Q3 2020 Update
Vice President - Product Development Craig Churman and portfolio managers Monem Salam, Elizabeth Alm, and Patrick Drum discuss the most recent quarter along with a host of other topics.
Q3 2020 Update
Craig Churman: Good day to everyone. This is Craig Churman with Saturna Capital, and this is the next in our series of sustainable webinars. Today, I am excited to include three of our portfolio managers that will cover a wide range of information on how our strategies have been doing this year. We’ve actually had a very good year. And maybe a little peek under the hood in terms of some of the securities that have done well and a little bit on our process. But I was most excited about this webinar because we really started, earlier this year, talking about why strong balance sheets matter and I think I’m gonna hear a lot of that today in terms of the balance sheet and how that really helps our holdings, particularly in times of volatility. And we’ve had a real strong performance in some of our technology stocks. And everybody knows that technology has had a great run. So, we’ll start with Monem Salam, who is the lead PM on Amana strategies, particularly on Amana Income and Amana Developing World, who will also be able to share some insight on our Sustainable Equity strategy and Amana Growth. And then we’ll go on to Elizabeth Alm, who you know as both a portfolio manager on our Sustainable Bond strategy but as we did in one of the recent webinars, Elizabeth has a lot of insight into the impact of the strategies around it. And where we produce our ESG scores. And then we’ll wrap it up with Patrick Drum on the PM side, and Patrick will give some insights into the Amana Participation Fund and doing his 5-year victory lap, we just passed five years with that fund. And it’s been a great success in terms of its performance and the value it’s had for our clients. So, I’d like to start with Monem, and Monem is gonna walk through our equity strategies and give us some insights there. So, Monem, if you want to get started on our equity strategies?
Monem Salam: Thank you very much, Craig. And thank you, everyone, for joining on the call. What I’d like to do is I’ll start talking a little bit about the Amana Income Fund, move on to Growth, and then Developing World. As most of you know, or are probably familiar with, there was, earlier this year, a portfolio manager change. And so, Nick Kaiser, who has been managing both the Growth Fund and the Income Fund for quite a long time, in fact, for both of them, almost since their inception, actually stepped down from the PM position, became a Global Strategist, and still remains active in the firm but just not in the PM role. And so, myself, I took over the Income Fund and the Developing World. And Scott Klimo took over the Growth Fund and we’re cross Deputy Portfolio Managers on each of the different funds. So, we’ve been at this for a long time. We know what the strategy is supposed to be doing. And so, it’s a good transition point for us to be able to do that. So, starting off with our oldest fund, which you know probably, this year celebrating its 34th year, the Amana Income Fund. You know, the strategy basically... look at the objectives because it’s really important to be able to understand each of the fund’s objectives, and that’s what drives us to manage the way that we do in each of the portfolios that we have. So, the objective of the Income Fund is actually current income and capital preservation with a focus on current income. And that’s really, really important. So, what we’re doing here is, over the long run, our goal is to be able to, you know, try to preserve capital but really in the shorter term, it’s really looking for those companies that are paying higher dividends and we can buy them and then hold them for the long run.
