Q1 2015 • March 31, 2015 | Saturna Capital

 

 

Navigating Today's Volatile Markets

 

Environment

Stock market performance in the first quarter was essentially unchanged for commonly cited US indices such as the S&P 500 or the Dow Jones Industrials. But the tech-heavy Nasdaq Index gained 3.86%, and the Russell 2000 Index rose 4.32%. The broadly accepted rationale for the disparity is that larger companies represented in the S&P 500 have significant overseas exposure, while those in the Nasdaq and Russell indices are generally smaller and more domestically oriented. The US Dollar Index (DXY) zoomed to a multiyear high as the greenback strengthened, which can erode overseas sales and earnings.

Elsewhere in the world, weaker currencies and central bank quantitative easing have supported buoyant stock market performance in local currency terms. The Nikkei 225 gained 10.69% (yen) and 10.24% (US dollar) as the dollar-yen exchange rate was stable over the quarter. From the end of July though the end of December, however the yen weakened -14.18% against the dollar, so the returns for dollar-based investors depend on the period under review. For example, the European Stoxx 50 Index soared 17.93% in euro terms over the first quarter. Translate that into dollars, however, and the gain was only 4.55% due to significant euro weakening. In Europe and Japan the rationale for strong local performance is the exact opposite of the US; larger companies captured in the major indices tend to have a significant portion of overseas (US) sales providing a solid boost to their local currency results.

US Dollar Index

The issue of currency exchange rates received a jolt in mid-January when the Swiss central bank abandoned its effort to contain the Swiss franc.¹ Tensions within the eurozone and concerns about Greece resulted in a flight to safety in strong currencies that exerted heavy appreciation pressure on the franc. Fearing diminished local industry competitiveness, the bank adopted a policy in early 2012 of selling francs and buying euros to maintain the 1.20 level. After three years of success, the bank threw in the towel, and on January 15 the Swiss franc spiked from 1.20 to 0.98 in a single day. A 20% strengthening of a currency in a day imparts significant deflationary pressures — pressures that were already building within Europe and that are now manifest in negative sovereign yields across the continent.

Economically in the US it's déjà vu all over again. Atrocious weather across much of the country restrained economic activity in the first quarter of 2014 leading to concerns over the pace of recovery that were ultimately proven unfounded.

This year, winter brought us a replay, and once again indicators of first quarter activity are looking weak. Are these signs of an impending downturn or just another meteorological blip? We believe the latter. It's hard to go shopping or even get to work when your car is buried under three feet of snow. Fundamentally, several indicators appear positive, including unemployment, loan growth to nonfinancial business, declining debt burdens among consumers, and rising consumer confidence. The strong dollar will undoubtedly create challenges for exporters, but the US remains an economy primarily driven by domestic activity.

Civilian Unemployment Rate

Loans to Non-Financial Corporations

 

Household Debt Service Payments as a Percent of Disposable Person Income

University of Michigan: Consumer Sentiment

 

Outlook

We are sanguine regarding the prospects for US equities for the remainder of the year. Negative earnings adjustments have dominated year-to-date, but the winter weather and the strengthening of the US dollar largely explain this development. The significant returns of the past several years are unlikely to continue, but we see few signs of impending disaster. In Europe the fears of a "Grexit" are growing, which presents a short-term risk, but Greece is a minor part of the eurozone and economic indicators of late point toward a recovery that's gathering pace. Even Warren Buffett believes a Greek exit from the euro would be manageable.² We remain unconvinced that Abe-nomics will provide a long-term solution to Japan's problems, but the vastly weaker yen has provided a boost to exporters, and we are starting to see some wage increases among those companies that benefit most directly, such as Toyota. 

In emerging markets conditions varied widely. South and Central America posted negative returns in the quarter, led by corruption-based disaster in Brazil. Eastern Europe managed a small gain due to a rebound in Russia, but Turkey was weak. South Africa provided positive returns as the rand stabilized somewhat against the dollar. Asia Pacific was the big winner in the quarter, led by China, South Korea, and Taiwan. New signs of economic slowing appear every day in China, but the stock market has soared on expectations that further slowing will lead to government support measures.

