March 27, 2020, marks five years since the launch of the Saturna Sustainable Funds. In that time, assets of the Funds have grown 539%, supporting investors with an innovative approach to sustainable investing and a collection of thought-provoking white papers, practice management tools, and impact reports.
Common sense tells us markets are not linear, while the old joke tells us “common sense” is anything but. Until the fourth quarter of 2018, market volatility had become easy to forget amid steady gains and minimal drawdowns following the Global Financial Crisis (GFC). In the fourth quarter of 2018 we received a lesson in the lack of linearity, but the bull market of 2019 quickly healed wounds and the downturn faded from memory. This year, after a buoyant start to the new decade, investors suddenly woke to the realization that the novel coronavirus and associated COVID-19 illness are serious issues with unpredictable, yet hugely significant economic ramifications. This provided a renewed reminder that markets can fall as easily as rise, and often do so violently.
Nerves of steel may be
required . . . but we think
opportunities in equities
are especially good.
The sell-off has been jarring but one need only zoom out 15 months to find a market level lower than the first quarter S&P 500 Index close of 2584.59. The downturn in the fourth quarter of 2018 took the Index to a low close of 2351.10 on December 24, while the corona-crisis dropped the index to 2237.40 on March 23 before rebounding. The sell-off was fast and the recovery to date has been unpredictable, leading us to repeat a core maxim; we believe the best course of action is to remain invested. When markets are suffering double-digit single-day declines and breaking records set in the 1920s and 30s, nerves of steel may be required…but we think such drawdowns can present good opportunities in equities. Time and again, investors exit the market after it has already declined, thinking they’ll get back in at a lower point, only to watch market indices rebound past their point of sale. It’s difficult to remain invested today. It was also difficult to remain invested during the GFC but the S&P 500 Index was back above water within two years. Measured from the trading day before Lehman Brothers declared bankruptcy on September 15, 2008, through the pre-virus peak on February 19, 2020, the S&P 500 Index has enjoyed an 11.40% annualized return.
We cannot give any assurances that the market will not re-test the lows of March. With the widespread economic disruption caused by the virus and the unprecedented government actions taken to combat it, further swoons are, perhaps, inevitable. That, however, does not detract from our message that attempting to time such moves will likely diminish portfolio values. It may be easier for investors to maintain their market exposure when reviewing current valuations. Stretched valuations have been a source of concern for some time. Reduced tax rates, improving margins, and higher returns on capital from a tech-heavy market have all been rolled out as explanations. Of course, the current economic slowdown/shutdown will dramatically depress earnings for a time, but investors are likely to look through that to the day when conditions return to normal. In this sort of environment, the Shiller P/E ratio (also known as the CAPE ratio)1 becomes the best lens through which to view valuations. As we can see in the chart below, the Shiller P/E ratio has returned to the 30-year median. While not representing the fire sale valuations of the GFC, one can make the case that the financial disruptions of that time raised legitimate questions regarding the survival of the system, while the coronavirus is an exogenous event from which we should be able to recover. Certainly, China has presented encouraging signs in that regard.
A Source of Resilience
We believe the Saturna Sustainable Funds are well-placed for the current environment, especially in light of concerns surrounding financial sustainability and liquidity. The core investment philosophy of the Saturna Sustainable Funds has always been to seek companies demonstrating financial sustainability, which can be likened to a moat protecting against the slings and arrows of outrageous fortune. We believe minimizing losses plays a key role in investment success. When logistics grind to a halt, customers evaporate, and liquidity tightens, a strong balance sheet and skilled management can provide resilience and financial strength that has undoubtedly been a contributing factor to Fund performance. While absent specific debt guidelines for the Funds, we rate companies based on the level of their total debt to market capitalization, assigning a letter grade to different levels, with A-rated stocks being the least indebted, D-rated stocks the most financially stretched, and F-rated stocks engaged in prohibited activities. Over the first quarter of the year we see a clear correlation between debt levels and stock performance.
Performance of US Equities with market capitalization greater than $5 bn as of 3/31/20202
|Letter Grade||A||B,C or D||F||All|
|Median Total Return YTD||-18.69%||-24.63%||-28.86%||-21.74%|
|Average Total Return YTD||-17.17%||-25.44%||-27.72%||-21.50%|
|Number of Companies||262||101||118||481|
|Median Mkt Cap (bn USD)||$16.43||$12.44||$16.51||$15.69|
A wide range of variables determines how any stock performs but removing financial frailty from the equation makes intuitive sense. We might also note it accurately describes the approach Saturna Capital takes to managing its own business. Our balance sheet reflects our investment philosophy, with no debt and ample reserves. He’s no Shakespeare but Warren Buffet once observed, “It’s only when the tide goes out that you learn who’s been swimming naked.” Rest assured, Saturna Capital is appropriately attired.