Monem Salam: Now, what does that mean for us? You know, we typically look for companies that are paying dividends over and above the S&P 500 when we actually purchase them. And as many of you know, as a long-term advisors and shareholders in our funds, we don’t tend to trade a lot of equities within our portfolios and that’s by design. We like the companies that we purchase; we take our time doing it. But once we do, we let the companies germinate and really come to fruition of whatever our investment thesis was when we actually did it. So, specifically regarding the Amana Income Fund, you know, it is heavy in technology, also materials and those companies. But the technology is a little bit different because it’s actually in higher-yielding technology companies. So, we’ll own companies like Cisco and Microsoft—when we first bought it, it was actually a higher dividend—so those type of companies. We don’t own Apple or other, faster-growing companies because of the lack of dividends. That’s really reserved for the Growth Fund. I think throughout this year, I mean the strategy for all of the different funds actually worked out pretty well in the fact that both the Income Fund and the Developing World Fund, if you look at their protection on the downside earlier this year in March, that helped quite a bit. And so, not only did that happen in March also, but in August and September when the volatility was high, again, we were able to outperform. The Income Fund was close to 200 basis points above the benchmark, which in this particular case is the S&P 500. You know, looking forward, there’s always clouds on the horizon. But I think one of the things of particular note is, I mean... the pandemic is something that will be a consistent problem later on this year and into next year, as well. Not only about what the case counts are gonna be, but also how the vaccine is gonna work out, but you know, the market itself, in our opinion... the vaccine is gonna be a one-day event. But really, the distribution of the vaccine, globally, is really what’s gonna take more time than a lot of people are realizing. So, yes, we might be waiting for a V Day when the FDA announces a vaccine is approved, but then comes the real work, which is actually to get the distribution out there and be able to do it. So, a lot of the companies we own, pharmaceutical-wise, in the Income Fund, are actually geared toward that. So, the pharmaceuticals, the Johnson & Johnsons, the Eli Lillys. So, Honeywell for example. A large conglomerate. They actually make the vials to be able to have the distribution made. So, those are the types of companies we really look at. The main theme regarding the Developing World Fund kind of moving over to, you know, to that fund. You know, it started in 2009, looking at roughly about 11 years on the fund.
Monem Salam: Our strategy there is to be able to... the objective there is long-term capital growth and what we’re looking for is those companies that are in the emerging markets, obviously smaller, but faster-growing, being able to hold them and really go along for the ride as they penetrate into markets in the emerging markets. And some of them have actually graduated and they’re still in the emerging markets but now they’re beginning to get significant exposure in developed markets, as well. For example, Tencent can speak to that. You know, they have very popular games that are actually known and played worldwide from there. And again, the story here on the Developing World Fund... you know, I do think you can look at it from a decade-long perspective. The 2000s were very, very strong when it came to the developing world. The 2010s pretty much looked like, “Let’s write ‘em off.” Right? Even the MSCI EM was actually pretty much flat for the entire decade. But I do think that now comes the next decade, which is the 2020s, where I do think that you are gonna see not only the companies doing well but also a little bit of a shift in the strength of the dollar. We’ve had a fairly strong dollar over the past decade, and so I think there is some time for the dollar to weaken and when it does, I do think that the Fund will actually do well.
Monem Salam: And lastly, coming to the Growth Fund, which is our flagship... our largest fund. Again, keeping in mind that I am the Deputy Portfolio Manager on that, you know, I think that it’s had a great run and one of the major reasons why is because we’ve actually held onto the companies that we felt were gonna do well not over, you know, one cycle but over multiple cycles of whatever economic cycles we’ve had. And so, you know, holding onto Apple, holding onto Adobe, you know, those type of companies, really helped us quite a bit. Intuit is another one there. And so, on the Growth Fund, our objective is capital growth, right? We’re not really looking at any income. We’re not looking for dividends. And so, we’re really positioned in a way to be able to take advantage of that. Right? This past year, the stocks or companies we’ve owned—we own over 40% in the technology area—have actually done really well. Apple, right up to roughly about an 8% position, but we have other ones as well, including Adobe, which is kinda getting up there at about 7.5% of holdings also. Again, same kind of thing on all three funds strategies. We look at them on an overall basis. So, I think, with that, I’ll stop, turn it back over to Craig, and like I said, later if there are any questions, I’d be happy to be able to answer them.
Craig Churman: Yeah, Monem, I don’t know if you know this one but one of the names that I looked at, we have a pretty heavy concentration in tech, particularly in the Growth Fund. And Gartner was an example of one that’s really underperformed this year and that... their business, while it’s tech-related, was tied to the travel and events side, because they did so many... so we’ll look at it, and we like the company over the long-term, and it just hit a blip this year. And that would be an example of someone we’ll hold through the cycle because we’re really strong and the firm and the strategy and it fits nicely in our portfolio and it’s complimentary to the other tech stocks that we’ve been long for a long time.
