Q3 2020

The ESG Environment

Just when one thinks 2020 has run out of tricks, it throws another tantrum in the form of exploding conflagrations across California, Oregon, and parts of Washington, while simultaneously inundating the Gulf Coast with multiple tropical storms and hurricanes.  The record extent of the wildfires, along with an Atlantic season so active that we ran out of letters to name storms and had to switch to the Greek alphabet (Hurricane Delta jumped to Category 4 during writing and the Gulf Coast is again in the crosshairs), further cements our position in the Anthropocene¹ and the irrefutable conclusion that human influence has spread beyond environmental degradation and extinction to planetary-wide changes to the atmosphere and oceans.  Absent serious and immediate steps toward revolutionizing our modus operandi, we will render the Earth uninhabitable across vast swaths, a progression most damaging to those least able to afford it in the developing world and those at the lower end of the socioeconomic scale in the developed world but also far from inconsequential for the wealthiest segments of the population.

In response, we have continued to refine our approach to sustainable investing.  We seek additional opportunities to raise the impact of our funds through investment in alternative sources of energy such as wind power, further researching the developments in battery-powered transportation, and attempting to identify those companies that may drive the transition and benefit from the nexus of solar power generation and battery storage.  At the same time, we have worked to increase the rigor of our carbon screening process, identifying not only companies that achieve relatively low emissions, but ensuring that they remain relentless in efforts to limit emissions and that goals, once set, are met.

The pandemic and resultant economic dislocation has also afforded an opportunity to revisit the social commitments of our investments.  Not surprisingly, strong environmental and social performance often go hand in hand with good governance, and we have continued to seek opportunities to engage with companies on board diversity, executive pay, and other governance issues.

Market Environment and Outlook

Extending the unpredictability of 2020, markets charted an aggressive course through the third quarter.  Following the abrupt sell-off in late February and early March, the S&P 500 Index quickly recovered in the second quarter and accelerated its ascent through the end of August, peaking on September 2 and providing a total return of 15.85% for the quarter through that date.  Then, a 9.5% correction through September 23 ensued, returning to levels last seen in late July.  A rebound into the final week of September pushed the index return to 8.93% for the quarter and 5.57% year-to-date.  The European and Japanese markets reflected this pattern to a less dramatic extent.

The unusual August melt-up may be attributed to a number of theories including retail options trading, a single large investor’s positioning, and of course, unspecified Federal Reserve actions.  The construction of the benchmark S&P 500 Index certainly contributed to the rise: at the peak, the five largest companies by market capitalization (Apple, Microsoft, Amazon, Facebook, and Alphabet) comprised more than 22% of the index.  The price action of those five companies influence the benchmark performance as much as the bottom 363 companies combined. 

Market action since late March indicates investors have looked past many of the factors that precipitated the poor first quarter performance, but the disturbing resilience of the coronavirus in the US, combined with its resurgence across Europe and Canada, prevents us from signaling the all-clear.  That’s especially true given the onset of cooler weather across the northern hemisphere and the announcement that the virus has spread throughout the Trump administration, including the president and the first lady.  While wishing POTUS and FLOTUS, as well as other members of the government who have tested positive, speedy recoveries, the fourth quarter of 2020 has already continued the trend set in the first three, that is, uncomfortably unpredictable.  Measures of expected volatility are forecast to remain elevated through December of this year – the biggest surprise to the market would be an uneventful election and a wind-down of COVID infections.  That does not represent our base case, especially in light of President Trump’s recent illness.

Currently, the state of the economy stands as our biggest concern.  Federal Reserve Chairman Powell shares those concerns, stating, “At this early stage, I would argue that the risks of policy intervention are still asymmetric.  Too little support would lead to a weak recovery, creating unnecessary hardship.”²  Democrats and Republicans have failed to agree on additional stimulus measures and, absent bringing the spread of COVID-19 under control, economic indicators have weakened, particularly in the realm of employment.  While the unemployment rate dropped to 7.9%, a significant improvement from April’s 14.7%, the figure was distorted by 700,000 people dropping out the labor force and pushing the September labor participation rate down to 61.4% from 61.7% in August and 63.4% last February.  We must also recognize that many people are taking anything they can get in the current environment; a reality reflected by the Federal Reserve U-6 measure.  U-6 takes the unemployment rate and adds those employed part time or only marginally attached to the labor force.  The U-6 rate for September was 12.8%, lower than its peak this past spring.  Looking to pre-COVID times, it’s the highest reading since December 2013.

