Q2 2018 Commentary | Saturna Sustainable Funds | Saturna Capital


Following a volatile first quarter, US equity markets steadily recovered until a ratcheting up of trade rhetoric and tit-for-tat tariffs in mid-June undermined confidence and shaved a few points off US returns. Other markets, the developing economies in particular, suffered greater damage. The MSCI Emerging Markets Index had a stellar 2017, rising 37.28% and, in the first quarter of this year, managed to eke out a 1.42% gain. In the second quarter, however, the index shed -7.83%. Investors perceive that emerging markets, especially in Asia, are likely collateral damage in any trade war that breaks out between the US and China. There are other causes and rising interest rates in the US have also played a role. In their “hunt for yield,” many investors were willing to venture into the developing world and assume additional risk in return for higher yielding bonds and equities. The flow of funds had the further benefit of maintaining or even strengthening exchange rates versus the US dollar, with exceptions such as Venezuela, Argentina, Brazil, and Turkey. As US Treasurys and the US dollar edged higher, investors pulled back from their emerging markets exposure, which has sent markets and currencies swooning.  The fallout will take more than a single quarter to settle. 

The US economy is underpinned by a strong job market, with the unemployment rate falling from 4.1% to 4.0% during the quarter, matching the lowest rate in nearly 50 years. Many long-term unemployed have also returned to work. The level of initial unemployment claims as a percentage of the working age population is the lowest on record.  Although wages show incipient signs of acceleration above the 2-2.5% annual growth that has prevailed over the past couple of years, there is still substantial leeway for higher wage growth in comparison to the 4% level that coincided with pre-recession peaks reached in the early and late 1990s and the late 2000s.

Inflation has recently been tracking closer to the Federal Reserve’s 2% target after undershooting for most of the past 10 years. In its May meeting, the Fed introduced a new word – “symmetric” – to emphasize that this inflation level is a “target” and not a “ceiling.” While it remains unclear how much inflation in excess of the 2% target the Fed may be willing to accept, we calculate that core inflation (the Consumer Price Index excluding food and energy) could run at 3% through September 2020 before it makes up for the cumulative undershoot over the past 10 years. Headline CPI – including food and energy – could run at 3% until January 2024 before making up its cumulative shortfall!

One notable feature of the current rate-hiking cycle is how slowly the rate increases are coming – about half the pace compared to the previous five Fed tightening cycles.  Forward guidance suggests the Fed will continue at a similar pace, which itself suggests some tolerance for a higher rate of inflation. Besides the Fed, the overall US government may also have an incentive to live with a higher inflation rate for a while. Higher inflation increases the (nominal) size of the US economy, while the level of already-issued government debt stays fixed. This increases the economy’s debt service capacity and could help offset recent legislative actions that have increased budget deficits, such as tax cuts and spending increases. Meanwhile, the administration’s aggressive actions on trade are likely to result in price increases.

Although these forces and incentives may portend higher wages and inflation, so far at least, the financial markets do not seem to buy into the possibility. Breakeven inflation rates, which are derived from fixed-rate Treasurys and inflation-indexed Treasurys (TIPS), show expected inflation of just over 2% for the next five to 10 years. The yield curve has also been flattening – with the difference in yield between the 10-year Treasury and the 2-year Treasury the lowest since 2007.  A very flat yield curve – or particularly an inverted yield curve where shorter-term rates exceed longer-term rates – is a signal that financial markets are more concerned about downside risks to economic growth than about inflation. 

One sector that’s been nearly bulletproof regardless of economic and political gyrations is Technology.

The cyclical semiconductor market continues to be an area of strength in the global economy.  Semiconductor sales once again set a new all-time high in May, rising by more than 20% for the 14th straight month, according to the Semiconductor Industry Association. The World Semiconductor Trade Statistics (WSTS) organization releases growth forecasts in the spring and fall of each year.  Since the fall of 2016, the WSTS upwardly revised each of its semi-annual forecasts. The spring 2018 market forecast sees the global semiconductor market growing 12.4% in 2018,1 up from the 7.0% growth expected in the November 2017 forecast.This sharp upward revision reflects growth in all major categories, led by Memory at 26.5%, followed by Analog Integrated Circuits at 9.5%. In 2018, all geographical regions are expected to grow, led by demand from the data center, auto, and industrial sectors. This forecast follows a solid 2017 where the industry expanded 21.6% year-over-year, its best growth year since 2010.