Monem Salam: Thanks, Craig, and also the other part of it, which actually helps us long the cycles is investing according to Islamic principles and also ESG as well. And the reason is because we’re buying companies that are fairly low-debt and can ride out these cycles. So, if you’re seeing a company come out with announcements now... for example, AMC or Carnival Cruise lines and they’re saying they’re running out of cash and they need to be able to raise money or they’re not gonna be able to operate... You know, we’re owning companies that don’t necessarily have that problem because they’re not in debt and usually they have a fairly sizable cash position that can ride out any kind of a downdraft that you have in the economy.
Craig Churman: Very good. So now, I’m gonna turn it over to Elizabeth. Elizabeth is the Deputy on the Saturna Sustainable Bond Fund and she tends to interweave what we’re doing on the impact side with the Sustainable Bond. So, Elizabeth, if you can give us a little insight on how that fund is doing this year.
Elizabeth Alm: Absolutely. So, we’re really pleased to have recently published our Impact Report where you can see an in-depth look into our process and our KPIs, but really, our investment process continues to be fully integrated around ESG. We really do think that it provides a more complete understanding of future opportunities and risks compared to traditional fundamental analysis. The Fund’s strategy in global bonds means that we invest across the world and across currencies and so, really this in-depth look at sustainability is all the more important. In terms of parts of that that we’re focusing on through this crisis and through the challenges that we’re seeing with COVID, obviously credit fundamentals are really part, a huge part of our analysis.
Elizabeth Alm: But, as are the technical considerations of a bond portfolio. So, we’ve been really focused on current positioning, relative value, coupon structure, and for the global bond fund, this also includes currency diversification and movements. But, incorporating ESG’s risks and opportunities are just important to a lot of our goals for the portfolio of current income and capital preservation. We’ve been incorporating risks related to climate change but also reputational risks. For example, child labor in the supply chain. The tools that we’ve been using throughout the year, they include our proprietary ESG scoring model, we have a carbon risk model, but also a qualitative analysis of the investment. We’re looking trajectory, story, and of course, governance. The Impact Report, I really encourage everyone to take a look at that because it’s a great tool to use to understand our process and how we perform over time. For example, the Sustainable Bond Fund has around 75% less carbon intensity than the MSCI All World Index. In terms of performance, the main driver of positive performance in the first quarter for the Fund were really our positions in US Treasury Bonds. You saw the US yield curve experience a massive downward shift during the first three months of the year as investors flew to quality and as the pandemic hit. However, the second and third quarters, we really saw Treasury yields remaining stable and the fund returns were driven by a strong recovery of corporate yields and recovery of foreign currency positions relative to the US dollar. Over the past few months, we’ve expanded positions in the Euro and select floating-rate securities. In terms of some of the history, on March 23rd, you did see credit spreads of corporate bonds with their widest level since 2008, but since that time we’ve really seen a huge recovery as spreads tightened significantly, as a result of several factors, including a great deal of support from the Fed. In terms of the third quarter, you did see a change in sentiment. Non-investment grades corporate bonds saw the spreads widen over the quarter, especially in the BB range. Meanwhile, investment-grade corporate credit saw continued tightening, especially in the short end and we have benefited from that tightening. So, for the Fund, we continue to focus on purchasing holdings that are really well-positioned with strong cash flow and financial flexibility and that’s been our focus. We position the portfolio defensively, geared to withstanding an extended economic recovery or even possible a second wave of COVID.
Craig Churman: Thank you, Elizabeth. Maybe I’ll ask you this question, now, because it was gonna come up later. But I understand that we’re gonna do a separate Impact Report on the Amana Funds?
Elizabeth Alm: That is correct. That should be forthcoming soon, and then we’ll be able to provide a lot more detail on the Amana Funds, specifically, and how they compare to each other and also several benchmarks.
