Q4 2017 • December 31, 2017 | Saturna Capital


Not What You Might Have Expected from the Headlines

2017 was a remarkable year for equity markets around the world but not entirely in the way we normally think of a “Great Year for Stocks."  While the percentage gains were significant, they were not unprecedented.  As recently as 2013, the S&P 500 Index (SPX) returned 32.39% compared to the 21.82% gain of 2017.  That said, the consistency of price appreciation and absence of reversals (volatility) was unprecedented.  There was not a single month during 2017 when the total return of the S&P 500 was negative.1  Considering multiple Fed rate hikes, escalating tension with North Korea, President Trump’s restive Twitter rhetoric, administration departures, and an ongoing FBI investigation, that’s pretty surprising.  We saw similarly steady market appreciation in 1995 and 2006, but in each of those years the total return was negative for at least one month.  Our data goes back to 1986, and 2017 is the first year since then that the monthly total return record was unblemished.  Have investors become so accustomed to buying dips that the slightest price decline brings support?  While that may play a role, other factors were likely at work.  The first may be that analysts did not start the year with excessive optimism.  Usually the consensus estimate for aggregate market earnings declines, often precipitously, from the initial figure.  In 2017, however, earnings estimates were stable throughout the year, supported by better-than-anticipated economic performance and a weakening of the US dollar, which increases earnings for US companies selling abroad.  As a result, earnings themselves provided support for the market’s rise. 

Secondly, hope springs eternal, and despite multiple failed attempts to repeal the Affordable Care Act, tax reduction remained firmly in Republican sights.  Growing confidence that a bill would be passed contributed to the strongest market appreciation of the year during the fourth quarter.  That confidence was rewarded with the tax bill’s passage and a cut in the corporate tax rate from 35% to 21%.  While the median tax rate paid by profitable, large US corporations is lower than either the previous or new statutory rates (as low as 16% according to Forbes2), companies that primarily operate in the US and smaller companies lacking an army of tax accountants will undoubtedly benefit from the reduction.  Other beneficiaries are companies with large piles of cash stashed overseas.  On one hand, the tax bill imposes a “deemed repatriation” tax of 15.5% on liquid assets and 8% on less liquid assets,3 so overseas cash is no longer shielded from taxation.  Nor will future earnings be shielded as the US moves to a territorial taxation system.  On the other hand, 15.5% is more attractive than 35%, and the strategies companies have adopted to create profits overseas have clearly paid off.  Whether the tax system reform spurs companies to bring money back to the US will depend on their individual circumstances and the most efficient uses for their overseas assets.  Apart from the lower rates, that may be the most important aspect of the tax reform bill.  Companies will have less incentive to allocate cash solely to reduce taxation and more incentive to allocate cash in the most economically efficient fashion.

While all eyes were focused on US stock market returns and tax reform, overseas markets did just as well and often better.  Japan’s TOPIX Index returned 26.61%.4  Germany’s DAX Index and the French CAC 40 Index gained 28.25% and 28.28%, respectively, while Hong Kong’s Hang Seng Index soared 40.22%.  As noted earlier, economic growth exceeded expectations, especially in Europe and Japan, and returns in those regions were helped by currency strength versus the US dollar.  Even emerging markets joined in for the first time in several years with the MSCI Emerging Markets Index gaining 37.28%.


2018 brings a new tax regime, a new head of the Federal Reserve, and, potentially, a new push to restore US infrastructure.  In the right combination, these could lead to another year of respectable stock market returns, and the best course of action for most is to remain fully invested.  Arguably, the tax bill should lead to a one-time reset of stock prices as the future benefits of lower taxes are discounted at an appropriate rate and reflected in valuations.  Whether that has already happened cannot be determined precisely, but we see two effects.  Companies are starting to provide updated earnings guidance in light of the bill, and for domestically oriented firms the increases can be surprisingly large.  Other companies that have engaged in international tax minimization strategies are revealing their bills for deemed repatriation, which can also be large.  Some, such as Apple, had fully reserved for the potential taxation of their overseas earnings and will enjoy hefty write-backs.  Most companies, however, have not.  The tax bills involve real cash and will sting but are unlikely to affect share prices significantly given the other benefits of the bill.

Following three rate increases in 2017, we expect only two additional hikes this year.  We believe the normalization of interest rates to be a positive development and are not concerned that the increases will choke off economic activity.  The wild card is new Federal Reserve Chairman Jerome Powell supplanting Janet Yellen, who had the misfortune to be appointed by Barack Obama, making it inescapable that Donald Trump would replace her.  Mr. Powell is certainly qualified to assume the role, but change always brings uncertainty.  Will he maintain the pace of rate hikes or pause and risk a resurgence in inflation?