 

Sextant Growth

In the first quarter Sextant Growth Fund returned 1.91%, versus 0.95% for the S&P 500, and 3.84% for the Russell 1000 Growth Index. The average for the Morningstar Large Growth category was 3.45%. Morningstar includes Sextant Growth in this group based on analysis of the portfolio's characteristics.

After 2014, in which the Fund finished in its Morningstar category's top 17 percent of over 1,700 portfolios, our performance reversal in 2015's first quarter versus other large-capitalization, domestic growth managers was disappointing.

Interestingly, some of the same stocks that led to 2014's outperformance resulted in relative weakness in early 2015. Perhaps it is just a question of timing. We at Saturna trade much less often than our peers, so we are most concerned about how our securities perform over full market or business cycles.

Top contributor Salix Pharmaceuticals was acquired by Valeant Pharmaceuticals on April 1, 2015 (but announced on March 16, 2015) for a total $15.8 billion enterprise value, or for $173.00 cash per share. We had bought the stock in July and August 2013 for between $67.06 and $72.08 per share.

With regard to our 10 largest detractors, the average price-only (i.e., excluding dividends) return on these same 10 stocks in 2014 was 24.6%, versus 11.4% for the S&P 500. Delta Airlines did the best last year at 80.5%. The worst performer was Lincoln Electric at -1.8%.

In the near term, we worry somewhat about continued underperformance in Transportation sector companies, such as Delta and Union Pacific, due to the impact of continued oil price volatility and weakness in the Industrial sector. Delta is also negatively impacted by the strength of the US dollar. In 2014, 29% of Delta's revenues were international. Nonetheless, we still are pleased to hold these investments for the long term.

The Sextant Growth Fund seeks to invest in larger, US companies with, among other traits, prospects to grow their earnings per share 10% per annum. Some peers have outperformed us early in 2015 by transitioning to Consumer Discretionary and Consumer Staples sector stocks that often do well when investors are nervous. In the near term, we are nervous, too. However, we find few Growth Fund opportunities in Consumer sectors because these companies are often richly valued for relatively slow sales and earnings growth. For example, Procter & Gamble, which is an American Consumer Staples darling, traded at 19 times 2016 earnings on April 7, 2015. The Wall Street consensus forecast for Procter's secular earnings growth rate is only 6%. Furthermore, the stock's price/earnings ratio is about as high as it has been in 10 years.

As of March 31, 2015

Ten Largest Contributors Return Contribution
Salix Pharmaceuticals 50.35% 0.79
Medivation 29.58% 0.66
Apple 13.17% 0.61
Power Solutions International 24.57% 0.46
Borg-Warner Automotive 10.30% 0.32
Boeing 16.17% 0.28
Alaska Air Group 11.09% 0.22
Lowe's 8.49% 0.19
CVS Health 7.55% 0.18
Hain Celestial Group 9.88% 0.15
Ten Largest Detractors Return Contribution
F5 Networks -11.90% -0.42
Delta Air Lines -8.42% -0.38
EMC -13.80% -0.21
Union Pacific -8.67% -0.20
United Parcel Service, Class B -12.17% -0.18
Fastenal -12.33% -0.10
Norfolk Southern -5.58% -0.09
Lincoln Electric Holdings -4.93% -0.08
Johnson & Johnson -3.12% -0.07
Chubb -1.73% -0.02
Top Ten Holdings Portfolio Weight
Apple 4.9%
Delta Air Lines 4.0%
Fastenal 3.2%
F5 Networks 3.0%
Borg-Warner Automotive 2.9%
Medivation 2.9%
Facebook, Class A 2.9%
Honeywell International 2.6%
Ashland 2.6%
CVS Health 2.5%
 

Sextant International

After a poor 2014 international markets started the year with a bang as the MSCI EAFE Index jumped 5.00% in the first quarter. Markets from Europe to Japan were buoyed by central bank activity and weakening currencies that boosted the outlook for exporters. The Sextant International Fund kept pace with the index, rising 4.89%. Whether caused by quantitative easing and depreciating currencies or a coincident development, Europe appears to be pulling out of its extended period of economic malaise. March manufacturing data showed business activity accelerating in Germany, Spain, and Italy, while maintaining positive if muted expansion in France. March marked the second consecutive month of rising economic activity across the big four eurozone nations. While not a part of the eurozone, the United Kingdom has also been registering solid figures with the March services PMI clocking in at 58.9 and the manufacturing PMI at an eight-month high of 54.4 – both well above the 50 mark that delineates expansion from contraction. We have a slight underweight position in Europe and are seeking new investment candidates across the region. With the Fund fully invested we would look to source cash from non-benchmark positions in Canada and Mexico.

