Q2 2017 • June 30, 2017 | Saturna Capital


Carpe Diem

While markets continued to advance in the second quarter, the pace slowed appreciably from the first; unsurprising considering that signature initiatives of the Trump administration – replacing the Affordable Care Act, tax reform, and infrastructure development – have failed to launch. In the absence of political momentum, companies stepped up, with the S&P 500 constituents reporting first-quarter earnings growth of 13.81%, a surprisingly strong number that eases concerns over market valuation. Information Technology, Financials, and Materials led the earnings charge, but the strength was broad-based, and only Telecommunications reported a year-on-year decline. 

Looking at sector performances, there has been some shuffling at the top and bottom of the order, but, generally speaking, sectors that performed well in Q1 continued to do so in Q2, while those that lagged in Q1 remained weak. Information Technology remained the top-performing sector through the first half; logical given its earnings growth. Nonetheless, in Q2, Technology surrendered some of its performance lead to Health Care.  Health Care has not been among the top performers in growing earnings, but after a difficult 2016 it remains inexpensive relative to the overall market. Industrials stocks continued to do well despite modest earnings performance, likely reflecting reflation hopes.


While US conditions have been good for stock market investors, the global environment has been ebullient.  Most European markets have experienced double-digit returns in US dollars.  The UK was a notable exception following the prime minister’s misguided decision to call early elections in hopes of strengthening the conservative hand in negotiating the terms of the UK’s exit from the European Union (EU).  Instead, the Tories lost their majority and have had to bring in a minority partner to form a government, a development that has added uncertainty to Brexit.  Elsewhere, China, Taiwan, and South Korea have also experienced double-digit stock market appreciation.  Mexico has enjoyed a strong performance, supported by the recovery in the value of the Mexican peso, while Canada has been an outlier, stumbling on the back of weaker commodity prices.  Inflation and interest rates are generally low around the world, and foreign exchange rates have been stable, although the weakening of the US dollar against the euro has contributed to dollar-based returns in those markets.  Despite the unconventional stance adopted by the US toward its allies, there are no major flashpoints.  North Korea’s test of an intercontinental ballistic missile (ICBM) and the stand-off between Qatar and other Middle Eastern countries present challenges but nothing new. 

For sustainable investors, an interesting development in 2017 has been the significant underperformance of the Energy sector.  The oil market has been thrown into confusion by the rapid increase in US production despite lower prices, as well as the futility of the Saudi/OPEC attempt to restrict production as Iraq, Libya, and Nigeria raise output.  Further confusion may result from Qatar’s decision to sharply increase natural gas production in response to the economic embargo imposed by Saudi Arabia, Bahrain, the United Arab Emirates, and Egypt.  Already the world’s largest supplier of liquefied natural gas, Qatar’s production hike will almost certainly lead to reduced prices and substitution of gas in place of dirtier fuels. 

Why do we raise the topic of oil?  Because of the exciting possibility for alternative drive trains, power generation, and storage models to render the entire issue moot.  The rapid fall in lithium-ion battery prices has pushed expectations for electric car sales higher.  Tesla’s Model 3 will begin deliveries this quarter with hundreds of thousands of pre-orders to fill.  Meanwhile, Volvo has announced that that by 2019 all its new vehicle introductions will be hybrid or all-electric,2 and France plans to ban the sale of all gasoline and diesel-fueled vehicles by 2040.3  Given that transportation accounts for 69.8% of oil consumption in the United States,4 these are important developments.  And let’s not forget the opportunity for automated driving and the sharing economy to reduce the number of vehicles produced, which is itself a carbon-intensive activity. 

Perhaps the most revolutionary development is the agreement among Tesla, French energy company Neoen, and the government of South Australia to install a 100-megawatt battery farm at the Hornsdale Wind Farm.  That’s sufficient to power some 30,000 homes.  South Australia has been suffering from repeated power outages over the past year, and Elon Musk has guaranteed to complete the farm within 100 days or it will be free.5  This isn’t Tesla’s first large battery facility – it recently completed an 80-megawatt facility in Southern California – but it is the largest.  Battery storage has most commonly been associated with solar, but this agreement demonstrates flexibility and, perhaps, points the way to distributed generation.  These developments illustrate the exciting opportunities for ESG investors to participate in truly revolutionary changes in global transportation, power generation, and distribution. 