For the initial 2019 forecast, all major product categories and regions are expected to grow with the overall market up 4.4%. Sensors are anticipated to provide the highest growth followed by Optoelectronics and Analog Integrated Circuits. Demand is again forecast to be broad-based across geographies and sectors. A notable incremental contributor for the second half of 2019 demand is the construction of the 5G wireless network. If the 2018 forecast is correct, it will be the second year in a row with double-digit percent growth – the first time since 2003 and 2004, when the industry recovered from the internet bubble collapse. The last industry year-over-year decline was a mild -0.5% in 2015. 

The adoption of semiconductors across many industries leads some market observers to believe the industry has evolved from a product-introduction, boom-bust cycle to a broad based, secular demand trend. Consequently, over the next three to five years, market forecasters expect semiconductors to continue to grow, albeit at slower rates that are more in line with the 2019 forecast. 


One question on investors’ minds is the outcome of the November elections. The Republicans likely will lose seats, as usually happens to the party in power at midterm elections. With 35 Senate seats up for election and Democrats defending 26 of them, Republicans are in an advantageous position despite their narrow majority. Were they to lose a seat, they still hold the vice-presidential tiebreaker. We anticipate continued Republican control, a sentiment with which the political betting markets currently agree. Naturally, every seat is in play in the House of Representatives, and whether it changes hands is anybody’s guess. Still, the Democrats may hold a slight advantage. A divided government is often considered the best way to avoid ruinous legislation, and, with Democrats in control of the House, it would be hard to pass further changes to tax or spending programs. It’s easy to imagine, however, a spate of investigations. In short, we don't see politics having much impact on the market one way or another for the remainder of the year.


Saturna Sustainable Bond Fund

As of midyear 2018, the Sustainable Bond Fund has declined -1.30%, performing relatively better than the -1.51% return of its benchmark FTSE World BIG Bond Index.  A portion of the performance difference can be explained by the nearly 30% exposure to euro currency in the benchmark versus euro exposure closer to 3% in the Fund.  The portfolio was invested among 38 separate issues offered by 35 different issuers, posting a modified duration of 2.70 years and a 30-day yield of 3.55%.  

The two top-performing issues for the quarter are US dollar denominated securities.  The top performer was document storage provider Iron Mountain (IRM 5 ¾ 08/15/24), with a total return of 2.97%, followed by telecommunications equipment manufacturer Nokia (NOKIA 3 3/8 06/12/22) posting a return of 1.50%.  The two worst-performing issues were non-US denominated securities.  The poorest performing security was the Mexican peso denominated sovereign debt issue with a return of -6.90%, followed by New Zealand dollar denominated sovereign debt with a return of -5.83%. 

The old adage that things come in threes may help offer context to the market volatility during the first half of 2018.  The triad of factors include increasing interest rates, a strong US dollar, and trade war tensions.

Change in US Interest Rates
  Dec. 16, 2015 Jun. 30, 2018 Change
3 Month LIBOR  0.25% 2.34% 827.40%
1 year US T-Bill  0.69% 2.32% 237.70%
2 year US Gov. Note  1.01% 2.54% 152.20%
5 year US Gov. Note  1.75% 2.75% 57.20%
10 year US Gov. Note  2.30% 2.88% 25.30%
30 year US Gov. Note  3.00% 3.03% 0.70%
Source: Bloomberg

On June 13, 2018, Federal Reserve Chairman Jerome Powell announced that the Federal Open Market Committee (FOMC) voted to increase the target range for the federal funds rate from 1.75% to 2%.  The FOMC’s decision marked the seventh interest rate hike since they began taking steps toward normalizing monetary policy on December 16, 2015.  The Fed also announced that it expects there to be two more rate hikes before the end of this year.3  Since that time, short-term interest rates have experienced a material increase as the 3-month LIBOR rose by a factor of eight, and the one-year US Treasury has more than doubled.

The knock-on effect of rising interest rates is that borrowing costs are rising.  This is particularly true for those with floating rate debt obligations, such as consumer credit cards, which are typically benchmarked to the prime lending rate.  

The US dollar has also demonstrated strength relative to the currencies of its primary trading partners throughout the first half of the 2018, with notable appreciation taking place during the second quarter.  This is a strong contrast from 2017 when the US dollar demonstrated broad weakness.  A strong US dollar has some advantages in making foreign imported goods cheaper; however, this also makes US exports more expensive.  A strong US dollar also makes it much more expensive for foreign government and corporate issuers to service their US dollar debt – particularly in a higher interest rate environment. 


