Markets across the globe were muted in the third quarter, with the S&P 500 posting a modest 0.58% return and the MSCI ACWI Index falling -0.95%. Emerging markets presented a dark spot, with the MSCI Emerging Markets Index falling -8.09% during the quarter.
Over the past five years, the S&P 500 Index produced positive quarterly returns for 17 out of 20 quarters. Remarkably, the S&P’s positive-return trend continued during the COVID pandemic. Since the beginning of March 2020, the Index produced positive monthly returns 14 out of 19 times despite (or because of?) harrowing circumstances.
September 2021 produced one of those few negative-return months as market volatility reasserted itself in the capital markets almost in lockstep with the seasonal onset of autumn. Following the September meeting of the Federal Open Market Committee (FOMC), the capital markets’ views on deflation, inflation, or reflation and global GDP trends once again shifted, this time from a deflationary to an inflationary outlook. Nominal interest rates rose, the US Dollar Index rallied, commodities — excluding energy — declined, and equities began to falter, notably in the Technology sector, which benefits from a deflationary outlook. This sorting is likely to continue, shifting back and forth as the effects of the pandemic and policymaker response become apparent.
Global central banks are signaling an end to the unprecedented highly accommodative monetary policies. The recent FOMC hawkish tone, with US legislature gridlocked over fiscal spending, points to a tightening of conditions sometime soon, which is typically negative for the capital markets. The rise in US 10-year Treasury yields from 1.310% on August 31 to 1.535% on September 30 is a byproduct of this market volatility. While an increase of 20 basis points may not seem like a large movement when measured on a nominal basis, it does represent a 21% increase in interest rates. During periods of monetary policy shifts, market volatility often reasserts itself among the capital markets.
Exiting the third quarter, the unwinding of the deflation trade and back-up in rates paused the ongoing equity rally led by Technology growth stocks. Combined with elevated valuations, US equities demonstrated vulnerability to another growth/value rotation, or perhaps a correction. September marked a quick reversal of the growth/value trend, with growth trailing. Despite unprecedented expansion of the Federal Reserve’s balance sheet and money supply, the US dollar Index remained range-bound, year-to-date.
For now, the inflation theme appears ascendant as supply shocks and deglobalization concerns impact price levels, offsetting some leading indicators of slower global growth. Energy markets, led by natural gas, strengthened as supply constraints met the seasonal demand increase in the northern hemisphere. At this point, the knock-on effects are unclear; however, it reasonable to anticipate that these high energy prices will hamper future economic activity and slow the global recovery. The rise in energy prices is also likely to increase inflationary pressures, which, in turn, is likely to lead market participants to anticipate higher interest rates – at least over the near-term.
US consumer sentiment slackened during the quarter to its lowest point in seven months, but still retained a positive bias. While wages were mixed, hourly compensation for US non-farm businesses and job openings both set a record in the second quarter 2021. Policymakers’ plan for the reduction in stimulus benefits combined with higher wages are expected to lift employment over the upcoming quarters. Yet the Citibank Economic Surprise Index trended negative, suggesting that economic forecasters are behind in assessing a slower-than-expected economy.
The global Purchasing Managers’ Index (PMI) remained positive over the quarter but trended down, with the US remaining the strongest market. Notably, China reported a neutral outlook which will likely decline into the fourth quarter with recent electrical system interruption and Communist party policy decisions to restrain some economic sectors. China’s intent to reorder its economy to promote “common prosperity” presents a risk to future global GDP growth that may yet be incorporated into forecaster and investor views. In addition, the slow-moving default of the real estate development company, the Evergrande Group, may signal at least two changes in the China outlook: a policy shift from protecting too-big-to-fail companies and changing from an infrastructure-led to a consumer-led economy. These events may signal slower growth rates in China as well as growth rates of global GDP in the future.
Eventually, the US economy needs to perform ex-stimulus by demonstrating consecutive improving GDP reports and employment trends. Absent some external shock, into the first half of 2022, we expect the markets to sort out these trends and come to grips with a reflation, inflation, or deflation medium-term outlook. Until that point, equity markets will likely remain on-trend while discounting re/inflation vs. deflation and rotating between growth and value. A fall back to a deflationary outlook with economic prices reset higher will restart the trends witnessed in the second half of 2020. This may occur if the economic impact of fiscal stimulus proves disappointing.
Airing out inflation jargon
Inflation – A decrease in the purchasing power of money, often observed in rising prices of goods and services.
Deflation – A general reduction in the prices of goods and services; sometimes caused by an increase in productivity or a decrease in demand.
Reflation – A monetary policy intended to expand output and stimulate spending. Examples include: tax cuts, lowering interest rates, and increasing the money supply.