Craig Churman: Right, cause the Impact Report that we just published covers both Sustainable Equity and Sustainable Bond, but we’re doing a separate report that would just cover the Amana Funds.
Elizabeth Alm: That’s correct.
Craig Churman: I hear it’s very close to publication. Okay. And next, we’ll have Patrick Drum. Patrick will talk about the Amana Participation Fund and we do have a lot of investors in that fund, and a lot of advisors that support that, and we’ll congratulate Patrick because at the end of September, he celebrated the 5-year Anniversary of that fund. You know, fortunately we have Patrick on board to manage that and Elizabeth is the Deputy on that fund, so the two of them collaborate pretty closely on that fund.
Patrick Drum: Indeed. And thank you. Good morning to everyone. I want to thank each one of you for joining our call. Again, my name is Patrick Drum. I’m Portfolio Manager of the Amana Participation Fund. Elizabeth Alm is the Deputy and is regularly involved in providing sort of that depth, in-depth analysis. And it really helps elevate us to think about broader sets of risks. As Craig has mentioned, the end of the third quarter marked a significant and important milestone as it represents the Amana Participation Fund’s five-year anniversary. I cannot tell you how... it’s been quite a journey. A lot of fun, at that. I couldn’t be more humbled to have this opportunity, collectively. We are extremely pleased to share that the Fund surpassed over $130 million at the end of September. It’s a monumental accomplishment when you consider that the Fund began with like $5 million at the end of September 2015. I want to stress that the Amana Participation Fund is a reflection of our concerted team efforts and many, many late nights and early mornings to work with local communities either found in the Middle East—specifically the GCC—or Asia to either affect trades or obtain on-the-ground information. And while the Amana Participation Fund is the newest member of the Amana fund family, its success has been a family affair. So, the third quarter, getting everyone a little up to speed, in my mind has largely been quiet when compared to the first quarter and the onset of the second quarter, with the byproduct of the massive monetary and fiscal programs led by governments and social banks around the world. The size of these monetary programs are just really quite hard to fathom. Give you a couple of stats of things that caught my attention and all of our attention over this time period. In the six-month period ending mid-year of 2020, the combined balance sheets of the Federal Reserve and the European Central Bank have grown by 50%, up from $9.1 trillion to $14 trillion. Try to somehow wrap your head around that.
Patrick Drum: Oil, also during the first and second quarters, experienced considerable volatility and that was, a mild understatement, a bit of a fallout from the OPEC+ back in March whereupon Saudi engaged in a very aggressively supply glut and were now where we can actually say that not only are rates negative but oil has touched negative at one point. Even though, with all of the kind of challenges—and Monem was highlighting—there’s always going to be something on the horizon to potentially garner your attention or concern. As Elizabeth was highlighting some of our attention to reducing risks: we are taking defensive positions. And some of the ways we have been reducing volatility is by limiting our exposure in what are known as procyclical sectors that may experience greater financial strain during this broad economic downtown. Among some of these is that we are simply sidestepping real estate development companies, real estate operating companies, luxury companies, and tourism. And this is, in part, specifically talking more about the Amana Participation Fund because the regions of the world such as Dubai and so forth are very sensitive to GDP growth, tourism, and so forth. And these periods of financial stress do call for greater emphasis on what we view as countercyclical industries that can help protect investors through allocation of industries better positioned to weather this storm. This includes utilities, communications, consumer staples—an example would be food companies—you know? So, in addition to that we’ve retained a little bit of a higher of a cash balance just to help sort of stabilize the NAV of the fund. Nothing substantially of a real large positioning at this particular point. A little higher than average. But it’s just more of an added measure as we’re all sort of taking this anticipatory view of increased volatility coming into the election. And also, I expect a bit of this volatility to provide opportunities for other issues that I’ve been really keeping an eye and would rather acquire at more favorable prices. Just kind of providing, in addition to the United States and Europe, the Middle East in particular has also engaged in very similar large stimulus programs. The UAE, for example, rolled