Morningstar Advisor - February/March 2009 - 50

Undiscovered Managers Solid Investing Lessons from Islamic Finance Investing under Sharia leads to strategies that all investors would do well to consider: r Keep turnover low: According to Sharia, excessive trading is speculation, which is prohibited by the Quran. In the secular world, it drives up costs and can weaken aftertax returns. r Avoid companies with huge debts: Islamic investing restricts paying and receiving riba (interest), which eliminates companies that have a lot of debt on their balance sheets. As we’ve seen, companies that carry huge debt loads are more vulnerable during times of economic stress than companies that have a lot of cash on hand. r Hold a core of stable stocks: Sharia calls for caution and restraint. Buying and holding a basket of well-financed, wide-moat stocks can keep a portfolio’s performance on an even keel through booms and busts. markets over the past couple of years. Their avoidance of companies with lots of debt has also been a boon in this period of tight credit. In 2007, Amana Income was one of the best-performing funds in Morningstar’s large-value category, a group heavy in financial stocks. Both funds ranked near the top of their categories in 2008, even though their returns were ugly in absolute terms. But that’s not the whole story. Both Amana Income and Amana Growth have outstanding long-term records and were at the tops of their respective categories from 2004 through 2006, when financial stocks were still racking up big gains. Kaiser’s stock-picking approach, in which he buys good firms with lots of potential and hangs on to them for a long time, is ultimately responsible for the funds’ stellar records. His instincts have resulted in impressive gains from some stocks, but both funds hold a core of stable stocks that keep performance on an even keel, in keeping with the Sharia principles of caution and restraint. One winner has been Apple AAPL, a top holding in Amana Growth and long one of Kaiser’s favorites. Saturna has been using Apple products for nearly 20 years (all the computers in the office are Macs), and Kaiser bought the stock back when it was out of favor. The enormous popularity of the iPod has caused an exponential jump in Apple’s stock price, and Kaiser rode it all the way to the top. The stock has taken a beating in the recent market downturn, but Kaiser still likes it and has no plans to sell. Helping make up for the short-term woes of Apple and other longtime holdings have been health-care stocks such as Johnson & Johnson JNJ and Barr Pharmaceuticals BRL, which have held up relatively well. Kaiser takes a similarly diverse approach in Amana Income, though the focus there is on dividend-paying stocks rather than those with long-term growth potential. Even apart from financials, many traditionally dividend-rich stocks, such as most utilities, are unavailable to Kaiser because of their heavy debt loads, but he has still found good stocks. Longtime commodity holdings, such as EnCana ECA, drove returns until recently, but now that they’ve tumbled in price, consumer stocks such as Kellogg K and Kimberly-Clark KMB have become more prominent and are keeping the fund in good shape. A significant cash position, at times more than 25% in the past year, has also helped the fund weather the market storm, though the fund is not allowed to earn interest on that cash. The results have pleased the funds’ Muslim clients, but also non-Muslims who like the funds’ performance and Saturna’s ethical standards. One of these is Kenneth Aulbach of Investors Capital Advisory Services in Lynnfield, Mass., who works with 700 advisors and has been putting money into the Amana funds on behalf of their clients. “I’m usually not a fan of socially screened funds, and in this case, I was very sensitive because of the geopolitical climate,” he says. “But I’ve been very impressed with Saturna, and the numbers speak for themselves. I think they do all the right things to be successful in our business.” Staying Grounded Since the 1970s, and especially in the past decade, there has been an explosion in Islamic financial instruments that look like traditional investments. For example, a sukuk is a contract that resembles a bond. It provides a regular stream of income over a fixed period, but this income consists of profits from an underlying asset, rather than interest. Several types of mortgagelike instruments that are Sharia-compliant have been developed; in one of these, a buyer forms a partnership with a bank and gradually purchases a house over time, paying service charges that are comparable to interest payments. Putting It All Together The success of the Amana funds has brought in lots of new assets, as well as new publicity for Kaiser, Salam, and the rest of the team. While this success has allowed Saturna to expand into new areas and hire more people, it has not changed the firm’s core philosophy. If anything, Kaiser seems to have made an effort to remain grounded and keep the shareholders’ interests in mind. “Integrity to clients was one of Saturna’s founding principles, and we’re still proud of our corporate culture and squeakyclean management,” Kaiser says. As the stellar performance of the Amana funds shows, good investment results and strong principles can definitely go hand in hand. K David Kathman is a mutual fund analyst with Morningstar. With all these restrictions, you might think that the Amana funds would have a tough time competing for investors’ dollars, but in fact, the opposite has been the case. Certainly, both Amana funds have benefited in the short term from their lack of financial stocks, given the financial meltdown that has rocked the 50 Morningstar Advisor February/March 2009

Morningstar Advisor - February/March 2009

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