Disinflation – A temporary slowing in the rate of inflation and considered the opposite of reflation.
Stagflation – A slowdown in economic growth during a period of rising inflation; sometimes called “recession-inflation.”
Saturna Sustainable Bond Fund
For the quarter ended September 30, 2021, Saturna Sustainable Bond Fund returned -0.68%, relative to -1.00% for the FTSE WorldBIG Index. For the trailing 12-month period, the Fund posted a return of 2.32%, outperforming the Index by 403 basis points, which returned -1.71%.
Green and Sustainable Bonds
As of the quarter-end the portfolio had 20.68% in green bonds, 6.14% in bonds specifically designated sustainable by the issuer, and 1.76% in sustainably-linked bonds (it should be noted that all holdings of the Fund are screened for sustainable characteristics). Green bonds are primarily used to support specific climate-related or environmental projects while sustainable bonds generally can have a wider purpose including social impact. Sustainably-linked holdings are issues where the failure to meet a carbon target will result in increased payments to the bondholder. One holding in the sustainable bond category is the Amaggi sustainability bond. The proceeds of these bonds will be used for preservation of natural resources and biodiversity, climate change mitigation, socio-economic advancement, and employment programs designed to alleviate unemployment and food insecurity, among other uses. Amaggi is one of the largest vertically integrated agribusiness companies in Latin America operating across the agribusiness value chain. The company is a large-scale producer of agricultural commodities, a grain originator, a processor, and a trader, with operations and offices in Brazil, Norway, Netherlands, Switzerland, Argentina, and Paraguay. Due to the large scale of the company’s operations, we believe that qualified use of proceeds for specific high-impact sustainability projects is a good addition to the Sustainable Bond Fund.
The Fund is able to participate in unique opportunities like those Amaggi offers because of an extensive credit review and a strong financial profile for the “BB” rating category. Even with stronger economic growth on the horizon, we continue to focus on purchasing holdings well positioned with strong cash flows and financial flexibility. Defensive positioning in the portfolio is geared to withstand an uneven economic recovery and possible challenges with emerging coronavirus variants. Globally, we recognize recovery is uneven; vaccination rates have a wide dispersion in high income versus low-income countries. In conjunction with extensive credit reviews, we have added more to the “BBB” space, reallocating from “AAA” securities anticipating stronger cash flows. The second-best performing security in the Fund was the “BBB” rated MAF Sukuk (4.638% 2029), returning 2.16% for the third quarter.
Currently the portfolio has a total exposure to foreign currency of 36.12%. Foreign currency movements were the primary drivers of lower performing securities for the quarter.
The Brazilian real depreciated -8.7% relative to the dollar last quarter, showing more volatility after appreciating 13.41% the quarter before. The two lowest performers were both denominated in the real, with negative performance driven by currency movements. The “AAA” rated IFC bond of 2023 and the Brazilian sovereign bond of 2022 are denominated in the real and returned -8.59% and -7.4% respectively. Over the quarter, the Fund added exposure to the Norwegian krone, and decreased exposure to the euro. The Fund continued to maintain an underweight to the euro relative to the FTSE WorldBIG Index, holding 9.17% while the Index maintained an allocation of around 31%.
Yield Curve and Maturity Distribution
Changes in inflation expectations have been a driving force in the changing shape of the yield curve. At the beginning of May, commodities started to rollover, led by the much talked about price of lumber but also seen in grain and industrial metal prices. However, Treasury rates fell after the second quarter, with the 30-year falling from 2.08% on June 30 to as low as 1.8% in early August. This trend changed after the Federal Reserve meeting in September, which spurred rates higher. The long end of the curve rose 23 basis points, ending the quarter at 2.05%. The five-year Treasury reached its highest levels since February of 2020, ending the quarter at 0.97%. The increase was largely driven by the Fed’s message that it might begin the taper process in November combined with an increased outlook for inflation and rates for 2022.
Inflation expectations as measured by the five-year breakeven have trended upward toward their March highs, and towards their highs since 2008.1 Higher oil prices and continued supply-chain problems have added to investors’ views that inflation will continue to be an issue. Global supply-chain bottlenecks are expected to constrain manufacturing output and impact prices well into next year due to labor shortages, lockdowns in Asia, and increasingly complex shipping logistics.2
Floating rate securities dominated two of the top three best performing securities this quarter due to anticipated rate increases. The top security was the krone-denominated Odfjell floating rate bond of 2025. The Nextera floating rate bond of 2067 also posted a good return.
Year-to-date, the Fund had an effective duration (price sensitivity to changes in interest rates) of 3.24 years. This is down from 5.4 years as of the end of 2020. The Fund moved out of maturities in the 10+ year space due to the steepening yield curve and sold the positions in long Treasurys.