out, in March, a package—it’s equivalent to about $28 billion for both stabilizing companies and providing a variety of capital buffers for banks and so forth. Saudi Arabia rolled out similar programs of about the equivalent of $13 billion. Bahrain has already been spending well over half a billion to the private sectors in a way to help stabilize that region. Qatar has taken a little more of a longer-term strategic view of offering a $20 billion package over a 3-year period. Kuwait has followed similar aspects. And Indonesia has really been more interesting. They have really engaged in some very progressive monetary and legislative programs. Though they have suspended their constitutional amendment to retain a deficit ceiling of 3%, they have really provided measures that have been proven attractive to foreign direct investment in that region. Some of the content about risk and returns and attributes... Recently I published what we call a Yardarm, sort of regular communications, and I encourage you to look at it, because it really characterizes how do sukuk move or the investment related performance and just attributes as to oil, other securities, and so forth. The Yardarm is called, “Beyond Bonds: Are Gulf Regional Sukuk The Ultimate Asset Allocation Tools?” And I think it provides a little bit more of a deeper dive as to sort of the attributes of this unique market. But thank you.
Craig Churman: Thanks, Patrick, and I do have a couple of questions. Monem, I can send this one your way. There are more opportunities in international markets and value funds and the point being that the Developing World and the Income Fund might be attractive, other than the Growth Fund. I don’t know, Monem, maybe that’s right in your wheelhouse.
Monem Salam: Yeah, thank you. Yeah, so I mean, I think that story has been talked about for a long time and so the more you talk about it, the more maybe eventually it will come true. The issue is that the growth companies that are in the US, that are becoming larger and larger—the Apples and the Microsofts, the Amazons, everybody knows what they are—and they begin to make more and more, you know... As they begin to become more sizable in the index, it’s almost like a virtuous cycle for them—maybe vicious if it goes on the downside—and that is the more money that goes into the S&P 500, the more valuation they have just because of the market cap itself. That being said, these are also the companies that actually benefitted, probably on a margin basis, the most out of this crisis because they were all in the technology area and everybody was shifting online. You know, whether you look at the plumbing, whether you look at the delivery, whatever you look at, technology was benefitting from it. So, you know, there was a reason for that run up, but I think at any given point, that runup becomes overvalued and there will be a pullback. In that opportunity, I think that’s where you have the opportunity for both value and also for international as the questioner asked. The real value... and you could argue that even Europe, if you look at it from an international perspective, and Japan in the developed markets... they haven’t rallied as much as the US has, and so there is some underlying value there. But also, at the same time, you have the issue between the Euro and the Dollar as well, where if the Dollar does weaken then the Euro will obviously get stronger. Opportunities are there and really, it’s more a matter of finding those opportunities because as a whole, right? You know, Europe has consistently underperformed. So, it’s really trying to find the value is in that and looking for companies that, over the five to ten-year period, are really going to outperform there. Developing World is very similar, as well. A lot of the countries in the emerging markets have actually implemented policies to be able to combat COVID-19 that they haven’t done in the past. Patrick just mentioned regarding Indonesia, what they were able to do, but that’s across the board you’re finding more and more governments willing to be able to do deficit spending to be able to keep their economies going but also to be able to help the people that are suffering in the economy. So, that, over the long run, in my opinion, is actually gonna be more beneficial for the developing world. Also, at the same time, you know, the developing world countries typically, like for example, out of the 2008 financial crisis, they actually rallied quite a bit more than, you know, the US or even developed markets, so I would probably expect that same thing to happen again.
Craig Churman: So, I have another question for the Amana Income Fund, but I think I’m gonna defer to Elizabeth on this. And Elizabeth, one of the challenges we have is Morningstar dropped Amana Income from five globes to one globe recently, when they did their reset on their analysis. Maybe you can give us some insight on what we see in what Morningstar did and also the fund itself, Amana Income.
