately punished due to the growing fear of a double dip recession.
With the market correcting -17.27% from the top this quarter, equities are starting to offer better valuations for long-term investors. We continue to maintain a view that the U.S. economy will continue to grow, albeit at low levels. However, Europe remains a wild card. How the sovereign debt crisis resolves itself will have significant influence on how our economy performs, and the extent of this impact is difficult to quantify.
Aside from the economic implications, headline risk from Europe matters because it has caused overall market volatility to increase, and during volatile times all securities tend to trade in same direction — their correlation tends to head toward 1. This phenomenon can hurt bottom-up value managers since their holdings tend to follow the market down despite attractive valuations and strong underlying fundamentals.
However, if European leaders are able to find a tenable long-term solution to the current problem, this will remove a significant risk premium from the market. Individual securities should then decouple from the overall market, and their share prices should better reflect their business dynamics. Further, the Federal Reserve's continued commitment to hold both short-term and long-term rates low should be supportive of equity valuations once European fiscal and monetary headline risks dissipate.
AMANA INCOME FUND
For the calendar quarter ended September 30, 2011, the Amana Income Fund had a total return of -14.15% as compared with -13.87% for its S&P 500 Index benchmark. The Amana Income Fund underperformed the S&P 500 Index by 118 basis points for the one-year period. For the three years ended September 30, 2011, the Fund outperformed the S&P 500 Index by 7.89%.
In the third quarter, Amana Income made modest portfolio adjustments to reduce the Fund's exposure to the Materials and Energy sectors, in part due to a shift in company-specific fundamentals, and also as a result of changes in overall market sentiment. Aside from these sectors, of note is the Fund's disposition of its entire position in McGraw-Hill. It was sold due to concerns over its rising political risk: Standard & Poor's is a division of McGraw-Hill, and following its downgrade of the country's creditworthiness, it has become the object of much scrutiny. Other notable names that were sold include Arch Coal (Materials), Rio Tinto (Materials), Energen (Energy), and BHP Billiton (Materials). The Fund added to its position in Emerson Electric during the quarter.
Despite reducing its weight in the Materials sector, the Amana Income Fund remains overweight relative to the S&P 500 Index. The other significant overweight is Industrials. The Fund continues to be underweight the Information Technology sector.
Best performers were dominated by defensive names in the Consumer Staples and Health Care sectors. Bristol-Myers Squibb, Kimberly Clark, General Mills, and Colgate-Palmolive were among the best performing names. The laggards included cyclicals such as US Steel, Tenaris, and Freeport-McMoRan Copper and Gold, as well as the German chemical company BASF.
AMANA GROWTH FUND
Market volatility in the third quarter of 2011 highlighted Amana Growth's value orientation as the Fund posted strong relative performance. For the calendar quarter ended September 30, 2011, the Amana Growth Fund had a total return of -13.36%, outperforming its S&P 500 Index benchmark by 51 basis points. For the one-year period, the Amana Growth Fund underperformed the S&P 500 Index by -3.68%. For the three-year period ended September 30, 2011, the Fund outperformed the S&P 500 Index by 8.42%.
In the third quarter, Amana Growth made portfolio adjustments that resulted in a decrease in the Fund's exposure to some deep cyclical sectors. As with the Amana Income Fund, McGraw-Hill was sold entirely and the Fund also decreased its allocations to the Materials and Consumer Discretionary sectors. In these sectors, sales included Teck Resources, CONSOL Energy, Noble, and Rio Tinto. The Fund also sold American Eagle Outfitters and Coach, which brought our Consumer Discretionary allocation to 11.86%, compared to 10.69% for S&P 500.
Another notable name that was sold was China Mobile. The entire position was sold upon our return from a recent research trip to China, during which we met with China Mobile's management and confirmed the company's purchase of 20% of Shanghai Pudong Bank. Shanghai Pudong does not fit strategically with China Mobile's long-term growth prospects, nor does it comply with Amana Growth's investment mandates.
We are comfortable with the business fundamentals and capital liquidity of the remaining companies in Amana Growth's portfolio. Their ability to execute their business plans appears to remain solid, and earnings guidance continues to suggest as much. They should be well positioned to endure the current bout of market volatility.
Following modest defensive trades, the Fund remains overweight Information Technology, and consistent with its investment mandate, continues to have no exposure to the Financials sector. It is also underweight the Energy sector.
As with the Amana Income Fund the best performers for the third quarter were dominated by defensive names such as Church & Dwight, TJX, Eli Lilly and Clorox. However, a number of technology-oriented firms also provided support. These included Apple (the best performer among the holdings), Amazon.com, IBM and Google. Laggards included Agilent and Hewlett-Packard, both of which had poor earnings relative to guidance and a shake-up in the executive suite. The decline in energy prices also saw some oil and gas names sell off. These included Encana and Suncor Energy.