Mr. Powell’s actions may be governed to an extent by whether Congress and the president are able to agree on an infrastructure program. That US infrastructure is in dire straits cannot be seriously argued.  The time to aggressively invest (more aggressively than the stimulus package) would have been in the aftermath of the Global Financial Crisis when interest rates were lower and there was slack in the economy. Instead, having just passed a tax bill that is expected to raise the deficit by $1.5 trillion and with unemployment at levels many economists consider “full employment,” former budget hawks have suddenly become unconcerned about deficits.  The odds of some sort of infrastructure package making its way through Congress seem better than even. As tensions simmer between the United States and North Korea and/or Iran, further stimulus from an increase in defense spending may also be in the cards. What that means for the deficit, inflation, rate hikes, the value of the US dollar, and the stock market remains to be seen, but we feel confident in saying that the potential for an economic downturn will not present a significant risk in 2018.


Saturna Sustainable Bond Fund

Investors were handsomely rewarded throughout 2017 as investment assets demonstrated strong overall performance across the board. Equities towered to all-time highs. Commodities such as oil experienced a supportive rebound, rising from an average price per barrel of $43.44 throughout 2016 to $50.85 in 2017, reflecting a 17% increase. Fixed income securities continued to demonstrate favorable performance across domestic investment grade, high yield, and emerging debt categories. In fact, European high-yield debt now trades at a slightly lower yield than that offered by five-year US Treasurys. For example, at the end of December 2017, the BofA Merrill Lynch Euro High Yield Index offered investors a yield of 2.60%, while five-year US Treasurys yielded 2.20% — a baffling outcome in the years following the Global Financial Crisis, driven in large part by the European Central Bank’s continuation of quantitative easing and its monthly US$35 billion asset purchase program.5

Throughout 2017, the Federal Reserve deepened its resolve to normalize monetary policy by raising the federal funds rate three times. On December 14, 2017, the Federal Open Market Committee (FOMC) raised interest rates by another quarter of a percent from 1.25% to 1.50%, signaling it would stay on a similar path next year amid a leadership transition. The Fed’s December rate hike represents the fifth interest rate increase in eight quarters since the FOMC initiated “normalization” in December 2015.

2017 marked a considerable contrast to 2016 with respect to high asset valuations and historically low volatility as measured by the CBOE Volatility Index (VIX) that has declined to levels not seen since 2007.6 Some of the largest economies around the world, such as Europe and Japan, continued with their monetary stimulus programs in an attempt to spur economic growth. It appears that some of these measures are beginning to take hold. For example, the Fed announced that the US economy is on track to expand 2.5% in 2018, up from the prior forecast of 2.1%.7 The International Monetary Fund revised China’s 2017 year-end growth projections from 6.7% to 6.8%, while the eurozone is expected to grow 2.2% this year, the fastest pace since 2007.8,9

With central banks in Europe and Australia soon expected to follow the Federal Reserve’s monetary normalization path, 2018 may see elevated risks and bring challenges for investors. The Saturna Sustainable Bond Fund is positioned to meet its objective of capital preservation and current income by taking a more defensive posture. At year-end 2017, the Fund’s effective duration was 2.51 years, down slightly from 2.56 the prior year. The Fund generated a 30-day SEC yield of 3.16% and was diversified among 45 separate issues. Currently, the Fund allocates 75.31% of its net assets to the US dollar, followed by 7.15% to the Canadian dollar, 5.93% to the Mexican peso, 4.67% to the New Zealand dollar, 4.14% to the Australian dollar, and 2.80% to the Norwegian krone.

As of year-end of 2017, the Saturna Sustainable Bond Fund returned 5.89% compared to the 7.43% return of the Citi World Broad Investment-Grade Bond Index (WorldBIG). The underperformance can be attributed, in part, to the index’s heavy euro weighting. For example, the WorldBIG benchmark at year-end allocated 31.10% to the euro. The Fund’s large underweighting in this region reflects an extraordinarily high concentration of negative yielding debt there that has led to an environment of low income relative to risks, which runs counter to the Fund’s objective of capital preservation.

The Fund’s top-performing securities in the quarter include Puget Sound Energy’s floating rate note (PSD Float 06/01/67) returning 2.56%. Washington state-based PSE serves over 1 million customers throughout the Northwest. In 2016 it sourced 40% of its power generation from water and wind.

