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Q3 2023

In the third quarter of 2023, investor attention was primarily focused on the interest rate environment (ignoring political issues, such as Congressional battling over budgets, funding, and the Speaker of the House). While Federal Reserve rate increases moderated, the target rate was raised 25 basis points (bps) at the July meeting, and the current outlook envisages one additional hike. The yield curve moved aggressively higher and became somewhat flatter, perhaps bolstering those in the soft-landing camp. It did not bolster Technology stocks, with the typical and debatable explanation being that rising rates damage “long duration” stocks (companies anticipated to provide growth for years into the future), since higher discount rates reduce the present value of future cash flows.

Opinions vary as to what triggered the upward shift in the yield curve. A reaction to Fed statements about higher for longer, the return of the term premium, higher growth expectations, Fitch downgrading the US credit rating, increased US issuance, and even a reduction in Chinese buying were all mentioned as candidates. While backward looking, one cannot understand what the curve implies for the future without understanding why it moved in the first place. Undoubtedly, none of the factors operated in isolation; some combination was at work. The higher growth expectations camp received a boost in early October when the Bureau of Labor Statistics’ Job Openings and Labor Turnover Survey (JOLTS) reported that the upwardly adjusted 8.92 million job openings in July had spiked to 9.61 million in August.¹ The report was well ahead of consensus expectations and investors promptly punished the bond market, raising the 10-year Treasury yield to 4.79%, the highest since 2007.^2,3 Naturally, the stock market fell in response, led by the Technology sector, with only the Utilities and Energy sectors bucking the trend.

We have sympathy for the higher growth expectations narrative, given US economic resilience to date. Indeed, the Atlanta Fed’s GDPNow model forecasted third quarter growth at a remarkable 4.9%.⁴ However, various government programs such as student debt forbearance, the unique US feature of 30-year fixed-rate mortgages, and aggressive corporate debt issuance during the pandemic have all served to ameliorate the effect of rising rates. That will not persist. Interest rates may be a blunt instrument, but there is such a thing as blunt force trauma. It would be wishful thinking to expect the economy not to feel the blow.

Outlook - Smooth Sailing Gives Way to Choppy Waters?

Thomas Barkin, the president of the Richmond Federal Reserve, was a recent guest on the Bloomberg podcast Odd Lots. Given our nautical proclivities, we appreciated his metaphor comparing the inflationary environment to sailing. Throughout the 2010’s, the US economy largely sailed downwind. Now, we are sailing into a headwind. “You can go a lot faster downwind,” he said, “but you can also sail into the wind. You just have to tighten your sails.”⁵ Mr. Barkin could have taken his metaphor even further had he said the US economy sailed on a broad reach (the position relative to the wind that allows for the fastest speed). Nonetheless, sailing into a headwind seems an apt description of the future given the litany of obstacles ahead, to which we can now add the vacating of the position of Speaker of the House.

Although the US economy’s performance has defied expectations, it’s the extrapolation of past trends that leads to surprise. Recessions are difficult to predict precisely because the precipitating events are typically non-linear. Will rapidly rising rates lead to additional bank failures, as we saw in March 2023? After all, the current yield on the 10-year Treasury is roughly 130 bps higher than it was at first quarter-end. Will a government shutdown heading into the holiday season batter retail activity? Will higher long-term rates dampen investment? What about possible overseas catalysts as the strengthening dollar pressures global economies, especially those reliant on commodity imports that are often priced in dollars? Perhaps none of these things will happen. Perhaps they all will. We do know that attempting to add value by speculating on such developments typically has the opposite effect. Regardless of the wind direction, we steer our portfolios to mitigate the stormiest seas.

Saturna Sustainable Bond Fund

Performance Summary

As of September 30, 2023

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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 31, 2023 and incorporate results from the fiscal year ended November 30, 2022. 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, 2024.

^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. 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, 2023

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

© 2023 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, 2023. 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, 2023. 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 Job Openings and Labor Turnover Survey. US Bureau of Labor Statistics. https://www.bls.gov/jlt/

² United States Job Openings. Trading Economics. https://tradingeconomics.com/united-states/ job-offers

³ Bretell, Karen. 10-year yields hit 16-year peak as Fed seen higher for longer. Reuters. September 21, 2023. https://www.reuters.com/markets/rates-bonds/10-year-yields-hit-16-year-peak-fedseenhigher- longer-2023-09-21/

⁴ GDPNow. Federal Reserve Bank of Atlanta. https://www.atlantafed.org/cqer/research/gdpnow

⁵ The Fed’s Tom Barkin On the Impact of Higher Interest Rates. OddLots. October 2, 2023. https:// podcasts.apple.com/us/podcast/oddlots/id1056200096

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 4.52% and the 30-Day Yield for Saturna Sustainable Equity Fund would have been 0.72%. Unsubsidized yield does not adjust for any fee waivers and/or expense reimbursements in effect.

Effective duration is a measure of a fund’s sensitivity to changes in interest rates and the markets. Effective duration differs from modified duration in that it accounts for the optionality embedded in call options and other security-specific covenants that can change expected cash flows as the result of the movement of interest rates. Longer durations tend to indicate greater sensitivity to interest rate changes than shorter durations.

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.