Q3 2021

For the third quarter of 2021, the Amana Income Fund Investor Shares returned -2.54% and the Institutional Shares returned -2.50%.  The benchmark S&P 500 Index returned 0.58% for the same period.  Year-to-date returns for the Investor Shares and Institutional Shares were 7.69% and 7.85%, respectively, while the Index returned 15.92%.

A resurgence of COVID-19 infections weighed on the global economic recovery during the quarter.  Supply chain and logistics backups resulted in shortages and price spikes, particularly in the automobile and semiconductor industries, threatening both sales growth and profit margins. As the third quarter ended, equity markets had fallen from recent highs and investors turned their attention to:

1. A pessimistic outlook from corporate earnings reports as the backups in throughput threatened to weigh on both sales growth and profit margins;
2. The increasing concern that inflation is not temporary due to post-pandemic resurgence in economic activity, but rather a more sustained increase over the next few years; and
3. Worries that China’s highly indebted property sector could be facing a similar situation to what the US faced in 2008.  This was sparked by the country’s second largest property developer, China Evergrande, announcing a delay in an interest payment of its bonds.

Despite the concerns listed above, the economy seemed to remain resilient, leading the Federal Reserve to forecast an unwinding of monetary stimulus. Interest rates nudged higher, driven in part by perennial haggling in Congress over raising the debt ceiling, and the renewed threat (albeit remote) that the US could default on debt payments if legislators and policymakers can’t work out a solution.

The Fund's strongest performer during the quarter was pharmaceutical manufacturer Pfizer.  The company submitted trial data to the FDA for use of its COVID-19 vaccine for younger children, and it is widely expected that the FDA will approve it.  Health authorities also began recommending booster shots of the Pfizer vaccine for select populations, further increasing demand for vaccinations.

The industrial coatings manufacturer PPG was the Fund’s worst performer in the quarter, as the supply chain backups impacted its earnings outlook.  Other industrial and materials companies, including 3M and Air Products & Chemicals, also suffered double-digit losses during the quarter due to similar concerns.

The supply chain issues impacting the global economy raised questions about the fragility of the trade and logistics management practices that have been embraced by operations teams for decades.  The amount of time it could take to untie these knots is unknown, and if companies choose to rethink their approach to inventory and supply management, the transition could mean several years of pressure on margins and lower returns on capital.

Another broad global concern on the horizon involves a host of issues in China, the world’s second largest economy.  President Xi is poised to stay in office for a third term after consolidating his power beyond that of his recent predecessors, with the threat of autocratic rule; continuing troubles in China’s indebted and overheated property market could weigh on global demand and spread financial contagion beyond its own banking system; and the country’s policing of speech and criticism outside of its borders, particularly amid concerns about forced labor and other human rights abuses of the country’s Uighur population, raise a dilemma for western companies that want to maintain or increase business in China’s large economy while staying true to democratic principles and not alienating customers and stakeholders outside of China.

For the third quarter of 2021, Amana Growth Fund Investor Shares returned 0.95%, ahead of the 0.58% return of the S&P 500 Index, as well as the NASDAQ Composite return of -0.22%.  Year-to-date the Investor Shares have gained 14.96%, trailing the 15.92% return of the S&P 500 Index but leading the NASDAQ’s 12.67% rise.  While returns were positive and ahead of benchmarks, the quarter demonstrated a Jekyll and Hyde-like split personality in terms of index and sector performance.  Solid mid-single digit returns through July and August reversed in September as the S&P 500 Index shed -4.65%.  That did not come as a complete surprise, since September holds the top spot as the worst month for stock market returns.¹  More interesting was the previously moribund Energy sector roaring to life.  The Finance sector, especially regional banks, also rebounded after treading water through much of the quarter.  The reanimation of Finance largely relied on higher rates as the yield on the 10-year Treasury bottomed at 1.17% in August and finished the quarter at 1.49%.  At the same time, higher rates punctured the short-term attractiveness of much of the Technology sector.