Japan's stock market has fully participated in the rising international tide of late, although the economic rationale for doing so remains less compelling. We have long opined that Abenomics will not achieve its goals unless the third arrow of regulatory and structural reform finally takes flight. To date, it remains in the quiver, and Japan's PMIs are moving in the opposite direction from Europe with the March headline seasonally adjusted Business Activity Index at 48.4, indicating contraction. The manufacturing PMI remains barely in expansionary territory at 50.3, the lowest reading since last October. These are disappointing figures illustrating that currency alone cannot do the heavy lifting, especially for firms with imported costs and domestic markets. Exporters certainly benefit, although a good chunk of Japan's exporting activity was transferred offshore over the past two decades. Japan faces an unprecedented demographic challenge, and it continues to provide Europe with a roadmap of what not to do when arriving at the same point. We are significantly underweight the benchmark in Japan and anticipate that will continue to be the case.

By sector, we had good performance in Consumer, Health Care, Materials, and Technology. Our large underweight in Finance created a headwind since the sector performed well internationally, in contrast to the United States. Performance in the Industrials sector was weak and will be a key area of focus over the coming months.

Despite our Japan underweight, Toyota Motor and Mitsubishi appeared among the Fund's top performers.

As of March 31, 2015

Ten Largest Contributors Return Contribution
Novo Nordisk ADS 28.07% 1.55
Nice Systems ADS 20.65% 0.87
BASF ADR 19.28% 0.68
Novartis ADR 9.42% 0.56
Toyota Motor ADS 11.48% 0.49
Dassault Systems ADR 10.49% 0.40
Wolters Kluwer 6.45% 0.36
Pearson ADS 17.13% 0.30
Shire ADS 12.86% 0.29
Mitsubishi UFJ Financial ADR 12.48% 0.25
Ten Largest Detractors Return Contribution
ASML Holding -6.31% -0.42
Toronto-Dominion Bank -9.55% -0.39
Cenovus -17.14% -0.22
Quimica y Minera Chile ADS -21.90% -0.22
Turkcell Iletisim Hizmetleri ADR -13.82% -0.16
BCE -6.50% -0.15
Telus -6.89% -0.13
Potash Corp. of Saskatchewan -7.78% -0.11
Banco Santander ADS -8.42% -0.08
Copa Holdings, Class A -1.88% -0.05
Top Ten Holdings Portfolio Weight
Novo Nordisk ADS 7.1%
Novartis ADR 6.3%
Wolters Kluwer 6.2%
ASML Holding 6.2%
Nice Systems  ADS 5.2%
Toyota Motor ADS 4.7%
Dassault Systems ADR 4.3%
BASF ADR 4.2%
Belmond, Class A 4.0%
Toronto-Dominion Bank 3.6%
 

Sextant Core

The Sextant Core Fund posted a total return of 0.90% for the quarter ended March 31, 2015, significantly lagging the benchmark Dow Jones Moderate Portfolio Index by 1.36%. The performance of the equity portion of the Fund's portfolio was roughly in line with returns experienced in US equity markets. However, the Fund's fixed income allocation was significantly underweight US government securities, which saw a significant rally in the quarter. The benchmark US 10-Year Treasury yield started the quarter at 2.173% and ended the quarter at 1.924%, reflecting a significant rally in government bonds. In addition, the Fund's investment grade corporate bonds did not fully participate in the rally as spreads widened on BBB rated bonds while remaining relatively unchanged for higher rated issues.

Health Care names performed well with prostate cancer drug Xtandi sales driving up the stock price of Medivation, and a buyout of Salix Pharmaceuticals by Canada-based Valeant also helping to produce outsized returns for this sector.