Saturna Sustainable Bond Fund
For the quarter ended March 31, 2020, Saturna Sustainable Bond Fund returned -1.91% relative to 0.33% for the FTSE World Big Index and -5.02% for the Morningstar World Bond category. For the one year period ended March 31, 2020, the Fund returned 1.31% compared to 4.94% for the Index and -1.16% for the Morningstar category.
As of March 31, 2020, the Fund had a 30-day yield of 2.08% and an effective duration (price sensitivity to changes in interest rates) of 4.60 years.
The main drivers of positive performance this past quarter were the positions in US Treasury bonds. The Treasury yield curve experienced a massive shift downward during the first three months of the year as investors flew to quality. The Fund extended duration from 3.20 years to 4.60 years primarily with the purchase of long Treasuries and adding to high quality long corporates. The Maturity Breakdown chart below details the shift in the Fund’s maturity distribution. The top performers in the Fund over the past quarter were the 2048 and 2038 Treasury positions which produced a total return of 22.47% and 16.52%, respectively. The Index tends to have a longer duration and more exposure to Treasury bonds and sovereign debt as it’s not held to a sustainable mandate. However, this also means it will be more sensitive to interest rate changes should the Treasury curve experience further volatility.
The Sustainable Bond Fund has been expanding positions in higher grade corporate issues, while making strategic curve allocations with the use of Treasurys. As shown in the Bond Ratings Breakdown chart, the Fund deployed cash to higher grade securities, including Treasurys and AAA corporates.
Going into the second quarter, corporate credit will be viewed with increased scrutiny due to the heightened risk of downgrades and unprecedented economic challenges that lie before us. As the crisis has been unfolding, we have been focusing our credit research in BBB and lower rated corporate bonds, paying special attention to corporate liquidity and flexibility. Our goal has always been to choose good companies and invest through cycles. Our robust security selection process, which emphasizes governance, resiliency, and sustainability, is constantly evolving with the unfolding events. During March, $92 billion worth of debt was downgraded from investment grade to high-yield. We must be highly vigilant during these times of volatility and this includes looking for select opportunities in the form of excellent but mispriced bonds.
Currently, the portfolio has a total exposure to foreign currency of 24%. Many currencies took a big hit relative to the dollar during the first quarter. The lowest performing bonds in the portfolio suffered from these currency movements. The Fund has a 1.85% position in the Colombian peso which depreciated -18.5% relative to the dollar, and a 2.43% position in the Brazilian real which depreciated -22.8%. Full currency exposure is detailed in the chart below.
Socially and economically, the first quarter of 2020 was defined by the coronavirus. As governments across the world instituted social distancing policies economies ground to a halt and central banks rushed to stem the economic impacts of the pandemic. The US Federal Reserve reacted quickly, cutting the federal funds target rate by 1.5% through two emergency interventions on March 3 and 15.
Changes in the yield curve over the course of the quarter provide a telling depiction of events. At the end of 2019 the yield curve was upwards sloping with 30-year US Treasury bonds yielding 2.39%. By the end of the quarter, the 30-year Treasury yield had dropped to 1.32%. By the end of February, investor concerns of the spreading coronavirus had become implanted. On February 28, much of the yield curve had become inverted, with 30-year US Treasury bonds now only 0.2% higher than the 1-month Treasury bill. By quarter end, the yield curve had again steepened, albeit at a lower level, due to Fed cuts on short-term rates.
As of March 31, 2020
|Top 10 Holdings||Portfolio Weight|
|US Treasury Bond (4.50% 05/15/2038)||4.91%|
|US Treasury Bond (3.375% 11/15/2048)||4.87%|
|First Abu Dhabi Bank||4.51%|
Credit ratings are the lesser of S&P Global Ratings or Moody’s Investors Service. If neither S&P nor Moody’s rate a particular security, that security is categorized as not rated (except for US Treasury securities and securities issued or backed by US agencies which inherit the credit rating for the US government). Ratings range from AAA (highest) to D (lowest). Bonds rated BBB or above are considered investment grade. Credit ratings BB and below are lower-rated securities (junk bonds). Ratings apply to the creditworthiness of the issuers of the underlying securities and not the Fund or its shares. Ratings may be subject to change.
