2014 is Saturna Capital's 25th Anniversary

Values-Based Global Equity Managers Contact1-800-728-8762

Following the Principles of Islamic Finance

Quarterly Commentary

Q3 2013 · September 30, 2013


Despite the global market weakness experienced last June, "Sell in May and Go Away" would not have been valuable advice this year as markets rebounded smartly in the third quarter, with growth indices performing especially well.

Last quarter we discussed the Federal Reserve's announcement concerning quantitative easing (QE) tapering and how such a development might influence markets. While our conclusions were sanguine regarding the potential effect of the removal of extraordinary monetary policy (After all, wouldn't that indicate a strengthening economy?), the implementation now appears further away than we might have anticipated last July. For one thing, the Fed has awakened to the fact that its profligate printing over the past several years has flooded world economies in general, and emerging markets in particular, with cheap and easy money. The mere suggestion of pulling the monetary rug out from underneath these economies led to rapid declines in stock markets and currencies. In most instances these declines reversed sharply over the course of the third quarter as the perception that QE tapering was not close at hand gained ground. The initial negative market reaction and some uninspiring US economic statistics contributed to that perception. Fed Chairman Ben Bernanke may state that he runs monetary policy for the United States and not for the world, but surely he understands the weakness of that position given the global importance of the US economy and the existence of the phrase "carry trade." Just as surely, he understands the US does not exist in a vacuum and that problems in emerging markets have a way of rippling around the world, as seen with the Mexican currency crisis of 1994, the Asian currency crisis of 1997, and the Russian debt crisis of 1998.

Worried about getting paid in four weeks but not in six months?

But all of that is so third quarter. As we entered the fourth we were forced to ask, "How many bullets are in the revolver the government is currently pointing at its head in a twisted game of Beltway Roulette?" Once again the government was shut down — a development the equity markets initially took in stride, rising briskly the day the federal government "closed." Bond markets were equally relaxed (mostly). As the prospects for adult behavior and a resolution to this manufactured crisis receded, however, concerns mounted; especially as people began to question whether the actions of the House of Representatives truly concerned the Affordable Care Act or if they were setting the stage for a larger debacle over the debt ceiling. While the government shutdown was an inconvenience for many and a potentially significant problem for hundreds of thousands of government workers who had been furloughed and may or may not be paid (a category that does not include our elected representatives), it was survivable with only minor disruption to financial markets. Survivable unless you happen to be on an aircraft that falls out the sky because of a maintenance issue that wasn't spotted by one of the 3,000 Federal Aviation Administration safety inspectors who had been furloughed.¹

Failing to raise the debt ceiling (in other words, Congress failing to take the necessary steps to satisfy obligations it has itself incurred through the legislative process) would be an entirely different issue. The last time US default emerged as a possibility, Standard & Poor's lowered the country's credit rating from AAA to AA+, and the yield on 10-year Treasurys jumped 50 basis points before settling down once the ceiling was raised. Recent political activities have given S&P the justification to say, "We told you so."

US Government 10-Year Generic Treasury Yield

While the bond market has yet to register significant concern (although it's interesting to note that the yield on four-week Treasury bills has moved above the yield on six-month bills), that is unlikely to remain the case as we near the projected October 17 date when the treasury's extraordinary accounting measures will be exhausted and the government's borrowing authority halted. The inability to borrow does not imply immediate default as the government has cash on hand and can still collect revenue. It would only be a matter of days, however, before bills went unsettled. Whether that would initially include missed payments on US-government-issued debt is unknown, but such a development would immediately mark the nation's transition from deadbeat to default. And it would be a disaster.

As the United States Treasury noted in a report released October 3, 2013:

A default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, US interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.²

Of course, there are those who argue the debt ceiling, created by Congress in 1917, is a gimmick that could easily be circumvented by another gimmick, such as the treasury minting a trillion dollar platinum coin.³ While possibly a work-around, that hardly seems a viable solution, and it would do little to enhance the standing of the US government. We fervently hope the issue will have been resolved by the time this report goes to press. There are only so many times one can pull the trigger before somebody gets shot.