The Fund was opportunistic in the few trades it executed this quarter, selling French drug maker Sanofi into a rally while adding ophthalmic drug maker Akorn to the portfolio after a significant sell-off. The fund also added to its positions in Consumer Staples.

In equities, HSBC was beset by a series of regulatory failings, and the news weighed on the stock price. Chilean company LAN Airlines was also especially hard-hit as increased competition within the all-important Brazilian market combined with weakening US/local foreign exchange differentials weighed on the stock price. Utilities were also weak, likely a consequence of profit-taking, which hurt the Fund as it maintains a higher-than-benchmark weight to the sector.

As of March 31, 2015

Ten Largest Contributors Return Contribution
Medivation 29.58% 0.50
Salix Pharmaceuticals 37.47% 0.49
Novo Nordisk ADS 28.07% 0.36
Lowe's 8.49% 0.13
Republic of Chile (3.875% 8/5/2020) 2.74% 0.07
Honeywell International 4.91% 0.07
ADT (4.125% 06/15/2023) 4.16% 0.06
American Express (5.50% 09/12/2016) 3.73% 0.05
Express Scripts Holding 2.48% 0.04
GE Capital (5.35% 04/15/2022) 3.32% 0.04
Ten Largest Detractors Return Contribution
LATAM Airlines ADS -32.72% -0.45
ConocoPhillips -8.88% -0.14
HSBC Holdings ADR -7.76% -0.13
Toronto-Dominion Bank -9.55% -0.13
NRG Energy -5.98% -0.10
Qualcomm -6.17% -0.09
Kimberly-Clark -6.54% -0.08
Chubb -1.73% -0.03
Canadian National Railway -2.61% -0.03
NextEra Energy -1.38% -0.02
Top Ten Holdings Portfolio Weight
Republic of Chile (3.875% 8/5/2020) Bond 2.4%
Fannie Mae (2.00 05/16/2017) Bond 2.2%
Bellsouth Capital Funding (7.875% 2/15/2030) Bond 2.2%
3M  Equity 2.2%
Medivation Equity 2.1%
Express Scripts Holding Equity 1.9%
PepsiCo Equity 1.8%
Procter & Gamble Equity 1.8%
SK Telecom ADR Equity 1.8%
Chubb Equity 1.7%
 

Sextant Global High Income

The Sextant Global High Income Fund celebrated its third anniversary at the close of the first quarter of 2015. The Fund returned -1.25% in the first quarter and completed the period with $8.0 million in total assets, including 5.9% in cash and income receivable.

Fund/Benchmark/Category Q1 2015 Return Annualized
return since inception
(03/30/2012)​
Sextant Global High Income Fund -1.23% 4.29%
S&P Global 1200 Stock Index* 2.19% 12.45%
Bloomberg Global High Yield Corporate Bond Index 0.42% 5.83%
Morningstar World Allocation** 1.88% n/a

The Fund's fourth quarter performance was impacted by weakness of the Canadian dollar (Whistler and Reitmans common stocks) and the Brazilian real (Itau Unibanco and CCR common stocks). Both currencies have lost considerable value against the dollar over the past 18 months, and have gone from unattractive to quite attractive in our view. The recent strength of the US dollar and corresponding weakness in a number of foreign currencies has finally piqued our interest in non-dollar bonds for the first time since the Fund's inception three years ago.

Among the Fund's strongest performers in the quarter were its European equities, particularly BASF (up 19.28%). This stock bounced back from a poor fourth quarter of 2014 and rewarded our decision last quarter to increase its position size, now the largest in the Fund at 2.9%.

During the quarter we added two new "distressed" fixed income positions: the 9.25% 2017 US dollar bonds of the Ukraine, and the 8.875% 2019 bonds of Goodrich Petroleum. Including Puerto Rican municipal bonds, the Fund's "distressed" positions (which we might characterize as bonds trading below 80% of par value) comprised roughly 6% of its holdings at the end of the quarter.

