And The Beat Goes On
Equity indices around the world continued their remarkably steady march higher over the third quarter, despite the war of words that erupted between Donald Trump and North Korean leader Kim Jong-un; an exchange that caused serious people to discuss the risk of miscalculation leading to nuclear war. On a more mundane level, there were indications the European Central Bank may be close to ending its extraordinary monetary policy; a hurricane battered the Texas Gulf Coast leaving Houston largely under water; another hurricane devastated heavily indebted Puerto Rico; and independence referendums in Iraqi Kurdistan and Spain’s Catalonia passed overwhelmingly, sparking tension between the regional and central governments, while making their neighbors nervous. A lot happened in the third quarter, and none of it caused more than a blip in the stock market.
Perhaps none of these events carry negative implications for corporate earnings or the investment environment, although it’s hard to believe a nuclear exchange wouldn't cause disruption. Some events may even be positive for certain sectors, as illustrated by sharply higher car sales in October, driven by replacement demand in Texas and Florida. Alternatively, market resilience may represent a victory of hope over experience. Having failed to achieve any legislative victories to date, Republicans have set their sights on tax reform. The plan, which remains short of detail, has been questioned in some quarters for potentially raising taxes on the middle class while cutting taxes for the wealthy. Many prominent economists have expressed doubt surrounding the claims concerning deficit reduction. Additionally, several Republicans have voiced reservations over some aspects of the plan, particularly the potential removal of mortgage interest deductibility, clouding the prospects for passage. Regardless, the market remains unconcerned.
Maybe we shouldn’t be surprised by the “no drama” market of 2017 since that’s largely been the case since stocks bottomed in 2009 in the wake of the Global Financial Crisis…which may provide a clue as to the bull’s resilience. There’s an unstoppable force (demographics) pushing against a clearly moveable object (stock values). The two largest age cohorts in the United States are 20-29 and, more relevant to our point, 50-59. The Baby Boom may have started in 1946, but it really got underway in the early 1950s and accelerated into the 1960s, as shown in the chart below. People between the ages of 50-64 account for 19.9% of the US population. Meanwhile, all cohorts above the age of 69 account for just over 10% of the population. A reasonable assumption would be that the older citizens are drawing down their retirement portfolios, while a group that’s twice as large, many of whom have likely undersaved for retirement or have concerns about the future viability of Social Security, are ramping up their savings. What happens when we transition to the retired making up a much larger portion of the population will not be known until the next decade. Until then, for investors not yet in retirement or just beginning their retirement, staying fully invested remains the best strategy.
On a shorter-term view, and despite the risks of complacency, our outlook remains largely the same as at the end of the second quarter – economic conditions are generally good and improving around the world, interest rates remain low, and corporate earnings should grow, supporting current valuations. Nothing on the visible horizon presents a significant risk to equity markets.
Saturna Sustainable Bond Fund
For the trailing 12-month period ended September 30, the Saturna Sustainable Bond Fund returned 3.68% compared to -0.73% offered by the Citi World Broad Investment-Grade Bond Index. Year-to-date, the Sustainable Bond Fund returned 6.31% compared to 6.33% offered by the Index. The portfolio was invested among 44 issues from 38 issuers, posting a modified duration of 2.88 years and a 30-day yield of 3.04%. The outperformance over the past 12 months can be attributed to a combination of security selection, unrealized gains of the Fund’s fixed-to-float rate securities, and the appreciation of its foreign currency denominated securities relative to the US dollar.
Top performers for the quarter include Norwegian krone denominated securities. The Fund’s best-performing issue, with a return of 5.67%, was Nestle Holdings (NESNVX 2¾ 04/15/20), a longstanding, distinguished sustainability leader in the food and beverage industry. Taking second place with a return of 5.51% is automobile manufacturer BMW (BMW 2¾ 04/25/19), a company with a long tradition of integrating sustainable considerations into its core business strategy while also being recognized as the only automotive company continuously listed on the Dow Jones Sustainability Index (DJSI) since its beginning.1 The two worst-performing issues over the quarter include Teva (TEVA 2.8 07/21/23), a generic drug and pharmaceutical manufacturer headquartered in Israel, and NextEra Energy (NEE Float 06/15/67), the world’s largest generator of renewable energy from wind and sun headquartered in Juno Beach, Florida, posting returns of -1.38% and -1.08%, respectively.