Complacency often represents the greatest risk, and there’s a lot of it going around.  Last quarter we discussed the historically low levels of volatility, a situation that continues.  Unemployment stands at a 16-year low of 4.3%6 and the 10-year Treasury yield at 2.35%.7  The Federal Reserve has raised interest rates three times in the current tightening phase, and, at 1.50%,8 the discount rate has narrowed the gap with Treasury bonds.  To date, the US economy and stock market have handled the removal of quantitative easing and transition to traditional tightening with aplomb.  Will that continue to be the case?  Such thoughts occupy the minds of some members of the Federal Reserve Open Market Committee.  According to the minutes from the June meeting, “…a few participants expressed concern that subdued market volatility, coupled with a low equity premium, could lead to a buildup of risks to financial stability.”9

On the other hand, there are times when conditions change measurably for the better.  The populist/nativist political trend in Europe that started with the UK’s decision to exit the EU has stalled with Emmanuel Macron’s stunning victory in the French presidential election and the subsequent success of his En Marche! party in winning a majority of seats in the National Assembly.  Macron has set a centrist course, expressing strong support for the EU, while stressing the need to ease France’s regulatory regime and tame its debt and deficits.  Losses by anti-EU fringe parties in Italy and Germany support the idea that Brexit may have provided a wake-up call rather than an omen.  It’s worth remembering that reforms enacted under previous German Chancellor Gerhard Schröder in the late 1990s through the early 2000s set the stage for Germany’s economic performance today.  France may never match Germany, but any improvement in the regulatory environment of the EU’s second-largest economy (after the UK exits) is positive for the EU and global economic activity.


Saturna Sustainable Bond Fund

For the trailing 12-month period ending June 30, the Saturna Sustainable Bond Fund returned 3.93% compared to -1.86% offered by the Citi World Broad Investment-Grade Bond Index.  When measured year-to-date, the Fund returned 5.06% compared to 4.32% offered by the Index.  The slight outperformance can be attributed to security selection, unrealized gains offered by its float-to-fixed rate securities, and the non-US dollar denominated currencies appreciating relative to the US dollar.  The portfolio was invested among 44 securities from 37 different issuers, posting a modified duration of 2.78 years and a 30-day yield of 2.65%.

The first half of 2017 was marked with a depreciating US dollar, falling interest rates for longer dated notes, and continued normalization of monetary policy by the Federal Reserve.  In the rest of the world, the United Kingdom offered yet another political surprise as Prime Minister Theresa May's Conservative Party experienced a meaningful setback on June 10, 2017, when it attempted to strengthen its position ahead of the country's Brexit negotiations with Europe.  Throughout this period oil prices continued to drop while world equity prices rose.

June 14 saw the fourth interest rate hike since the Global Financial Crisis (GFC).  US interest rates have slowly been creeping upward since the Federal Open Market Committee's  (FOMC) first interest rate hike post-GFC on December 16, 2015.  This rise in interest rates has been stubbornly slow with the front end of the yield curve that represents shorter maturities, such as one and two-year US government notes, experiencing the greatest rise.  The longer maturities, such as the 10-year notes, were relatively unchanged, and the 30-year notes fell.  The accompanying table provides a cogent example of the change in interest rates since the original hike in December 2015.

We anticipate this trend may continue – short-term rates rising while longer duration rates remain low over the second half of the upcoming year.  Fed Chairwoman Janet Yellen offered favorable guidance for economic activity following the June 14 interest rate hike by stating, "Our decision reflects the progress the economy has made and is expected to make."  The majority of Fed officials see at least one more rate hike taking place over the second half of the year. 

Given our current expectations for a rising interest rate environment, the Fund is well situated from a credit perspective to meet its investment objective of capital preservation and current income while focusing on issuers that are better positioned relative to their peers from an environmental, social and governance (ESG) perspective.

As of June 30, 2017

Top Ten Holdings Portfolio Weight
 NextEra Energy Capital (FPL Group)  4.85%
 Chubb  4.10%
 Puget Sound Energy  3.96%
 America Movil  3.78%
 Aramark Services  3.72%
 Nokia OYJ  3.57%
 Bancolombia  3.26%
 Mexico Bonos Desarrollo  3.24%
 New Zealand Government  3.08%
 Homestreet 3.05%
Bond Quality Diversification
Moody's Investors Services
Aaa 9.54%
Aa 10.58%
A 14.46%
Baa 31.87%
Ba 20.10%
Unrated 11.17%
Cash and equivalents 2.28%

Credit ratings are determined by Moody's Investors Service, a Nationally Recognized Statistical Rating Organization. If Moody's does not rate a particular security, that security is categorized as not rated.