Saturna Sustainable Equity Fund
During a quarter of extreme volatility and significant upheaval, the Saturna Sustainable Equity Fund’s defensive characteristics helped it to outperform both its benchmark S&P index and its Morningstar peer group. In January, a buoyant month despite the novel coronavirus’ emergence in the US, the Fund outpaced the S&P Global 1200 Index, declining -0.51% versus -0.87% for the benchmark. February subsequently experienced a dramatic rise in the seriousness of the epidemic, its geographic spread, and its impact on economies and markets. Nonetheless, the Sustainable Equity Fund continued to outperform, declining -5.38% compared to the benchmark’s -8.19%.
Ultimately, the Fund returned -14.69% over the course of the first quarter, exceeding both the S&P Global 1200 Index, which returned -20.72%, and the Morningstar World Large Stock category average, which returned -21.05%.
At the close of the quarter, Hartalega Holdings, Amazon, and Novo Nordisk proved to be well-positioned to endure virus-induced volatility, while the Fund’s three largest detractors – Johnson Matthey, CGI Group, and NXP Semiconductors – were challenged. Disney, another major detractor, illustrates the damage a pandemic can wreak: all Disney theme parks around the world have been closed, while movie attendance has collapsed. These developments will affect the firm’s full year earnings since people won’t go to Disney World twice due to having missed a previous trip. Regardless, we’re confident the business will recover, its streaming business could very well exceed expectations again, and the valuation has become attractive. We see the recent drawdown as an opportunity.
Hartalega’s impressive first quarter performance may be traced directly to its defensive position in an age of pandemic: as an innovator of nitrile, a non-latex substitute, Hartalega Holdings is the world’s largest manufacturer of disposable nitrile gloves. Amazon, too, is strategically positioned to weather a pandemic. Despite experiencing a “logistics backlog,”4 the online retailer “has been processing from 10% to 40% more packages than normal for this time of year.”5 During the first and second weeks of March, its website experienced 30% and 32% more traffic than the same weeks in 2019, respectively. Between February 20 and March 23, purchases of allergy, sinus, and asthma products jumped by a staggering 19,571% over the same period in 2019, and purchases of home and kitchen supplies jumped by 1,181%.6 Though further logistics and labor challenges may be ahead, Amazon is clearly where house bound consumers reroute from their brick-and-mortar grocery stores and pharmacies.
We believe the relatively strong performance from the Sustainable Equity Fund is due to Saturna’s focus on quality and sustainability measured in a variety of ways. Apart from investing in companies with low carbon intensity, superior social practices, and good governance, we also seek companies demonstrating financial sustainability in the form of low debt and consistently strong cash flows sufficient to fund operations and expansion. The tide is definitely going out and, to paraphrase Warren Buffet, we will soon learn who has been swimming au naturel.
Six of the Fund’s Top 10 Holdings in the first quarter were consistent with those from the previous quarter, with Hartalega Holdings, IHH Healthcare, Iberdrola SA, and Walt Disney Company replacing Siemens Gamesa Renewable Energy, Accenture, AIA Group, and Taiwan Semiconductor.
As of March 31, 2020
|10 Largest Contributors||Return||Contribution|
|Novo Nordisk ADS||5.44%||0.09|
|Kimberly-Clark de Mexico, Class A||-22.07%||-0.08|
|Reckitt Benckiser ADR||-6.97%||-0.08|
|10 Largest Detractors||Return||Contribution|
|CGI Group, Class A||-36.17%||-0.77|
|Mastercard, Class A||-18.99%||-0.61|
|Walt Disney Company||-33.21%||-0.57|
|Top 10 Holdings||Portfolio Weight|
|Dassault Systemes ADR||2.58%|
|Mastercard, Class A||2.31%|
|Walt Disney Company||1.90%|
As of March 31, 2020
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|Average Annual Total Returns (Before Taxes)||YTD||1 Year||3 Year||5 Year||Since InceptionB||Gross||Net|
|Sustainable Equity Fund (SEEFX)||-14.69%||-1.15%||6.46%||4.28%||4.22%||1.81%||0.75%|
|S&P Global 1200 Index||-20.72%||-9.45%||2.68%||4.08%||4.04%||n/a|
|S&P 500 Index||-19.60%||-6.98%||5.10%||6.72%||6.78%||n/a|
|Sustainable Bond Fund (SEBFX)||-1.91%||1.31%||1.56%||1.48%||1.47%||0.83%||0.65%|
|FTSE WorldBIG Index||0.33%||4.94%||3.90%||2.77%||2.69%||n/a|
|MSCI All Country World Index||-21.26%||-10.76%||2.05%||3.41%||3.40%||n/a|
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A By regulation, expense ratios shown are as stated in a Fund’s most recent prospectus or summary prospectus, dated March 27, 2020 and incorporate results from the fiscal year ended November 30, 2019. Saturna Capital, the Funds’ investment adviser, has voluntarily capped actual expenses of the Sustainable Equity Fund at 0.75% and actual expenses of the Sustainable Bond Fund at 0.65% through March 31, 2021.