The quarter-end marked a change among some central banks to reign in years of accommodative monetary policies following the global financial crisis (GFC). On September 6, the Bank of Canada raised its key interest rate from 0.75% to 1.00%, reflecting stronger than expected economic data. September’s interest rate increase represented the second rate hike by the Bank of Canada, with the first taking place on July 12, 2017. Last quarter marks the first time the Bank of Canada has raised rates since the GFC.2,3 Our neighbors in Mexico have also raised rates this year but at a much more vigorous pace relative to the US and Canada. The Central Bank of Mexico raised its lending rate four times this year from 5.75% at year-end 2016 to 7.00% on June 22, 2017, to slow the pace of inflation.4,5
In the US, the Federal Open Market Committee opted to hold off on an interest rate increase at its September 20 meeting. Fed Chairwoman Janet Yellen meanwhile indicated that the Federal Reserve remains on track to raise short-term interest rates later this year and shrink its balance sheet, which, according to her, is “well justified given the very substantial progress we’ve seen in the economy.”6 Since December 16, 2015, the FOMC has raised its primary lending rate four times, each time by a quarter of a percent.7 While most other major economies around the world have yet to begin to raise rates, the actions being taken by the North American economies reflect slow and incremental steps toward normalization of monetary policies.
It is interesting to note that while economic activities have improved since the FOMC’s first rate hike, long-term interest rates remain stubbornly low, as securities on the front-end of the yield curve, such as the 3-month Libor and 2-year US government maturities, experienced the greatest rise. Five-year Treasurys remain relatively unchanged, dropping 2.7 basis points in yield, while and the longer maturities, such as the 10 and 30-year notes, fell 7.2 and 8.4 basis points in yield, respectively. The accompanying illustration provides a cogent example of the change in interest rates over the past seven quarters.
|Change in US Interest Rates|
|Dec. 16, 2015||Sep. 20, 2017||Change|
|3 Month Libor||1.00%||1.32%||32.60%|
|1 year US T-Bill||1.28%||1.30%||1.60%|
|2 year US Gov. Note||1.20%||1.44%||20.20%|
|5 year US Gov. Note||1.93%||1.88%||-2.70%|
|10 year US Gov. Note||2.45%||2.27%||-7.20%|
|30 year US Gov. Note||3.07%||2.81%||-8.40%|
Note: The dates in this table correspond to FOMC meeting dates.
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 September 30, 2017
|Top Ten Holdings||Portfolio Weight|
|Puget Sound Energy||4.78%|
|NextEra Energy Capital (FPL Group)||4.74%|
|First Abu Dhabi Bank||3.58%|
|Bond Quality Diversification|
|Moody's Investors Services|
|Cash and equivalents||3.80%|
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.
Saturna Sustainable Equity Fund
Year-to-date, Saturna Sustainable Equity Fund was up 17.38%, subtly outperforming the S&P Global 1200 Index return of 17.18%, and the S&P 500 Index return of 14.24%. For the quarter, the Fund’s 3.77% return trailed S&P Global 1200’s 5.22% and the S&P 500’s 4.48%.
Koninklijke Phillips (15.02%) was the portfolio’s strongest contributor during the second quarter of 2017 and has a robust sustainable story. Phillips’ mission of making the world healthier through innovation fits soundly into our investment strategy. The management turnaround implemented by breaking out the lighting business is almost complete, and margin improvement shows the promise of that decision. Based on aging global demographics, health awareness, and the global move toward LED lighting, it’s a positive sign for the future of the company that “health tech” has replaced lighting as the brand signature, both in the retail segment (toothbrushes, shaving, and kitchen appliances) and in institutional machines for hospital use (ultrasound, MRI, and CT scanning).
Toronto-Dominion (13.75%), Canada’s second largest bank and one of the top 10 banks in North America, exceeded expectations this quarter. TD’s commitment to retail services and a conservative risk management program allow for its repeatable and growing earnings stream. Considering the size of the bank, having roughly 46% of their customers active online or mobile is a solid indication they are keeping pace with banking changes as society becomes more mobile.
France-based Dassault Systemes operates as a holding company for the sale of software solutions. Dassault is engaged in the development of various software solutions integrated in the 3DEXPERIENCE platform. A slow and steady growth company buoyed by the news of an expanded relationship with 3DS and Boeing, the quarter was splendid for Dassault. The 3DEXPERIENCE is now in planes, cars, America’s cup racing yachts, simulated digital 3D heart models, and many other products and industries. Dassault is a leader in this industry and has diversified outside the 3D realm. Due to its innovative solutions, its successful transition to a subscription model, and the high cost of switching after a company settles on engineering software, Dassault remains a place we like to be invested.
Once again Ramsay Health Care finds itself on the detractors list. With population aging and demand for medical facilities expected to outweigh availability, this is a long-term investment. Ramsay grew earnings and revenues over the quarter, but unfortunately for the short term, the share price decreased. Australia-based and focused, Ramsey continues to expand in France and the UK where the business environment is challenging. Related services like patient transportation, outpatient surgery centers, and other ancillary products should continue to add to revenue growth over time.
A disappointment this quarter was Nike. Nike is a global brand with an excellent sustainable strategy, and, after recovering in the second quarter, they slumped again in the third.