Our new investment in Ukraine's bonds suffered. We frankly expected the US and Western European countries to make a stronger offer of economic, political, and even military support — for among other reasons to buttress Ukraine's important strategic location between Russia and Europe — than we have witnessed, and we continue to evaluate the situation. We added the Goodrich Petroleum bonds after scouring the landscape of leveraged Exploration and Production companies in the aftermath of the plunge in oil prices. The competence and financial commitment of its management team, and their successful record of proving exploration acreage in Louisiana and Mississippi, support our belief that the company can survive a period of low oil prices.

As of March 31, 2015

Ten Largest Contributors Return Contribution
BASF ADR 19.28% 0.45
Daimler  15.49% 0.35
Novartis ADR 9.42% 0.21
Microchip Technology 9.17% 0.20
Sibanye Gold ADS 15.28% 0.17
GlaxoSmithKline ADS 9.57% 0.16
Goodrich Petroleum (8.875% 03/15/2019) 5.46% 0.15
Allegheny Technologies (5.875% 05/15/2023) 7.24% 0.14
Unilever 7.80% 0.14
New York Community Bancorp 6.21% 0.12
Ten Largest Detractors Return Contribution
Ukraine Government (9.25% 07/24/2017) -29.39% -0.65
Whistler Blackcomb Holdings -18.44% -0.53
Reitmans, Class A -23.49% -0.33
CCR -12.05% -0.25
Itau Unibanco Holding ADS -12.72% -0.22
Refresco Group (7.375% 05/15/2018) -10.63% -0.21
Royal Dutch Shell ADS -9.61% -0.20
Banco Santander ADS -8.42% -0.15
Orange ADS -5.38% -0.07
Groupe Bruxelles Lambert -3.20% -0.06
Top Ten Holdings Portfolio Weight
BASF ADR Equity 2.9%
Daimler Equity 2.6%
Grupo Bimbo (4.875% 06/27/2044) Bond 2.5%
CNOOC ADR Equity 2.5%
Microchip Technology Equity 2.4%
Total ADS Equity 2.4%
San Miguel (4.875% 04/26/2023) Bond 2.3%
Goodrich Petroleum (8.875% 03/15/2019) Bond 2.3%
Rent A Center (6.625% 11/15/2020) Bond 2.3%
Novartis ADR Equity 2.3%

Footnotes:

¹ Schweizerische National Bank Press Release. Swiss National Bank discontinues minimum exchange rate and lowers interest rate to -0.75%, January 15, 2015. http://www.snb.ch/en/mmr/reference/pre_20150115/source/pre_20150115.en.pdf

² Buhayar, Noah and Bloomfield, Doni. Buffett Says Greek Exit From Euro 'May Not Be a Bad Thing." Bloomberg Business, March 31, 2015. http://www.bloomberg.com/news/articles/2015-03-31/buffett-says-greece-exit-from-euro-zone-may-not-be-a-bad-thing-

 

Performance Summary

As of March 31, 2015

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Average Annual Total Returns (Before Taxes) 1 Year 3 Year 5 Year 10 Year Expense Ratio
  GrossA Net
Sextant Growth (SSGFX) 12.40% 15.20% 12.33% 8.36% 0.96%B 0.95%
S&P 500 Index 12.73% 16.10% 14.46% 8.01% n/a
 
Sextant International (SSIFX) 1.72% 3.24% 3.27% 5.97% 0.78%B 0.77%
MSCI EAFE Index  -0.48% 9.51% 6.64% 5.43% n/a
 
Sextant Core (SCORX)C 4.69% 6.16% 6.37% n/a   1.10%B 1.10%
Dow Jones Moderate Portfolio Index 5.73% 8.51% 8.61% 6.73% n/a
 
Sextant Global High Income (SGHIX)D -1.74% 4.29% n/a   n/a   1.31%B 0.90%
S&P 500 Global 1200 Index 6.41% 12.45% 10.44% 7.17% n/a
Bloomberg Global High Yield Corporate Bond Index -2.70% 5.83% 7.27% n/a   n/a
 
Sextant Short-Term Bond (STBFX) 0.88% 0.75% 1.34% 2.72% 1.19%B 0.75%
Citi USBIG Govt/Corp 1-3 Year Index 1.05% 0.93% 1.31% 2.93% n/a
 
Sextant Bond Income (SBIFX) 6.68% 3.79% 5.15% 4.63% 1.17%B 0.90%
Citi US Broad Investment-Grade Bond Index 5.70% 3.10% 4.40% 5.03% n/a

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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 1-800-728-8762 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.