Change in US compared to selected currencies
US dollar vs. 2017 YTD 2Q Change
Canadian dollar -6.92% 4.43% 2.05%
Mexican peso -5.43% 0.95% 8.30%
Euro -14.15% 2.75% 5.09%
British pound  -9.51% 2.35% 5.90%
Australian dollar -8.34% 5.30% 3.69%
Brazilian real 1.77% 14.42% 14.49%
Chinese yuan -6.74% 1.73% 5.00%
Source: Bloomberg

Adding to the market’s volatility is the uncertainty of US trade policy.  President Trump’s administration has announced numerous trade tariffs that affect our relationships with longstanding trading partners.  At this point, most countries have been responding with a tit-for-tat approach.  The uncertainty appears to have only one certain outcome – raising investors’ concerns.  Some countries look to exports as a major source of their economic activity.  China, Mexico, and Germany report that in 2017 exports made up 19.8%, 37.9%, and 47.2% of their GDP, respectively.4  If trade patterns become materially altered, we can expect negative impacts on global growth.

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, 2018

Top 10 Holdings Portfolio Weight
 NextEra Energy Capital (FPL Group)  4.87%
 Hartford Financial Services Group  4.81%
 Bank of Nova Scotia  4.77%
 Lincoln National  4.74%
 Iron Mountain  4.64%
 First Abu Dhabi Bank  4.42%
 Nokia 4.40%
 Koninklijke DSM 4.32%
 Telus  4.19%
 Hanmi Financial  3.68%
Bond Quality Diversification
AA 15.25%
A 15.87%
BBB 40.37%
BB 14.49%
B 4.64%
Not rated 5.56%
Cash and equivalents 3.82%

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

The Saturna Sustainable Equity Fund gained 0.94% for the quarter, underperforming the S&P Global 1200 Index, which rose 1.39%, but coming in ahead of the Morningstar World Large Stock Category average return of 0.62%.

Murata Manufacturing and TJX Companies showed the strongest performance among the Sustainable Equity Fund’s holdings this past quarter, in keeping with the strong performance we’ve seen with their year-to-date returns of 26.34% and 25.56%, respectively. 

Murata is a global leader in the manufacture of small electronics components and is primarily known for its capacitors – the pieces responsible for storing energy in nearly all electronics devices from mobile phones to home appliances.  In 2016, Murata’s share of the worldwide market for ceramic parts positioned it as the third largest manufacturer of glass, advanced ceramics, and refractories worldwide, by revenue.  Though the company has seen its business double in the last five years, Murata is firmly committed to sustainable growth and has established a number of policies relating to ethics, human rights, the environment, and other corporate social responsibility issues.  The “Murata Philosophy” was established in 1954 and outlines the company’s commitment to trustworthiness through compliance, transparency, and superior ethics, as well as the desire to advance society.

TJX Companies has a similar approach to responsible business – particularly in the area of corporate governance – and cites its “long-held principles of respect, integrity, and fairness” as the cornerstones that guide its business.  A global leader in off-price department stores (such as T.J. Maxx, Marshalls, Sierra Trading Post, and HomeGoods in the US), TJX Companies manages impact beyond just its stores’ operations by way of a Vendor Code of Conduct, ensuring that child labor, forced labor, and other objectionable working conditions stay out of its supply chain.  A supplier diversity program takes TJX Companies’ responsible supply chain a step further by seeking to support businesses that are owned by minorities, women, veterans, LGBTQ individuals, and persons with disabilities.  TJX’s stock price has risen nearly 500% in the past decade, 90% in the past five years, and off-price purchases are expected to take over another 3% of consumers’ closets by 2027.  We are pleased with the performance of TJX Companies and appreciate its careful attention to ESG issues.

Top underperformers in the second quarter include LATAM Airlines Group, Ramsay Health Care, and Siemens Gamesa Renewable energy.  LATAM, based in Santiago, Chile, is the largest airline in South America and has seen a steady increase of international passengers.  Flights between São Paulo and Lisbon began in early June, and the company intends to extend service to Munich before the first half of 2019.

This is the second quarter in a row that we’ve seen considerable underperformance from Ramsay Health Care, though we remain optimistic about its growth potential. 