B Saturna Sustainable Equity Fund and Saturna Sustainable Bond Fund began operations on March 27, 2015.
Performance data quoted herein represents past performance, which is no guarantee of future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than the performance data quoted herein. Performance current to the most recent month-end can be obtained by visiting www.saturnasustainable.com or calling toll-free 1-800-728-8762.
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 S&P Global 1200 Index is a global stock market index covering nearly 70% of the world’s equity markets. The FTSE WorldBIG Bond Index is a multi-asset, multi-currency benchmark, which provides a broad-based measure of the global fixed income markets. The MSCI ACWI covers approximately 85% of the global investable universe, with large- and mid-cap representation across 23 developed market and 23 emerging market countries. The MSCI ACWI Ex-US Index, produced by Morgan Stanley Capital International, measures equity market performance throughout the world excluding US-based companies. The CBOE Volatility Index, known by its ticker symbol VIX, is a popular measure of the stock market’s expectation of volatility implied by S&P 500 index options. When available, Saturna uses total return components of indices mentioned. Investors cannot invest directly in the indices.
As of March 31, 2020
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|Morningstar Ratings™C||Overall||1 Year||3 Year||5 Year||Sustainability RatingD|
|Sustainable Equity Fund (SEEFX)||★ ★ ★ ★||n/a||★ ★ ★ ★||★ ★ ★ ★||
Percent Rank in Category: 2
|% Rank in World Large Stock Category||n/a||5||15||25|
|Number of Funds in Category||751||864||751||619|
|Sustainable Bond Fund (SEBFX)||★ ★ ★||n/a||★ ★ ★||★ ★ ★||Not rated|
|% Rank in World Bond Category||n/a||33||52||51|
|Number of Funds in Category||186||210||186||170|
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The Morningstar Sustainability Rating is not based on fund performance and is not equivalent to the Morningstar Rating (“Star Rating”).
© 2020 Morningstar®. All rights reserved. Morningstar, Inc. is an independent fund performance monitor. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
C Morningstar Ratings™ (“Star Ratings”) are as of March 31, 2020. The Morningstar Rating™ for funds, or “star rating”, is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance (not including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.
D Morningstar Sustainability Ratings are as of February 29, 2020. The Morningstar Sustainability Rating™ is intended to measure how well the issuing companies of the securities within a fund’s portfolio are managing their environmental, social, and governance (“ESG”) risks and opportunities relative to the fund’s Morningstar category peers. The Morningstar Sustainability Rating calculation is a two-step process. First, each fund with at least 67% of assets covered by a company-level ESG score from Sustainalytics receives a Morningstar Portfolio Sustainability Score™. The Morningstar Portfolio Sustainability Score is an asset-weighted average of normalized company-level ESG scores with deductions made for controversial incidents by the issuing companies, such as environmental accidents, fraud, or discriminatory behavior. The Morningstar Sustainability Rating is then assigned to all scored funds within Morningstar Categories in which at least ten (10) funds receive a Portfolio Sustainability Score and is determined by each fund’s rank within the following distribution: High (highest 10%), Above Average (next 22.5%), Average (next 35%), Below Average (next 22.5%), and Low (lowest 10%). The Morningstar Sustainability Rating is depicted by globe icons where High equals 5 globes and Low equals 1 globe. A Sustainability Rating is assigned to any fund that has more than half of its underlying assets rated by Sustainalytics and is within a Morningstar Category with at least 10 scored funds; therefore, the rating it is not limited to funds with explicit sustainable or responsible investment mandates. Morningstar updates its Sustainability Ratings monthly. Portfolios receive a Morningstar Portfolio Sustainability Score and Sustainability Rating one month and six business days after their reported as-of date based on the most recent portfolio. As part of the evaluation process, Morningstar uses Sustainalytics’ ESG scores from the same month as the portfolio as-of date.
The Fund’s portfolios are actively managed and are subject to change, which may result in a different Morningstar Sustainability Score and Rating each month.
The Saturna Sustainable Equity Fund was rated on 100% of Assets Under Management and the Saturna Sustainable Bond Fund was not rated.