A By regulation, gross expense ratios shown are as of a Fund's most recent prospectus or summary prospectus, dated March 27, 2015, and incorporate results from the fiscal year ended November 30, 2014. Higher expense ratios may indicate higher returns relative to a Fund's benchmark. The Adviser has voluntarily capped actual expenses of Sextant Short-Term Bond at 0.75% and actual expenses of Sextant Bond Income and Sextant Global High Income at 0.90% through March 31, 2016.

Restated to reflect a reduction in the Advisory and Administrative Services base fee and a reduction in the maximum rate of the performance adjustment, as approved by the Board of Trustees on March 17, 2015. Please see the Statement of Additional Information for the actual dollar amount of fees paid to the adviser for the most recent fiscal year.

C Sextant Core Fund began operations March 30, 2007.

D Sextant Global High Income Fund began operations March 30, 2012.

The S&P 500 Index is an index comprised of 500 widely held common stocks considered to be representative of the US stock market in general. The MSCI EAFE Index is an international index focused on Europe, Australasia, and the Far East. The S&P Global 1200 Index is a global stock market index covering nearly 70% of the world's equity markets. The Bloomberg Global High Yield Corporate Bond Index is a rules-based, market-value weighted index engineered to measure the non-investment grade, fixed-rate, taxable, global corporate bond market. The Dow Jones Moderate Portfolio Index is a broad-based index of stock and bond prices. The Citi USBIG Govt/Corp 1-3 Year Index is a broad-based index of shorter-term investment grade US government and corporate bond prices. The Citi US Broad Investment-Grade Bond Index is a broad-based index of medium and long-term investment grade bond prices. Investors cannot invest directly in the indices.

 

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.

The Dow Jones Industrial Average (Dow or DJIA): A widely followed price-weighted index of 30 of the largest, most widely held U.S. stocks.

The Russell 2000 Index is an index of U.S. small-cap stocks that measures the performance of the 2,000 smallest U.S. companies in the Russell 3000 Index.

The Nasdaq Composite Index measures the performance of more than 5,000 U.S. and non-U.S. companies traded "over the counter."

The US Dollar Index is a free float capitalization-weighted index of the 500 most highly capitalized European companies.

The Nikkei 225 Stock Average Index is a price-weighted average of the 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange.

The European Stoxx 50 Index is a European blue chip stock index representing the leading 50 supersector stocks from 12 eurozone countries.

A Few Words About Risk

The Growth Fund may invest in smaller companies, which involve higher investment risks in that they often have limited product lines, markets, and resources, or their securities may trade less frequently and have greater price fluctuation than those of larger companies.

The International Fund involves risks not typically associated with investing in US securities. These include fluctuations in currency exchange rates, less public information about securities, less governmental market supervision, and lack of uniform financial, social, and political standards.

The Core Fund involves the risks of both equity and debt investing, although it seeks to mitigate these risks by maintaining a widely diversified portfolio that includes domestic stocks, foreign stocks, short and long-term bonds, and money market instruments.

Investment in the Global High Income Fund entails the risks of both equity and debt securities, although it seeks to mitigate these risks through a widely diversified portfolio that includes foreign and domestic stocks and bonds. Issuers of high-yield securities are generally not as strong financially as those issuing higher quality securities. Investments in high-yield securities can be speculative in nature. High-yield bonds may have low or no ratings, and may be considered "junk bonds."

The risks inherent in the Short-Term Bond and Bond Income Funds depend primarily on the terms and quality of the obligations in their portfolios, as well as on bond market conditions. When interest rates rise, bond prices fall. When interest rates fall, bond prices go up. Bonds with longer maturities (such as those held by the Bond Income Fund) usually are more sensitive to interest rate changes than bonds with shorter maturities (such as those held by the Short-Term Bond Fund). The Funds entail credit risk, which is the possibility that a bond will not be able to pay interest or principal when due. If the credit quality of a bond is perceived to decline, investors will demand a higher yield, which means a lower price on that bond to compensate for the higher level of risk.