Stepping away from government statistics, developments toward the end of the third quarter indicate the growing trend of long-term unemployment.  Disney announced the permanent lay-off of 28,000 employees³ who had been previously furloughed due to continued park closures.  American Airlines and United Airlines sent notices to 19,000 and 13,000 workers, respectively.  As the virus continues to spread, restaurants, movie theaters, gyms, hotels, and numerous other businesses are at risk of permanent closure.  While the job losses last April were jarring, they were largely thought at the time to be temporary.  According to the Labor Department, 3.8 million people lost their jobs permanently in September, nearly twice the level of permanent losses in April.

With the arrival of autumn weather, COVID infections soaring in certain states, the economy weakening, and the US November elections approaching, any number of news reports could shock a correction that we would look to as an entry point.  Depending upon the election outcome, expected tax policy changes could influence market action either up or down. Looking past the election, our base case is to remain positive on US equities as we believe the government will attempt to manage the economy with a combination of fiscal and monetary policies.  We expect policy makers have a bias to stimulate and provide more than adequate liquidity.  Perhaps we are not all Keynesians now, but we are Modern Monetary Theorists.

Saturna Sustainable Bond Fund

Saturna Sustainable Equity Fund

Performance Summary

As of September 30, 2020

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^A By regulation, expense ratios shown are as stated in a Fund’s most recent prospectus or summary prospectus, dated March 27, 2020 and incorporate results from the fiscal year ended November 30, 2019.  Saturna Capital, the Funds’ investment adviser, has voluntarily capped actual expenses of the Sustainable Equity Fund at 0.75% and actual expenses of the Sustainable Bond Fund at 0.65% through March 31, 2021.

^B Saturna Sustainable Equity Fund and Saturna Sustainable Bond Fund began operations on March 27, 2015.

Performance data quoted herein represents past performance, which is no guarantee of future results.  Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost.  Current performance may be higher or lower than the performance data quoted herein.  Performance current to the most recent month-end can be obtained by visiting www.saturnasustainable.com or calling toll-free 1-800-728-8762.  

The S&P 500 is an index comprised of 500 widely held common stocks considered to be representative of the US stock market in general.  The S&P Global 1200 Index is a global stock market index covering nearly 70% of the world’s equity markets.  The FTSE WorldBIG Bond Index is a multi-asset, multi-currency benchmark, which provides a broad-based measure of the global fixed income markets.  The MSCI ACWI covers approximately 85% of the global investable universe, with large- and mid-cap representation across 23 developed market and 23 emerging market countries.  When available, Saturna uses total return components of indices mentioned.  Investors cannot invest directly in the indices.

Performance Summary

As of September 30, 2020

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

© 2020 Morningstar®.  All rights reserved.  Morningstar, Inc. is an independent fund performance monitor. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely.  Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

^C Morningstar Ratings^™ (“Star Ratings”) are as of September 30, 2020.  The Morningstar Rating^™ for funds, or “star rating”, is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history.  Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes.  It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product’s monthly excess performance (not including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance.  The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star.  The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating metrics.  The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.

^D Morningstar Sustainability Ratings are as of August 31, 2020. The Morningstar Sustainability Rating™ is intended to measure how well the issuing companies of the securities within a fund’s portfolio are managing their environmental, social, and governance (“ESG”) risks and opportunities relative to the fund’s Morningstar category peers. The Morningstar Sustainability Rating calculation is a two-step process. First, each fund with at least 67% of assets covered by a company-level ESG score from Sustainalytics receives a Morningstar Portfolio Sustainability Score™. The Morningstar Portfolio Sustainability Score is an asset-weighted average of normalized company-level ESG scores with deductions made for controversial incidents by the issuing companies, such as environmental accidents, fraud, or discriminatory behavior. The Morningstar Sustainability Rating is then assigned to all scored funds within Morningstar Categories in which at least ten (10) funds receive a Portfolio Sustainability Score and is determined by each fund’s rank within the following distribution: High (highest 10%), Above Average (next 22.5%), Average (next 35%), Below Average (next 22.5%), and Low (lowest 10%). The Morningstar Sustainability Rating is depicted by globe icons where High equals 5 globes and Low equals 1 globe. A Sustainability Rating is assigned to any fund that has more than half of its underlying assets rated by Sustainalytics and is within a Morningstar Category with at least 10 scored funds; therefore, the rating it is not limited to funds with explicit sustainable or responsible investment mandates.  Morningstar updates its Sustainability Ratings monthly. Portfolios receive a Morningstar Portfolio Sustainability Score and Sustainability Rating one month and six business days after their reported as-of date based on the most recent portfolio. As part of the evaluation process, Morningstar uses Sustainalytics’ ESG scores from the same month as the portfolio as-of date.