Change in US interest rates
  Dec. 16, 2015 Jun. 30, 2017 Change  
3 Month LIBOR 0.25% 1.01% 302.40%
1 year US T-Bill 0.69% 1.23% 79.00%
2 year US Gov. Note 1.01% 1.38% 37.70%
5 year US Gov. Note 1.75% 1.89% 8.10%
10 year US Gov. Note 2.30% 2.31% 0.30%
30 year US Gov. Note 3.00% 2.84% -5.60%

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 2.42%.


Saturna Sustainable Equity Fund

Year-to-date, Saturna Sustainable Equity Fund was up 13.11%, outperforming the Morningstar World Large Stock category average return of 12.88%, the S&P Global 1200 Index return of 11.36%, and the S&P 500 Index return of 9.34%.   For the quarter, the Fund's 4.74% return also outpaced the S&P Global 1200's 4.27%, and the S&P 500's 3.09%, while the Morningstar World Large Stock category outperformed with an average return of 5.10%.  

People like us, who believe that the best companies are run with a long-term outlook (and a measurable awareness of environmental, social, and governance characteristics of their businesses), were understandably disappointed as the US withdrew from the Paris Climate Change Agreement this quarter.  We were pleased to note so many well-respected American CEOs and politicians decided and declared they would nevertheless uphold the standards of the agreement.   This inability of the US to follow through on its promises may mark the decline of influence the US has over global trends; making the argument, once again, for increased global allocations throughout investment portfolios.  

Taiwan Semiconductor, the Fund's largest position to date, led our outperformance.  This foundry continues to dominate the semiconductor market with 56% market share.  Its sprawling operations offer economies of scale competitors can't meet or beat, allowing the company to produce both old and new technologies according to demand.  We believe the company's success will continue into 2018 with nearly 100% of the 7-nanometer transistor market share.

Unilever, a sustainable darling, also contributed favorably this quarter.  Its "Connected 4 Growth" restructuring program announced last year is delivering results allowing Unilever to bring innovations to market faster both globally and locally.  The savings from this program have expanded margins, and it's refreshing to see management make necessary cuts in order to deliver solid returns to shareholders.  Unilever, as the "company that is trying to make sustainable living commonplace," is well positioned for continued outperformance. 

The Fund maintains a full position in Dutch health technology company Koninklijke Philips.  We like the self-help aspects of its products and expect the company to grow revenues in the mid-single digits.  With substantial net cash anchoring the balance sheet, and multiple strategic options to increase share value at its disposal, we remain steadfast in this position. 

 TJX Companies, owners of TJ Maxx, Home Sense, and other retail outlets, disappointed this quarter.  While TJX has been among the strongest performing retail stocks over the past few years, it detracted from performance in the second quarter.  Like many physical retailers, questions have been raised about its viability in a world dominated by e-commerce and Amazon – a company we don't own due to concerns about environmental impact, social impact, and corporate governance.  We believe TJX's core strengths of an unrivaled buyer group and sophisticated models for determining store-by-store inventory provide an enduring competitive edge. 

We are evaluating the position in Toyota.  Long viewed as a leader in automotive efficiency and quality, Toyota and Japanese cars in general no longer hold the quality advantage over Detroit of days past.  At the same time, it is relatively stronger in sedans versus trucks and SUVs, which is contrary to the trends we have seen in American consumer preferences.  Of course, Toyota also has significant operations around the world, but the company's margin performance has been weakening in all regions.

Pharmaceutical company Roche Holding detracted from second-quarter returns and has been eliminated from the portfolio as a result of our belief that competition from similar drugs are reducing its market share.  We will continue to watch Roche and be open to re-establishing a position if and when the price is attractive and the business is stable.

As of June 30, 2017

Ten Largest Contributors Return Contribution
Taiwan Semiconductor ADS 9.87% 0.51
Unilever 12.06% 0.39
Koninklijke Philips 14.37% 0.39
Samsonite International 16.64% 0.36
Novo Nordisk ADR 25.12% 0.33
3M 9.47% 0.3
AIA Group 17.24% 0.3
Adobe Systems 8.69% 0.27
Vestas Wind Systems 15.00% 0.26
Alphabet, Class A 9.66% 0.25
Ten Largest Detractors Return Contribution
TJX Companies -8.38% -0.23
Toyota Motor ADS -3.31% -0.09
Roche Holdings ADS -5.78% -0.09
Potash Corp of Saskatchewan -3.98% -0.08
China Mobile -1.62% -0.03
Kimberly-Clark De Mexico, Class A -0.73% -0.02
Johnson Matthey -1.39% -0.02
General Motors -0.12% -0.01
Apple 0.66% 0.02
Starbucks 0.27% 0.02
Top Ten Holdings Portfolio Weight
Taiwan Semiconductor ADS 5.23%
Murata Manufacturing 3.51%
Unilever 3.43%
3M 3.35%
Apple 3.31%
NXP Semiconductors 3.27%
Adobe Systems 3.25%
Toronto-Dominion Bank 3.24%
Dassault Systemes ADR 3.09%
Home Depot 3.00%