The second half of 2021 reflects a market that is still feeling the ripples from the pandemic. COVID-19 has proved highly disruptive, and the Delta variant adds uncertainty on a global level. Inflation continues to be on top of investors’ minds as supply-chain constraints and labor shortages could stunt growth while simultaneously raising prices.
With eviction and student loan payment moratoriums coming to an end and the workforce participation rate still well below pre-pandemic levels, there is the potential that savers will sit on their cash piles rather than stimulate the economy with consumption, having been scarred from the pandemic. As the dynamics of growth and inflation play out, we’ll be actively collecting clues and positioning our sails to take advantage of the prevailing wind.
As of September 30, 2021
|Top 10 Holdings||Portfolio Weight|
|Canadian Imperial Bank||4.52%|
|European Investment Bank||3.80%|
|NextEra Energy Capital||3.58%|
|Telfon Celular del Paraguay||3.56%|
|International BK Recon & Develop||3.35%|
|Bank of Nova Scotia||3.04%|
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
At the close of the third quarter, the Saturna Sustainable Equity Fund trailed the S&P Global 1200 Index, returning -0.93% vs. -0.65% for the Index. The year-to-date spread between Fund and Index was more pronounced, with returns of 4.60% and 12.49%, respectively.
Interest rates surged toward the end of September amid growing concerns that inflation expectations may become embedded. Unlike the “good” rise in rates at the start of the year that reflected renewed economic optimism with the vaccine rollout, the current increase may be linked to fears of supply chain disruptions persisting beyond initial expectations. As a result, the buoyant equity market experienced through much of the year rolled over in September on weakness among highly valued Technology stocks, broadly pulling down indices. Banks (which may benefit from higher rates) and energy stocks (as oil prices sharply rose) bucked the downward trend in September. Top performers among the Fund’s holdings for the quarter include Australian software company Atlassian, European semiconductor manufacturer STMicroelectronics, and Japanese electronic component manufacturer Murata Manufacturing.
Atlassian’s niche within the software industry is building products for teams of software developers and project managers. Atlassian’s position as the portfolio’s top contributor and top holding speaks to its relevance, but the company pulls its weight on the ESG front, as well. Atlassian takes an aggressive stance on climate change and in 2020 met its goal to run operations on 100% renewable electricity – five years early. The company has set additional goals to achieve net-zero emissions no later than 2050, as part of their company-wide alignment with a 1.5-degree Celsius trajectory.
STMicroelectronics has a goal of becoming carbon-neutral by 2027, and in 2020 reported that their greenhouse gas emissions were down 19% over the previous year. In 2020, STMicroelectronics was the only semiconductor company with targets approved by the Science Based Targets Initiative for limiting warming to 1.5 degrees Celsius, and their 2027 net-zero goal is recognized as one of the most ambitious in the industry. As greenwashing presents a growing concern within the ESG community, and as more and more funds engage in re-branding exercises that have little to do with pursuing sustainable investment practices, Saturna is proud to include several companies in its portfolios that, like Atlassian and STMicrolectronics, understand that commitments to sustainability and to quality products are self-reinforcing. Some investors are understandably wary of exorbitantly valued Technology stocks, and such stocks tend to be marquee holdings among ESG portfolios. For this reason, among others, our definition of sustainability includes financial sustainability, most often demonstrated by intelligent capital allocation leading to solid cash flows that can sustain a business without resorting to excessive leverage.
The 10 Largest Detractors for the third quarter included a few names that were top contributors in the second quarter – namely Adidas, L’Oreal, and Novozymes – and largely correlated with weakening consumer sentiment. Our investments in wind energy generators and components manufacturers continued to struggle in 2021, but we maintain our optimism that these companies are well positioned to generate healthy returns in the years to come.
Six of the Fund’s Top 10 Holdings in the third quarter were consistent with those from the previous quarter. Legrand, Novozymes, L’Oreal, and Adidas rotated out while Atlassian, Reckitt Benckiser Group, Tractor Supply, and Novo Nordisk rotated in.