Elizabeth Alm: Absolutely. So, Morningstar gets all of the underlying sustainability data from a company called Sustainalytics. And the change from five globes to one globe for the Amana Income Fund reflects a change in methodology that Sustainalytics made. Before, Sustainalytics used to rate companies as a best in class or a best in sector. So, when you looked at the sustainability ratings, they were only really mean to be compared within a sector. And, in order for Morningstar to use those ratings, they used to have to take the min, normalize them across sectors internally, and it could provide a globe rating for funds. However, Morningstar actually purchased Sustainalytics and it was after that purchase that Sustainalytics actually released risk ratings that were comparable across sectors. One of the results of this is that ratings reflect the Sustainalytics perceived risk of an overall sector. So, a company’s sector has much more impact on its overall score. For example, 98% of all industrial companies were downgraded in terms that Sustainalytics viewed them as having more risk than they did before. As a result, you really saw a large movement in funds that were focused in best in class sort of investments. And, this sort of volatility really highlights how important it is for us to have a good internal ESG analysis because we do not rely on external vendors. We use them as a data point but really, we take in all the data, we have our own viewpoint, and that does allow us to provide investors with more opportunity. For example, companies that are making good changes or are on the right trajectory or companies we think are going to improve in the future and we really see that as a good place for value creation.
Craig Churman: Yeah, so... Monem is looking... he’ll have probably a weighting in industrials and those would be stronger balance sheets that do pay a dividend because he’s trying to beat the S&P dividend and our internal rating is very high.
Elizabeth Alm: Absolutely. So, our upper weighting in industrials definitely had an impact as well as there was a large movement in pharma companies that were downgraded significantly under Sustainalytics’s new methodology. In part, that’s due to news factors and controversies are weighted more heavily in the new scoring system.
Craig Churman: Yeah.
Monem Salam: Craig, just one more thing. And this is really important for everybody to understand. You know, it wasn’t that the portfolio shifted and all of a sudden became from five to one. We still maintain and have maintained our own scoring system for what we consider good ESG companies that’s been there in the past and that continues to be now. What happened was the goalpost moved. And that’s not something we control. And so, you know, and that’s, again, what Elizabeth mentioned is very important. You need to be able to have your own values incorporated within ESG rather than trying to chase someone else’s values. Because those other values, as we can see from Sustainalytics, can easily change on you.
Craig Churman: And I think Scott and Bryce had done a white paper even before that change happened on just the variability in all of the ratings from the various agencies. And then, why we continue to invest in our own proprietary ratings system and continue to use that as our underlying information for making our decisions. So, that’s good. Thank you, Elizabeth. Thank you, Monem. So, if there are no more questions, I thank everybody for joining. If you look at the website, you might look at the Halal Money Matters podcast that Monem has been working on. They just released podcast number five. Monem, maybe you want to give us a couple of seconds on what podcast five is about.
Monem Salam: Yeah, thank you. So, Halal Money Matters, you can find it on both Apple and Google Play. We just launched it this year back in September though we’ve been working on it for quite a while. Basically, it will be covering topics on money from a halal perspective. The latest one that we have, it features us interviewing Amjad Quadri who is an expert in halal mortgages. Not only has he worked in the Islamic finance space with the mortgage side, but also on the investment side as well, which is what he’s currently doing right now. And so, we kind of interview him, talk about the different types of halal mortgages there are, the history of the actual industry, and where we’re seeing the industry going in the future.
Craig Churman: Okay, thank you, Monem. Looking forward to listening to that, myself. And so, thanks everybody. I look forward to our next webinar, which will be in November, post the election, so I’m sure we’ll have something to talk about then. And thank you once again for joining us on the Saturna Sustainable Webinars and we look forward to speaking to everybody again. Thank you.
Patrick Drum: Thank you.
Elizabeth Alm: Thank you.
Monem Salam: Thank you.
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