For the second consecutive quarter Intuit was the top contributor to Fund returns, joining ASML, Novo-Nordisk, Gartner, Apple, and Agilent in making a repeat appearance.  Except for Apple, each of those companies also appears among top year-to-date contributors.  The top contributors list provides the impression that Technology continued its strong run, but each of the aforementioned companies experienced mid-single to low double-digit share price declines in September.  Whether we are experiencing a major shift in market focus or another late-year hiccup remains to be seen. Gartner has had a tremendous year, appreciating just shy of 90% through the first three quarters.  Gartner provides IT research and advisory services, and the resumption of business activity has been a boon to its business.  While the Delta variant continues to affect in-person events, investors are looking ahead to a resumption of its conference business as well.  Alphabet was a new addition to the Fund this year, as we believed it important to have exposure to the top online media and advertising company in the world.  Some have raised concerns surrounding Alphabet’s exposure to political interference, but we take comfort from the belief that were the company to be broken up, it would quite likely be worth even more than as a single entity.

Last quarter, half of the detractors provided a positive return. That was plainly not the case for the third quarter.  With “transitory” inflation now likely to persist longer that originally anticipated, Federal Reserve tapering a near-term reality, and various government spending bills facing a rockier path, we are considering eliminating the Newmont position, which had existed as a hedge against dollar weakness.  In fact, the dollar has been strengthening of late as investors anticipate higher rates.  Except for Clorox, which we are selling, we remain committed to the other positions.  Amgen has been on the bubble, but stands as a prodigious generator of cash, pays an attractive dividend yield, and its growth prospects appear to be improving.  Valuation is also attractive, especially considering it features one of the cleaner profit and loss statements in terms of comparing earnings under Generally Accepted Accounting Principles (GAAP) to non-GAAP earnings.  The latter often exists to flatter the company’s outlook.  After hitting all-time highs in May, Norfolk Southern and Union Pacific experienced a dire third quarter, which we chalk up to disrupted supply chains affecting their volumes.

Since the end of the second quarter, no new positions have entered the Top 10 Holdings.

While developed markets were mostly flat across the third quarter, as seen in the S&P 500’s 0.58% total return during the period, developing markets sold-off with the MSCI Emerging Markets Index dropping -8.09%.  The driving force behind this weakness was concern over increased regulatory crackdowns on business by the Chinese Communist Party (CCP).  Towards the tail-end of the quarter, a looming debt default of the second largest property developer in China, Evergrande, also affected markets on a global level.  This played in the Fund’s favor as it had reduced its already-low exposure to Chinese firms to 8.31%, while in comparison the Index had a 33.44% weight and the Fund’s Morningstar category averaged 30.62%.  The Fund does gain exposure to China through its Hong Kong listings, where it has an 5.86% weight versus 0.41% for the Index and 2.03% for its Morningstar category.  As a result, the Investor shares returned -3.92% during the quarter, outperforming the benchmark by 417 basis points and the Morningstar category by 287 basis points.

The third quarter of 2021 was by no means the first instance where the Chinese government intervened in markets, but it did mark a sea change in President Xi’s relations with big business.  What stood out about the crackdowns were the depth of punishment and breadth of industries covered.  Joining Tech in the CCP’s crosshairs were education, gaming, gambling, luxury products, and housing, to name a few.  The rapid rollout of myriad unforeseen restrictions caused many to ask, is China investible?  An equally valid rebuttal: is investing in China even avoidable? To the former we have answered, with our lowered exposure, with a resounding “no.”  As for the latter question, as the world’s second largest economy and second fastest growing trillion-dollar economy, exposure to China through suppliers or sales in established, well-regulated, and calmer economies is a much more prudent strategy.

Given the upheaval riling Chinese firms, it’s not surprising that two of the four largest detractors from the Developing World Fund were Chinese internet stocks.  Tencent and Baidu are listed in Hong Kong – both are positions the Fund has exited.  Also in the bottom four detractors were TPI Composites, a renewable energy company with significant manufacturing capacity in China, and LG Household & Health Care, a luxury cosmetics firm that derives 16.46% of its sales and much of its growth from China.  Among the top four contributors were Silergy and Monolithic Power Systems, both benefiting from sustained demand for semiconductors.  Joining these semiconductor firms, Wilcon Depot and Techtronic Industries rounded out the top four contributors thanks to continued strength in the home improvement industry.

Whether China continues its historic path of integrating with the global economy or forges a divergent route towards hemispheres of influence will have wide-reaching implications for both developing and developed markets.  This is a story that didn’t begin in the third quarter of 2021 and won’t finish playing out in the fourth.  We believe that the actions taken in the third quarter were a signal that President Xi understands the deleterious effects of two Chinas (between rich and poor), and investors must understand Chinese history to know that it has always, in the long run, favored the rural poor over the urban rich.  Meanwhile, we’ll continue to look for ways to stay out of the CCP’s crosshairs and take advantage of the long-term growth trends expected from developing countries looking to integrate with the global economy.