Amana Income (AMANX)

As of September 30, 2013

Ten Largest Contributors Return Contribution
Rockwell Automation 29.30% 0.56
Nike, Class B 14.45% 0.39
Emerson Electric 19.41% 0.34
PPG Industries 14.53% 0.30
Air Products & Chemicals 17.15% 0.28
Carlisle 13.17% 0.27
Parker Hannifin 14.46% 0.27
United Technologies 16.60% 0.27
Illinois Tool Works 10.86% 0.26
Total ADS 20.58% 0.26
Ten Largest Detractors Return Contribution
Kellogg -7.87% -0.16
McCormick & Co. -7.59% -0.11
Exxon Mobil -4.11% -0.09
Intel -4.44% -0.09
Taiwan Semiconductor -4.86% -0.08
Microsoft -2.84% -0.07
PepsiCo -2.11% -0.05
Kimberly-Clark -2.16% -0.04
Abbott Laboratories -4.47% -0.04
Canadian National Railway -1.53% -0.04
Top Ten Holdings Portfolio Weight
Nike Class B 3.0%
W.W. Grainger 2.6%
Illinois Tool Works 2.6%
Bristol-Myers Squibb 2.5%
Colgate-Palmolive 2.4%
Honeywell International 2.3%
Rockwell Automation 2.3%
Novartis ADS 2.3%
Pfizer 2.3%
Canadian National Railway 2.3%

Asset Weighted Average Debt to Market Cap: 17.5%

In the third quarter Amana Income Fund performed well, rising 5.89% versus a 5.24% increase in the S&P 500 and a 3.94% gain in the Russell 1000 Value Index. Year-to-date the fund has gained 18.95% versus 19.79% for the S&P 500 and 20.50% for the Russell 1000 Value Index.

Despite another strong performance by the financials sector, the largest sector in the Russell 1000 Value Index, the Amana Income Fund outpaced the benchmark due to solid stock selection, especially among our industrial and materials positions, such as PPG Industries, Air Products, United Technologies, and others. Our industrials exposure stands significantly higher than the benchmark, so it's an important sector to get right. Our energy investments, led by ConocoPhillips and French oil major Total, also did well, as did the fund's consumer discretionary stocks with a strong contribution from Nike.

Consumer staples and technology stocks constituted our most significant detractors during the quarter. In most cases we have confidence in our investment thesis and must remember that stock markets and prices do not move in a linear fashion. In one or two other cases we are rigorously testing our investment thesis to determine if it remains accurate.

Amana Growth (AMAGX)

As of September 30, 2013

Ten Largest Contributors Return Contribution
Apple 21.16% 0.68
Akamai Technologies 21.50% 0.45
ASML Holding 24.85% 0.44
Amgen 13.96% 0.41
Adobe Systems 14.00% 0.41
Agilent Technologies 20.13% 0.38
Harris 21.29% 0.36
PetSmart 14.09% 0.31
Trimble Navigation 14.23% 0.31
TJX Companies 12.95% 0.29
Ten Largest Detractors Return Contribution
Potash Corp. Of Saskatchewan -16.29% -0.26
Monster Beverage -14.02% -0.21
Intel -4.44% -0.09
LATAM Airlines ADS -12.91% -0.09
Urban Outfitters -8.58% -0.08
Cisco Systems -2.99% -0.07
Church & Dwight -2.25% -0.06
International Business Machines -2.61% -0.06
PepsiCo -2.11% -0.05
EMCOR -3.60% -0.05
Top Ten Holdings Portfolio Weight
Google 3.6%
Apple 3.4%
Adobe Systems 3.2%
Amgen 3.1%
Intuit 2.6%
Qualcomm 2.6%
Johnson & Johnson 2.5%
Akamai Technologies 2.5%
TJX Companies 2.4%
Trimble Navigation 2.4%

Asset Weighted Average Debt to Market Cap: 12.3%

The Amana Growth Fund gained 6.63% in the third quarter, outpacing the S&P 500's 5.24% rise, but lagging the 8.11% pick-up in the Russell 1000 Growth Index. Year-to-date the fund has gained 12.50% versus 19.79% for the S&P 500 and 20.87% for the Russell 1000 Growth Index.

