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Q1 2024

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Saturna Sustainable Funds Q1 2024 Commentary

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The first quarter of 2024 provided several surprises, not least the US stock market’s strong performance following a buoyant 2023. The ebullience was not limited to the United States. Global stock markets performed impressively, apart from a few exceptions such as Brazil and China/Hong Kong. Germany, Italy, the Netherlands, and Japan all registered double-digit local currency returns. Markets advanced despite stronger than expected gross domestic product (GDP) growth and inflation readings that shifted the narrative from a March rate cut to a June cut to maybe no cuts in 2024. Positive GDP data and the Federal Reserve’s stance led to a tough quarter for the bond market as the yield on the 10-year Treasury rose from 3.88% at year-end 2023 to 4.20% as of March 31, 2024. That move helped to support the dollar; the DXY Index strengthened 3.19% during the quarter. While not a stock, gold provided the quarter’s biggest surprise by appreciating nearly in line with the S&P 500 Index – not what one would expect in an environment of rising rates and a strengthening dollar.

The recovery among Industrial stocks is more easily explained than gold’s resurgence. The sector notched the fourth best performance during the quarter, trailing Technology, Financials, and Communications. Technology and Communications benefited from continuing artificial intelligence (AI) excitement with Nvidia and Meta leading the way, while rates remaining higher for longer supported bank margins. The Industrial sector’s performance reflected several factors, including reshoring due to US-China tensions, solid economic performance, and money/incentives made available through the Inflation Reduction Act, the Infrastructure Investment and Jobs Act, and the CHIPS and Science Act. “Total Construction Spending: Manufacturing in the United States” demonstrates the dramatic effect these factors have had on manufacturing construction in the US. “In 2023, construction spending on new manufacturing facilities more than doubled compared with 2022,” said Niels Graham in an article for the Atlantic Council. “Companies spent, on average, $16.2 billion dollars a month building new production facilities.”¹

Eventually, construction leads to production, and we may have seen the first signs. The Institute for Supply Management (ISM) PMI reading was 50.3 for the month of March, indicating expansion, and was well ahead of February’s contractionary reading of 47.8.² 

Outlook

Despite the delayed rate cuts, the good news is that performance broadened as economic resilience boosted sentiment across a variety of sectors. Of course, over the long run, interest rate stability engendered by a steadily growing economy beats rate cut catnip. The first quarter continued some of the 2023 Magnificent Seven trends, with AI semiconductor star Nvidia maintaining its torrid pace, rising over 80%. Meta, Amazon, and Microsoft also performed strongly, outpacing the broad market. Alphabet appreciated by single digits. Apple and Tesla shares declined during the quarter, with Tesla falling nearly 30%. Nvidia, Meta, Amazon, and Microsoft combined contributed roughly half the return of the S&P 500.³ Since the days of the BRICs, a group of stocks or markets that move in sync must have a nickname; will the Fab Four’s momentum continue, or will they succumb to the forces that sidelined Apple and Tesla? We view those forces as: 1) valuation; 2) modest to disappointing earnings growth trajectories; 3) regulatory risk. Apple’s growth has been pedestrian for the past couple of years and looks set to continue, making its historically high valuation problematic. Tesla’s sales volume and earnings fell short of expectations, making its stratospheric valuation even more so. From a regulatory perspective, Tesla’s self-driving functions seem to always be under the microscope. In March, the EU fined Apple $2 billion for breaking anti-trust rules with its app store. Meanwhile, the US Department of Justice (DoJ) launched a case against the company for monopolizing the cell phone market.

How do these forces line up for the Fab Four? When it comes to earnings, most companies would kill for the growth these companies are forecasted to achieve over the next four years, ranging from a low of 17% annualized for Microsoft to a high of 39% for Nvidia.⁴ Price to earnings ratios range from a low of 24.6x for Meta to 43.5x for Amazon, whose earnings growth is estimated at 29% annualized. Given the strength of their business models and undeniable competitive advantages, valuations for the Fab Four strike us as supportable.

However, business model strength and competitive advantages bring us to the third force. Between the DoJ and the Federal Trade Commission (FTC), cases have been lodged against Alphabet, Amazon, Meta, and Apple. One wonders how long it will be until Microsoft draws scrutiny for its AI activities. The Yale Journal on Regulation published a (far from scientific but nonetheless enlightening) report in March, ranking how the courts will evaluate the strength of the cases based on predictions of 19 anti-trust professors.⁵ The Journal divided the cases into five buckets: Google Search, Google AdTech, Facebook, Amazon, and Apple. The clear consensus among the professors was that the government has the strongest case against Google in both Search and AdTech, although only the latter carries the risk of a breakup. Strangely, Apple is at risk from an adverse Google Search ruling since it could lead to the loss of an annual payment estimated to be as high as $20 billion to make Google the preferred search engine on its devices. Most respondents thought the government has no chance against Amazon, while the Meta and Apple cases are theoretically weak but toss-ups in the courts. Undoubtedly, these cases will persist for years, and the ultimate result may be irrelevant apart from opportunity cost, which shouldn’t be underestimated. Bill Gates has said the government’s case against Microsoft at the turn of the century distracted him from the rise of mobile phones, causing Microsoft to miss out. Others might say Microsoft’s distraction opened the door for Apple, Amazon, Google, and others. Could the same happen again?