Amana Participation Fund reached two significant milestones during the third quarter of 2021. On September 28, the Fund celebrated its six-year anniversary since its inception.  The Fund also surpassed $200 million in assets under management (AUM), reflecting a $50 million increase in AUM since the first quarter of 2021.  This accomplishment reflects a concerted team commitment to serve the community in providing an important asset allocation feature of capital preservation and current income that adheres to Islamic principles.   We want to sincerely thank our investors as we build on our success to serve you in attaining your personal investment objectives.

As we close out the third quarter of 2021, we find that market volatility has reasserted itself in the capital markets almost in lockstep with the seasonal onset of fall.  The increase of this market volatility can be primarily attributed to the Federal Reserve’s monetary policy as it relates to accommodative polices such as quantitative easing (QE) and its low-interest policy.  Market participants have anticipated an upcoming change in the Fed’s QE policy, in which the Fed acquires $120 billion a month in mortgages and US Treasury securities.  These accommodative policies were enacted to stabilize the financial markets in response to the markets selling off at the onset of the pandemic.  The Fed appears to be foreshadowing a $15 billion per month reduction in its QE program, with plans to wind it down entirely by mid-2022.²   The uncertainty of the specifics of the Fed’s QE wind-down in conjunction with the legislative wrangling of the Biden administration’s infrastructure program has fueled market volatility.  The rise in US 10-year Treasury yields from 1.310% on August 31 to 1.535% on September 30 is a byproduct of this market volatility. While an increase of 20 basis points may not seem like a large movement when measured on a nominal basis, it does represent a 21% increase in interest rates.  During periods of changes in monetary policy, it is common to see market volatility reassert among the markets.

There are other coinciding factors that appear to be contributing to the rise in market volatility to include rising energy prices, the potential default of China’s real estate developer, Evergrande, and the growing number of lockdowns and related restrictions regarding COVID-19.  Most notable is the change in the price of energy, particularly natural gas, which rose from $33.38 on January 1 to $82.29 on September 24 — a 252% increase! This rise in global energy prices has resulted in shortages around the world.  More recently, numerous factories in China, including many used in Apple and Tesla’s supply chain, have had to shut down due to power outages.³  At this point, the knock-on effects are unclear; however, it is reasonable to anticipate that these high energy prices will hamper future economic activity and slow the global recovery. The rise in energy prices is also likely to raise inflationary pressures, which, in turn, is likely to lead market participants to anticipate higher interest rates – at least over the near-term.

The rise in energy prices is also likely to be supportive of hydrocarbon-dependent economies, such as those in the Middle East.  The region continues to experience favorable economic activity; Saudi Arabia’s non-oil sector experienced a 10.1% increase in economic activity during the second quarter of 2021.  Current IMF estimates point to Saudi Arabia experiencing GDP growth of 4.8% in 2021 and 6.3% for 2022.⁴  This is a marked improvement in outlook after Saudi Arabia reported its 2020 GDP growth at -4.1%.⁵

Year-to-date, the Fund’s Institutional Shares returned 0.83% and the Investor Shares returned 0.75%.  Both share classes trailed the FTSE Sukuk Index’s return of 0.94%.  For the trailing one-year period, the Institutional Shares and Investor Shares provided annualized returns of 2.34% and 2.19%, respectively. The Fund’s performance can be attributed in part to the GCC region’s favorable investment climate but also to our investment process, emphasizing the ownership of high-quality issuers, led by management teams who exercise prudence and demonstrate sound, long-term financial practices.

For the month of September, the Institutional Shares provided a 30-day yield of 0.91% and the Investor Shares provided a yield of 0.66%.  The Fund reported a modified duration of 3.62 years for the quarter.  The Fund is diversified among 36 separate issues to meet its investment objective of capital preservation and current income while being entirely invested in US dollar-denominated securities.

The top two performing issues during the third quarter were Dar Al Arkan, a Saudi Arabian real estate developer, and Saudi Telecom.  The two worst performing issues over the quarter were Kuwaiti Financial House and DP World, a global shipping and logistics operator.

Over the upcoming fourth quarter we anticipate a supportive investment climate for sukuk investors to continue, given the low interest rates and accommodative fiscal and monetary policies.