The Amana Growth Fund's greatest exposure is in the technology sector, which performed well in the quarter and had a significant effect on the fund's performance, as six of the top ten contributors were technology stocks. Apple, which has not been a rewarding investment over the past year, sank below $400 at the end of the second quarter but staged a solid rally in the third quarter, which saw the release of the iPhone 5. Akamai, ASML, and Adobe were the other top technology stocks. Stock selection was also good among our consumer discretionary investments, with rearview mirror producer Gentex and retailers TJX, Lowe's, and PetSmart all enjoying solid gains.

Across the fund, allocation effect was positive in the quarter relative to the benchmark but was offset to an extent by poor performance among a few of our investments. Most significant was Potash Corp., which suffered a steep drop in late July due the collapse of a pricing cartel in Eastern Europe. Regardless of that development, the world will need more food, and global climate change will likely mean that it needs more fertilizer as well, conditions that are supportive of our long-term investment in Potash. Monster Beverage was the other key detractor. After a difficult 2012 that included worries of Food and Drug Administration investigations into the potential health risks of energy drinks, Monster had staged a solid rebound this year until lackluster sales growth in the second quarter disappointed investors.

Amana Developing World (AMDWX)

As of September 30, 2013

Ten Largest Contributors Return Contribution
Baidu ADS 64.16% 1.18
MercadoLibre 25.33% 0.74
Alamos Gold 28.89% 0.45
M. Dias Branco 21.22% 0.41
CNOOC ADS 22.43% 0.38
Aspen Pharmacare Holdings 14.13% 0.32
Freeport-McMoRan Copper & Gold 21.12% 0.32
Telenor 15.86% 0.31
AutoNavi Holdings ADS 23.53% 0.26
Petroleo Brasileiro ADS 15.42% 0.19
Ten Largest Detractors Return Contribution
Semen Indonesia -33.32% -0.67
Kalbe Farma -28.13% -0.54
Bangkok Dusit Medical Services -20.39% -0.49
Jasa Marga -24.61% -0.42
Telekomunikasi Indonesia ADS -15.04% -0.36
LATAM Airlines ADR -23.92% -0.33
Quimica Y Minera Chile ADS -24.38% -0.29
KPJ Healthcare -12.67% -0.23
Robinson Department Store -18.44% -0.23
Advanced Info Service -20.15% -0.18
Top Ten Holdings Portfolio Weight
MercadoLibre 3.6%
Baidu ADS 2.9%
Aspen Pharmacare Holdings 2.5%
Telenor 2.4%
M. Dias Branco 2.3%
VF 2.3%
Western Digital 2.2%
Dr. Reddy's Laboratories ADS 2.2%
Danone ADS 2.1%
Ford Otomotiv Sanayi 2.1%

Asset Weighted Average Debt to Market Cap: 15.3%

Year-to-date the Amana Developing World Fund has eked out a small gain of 0.19%, while the MSCI Emerging Markets Index has dropped 4.35%. The differential between the two narrowed in the third quarter as our regional allocation held back fund performance, with the fund gaining 1.61% against the benchmark return of 5.77%.

The two top performers in the quarter were both technology stocks: Baidu (China's Google) and MercadoLibre (South America's eBay). Baidu is a classic example of why we adhere to our investment approach. From April 2012 through the first half of this year, Baidu shares struggled, dropping almost continuously. We had confidence in our thesis and maintained the position, even adding to it as the share price fell. Then, between early July and the end of September, the share price leapt over 60%. It rose almost 40% in July alone. Had we decided to sell the position earlier with the idea of getting back in when we thought the time was right, would we have caught that move? Almost certainly not.

We have written extensively about Southeast Asia this year and have every confidence in our long-term investment thesis for the region. Emerging markets, however, can be volatile, and investors must be patient. Certainly that was the case in the third quarter because eight of our 10 poorest-performing stocks are located in Indonesia, Thailand, or Malaysia. Indonesia was particularly hard hit, with stock market weakness exacerbated by currency depreciation. For several years, cheap and plentiful dollars and the search for yield have led to significant emerging market capital inflows, an example of the aforementioned "carry trade." Fear of the end of quantitative easing has led to a reversal of some of those flows and a fair amount of investor panic in various emerging markets, including India, Brazil, and Southeast Asia. In some instances, India and Brazil for example, we are equally concerned. In the case of Southeast Asia, however, we view the recent sell-off as a buying opportunity.