Coming in second was Apple’s Australian dollar bond (AAPL 3.6 06/10/26) that returned 2.40%. Apple identifies that 96% of the electricity used in its global facilities came from renewable energy, reducing carbon emissions by nearly 585,000 metric tons. The two worst-performing issues during the quarter were Mexican peso denominated issues. The Mexican sovereign note (MBONO 6 ½ 06/10/21) fell -8.15%, and the America Movil bond (AMXLMM 6 06/09/19) fell -6.29%. The Mexican peso experienced a pronounced drop of -7.14% during the fourth quarter. Despite the decline, the peso still appreciated by 5.43% relative to the US dollar for the year.

As of December 31, 2017

Top 10 Holdings Portfolio Weight
NextEra Energy Capital (FPL Group) 4.71%
Puget Sound Energy 4.35%
Chubb 4.33%
First Abu Dhabi Bank 4.28%
Hartford Financial Services Group 4.17%
Lincoln National Corp 3.93%
Iron Mountain 3.70%
Telus 3.49%
Nokia OYJ 3.42%
Hanmi Financial 3.34%
Bond Quality Diversification
Moody's Investors Services
Aaa 2.17%
Aa 12.06%
A 14.06%
Baa 37.56%
Ba 17.58%
B 3.70%
Unrated 9.85%
Cash and equivalents 3.02%

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

For the calendar year ended December 31, 2017, the Sustainable Equity Fund returned 23.76%, which was slightly below the 23.84% return of its S&P Global 1200 Index benchmark. During the quarter, the Fund gained 5.44% versus 5.66% for the index. The Fund has an international framework, with assets allocated across 20 market economies. In terms of performance gain, our heavy allocation to the Technology sector has been the most rewarding, and we remain optimistic about our selections.

During the year, the Fund benefited from its Consumer Discretionary and Consumer Staples choices, especially Home Depot, Unilever, and Samsonite. In the Materials sector, 3M also performed well. With unemployment low and wages potentially growing with improved economic conditions, we believe these are names that will continue to add value to the portfolio.

During the fourth quarter, Hartalega Holdings saw a robust 60.65% return. As the inventor of nitrile gloves in 2002, Hartalega is now the world's largest manufacturer of disposable nitrile gloves that provide a hypoallergenic alternative to latex gloves. Repeated exposure to latex is a risk factor for latex allergies,10 indicating that as latex allergies increase, the demand for latex alternatives such as nitrile should increase as well. Hartalega is a constituent of the FTSE4Good Bursa Malaysia Index, which recognizes companies demonstrating a leading approach to addressing environmental, social, and governance risks; Hartalega takes an exemplary approach to human rights and fair labor practices.

The second-best performer this quarter was Nike, up 21.04%, which we’ve seen fluctuate substantially throughout the year. Nike underperformed in the third quarter, and short-term results are expected to be volatile as the company competes for popularity among other athletic brands. We continue to firmly believe in the long-term viability of Nike, and we support its strong commitment to improving its impact by embedding sustainability throughout its products and production.

Considerable underperformers in the last quarter were Vestas Wind Systems, down -22.96%, and Kimberly Clark de Mexico, down -11.27%. Vestas, a Danish manufacturer of wind turbines, overtook General Electric in 2016 as the top installer of wind turbines in the US,11 and at that time was viewed as having a wider base of global customers than GE. In 2017, wind energy surpassed hydropower as the biggest source of renewable electricity in the US,12 and Vestas’ success in the US could be inextricably tied to the attractive tax credits sustained under the Obama administration that may not survive the Trump era. Regardless, Vestas cites the US as one of the main contributors to orders in the fourth quarter, despite the substantial year-over-year drop in total orders. Vestas reports a strong balance sheet supported by a profitable growth strategy that is firmly on track. Renewable energy is expected to dominate future electricity generation worldwide, and wind will play an important role.

Meanwhile, Kimberly Clark de Mexico saw its sales increase 6%, but its net income decrease by 14%, during the quarter. As the Mexican subsidiary of Kimberly Clark, the company provides disposable consumer paper products to Mexico and Latin America. In its fourth quarter report of results, the company cites substantial price increases in fibers and electricity, as well as higher expenses relating to interest rates, as a few culprits in its profit decline. We will continue to evaluate the position against other opportunities that may be a better fit for our investment.