The Fund’s portfolios are actively managed and are subject to change, which may result in a different Morningstar Sustainability Score and Rating each month. 

The Saturna Sustainable Equity Fund was rated on 100% of Assets Under Management and the Saturna Sustainable Bond Fund was not rated.

Percent Rank in Category is the fund’s percentile rank for the specified time period relative to all funds that have the same Morningstar category. The highest (or most favorable) percentile rank is 1 and the lowest (or least favorable) percentile rank is 100. The top-performing fund in a category will always receive a rank of 1.  Percentile ranks within categories are most useful in those categories that have a large number of funds.

Footnotes to commentary

¹ The Encyclopedia of Earth. Welcome to the Anthropocene, 2020. http://www.anthropocene.info/ 

² Timiraos, Nick.  Fed’s Powell Says U.S. Faces ‘Tragic’ Risks From Doing Too Little To Support Economy.  Wall Street Journal, October 6 2020. https://www.wsj.com/articles/feds-powell-says-u-s-faces-tragic-risks-from-doing-too-little-to-support-economy-11601995201

³ Casselman, Ben, Gillian Friedman and Jeanna Smialek.  Workers Face Permanent Job Losses as the Virus Persists.  The New York Times, October 3 2020. https://www.nytimes.com/2020/10/03/business/economy/coronavirus-permanent-job-losses.html

⁴ Sekera, Dave.  Corporate Bonds Stand Out in Second Quarter.  Morningstar, July 8 2020.  https://www.morningstar.com/articles/991119/article

⁵ Cox, Jeff.  The fed is buying some of the biggest companies’ bonds, raising questions overs why.  CNBC, June 29 2020.  https://www.cnbc.com/2020/06/29/the-fed-is-buying-some-of-the-biggest-companies-bonds-raising-questions-over-why.html

Important Disclaimers and Disclosure

This publication should not be considered investment, legal, accounting, or tax advice or a representation that any investment or strategy is suitable or appropriate to a particular investor's circumstances or otherwise constitutes a personal recommendation to any investor. This material does not form an adequate basis for any investment decision by any reader and Saturna may not have taken any steps to ensure that the securities referred to in this publication are suitable for any particular investor. Saturna will not treat recipients as its customers by virtue of their reading or receiving the publication.

The information in this publication was obtained from sources Saturna believes to be reliable and accurate at the time of publication.

All material presented in this publication, unless specifically indicated otherwise, is under copyright to Saturna. No part of this publication may be altered in any way, copied, or distributed without the prior express written permission of Saturna.

The Saturna Sustainable Funds limit the securities they purchase to those consistent with sustainable principles. This limits opportunities and may affect performance.

Investing involves risk, including possible loss of principal. Generally, an investment that offers a higher potential return will have a higher risk of loss. Stock prices fluctuate, sometimes quickly and significantly, for a broad range of reasons that may affect individual companies, industries, or sectors. When interest rates rise, bond prices fall. When interest rates fall, bond prices go up. A bond fund's price will typically follow the same pattern. Investments in high-yield securities can be speculative in nature. High-yield bonds may have low or no ratings, and may be considered "junk bonds." Investing in foreign securities involves risks not typically associated directly with investing in US securities. These risks include currency and market fluctuations, and political or social instability. The risks of foreign investing are generally magnified in the smaller and more volatile securities markets of the developing world.

A Fund’s 30-Day Yield, sometimes referred to as “standardized yield” or “SEC yield,” is expressed as an annual percentage rate using a method of calculation adopted by the Securities and Exchange Commission (SEC). The 30-Day Yield provides an estimate of a Fund’s investment income rate, but may not equal the actual income distribution rate.  Without the voluntary expense cap, the 30-Day Yield for Saturna Sustainable Bond Fund would have been 1.80%.  Unsubsidized yield does not adjust for any fee waivers and/or expense reimbursements in effect.

Effective maturity and modified duration are measures of a fund's sensitivity to changes in interest rates and the markets. A fund's effective maturity is a dollar-weighted average length of time until principal payments must be paid. Longer maturities typically indicate greater sensitivity to interest rate changes than shorter maturities. Modified duration differs from effective maturity in that it accounts for interest payments in addition to the length of time until principal payments must be paid. Longer durations tend to indicate greater sensitivity to interest rate changes than shorter durations. Call options and other security specific covenants may be used when calculating effective maturity and modified duration.