Acquisitions (like that of Converse in 2012) could potentially help Nike regain market share lost to Adidas and Puma over the last year. This is a long-term story, and we are evaluating the holding and position size. Nike is one of the few Dow Industrial equities with a lower valuation year over year. Growth in the US has slowed, and Under Armour and Adidas outpace Nike abroad. That said, direct-to-retail sales rose 18%, the ability to customize offerings online is unique, and Nike is committed to expanding and profiting from online direct. Short-term results are going to be volatile, and rewards may come only to those who wait.
Starbucks (-7.47%) is another short-term weak/long-term strong name. We believe the valuation for Starbucks has gotten ahead of itself and that our commitment to the position will eventually be rewarded. Starbucks’ strong balance sheet, high margins, global branding, top-level transparency and reporting, and commitment to growing sustainably have us holding this name into the future. The company risks reliance on China growth and potential oversaturation of stores globally, and we will observe those threats carefully.
The top 10 holdings in the Fund are consistent with last quarter, with the exception of Koninklijke Philips, which replaced Home Depot on the list.
As of September 30, 2017
|Ten Largest Contributors||Return||Contribution|
|Koninklijke Philips ADR||15.02%||0.45|
|Dassault Systemes ADR||12.67%||0.4|
|Taiwan Semiconductor ADS||7.41%||0.4|
|Mastercard, Class A||16.47%||0.39|
|Toyota Motor ADS||13.47%||0.33|
|Ten Largest Detractors||Return||Contribution|
|Ramsay Health Care||-12.41%||-0.37|
|Nike, Class B||-11.82%||-0.26|
|Church & Dwight||-6.25%||-0.18|
|Siemens Gamesa Renewable Energy||-12.43%||-0.15|
|Kimberly-Clark de Mexico, Class A||-2.91%||-0.08|
|Vestas Wind Systems||-2.63%||-0.05|
|Top Ten Holdings||Portfolio Weight|
|Taiwan Semiconductor ADS||5.17%|
|Dassault Systemes ADR||3.22%|
|Koninklijke Philips ADR||3.13%|
Morningstar Sustainability Ratings™
Saturna Sustainable Equity Fund (SEEFX)
Percent Rank in Category: 1
Among 711 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 August 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 89%
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.
As of September 30, 2017
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|Average Annual Total Returns (Before Taxes)||YTD||1 Year||3 Year||5 Year||10 Year||Gross||Net|
|Sustainable Equity Fund (SEEFX)||17.38%||▲||13.22%||▲||n/a||n/a||n/a||1.40%||0.75%|
|S&P Global 1200 Index||17.18%||▲||19.62%||▲||8.51%||▲||11.58%||▲||4.88%||▲||n/a|
|S&P 500 Index||14.24%||▲||18.61%||▲||10.81%||▲||14.21%||▲||7.43%||▲||n/a|
|Sustainable Bond Fund (SEBFX)||6.31%||▲||3.68%||▲||n/a||n/a||n/a||0.92%||0.65%|
|Citigroup WorldBIG Index||6.33%||▲||-0.73%||▼||1.34%||▲||0.66%||▲||3.38%||▲||n/a|
|MSCI All Country World Index||17.75%||▲||19.29%||▲||8.02%||▲||10.78%||▲||4.44%||▲||n/a|
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Expense ratios shown are as stated in the Funds most recent Prospectus, dated June 2, 2017. Saturna Capital, the Fund's 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 June 2, 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.
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 3.02%.
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.
1BMW Group Sustainable Value Report 2016, page 17. https://www.bmwgroup.com/content/dam/bmw-group-websites/bmwgroup_com/ir/downloads/en/2016/BMW-Group-SustainableValueReport-2016--EN.pdf
2 Alini, Erica. Bank of Canada raises interest rate to 1% - and that’s not the end of it, economists say, Global News, September 6, 2017. https://globalnews.ca/news/3721332/bank-of-canada-interest-rate-hike/
3 Argitis, Theophilos. Bank of Canada Raises Rates for First Time in 7 Years, Bloomberg.com, July 12, 2017. https://www.bloomberg.com/news/articles/2017-07-12/bank-of-canada-raises-benchmark-rate-to-0-75-key-takeaways
4 Banxico overnight interbank rate, global-rates.com, October 5, 2017. http://www.global-rates.com/interest-rates/central-banks/central-bank-mexico/banxico-interest-rate.aspx
5 Canas, Jesus. Mexico Economy Expands in First Quarter; Fourth Quarter Revised Higher, Federal Reserve Bank of Dallas Mexico Economic Update, May 17, 2017. https://www.dallasfed.org/research/update/mex/2017/1703
6 Timiraos, Nick. Fed to Start Paring Holdings, Keeps December Rate Rise on the Table, The Wall Street Journal, September 20, 2017. https://www.wsj.com/articles/fed-keeps-december-rate-rise-on-the-table-eyes-slower-path-for-increases-1505930513
7 FED Federal Funds Rate, American central bank’s interest rate, global-rates.com. http://www.global-rates.com/interest-rates/central-banks/central-bank-america/fed-interest-rate.aspx