Morningstar Sustainability Ratings™

Saturna Sustainable Equity Fund (SEEFX)

Morningstar Five Globes

Percent Rank in Category: 3

Among 712 World Large Stock Funds


The Morningstar Sustainability Rating and the Morningstar Portfolio Sustainability Score are not based on fund performance and are not equivalent to the Morningstar Rating ("Star Rating").

© 2017 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.

Morningstar Sustainability Ratings are as of May 31, 2017.   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 50% 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 is subject to change, which may result in a different Morningstar Sustainability Score and Rating each month. 

The Funds were rated on the following percentages of Assets Under Management:

Saturna Sustainable Equity Fund 93%

The Saturna Sustainable Bond Fund was not rated by Morningstar for the period.

% 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.

The Saturna Sustainable Equity Fund and Saturna Sustainable Bond Fund began operations March 27, 2015, and have not yet received a Morningstar Star Rating.


Performance Summary

As of June 30, 2017

Scroll right to see more » »

  Expense Ratio
Average Annual Total Returns (Before Taxes) YTD   1 Year   3 Year   5 Year   10 Year   Gross Net
Sustainable Equity Fund (SEEFX) 13.11% 16.23% n/a   n/a   n/a   1.40% 0.75%
S&P Global 1200 Index 11.36% 19.47% 5.97% 11.93% 4.65% n/a
S&P 500 Index 9.34% 17.90% 9.60% 14.61% 7.17% n/a
Sustainable Bond Fund (SEBFX) 5.06% 3.93% n/a   n/a   n/a   0.92% 0.65%
Citigroup WorldBIG Index 4.32% -1.86% -0.32% 0.88% 3.77% n/a
MSCI All Country World Index 11.82% 19.42% 5.39% 11.13% 4.27% n/a

Scroll right to see more » »

Expense ratios shown are as stated in the Funds most recent Prospectus, dated March 27, 2017. Saturna Capital, the Fund's adviser, has voluntarily capped actual expenses of the Sustainable Equity Fund at 0.99% and actual expenses of the Sustainable Bond Fund at 0.89% through March 31, 2018.

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 Saturna Sustainable Funds began operations on March 27, 2015.

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 Citi 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. Investors cannot invest directly in the indices.


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.

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.



1 The Energy sector reported $8.5 billion in earnings for Q1 2017, compared to a -$1.5 billion loss in Q1 2016.  Due to the loss in the previous year (creating a negative denominator for any percentage change calculation) the resulting percentage change between the two periods using the absolute number method would be 667%, which may be misleading.

2 Boston, William. Volvo Plans to Go Electric, to Abandon Conventional Car Engine by 2019, The Wall Street Journal, July 5, 2017. https://www.wsj.com/articles/volvo-to-phase-out-conventional-car-engine-1499227202

3 Chrisafis, A, Vaughan, A. France to ban sales of petrol and diesel cars by 2040, The Guardian, July 6, 2017. https://www.theguardian.com/business/2017/jul/06/france-ban-petrol-diesel-cars-2040-emmanuel-macron-volvo

4 Center for Climate and Energy Solutions website, Oil Quick Facts. https://www.c2es.org/energy/source/oil

5 Guardian Staff.  Tesla to build world’s biggest lithium ion battery in South Australia, The Guardian, July 6, 2017.  https://www.theguardian.com/australia-news/2017/jul/07/tesla-to-build-worlds-biggest-lithium-ion-battery-in-south-australia

6 US Bureau of Labor Statistics, Civilian Unemployment Rate [UNRATE], FRED, Federal Reserve Bank of St. Louis.  https://fred.stlouisfed.org/series/UNRATE

7 Board of Governors of the Federal Reserve System (US), 10-Year Treasury Constant Maturity Rate [DGS10], FRED, Federal Reserve Bank of St. Louis. https://fred.stlouisfed.org/series/DGS10

8 International Monetary Fund, Interest Rates, Discount Rate for US [INTDSRUSM], FRED, Federal Reserve Bank of St. Louis.  https://fred.stlouisfed.org/series/INTDSRUSM193N

9 Minutes of the Federal Open Market Committee, June 13-14, 2017, page 9.  https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20170614.pdf