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Q3 2022

Excerpts from past Saturna Sustainable Funds Trust quarterly commentaries:

Q3 2019 – “Political tensions have been on the rise across the globe.”

Q3 2020 – “Uncomfortably unpredictable . . .”

Q4 2020 – “Valuations continue to be a point of contention.”

Q3 2021 – “It’s reasonable to anticipate that these high energy prices will hamper future economic activity and slow the global recovery.”

Q4 2021 – “We have little insight into inflation and interest rates in 2022.  The removal of fiscal and monetary stimulus implies tightening conditions.”

Times of tumult, such as we’ve seen this year, warrant reflection. The pandemic and the government’s shifting focus to issues at home overshadowed the saber-rattling seen in 2019.  Part of this shift included a flood of fiscal and monetary stimulus, which provided support to keep economies from succumbing to a microscopic agent, but eventually led asset prices to balloon and the economy to overheat.

With the S&P 500 down -23.87% year-to-date and negative news in abundance, investors have legitimate concerns; however, a longer-term view can be instructive.  In 2020, the S&P 500 returned more than 18%, only to be outdone by returns exceeding 28% in 2021.  Returns of this magnitude are not the norm.  Since 1928, the S&P 500 has averaged returns between 10% and 12%.  Despite this year’s decline, at the end of the third quarter, the S&P 500 still stood 16% ahead of where it finished at year-end 2019.

Investors may wonder if we’ve hit bottom; there have only been six instances in which the S&P 500 has fallen more than -20% since 1928.  At Saturna, we’re not in the business of timing market cycles, but we are in the business of managing risk.  So, which of the risks highlighted in previous quarterly commentaries remain relevant?

Geopolitical Risks

Russia’s invasion of Ukraine clearly shows that geopolitical risk remains in play.  Ukraine’s continued battlefield successes combined with Putin’s desperation and annexation of Ukrainian territory raises the nuclear stakes.  Any nuclear deployment almost certainly pulls NATO into the conflict.  Meanwhile, economic challenges in China, Xi Jinping’s confirmation for a third term as president, and US distraction in Ukraine raises the risks of China invading or blockading Taiwan.  Political tail risks of this nature are impossible to predict, but peaceful solutions to either the Russian-Ukrainian war or China-Taiwan tensions are, at best, distant.

Valuation

Valuations ballooned as central banks drove interest rates to zero.  Naturally, with central banks pivoting from a race to the bottom to a summit quest, valuations have come back to earth.  Still, valuations entail two data points: the price you pay and the earnings you expect.  While prices have plummeted, analyst earnings expectations remain overly buoyant.  Given concerns of looming recession and a strengthening dollar that diminishes overseas earnings for US companies, it’s reasonable to expect further declines in near-term earnings estimates.  While valuations are no longer eye-watering, they don’t provide a tailwind either.

Inflation and Interest Rates

Speaking of recession, what of the economic outlook? The Federal Reserve’s stance on “transitory” inflation damaged credibility.  Chairman Jerome Powell has studied Fed history, including the on-again/off-again policy of the Burns/Miller tenure during the 1970s, which ultimately required crushing rate hikes by Paul Volker to bring inflation under control.  Many forget that even Volker, with his inflation-fighting bona fides, initially erred in easing prematurely.  Despite the blunt tool of rate hikes and lagging statistical effects from housing, the Fed has little choice but to increase rates until irrefutable evidence emerges that inflation has been brought under control and expectations are, again, anchored.  Given continuing strength in employment, we refrain from predicting gross domestic product (GDP) trends, serving to illustrate the uncertainty that remains.

A New Risk – The Dollar

Whether the dollar’s strength is the risk or the manifestation of the myriad global risks at play, we’d be remiss to ignore the warning signs presented by a surging greenback.  A strong dollar compounds local stresses (such as ballooning government deficits in the UK) and fuels a troubling feedback loop.  Investor flight to safety drives strong dollar demand, all while borrowers – who have been pushed to issue dollar-denominated debt because of the currency’s citadel status – are forced to buy dollars at any price.  The rapid ascent of interest rates has made refinancing a nasty proposition.  These factors, and likely others, have driven the US dollar to levels not seen since the Asian Tiger Crises/Dotcom Bubble and the Volcker interest rate increases of the early 1980s, two volatile periods for investing.

Conclusion

With the year-to-date declines in global stock and bond markets, past developments including European war and rising rates have been discounted.  We cannot claim, however, that markets have sufficiently discounted the potential future risks described above.  Neither can we say with certainty that any of these risks will come to pass.  Who can predict Putin, the Fed, or Xi Jinping?  Given past evidence we can predict that those attempting to time their exit and entry into markets around such events will likely destroy value rather than enhance it.  We may also reasonably observe that companies featuring modest valuations, strong cash generation, and minimal debt may endure potential future market disruption better than their less favorably-positioned peers.

Saturna Sustainable Equity Fund

Saturna Sustainable Bond Fund

Performance Summary

As of September 30, 2022

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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, 2022 and incorporate results from the fiscal year ended November 30, 2021. 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, 2023.

^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.  The Bloomberg Barclays US Corporate High Yield Bond Index measures the USD-denominated, high-yield, fixed-rate corporate bond market.  Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.   When available, Saturna uses total return components of indices mentioned.  Investors cannot invest directly in the indices.

Performance Summary

As of September 30, 2022

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

© 2022 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, 2022. 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, 2022. 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 99% and the Saturna Sustainable Bond Fund was rated on 91% 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 Timiraos, Nick. “Fed Raises Interest Rates by 0.75 Percentage Point for Third Straight Meeting.” The Wall Street Journal, September 21, 2022. https://www.wsj.com/articles/fed-raises-interest-rates-by-0-75-percentage-point-for-third-straight-meeting-11663783397

² Kate Duguid, Adam Samson, and Colby Smith. “‘Volatility vortex’ slams into $24tn US government bond market.” Financial Times, September 27, 2022. https://www.ft.com/content/ea41ce6d-e8b2-465e-8dff-8b7fa71dc7b4

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 2.80% and the 30-Day Yield for Saturna Sustainable Equity Fund would have been 0.87%. 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.

Variable rate securities risk: Variable rate debt securities (which include floating rate debt securities) pay interest based on an interest rate benchmark. When the benchmark rate changes, the interest payments on those securities may be reset at a higher or lower rate and, as a result, such securities generally are less price sensitive to interest rate changes than fixed rate debt securities. However, the market value of variable rate debt securities may decline, or not appreciate as quickly as expected, when prevailing interest rates rise, particularly if their interest rates do not rise as much, or as quickly, as interest rates in general. Conversely, variable rate securities will not generally increase in market value if interest rates decline. However, when interest rates fall, there may be a reduction in the payments of interest received by the Fund from its variable rate securities.