Saturna Sustainable Equity Fund

Saturna Sustainable Bond Fund

For the quarter ended March 31, 2024, Saturna Sustainable Bond Fund returned 0.11%, relative to -1.86% for the FTSE WorldBIG Index. The trailing 12-month performance for the Fund was 4.38%, relative to 1.10% for the Index.

The first quarter of 2024 built upon the previous quarter’s momentum: financial assets demonstrated strong performance and valuations extended even further. Investor optimism that the US would avoid an economic recession and that the Federal Reserve would cut its benchmark interest rates sometime in the first half of 2024 continued into the first quarter as well. However, inflation was higher than expected in January and February, and investor consensus shifted to the possibility that the Fed would cut interest rates later in 2024. In January, the annualized consumer price index (CPI) was 3.9%, slightly above the expected 3.8%. In February, the annualized CPI reached 3.9%, above the expected 3.7%. The illustration “CPI Metric Compared to Federal Funds Rate” measures the US CPI Urban Consumers Less Food & Energy Index, the US CPI Urban Consumers Index, and the Federal Funds Target Rate - Upper Bound since January 2020 to the present.

This reversal in inflationary trends tempered — but did not dash — investor optimism; risk-assets experienced strong investment performance in the first quarter. Although inflationary pressures declined substantially, they did not decline enough to offer central banks the confidence to lower benchmark interest rates. This may motivate the Fed and other central banks to keep interest rates at their current high levels for an extended period.

Such a policy path would be viewed as prudent. A working paper published by the International Monetary Fund (IMF) in September 2023 found that in the more than 100 inflation shock episodes that have occurred since the 1970s, inflation was resolved in under five years for only 60%. Even in those “successful” cases, resolving inflation took over three years, on average.⁶

Using the three-year-average, it is reasonable to expect inflation in the US to subside around the first or second quarter of 2025. The Fed began raising benchmark interest rates on March 21, 2022. In June of 2022, US inflation measured by CPI peaked at 9.1%. Using the five-year average would suggest that inflation may subside by the first or second quarter of 2027.

“Most unresolved [inflationary] episodes involved ‘premature celebrations’ where inflation declined initially, only to plateau at an elevated level or re-accelerate,” said the IMF. “Countries that resolved inflation had tighter monetary policy that was marinated more consistently over time, lower nominal wage growth, and less currency depreciation, compared to unresolved cases.” The IMF paper is an important cautionary warning for investors. We are taking recent policy actions by central banks in stride, while keeping in mind that taming inflation takes time.

Maturity

Saturna Sustainable Bond Fund had a 14% exposure to bonds with 10+ year maturities, up from 10% at year-end 2023. During the first quarter, the Fund reallocated to bonds in the three-to-five-year bucket. Overall effective duration was decreased significantly from 3.29 years down to 3.01 years. The Fund’s duration was significantly shorter than that of the FTSE WorldBIG Index, which generally maintains around a 6.6-year duration. This differential was the primary reason for the Fund’s outperformance last quarter, as longer bonds generally underperformed shorter positions. The best performing security in the Fund was the State Street floating rate bond, which matures in 2047 but only carries a duration of 0.15 years. This bond returned 6.51% for the first quarter. The worst performing security was one of the longest bonds in the Fund, the Indonesian green sukuk maturing in 2051, which returned -6.74% for the first quarter.

Currency

At quarter-end, the portfolio had a total exposure of 42.96% to bonds denominated in foreign currency. Positions were increased in the euro-denominated bonds, Mexican peso-denominated bonds, and Columbian peso-denominated bonds.

The US dollar showed considerable strength during the quarter. As a result, most of the foreign currencies held in the Saturna Sustainable Bond Fund depreciated relative to the dollar, except for the Columbian peso and the Mexican peso. Securities denominated in those two currencies showed strong total returns and significantly contributed to the Fund’s overall outperformance. Mexican peso-denominated bonds altogether had a 4.22% return and Columbian peso-denominated bonds altogether returned 2.58%.

Credit Ratings

Corporate credit yields rose across the curve, with very large yield shifts — especially for “AA” and “A” rated corporate bonds – in the belly of the curve. “B” rated corporate bonds outside of eight years saw yields fall in the long end, displaying more stability than higher-rated securities.

 

Green and Sustainable Bonds

At quarter-end the portfolio had 35.42% in green bonds, 13.82% in sustainable and social bonds, and 3.09% in sustainability linked bonds. Green bonds are primarily used to support specific climate-related or environmental projects. Social bonds raise funds to address or mitigate a specific social issue and/or seek to achieve positive social outcomes. Sustainable bonds generally can have a wider scope that simultaneously address environmental and social ambitions. Sustainability linked holdings are issues where the failure to meet a target (such as a reduction in carbon intensity over a specific timetable) results in increased payments to the bondholder, either through a higher payment upon the maturity of the security or through raising the bond’s coupon payment.