Starbucks also underperformed this quarter, down -15.17%, perhaps an indicator of lagging sales and some fallout from the annual shareholders’ meeting at the end of March.  Activists turned out to protest Starbucks’ lack of progress on a number of its environmental goals, casting some doubt on the level of its commitment to sustainability.  Starbucks has continued to shine in areas such as hiring practices, and we remain optimistic the company can meet its sustainability challenges.  Starbucks also announced in June it would be closing 150 underperforming stores in the coming fiscal year but plans to continue opening new stores in the South and Midwest. 

While 3M, NXP Semiconductors, and Taiwan Semiconductor previously held spots in the portfolio’s top 10 holdings, they were replaced this quarter with Murata Manufacturing, Koninklijke Philips, and Accenture.

As of June 30, 2018

10 Largest Contributors YTD Return Contribution
Murata Manufacturing 22.83% 0.55
Adobe Systems 12.83% 0.51
TJX Companies 17.23% 0.37
Apple 10.76% 0.34
Koninklijke Philips 12.81% 0.33
Mastercard, Class A 12.36% 0.32
Home Depot 10.06% 0.27
Nike, Class B 13.04% 0.24
Johnson Matthey 13.76% 0.21
Microsoft 8.51% 0.20
10 Largest Detractors YTD Return Contribution
LATAM Airlines Group -35.39% -0.35
Taiwan Semiconductor ADR -13.37% -0.34
Ramsay Health Care -16.66% -0.32
Samsonite International -14.67% -0.030
3M -9.78% -0.28
Starbucks -15.17% -0.26
Valeo -15.25% -0.24
NXP Semiconductors -6.61% -0.19
Siemens Gamesa Renewable Energy -16.17% -0.16
Kimberly-Clark de Mexico, Class A -7.70% -0.13
Top 10 Holdings Portfolio Weight
 Adobe Systems  4.37%
 Dassault Systemes ADR  3.79%
 Apple  3.32%
 Murata Manufacturing  3.01%
 Home Depot  2.97%
 Toronto-Dominion Bank  2.91%
 Mastercard, Class A  2.90%
 Koninklijke Philips ADR  2.72%
 Unilever  2.70%
 Accenture, Class A  2.64%

Morningstar Sustainability Ratings™

Saturna Sustainable Equity Fund (SEEFX)

Morningstar Sustainability Rating - High - 5 Globes

Percent Rank in Category: 1

Among 726 World Large Stock Funds


Saturna Sustainable Bond Fund (SEBFX)

Morningstar Four Globes

Percent Rank in Category: 20

Among 265 World Bond Funds

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

© 2018 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, 2018. 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 Saturna Sustainable Equity Fund was rated on 92% and the Saturna Sustainable Bond Fund was rated on 60% 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.


Performance Summary

As of June 30, 2018

Scroll right to see more » »

  Expense Ratio
Average Annual Total Returns (Before Taxes) YTD   1 Year   3 Year   Since InceptionB   Gross Net
Sustainable Equity Fund (SEEFX) 2.08% 11.70% 6.89% 5.56% 1.37% 0.75%
S&P Global 1200 Index 0.35% 11.57% 9.29% 8.67% n/a
S&P 500 Index 2.65% 14.37% 11.93% 11.14% n/a
Sustainable Bond Fund (SEBFX) -1.30% -0.52% 1.94% 1.34% 0.84% 0.65%
FTSE WorldBIG Index -1.51% 1.42% 2.62% 1.90% n/a
MSCI All Country World Index -0.13% 11.31% 8.78% 8.22% n/a

Scroll right to see more » »

A By regulation, expense ratios shown are as stated in a Fund’s most recent prospectus or summary prospectus, dated March 28, 2018, and incorporate results from the fiscal year ended November 30, 2017.  Expense ratios are restated to reflect the ending of the Distribution (12b-1) Fees, as approved by the Board of Trustees on March 14, 2017.  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, 2019.

B Both Saturna Sustainable Equity 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.  Investors cannot invest directly in the indices. 

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 3.36%.


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.

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 WSTS Semiconductor Market Forecast Spring 2018, Press Release, June 5, 2018.

2 WSTS Semiconductor Market Forecast Autumn 2017, Press Release, November 28, 2018.

3 Sperling, Jonathan. Fed Chairman Jerome Powell Praises Economy After Vote to Raise Interest Rates, Fortune, June 14, 2018. http://fortune.com/2018/06/14/jerome-powell-fed-vote-raise-interest-rates/

4 Exports of goods and services data, The World Bank.