Please note: On September 25, 2013, Saturna Capital introduced Institutional Class Shares for each of the Amana Funds. Investors holding $100,000 or more in an individual Amana fund may register to transfer their shares to the institutional class; the key benefit of which will be a 0.25% reduction in fees.


¹ http://www.providencejournal.com/breaking-news/content/20131002-faa-inspector-worries-about-long-term-effects-of-shutdown-on-air-safety.ece

² http://www.treasury.gov/initiatives/Documents/POTENTIAL%20MACROECONOMIC%20IMPACT%20OF%20DEBT%20CEILING%20BRINKMANSHIP.pdf

³ http://www.nytimes.com/roomfordebate/2013/10/02/can-obama-ignore-the-debt-ceiling/government-doesnt-have-to-borrow-to-spend

As of September 30, 2013

Scroll right to see more » »

Average Annual Total Returns (Before Taxes) 10 Year 5 Year 3 Year 1 Year Expense Ratio
Amana Income Investor Shares (AMANX) 11.89% 10.10% 13.16% 21.20% 1.19%
Amana Income Institutional Shares (AMINX)¹ n/a   n/a   n/a   n/a   0.94%
S&P 500 Index 7.56% 10.01% 16.25% 19.34% n/a
Russell 1000 Value Index 7.96% 8.85% 16.24% 22.33% n/a
Amana Growth Investor Shares (AMAGX) 11.03% 9.00% 10.17% 12.53% 1.11%
Amana Growth Institutional Shares (AMIGX)¹ n/a   n/a   n/a   n/a   0.86%
S&P 500 Index 7.56% 10.01% 16.25% 19.34% n/a
Russell 1000 Growth Index 7.81% 12.05% 16.92% 19.27% n/a
Amana Developing World Investor Shares (AMDWX)² n/a   n/a   0.03% 2.00% 1.54%
Amana Developing World Institutional Shares (AMIDX)¹ n/a   n/a   n/a   n/a   1.29%
MSCI Emerging Markets Index 12.79% 7.22% -0.33% 0.98% n/a

Scroll right to see more » »

Expense ratios shown are as of the Funds' most recent Prospectus dated September 25, 2013.

Performance data quoted represents past performance, is before any taxes payable by shareowners, and is no guarantee of future results. Current performance may be higher or lower than that stated herein. Performance current to the most recent month-end is available by calling toll-free 888/73-AMANA or visiting Month-end Performance. Average annual total returns are historical and include change in share value as well as reinvestment of dividends and capital gains, if any. The 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. Shares of a Fund may only be offered for sale through the Fund's prospectus or summary prospectus.

The S&P 500 is an index comprised of 500 widely held common stocks considered to be representative of the US stock market in general. The Russell 1000 Growth Index measures the performance of the large-cap growth segment of the US equity universe. It includes those Russell 1000 Index companies with higher price-to-book ratios and higher forecasted growth values. The Russell 1000 Value Index measures the performance of the large-cap value segment of the US equity universe. It includes those Russell 1000 Index companies with lower price-to-book ratios and lower expected growth values. The MSCI Emerging Markets Index, produced by Morgan Stanley Capital International, measures equity market performance in over 20 emerging market countries. When available, Saturna uses total return components of indices mentioned. Investors cannot invest directly in the indices.

¹ Institutional Shares of the Amana Funds began operations September 25, 2013, and consequently have no returns to report.

² The Amana Developing World Fund began operations September 28, 2009.

A Few Words About Risk

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 www.amanafunds.com, or call us toll-free at 888/73-AMANA (888-732-6262).

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-US companies and in foreign markets. Investing in foreign securities involves risks not typically associated directly with investing in US 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 investmentor 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.

All material presented in this report, unless specifically indicated otherwise, is under copyright to Saturna. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied, or distributed to any other party, without the prior express written permission of Saturna. Unless otherwise indicated, all trademarks, service marks, and logos used in this report are trademarks or service marks of Saturna.

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 adviser prior to making 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 US 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, 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, which 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.

Carry trade: An investment strategy that attempts to profit from borrowing money in currency with low interest rates in order to invest in assets denominated in a currency with higher interest rates. In this strategy, the investor takes advantage of interest rate differentials but assumes the risk that the currency values may experience adverse fluctuations that can diminish or reverse the potential gain of "carrying" the foreign-denominated assets.