As of December 31, 2017

10 Largest Contributors YTD Return Contribution
Taiwan Semiconductor ADR 42.31% 1.99
Adobe Systems 74.85% 1.81
Apple 48.48% 1.35
Home Depot 44.61% 1.13
Unilever 41.35% 1.12
Samsonite International 63.50% 1.07
Dassault Systemes ADR 39.70% 1.02
3M 34.92% 1.01
Mastercard, Class A 47.68% 0.94
Ashmore Group 43.56% 0.88
10 Largest Detractors YTD Return Contribution
Potash Corporation of Saskatchewan -11.02% -0.30
Pandora -7.58% -0.17
Roche Holdings ADR -6.07% -0.09
Siemens Gamesa Renewable Energy -7.97% -0.09
Hasbro -4.02% -0.04
China Mobile 2.65% -0.01
Telekomunik Indonesia ADR -1.17% -0.01
Nestle ADR -0.70% -0.01
Walt Disney -0.09% 0.00
Randgold Resources ADR 1.66% 0.01
Top 10 Holdings Portfolio Weight
Adobe Systems 3.34%
Apple 3.22%
3M 3.14%
Toronto-Dominion Bank 3.12%
Home Depot 3.07%
Dassault Systemes ADR 3.04%
NXP Semiconductors 2.90%
Unilever 2.90%
Accenture, Class A 2.62%
Koninklijke Philips ADR 2.58%

Morningstar Sustainability Ratings™

Saturna Sustainable Equity Fund (SEEFX)

Morningstar Five Globes

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 November 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 91%

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.


Performance Summary

As of December 31, 2017

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  Expense Ratio
Average Annual Total Returns (Before Taxes) YTD   1 Year   3 Year   5 Year   10 Year   Gross Net
Sustainable Equity Fund (SEEFX) 23.76% 23.76% n/a   n/a   n/a   1.40% 0.75%
S&P Global 1200 Index 23.84% 23.84% 10.17% 12.15% 5.67% n/a
S&P 500 Index 21.83% 21.83% 11.42% 15.80% 8.49% n/a
Sustainable Bond Fund (SEBFX) 5.89% 5.89% n/a   n/a   n/a   0.92% 0.65%
Citi WorldBIG Index 7.43% 7.43% 1.96% 0.93% 3.13% n/a
MSCI All Country World Index 24.62% 24.62% 9.90% 11.40% 5.22% 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%.


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.

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.



1 Chicago Board Options Exchange. www.cboe.com/micro/buywrite/dailypricehistory.xls

2 Sherman, Erik. Trump’s Corporate Tax Slash Ignores How Little Companies Already Pay, Forbes.com, April 24, 2017. https://www.forbes.com/sites/eriksherman/2017/04/24/trumps-corporate-tax-slash-ignores-how-litte-companies-already-pay/#4be02e2558aa

3 Jopson, B, Fleming, S. US tax bill imposes steep levy on overseas earnings, Financial Times, December 15, 2017. https://www.ft.com/content/789e69f6-e1ea-11e7-a8a4-0a1e63a52f9c\

4 All foreign index return figures are expressed in US dollars.

5 Amaro, Silvia. ECB unveils plan to cut, but extend, its massive bond-buying program, CNBC, October 26, 2017. https://www.cnbc.com/2017/10/26/ecbunveils-plan-to-cut-its-bond-buying-program-and-extend-it-to-at-least-september-next-year.html

6 Loder, A, Banerji, G. The Snowballing Power of the VIX, Wall Street’s Fear Index, The Wall Street Journal, June 12, 2017. https://www.wsj.com/articles/youdont-know-vix-wall-streets-fear-gauge-is-now-a-multibillion-dollar-market-1497281745

7 Levitz, Eric. Federal Reserve Raises Rates, Gives Sunny Economic Forecast for 2018, New York Magazine, December 13, 2017. http://nymag.com/daily/intelligencer/2017/12/federal-reserve-raises-rates-gives-sunny-economic-forecast.html

8 IMF raises China growth forecast for 2017 to 6.8 per cent, South China Morning Post, October 10, 2017. http://www.scmp.com/news/china/economy/article/2114788/imf-raises-china-growth-forecast-2017-68-percent

9 Bouzanis, Angela. Economic Snapshot for the Euro Area, Focus Economics, November 22, 2017. https://www.focus-economics.com/regions/euro-area

10 Kumar, R Pradeep. Latex Allergy in Clinical Practice, Indian Journal of Dermatology, January/February 2012. https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3312665/

11 Gronholt-Pedersen, Jacob. Vestas leaps to top spot in U.S. wind market, Reuters, February 10, 2017. https://www.reuters.com/article/us-usa-windvestas-wind/vestas-leaps-to-top-spot-in-u-s-wind-market-idUSKBN15P12U

12 U.S. wind generating capacity surpasses hydro capacity at the end of 2016. U.S. Energy Information Administration, March 6, 2017. https://www.eia.gov/todayinenergy/detail.php?id=30212