AMANA DEVELOPING WORLD FUND
Most emerging markets suffered disproportionately from recent global sell-offs as increased volatility forced investors to reassess their risk appetite. During market volatility, emerging economies tend to be affected much more deeply than advanced economies since most of the developing world's capital markets are relatively small and illiquid. Once investors decide to sell their emerging markets exposures, lower levels of liquidity in these markets tend to exaggerate selling pressure due to an absence of buy-side bids. During the quarter, the Amana Developing World Fund was down -10.78% as compared with -22.49% for the MSCI Emerging Markets Index. The Developing World Fund's 11.70% outperformance relative to the index has also positively impacted longer-term performance. The Fund's one-year return was an impressive 6.55% in excess of its MSCI Emerging Markets benchmark.
Amana Developing World Fund came into the quarter with a significant cash position, and as a result experienced less volatility than many of its peers. With some of the available capital, the Fund took advantage of market volatility to initiate new positions and add to existing positions at attractive valuation levels.
Specifically, we initiated a position in Total Access Communication, a leading cellular service provider in Thailand. We also added to the Fund's position in LAN Airlines, the largest Latin American airline, as well as Turk Telekomunikasyon, Alamos Gold, VF Corp, Sasol, and Kalbe Farma. These companies operate solid, long-term business franchises in their respective markets and have operations located in fundamentally strong countries.
Given the low weighting of Health Care in the MSCI Emerging Markets Index benchmark (1.14%), it is not surprising that the Fund is overweight this sector. Even with its large cash reserve, the Fund is 4.81% overweight relative to the index. As with the other Amana Funds, the Amana Developing World Fund is underweight the Financial sector. This is significant as the Financials sector is by far the heaviest weighted sector in the MSCI Emerging Markets Index.
Best performers were diverse. The top performer was a Consumer Discretionary stock (VF Corp), followed by a number of companies in defensive sectors. These include Mead Johnson Nutrition (Consumer Staples), Colgate-Palmolive (Consumer Staples) and Telekomunik Indonesia (Telecommunications). Bottom performers, in terms of total return, included Basic Materials companies Tenaris, Freeport-McMoRan, Anglo American, and Southern Copper; and Energy companies Petro-Bras and Enersis; as well as holdings names spread across diverse sectors.
Top Ten Holdings
|Amana Income Fund|
|Procter & Gamble||2.1%|
|Other Portfolio Securities Mentioned|
|Freeport-McMoRan Copper and Gold||1.0%|
|Amana Growth Fund|
|International Business Machines||2.5%|
|Johnson & Johnson||2.1%|
|Other Portfolio Securities Mentioned|
|Church & Dwight||1.5%|
|American Eagle Outfitters||0.0%|
|Other Securities Mentioned|
|Shanghai Pudong Bank||0.0%|
|Amana Developing World Fund|
|Mead Johnson Nutrition||2.0%|
|LAN Airlines ADS||1.9%|
|Dr. Reddy's Laboratories ADR||1.5%|
|Total Access Communication||1.5%|
|Other Portfolio Securities Mentioned|
|Telekomunik Indonesia ADS||1.5%|
|Anglo American ADR||1.2%|
|Freeport-McMoRan Copper and Gold||0.8%|
|Petroleo Brasileiro ADR||0.6%|
Q3 2011 Performance
|Average Annual Total Returns (Before Taxes)||10 Year||5 Year||3 Year||1 Year|
|As of September 30, 2011|
|Amana Income||▲ 7.32%||▲ 3.78%||▲ 3.73%||▼ -0.04%|
|S&P 500 Index||▲ 2.81%||▼ -1.18%||▲ 1.23%||▲ 1.14%|
|Russell 1000 Value Index||▲ 3.36%||▼ -3.52%||▼ -1.53%||▼ -1.89%|
|Amana Growth||▲ 8.17%||▲ 2.82%||▲ 3.89%||▼ -2.54%|
|Russell 2000 Index||▲ 6.15%||▼ -1.01%||▼ -0.36%||▼ -3.53%|
|Russell 1000 Growth Index||▲ 2.93%||▲ 1.62%||▲ 4.69%||▲ 3.78%|
|Amana Developing World Fund¹||N/A||N/A||N/A||▼ -9.53%|
|MSCI Emerging Markets Index||▲ 16.01%||▲ 4.99%||▲ 6.44%||▼ -16.09%|
As of the Funds' most recent Prospectus dated September 9, 2011, the expense ratios were 1.21% for Amana Income, 1.14% for Amana Growth, and 1.61% 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.
Performance data quoted herein represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor's shares, 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
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