As of September 30, 2021
|10 Largest Contributors||Return||Contribution|
|Atlassian, Class A||52.39%||0.82|
|Novo Nordisk ADS||15.22%||0.27|
|Accenture, Class A||8.83%||0.18|
|10 Largest Detractors||Return||Contribution|
|Siemens Gamesa Renewable Energy||-23.57%||-0.36|
|Top 10 Holdings||Portfolio Weight|
|Atlassian, Class A||2.39%|
|Reckitt Benckiser Group ADR||2.16%|
|Accenture, Class A||2.10%|
|CGI Group Inc Class A||2.09%|
|Novo Nordisk ADS||2.01%|
As of September 30, 2021
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|Average Annual Total Returns (Before Taxes)||YTD||1 Year||3 Year||5 Year||Since InceptionB||Gross||Net|
|Sustainable Equity Fund (SEEFX)||4.60%||14.73%||14.54%||13.90%||10.14%||0.78%||0.75%|
|S&P Global 1200 Index||12.49%||28.46%||13.19%||14.11%||11.22%||n/a|
|S&P 500 Index||15.92%||30.00%||15.95%||16.89%||14.17%||n/a|
|Sustainable Bond Fund (SEBFX)||-0.77%||2.32%||3.24%||2.57%||2.34%||0.85%||0.65%|
|FTSE WorldBIG Index||-4.47%||-1.71%||4.15%||2.04%||2.71%||n/a|
|MSCI All Country World Index||11.49%||27.98%||13.10%||13.76%||10.84%||n/a|
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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 30, 2021 and incorporate results from the fiscal year ended November 30, 2020. 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, 2022.
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.
As of September 30, 2021
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|Morningstar Ratings™C||Overall||1 Year||3 Year||5 Year||Sustainability RatingD|
|Sustainable Equity Fund (SEEFX)||★ ★ ★ ★||n/a||★ ★ ★ ★ ★||★ ★ ★ ★||
Percent Rank in Category: 2
|% Rank in World Large-Stock Category||n/a||22||60||28|
|Number of Funds in Category||287||338||287||253|
|Sustainable Bond Fund (SEBFX)||★ ★ ★ ★||n/a||★ ★ ★||★ ★ ★ ★||
Percent Rank in Category: 4
|% Rank in World Bond Category||n/a||95||10||17|
|Number of Funds in Category||186||198||186||161|
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The Morningstar Sustainability Rating is not based on fund performance and is not equivalent to the Morningstar Rating (“Star Rating”).
© 2021 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, 2021. 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, 2021. The Morningstar Sustainability Rating™ is intended to measure how well the issuing companies of the securities within a fund’s portfolio are managing their environmental, social, and governance (“ESG”) risks and opportunities relative to the fund’s Morningstar category peers. The Morningstar Sustainability Rating calculation is a two-step process. First, each fund with at least 67% of assets covered by a company-level ESG score from Sustainalytics receives a Morningstar Portfolio Sustainability Score™. The Morningstar Portfolio Sustainability Score is an asset-weighted average of normalized company-level ESG scores with deductions made for controversial incidents by the issuing companies, such as environmental accidents, fraud, or discriminatory behavior. The Morningstar Sustainability Rating is then assigned to all scored funds within Morningstar Categories in which at least ten (10) funds receive a Portfolio Sustainability Score and is determined by each fund’s rank within the following distribution: High (highest 10%), Above Average (next 22.5%), Average (next 35%), Below Average (next 22.5%), and Low (lowest 10%). The Morningstar Sustainability Rating is depicted by globe icons where High equals 5 globes and Low equals 1 globe. A Sustainability Rating is assigned to any fund that has more than half of its underlying assets rated by Sustainalytics and is within a Morningstar Category with at least 10 scored funds; therefore, the rating is not limited to funds with explicit sustainable or responsible investment mandates. Morningstar updates its Sustainability Ratings monthly. Portfolios receive a Morningstar Portfolio Sustainability Score and Sustainability Rating one month and six business days after their reported as-of date based on the most recent portfolio. As part of the evaluation process, Morningstar uses Sustainalytics’ ESG scores from the same month as the portfolio as-of date.
The Fund’s portfolios are actively managed and are subject to change, which may result in a different Morningstar Sustainability Score and Rating each month.
The Saturna Sustainable Equity Fund was rated on 100% and the Saturna Sustainable Bond Fund was rated on 80% of Assets Under Management.
Percent Rank in Category is the fund’s percentile rank for the specified time period relative to all funds that have the same Morningstar category. The highest (or most favorable) percentile rank is 1 and the lowest (or least favorable) percentile rank is 100. The top-performing fund in a category will always receive a rank of 1. Percentile ranks within categories are most useful in those categories that have a large number of funds.
Footnotes to commentary
1 The breakeven inflation rate represents a measure of expected inflation derived by subtracting the real yield of the inflation linked maturity curve from the yield of the closest nominal treasury maturity.
2 Chuin-Wei Yap, William Boston, and Alistair MacDonald. Global Supply-Chain Problems Escalate, Threatening Economic Recovery. The Wall Street Journal. October 8, 2021. https://www.wsj.com/articles/supply-chain-issues-car-chip-shortage-covid-manufacturing-global-economy-11633713877
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 1.77% and the 30-Day Yield for Saturna Sustainable Equity Fund would have been 0.45%. 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.