As of March 31, 2024

Top 10 Holdings	Portfolio Weight
United Utilities	4.56%
Canadian Imperial Bank	4.55%
Inter-American Devel BK	4.50%
Asian Development Bank	4.35%
INTL BK RECON & DEVELOP	4.28%
INTL BK RECON & DEVELOP	4.17%
MAF Global Securities	3.84%
First Abu Dhabi Bank PJSC	3.83%
New York City NY HSG Dev Corp	3.83%
AXA	3.78%

Performance Summary

As of March 31, 2024

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^A By regulation, expense ratios shown are as stated in the funds' most recent prospectus or summary prospectus, dated March 29, 2024, and incorporate results from the fiscal year ended November 30, 2023. 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, 2025.

^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. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.   When available, Saturna uses total return components of indices mentioned.  Investors cannot invest directly in the indices.

Performance Summary

As of March 31, 2024

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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: 4             Among 8,252 Global Equity Large Cap Funds
% Rank in Global Large-Stock Blend Category	n/a	61	89	48
Number of Funds in Category	338	354	338	300
Sustainable Bond Fund (SEBFX)	★ ★ ★ ★	n/a	★ ★ ★ ★	★ ★ ★ ★	Percent Rank in Category: 7             Among 2,510 Global Fixed Income Funds
% Rank in Global Bond Category	n/a	32	17	14
Number of Funds in Category	168	173	168	149

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The Morningstar Sustainability Rating is not based on fund performance and is not equivalent to the Morningstar Rating (“Star Rating”). 

© 2024 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, 2024. 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, 2024. 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 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% and the Saturna Sustainable Bond Fund was rated on 91% of Assets Under Management.

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 Graham, Niels. “The IRA and CHIPS Act are supercharging US manufacturing construction.” The Atlantic Council, February 13, 2024. https:// www.atlanticcouncil.org/blogs/econographics/the-ira-and-chips-act-are-supercharging-us-manufacturing-construction/#:~:text=In%20 2023%2C%20US%20construction%20spending,month%20building%20new%20production%20facilities.

² “March 2024 Manufacturing ISM Report on Business.” Institute for Supply Management. https://www.ismworld.org/supply-managementnews- and-reports/reports/ism-report-on-business/pmi/march/

³ Singh, Hardika. “The Stock Market’s Magnificent Seven is Now the Fab Four.” The Wall Street Journal, April 1, 2024. https://www.wsj.com/ finance/stocks/the-stock-markets-magnificent-seven-is-now-the-fab-four-2dff87ac?st=hzs6czx94nd98xv&reflink=article_email_share

⁴ Earnings growth and PER figures are derived from estimates appearing on LSEG Workspace and stock prices as of April 2, 2024.

⁵ Crane, Daniel A. “Ranking the Big Tech Monopolization Cases.” Yale Journal on Regulation, March 26, 2024. https://www.yalejreg.com/nc/ ranking-the-big-tech-monopolization-cases-by-daniel-a-crane/

⁶ Ari, Anil, et al. “One Hundred Inflation Shocks: Seven Stylized Facts.” IMF Working Papers. International Monetary Fund, September 15, 2023. https://www.imf.org/en/Publications/WP/Issues/2023/09/13/One-Hundred-Inflation-Shocks-Seven-Stylized-Facts-53915

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 3.936% and the 30-Day Yield for Saturna Sustainable Equity Fund would have been 0.524%. Unsubsidized yield does not adjust for any fee waivers and/or expense reimbursements in effect.

Effective duration is a measure of a fund’s sensitivity to changes in interest rates and the markets. Effective duration differs from modified duration in that it accounts for the optionality embedded in call options and other security-specific covenants that can change expected cash flows as the result of the movement of interest rates. Longer durations tend to indicate greater sensitivity to interest rate changes than shorter durations.

Variable rate securities risk: Variable rate debt securities (which include floating rate debt securities) pay interest based on an interest rate benchmark. When the benchmark rate changes, the interest payments on those securities may be reset at a higher or lower rate and, as a result, such securities generally are less price sensitive to interest rate changes than fixed-rate debt securities. However, the market value of variable rate debt securities may decline, or not appreciate as quickly as expected, when prevailing interest rates rise, particularly if their interest rates do not rise as much, or as quickly, as interest rates in general. Conversely, variable rate securities will not generally increase in market value if interest rates decline. However, when interest rates fall, there may be a reduction in the payments of interest received by the Fund from its variable rate securities.

About the Authors

Jane Carten MBA
President
Portfolio Manager,
Saturna Sustainable Equity Fund

Patrick Drum MBA, CFA^®, CFP^®
Senior Investment Analyst
Portfolio Manager,
Saturna Sustainable Bond Fund

Elizabeth Alm CFA^®
Senior Investment Analyst
Deputy Portfolio Manager,
Saturna Sustainable Bond Fund

Scott Klimo CFA^®
Chief Investment Officer
Deputy Portfolio Manager,
Saturna Sustainable Equity Fund