Percent Rank in Category is the fund’s percentile rank for the specified time period relative to all funds that have the same Morningstar category. The highest (or most favorable) percentile rank is 1 and the lowest (or least favorable) percentile rank is 100. The top-performing fund in a category will always receive a rank of 1. Percentile ranks within categories are most useful in those categories that have a large number of funds.
Footnotes to commentary
1 The price-to-earnings (P/E) ratio is the share price of a company’s stock divided by its reported earnings per share. The P/E ratio is also referred to as the “multiple” of a company’s earnings. The cyclically adjusted price-to-earnings (CAPE) ratio uses a 10-year moving average to smooth out variations in corporate profits that can occur during business cycles. Popularized by Yale University professor Robert Shiller, the CAPE ratio is also known as the Shiller P/E ratio.
2 Total return for each company calculated from December 31, 2019 through March 31, 2020. Letter grades are calculated based on proprietary score using financial statement data from Thomson Reuters as available on December 31, 2019, including total debt, total assets, accounts receivable, and average month-ending market capitalization for each company during calendar year 2019.
3 Smith, Molly. Virus Sell-Off Turns Bonds Into ‘Fallen Angels.’ Here’s Why Downgrades Matter, Bloomberg, March 31, 2020. https://www.bloomberg.com/news/articles/2020-04-01/bond-downgrades-by-the-boatload-and-why-they-matter-quicktake
4 Nguyen, Nicole. Shipping Delays? Out-of-Stock Items? Amazon Isn’t the Only Shop Online, Wall Street Journal, April 6, 2020. https://www.wsj.com/articles/shipping-delays-out-of-stock-items-amazon-isnt-the-only-shop-online-11586165400
5 Mattioli, Dana and Herrera, Sebastian. Amazon Struggles to Find Its Coronavirus Footing. “It’s a Time of Great Stress,” Wall Street Journal, March 31, 2020. https://www.wsj.com/articles/amazon-struggles-to-find-its-coronavirus-footing-its-a-time-of-great-stress-11585664987
Important Disclaimers and Disclosure
This publication should not be considered investment, legal, accounting, or tax advice or a representation that any investment or strategy is suitable or appropriate to a particular investor's circumstances or otherwise constitutes a personal recommendation to any investor. This material does not form an adequate basis for any investment decision by any reader and Saturna may not have taken any steps to ensure that the securities referred to in this publication are suitable for any particular investor. Saturna will not treat recipients as its customers by virtue of their reading or receiving the publication.
The information in this publication was obtained from sources Saturna believes to be reliable and accurate at the time of publication.
All material presented in this publication, unless specifically indicated otherwise, is under copyright to Saturna. No part of this publication may be altered in any way, copied, or distributed without the prior express written permission of Saturna.
The Saturna Sustainable Funds limit the securities they purchase to those consistent with sustainable principles. This limits opportunities and may affect performance.
Investing involves risk, including possible loss of principal. Generally, an investment that offers a higher potential return will have a higher risk of loss. Stock prices fluctuate, sometimes quickly and significantly, for a broad range of reasons that may affect individual companies, industries, or sectors. When interest rates rise, bond prices fall. When interest rates fall, bond prices go up. A bond fund's price will typically follow the same pattern. 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." Investing in foreign securities involves risks not typically associated directly with investing in US securities. These risks include currency and market fluctuations, and political or social instability. The risks of foreign investing are generally magnified in the smaller and more volatile securities markets of the developing world.
A Fund’s 30-Day Yield, sometimes referred to as “standardized yield” or “SEC yield,” is expressed as an annual percentage rate using a method of calculation adopted by the Securities and Exchange Commission (SEC). The 30-Day Yield provides an estimate of a Fund’s investment income rate, but may not equal the actual income distribution rate. Without the voluntary expense cap, the 30-Day Yield for Saturna Sustainable Bond Fund would have been 1.80%. Unsubsidized yield does not adjust for any fee waivers and/or expense reimbursements in effect.
Effective maturity and modified duration are measures of a fund's sensitivity to changes in interest rates and the markets. A fund's effective maturity is a dollar-weighted average length of time until principal payments must be paid. Longer maturities typically indicate greater sensitivity to interest rate changes than shorter maturities. Modified duration differs from effective maturity in that it accounts for interest payments in addition to the length of time until principal payments must be paid. Longer durations tend to indicate greater sensitivity to interest rate changes than shorter durations. Call options and other security specific covenants may be used when calculating effective maturity and modified duration.