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March 31, 2006
Amana Funds Continue Strong Performance
    by Bill Baue

The Amana Funds' Islamic principles coincide with sound investment strategies that have helped fuel strong financial performance over the past three years.

Earlier this month, Saturna Capital won the 2005 Best Islamic Fund Manager Award from Failaka International, which tracks about 100 Islamic funds worldwide, for its management of the Amana Growth Fund (ticker: AMAGX) and Amana Income Fund (AMANX). As with other socially responsible investing (SRI) funds, the Amana funds apply ethical criteria. Specifically, the funds follow Fiqh Council of North America (FCNA) guidelines based on Shari'ah Law that screen alcohol, pornography, gambling, and pork processing, among other exclusions.

"The Amana Growth Fund has been on fire recently," said David Kathmann, an analyst with Morningstar, which gave both Amana funds its top rating of five stars (on a scale of one to five).

The Amana Growth Fund's three-year annualized returns of 28.66 percent place it in the third percentile for the period ending February 28, 2006, according to data provided by Thomson Financial Network. This means the fund outperformed 97 percent of its peer large cap growth funds (SRI and non-SRI). The Amana Income Fund is not far behind, with three-year annualized returns of 24.85 percent, placing it in the sixth percentile.

"The Islamic principles haven't necessarily been a major factor in the fund's performance--the main factor has been portfolio manager Nick Kaiser's great job of stock-picking," Mr. Kathmann told "He follows what I think are pretty sound investing principles anyway, whether or not they are Muslim."

"The fact that he's a buy-and-hold investor helps with performance, and isn't unrelated to Islamic principles in that excessive trading is considered a form of gambling, which is prohibited by the Koran according to the Islamic scholars that advise the fund," Mr. Kathmann explained. "He's not trying to bet on what direction the stock is going--he's owning for the long-term, which I think is a good practice anyway."

While many managers set triggers to sell when a stock hits a certain price, Mr. Kaiser will hang onto companies if their integrity remains intact. For example, the largest holding in the Amana Growth Fund is Apple (AAPL), which gained more than 50 percent in 2005, as did Genentech (DNA) and EnCana (ECA), justifying the buy-and-hold strategy. Other holdings that have fueled financial performance include foreign stocks (which account for about 20 percent of the portfolio), such America Movil (AMX) and Business Objects (BOBJ).

Perhaps the most distinctive aspect of Islamic investing is the prohibition against riba, or interest, which the Koran identifies as usury and a form of oppression in that it perpetuates cycles of poverty. This exclusionary screen results in the near total lack of financial companies in Islamic portfolios, distinguishing it from SRI funds that are often overweight in financials.

The impact of this screen on performance has been a mixed bag over the past three years, according to Mr. Kathmann, as financial company returns have risen as interest rates dropped, but have waned more recently as interest rates have been on the rise. The ban on interest also prohibits the funds from holding companies with significant amounts of debt.

"The funds can't totally eliminate companies with any debt because that would shrink to a practically nonexistent universe," said Mr. Kathmann. "Kaiser tries to keep it under a threshold of one-third debt-to-capital ratio, and that's a good long-term strategy, because companies with lower debt tend to be healthier."

The Amana funds resemble other SRI funds such as the Domini Social Equity Fund (DSEFX), which Mr. Kathmann also covers, in being overweight in technology and underweight in industries. However, Morningstar is in the process of formalizing a distinction between religious and non-religious funds in its SRI universe by segregating them into separate tracks.

Morningstar is also renowned for its vigilance on expense ratios, which is 1.66 percent for the Amana Growth Fund (the Amana Income Fund comes in only slightly lower at 1.61 percent.)

"That's fairly high for a large cap fund, which tend to have lower expense ratios," said Mr. Kathmann. "But SRI funds in general often have higher expense ratios, and this is a small fund from a small shop, which is another factor resulting in higher expense ratios."

"This fund has been doing great for the past three years, and when a fund is doing great, people tend to not care as much about expense ratios," he added. "When a fund isn't doing as well, the expense ratio is much more important, because it can take a big chunk out of returns."

This prompts a cautionary note from Mr. Kathmann, who injects a reality check that markets tend to move in cycles.

"Even though this fund has done great the last three years, I wouldn't expect it to keep doing that great in the future," Mr. Kathmann said. "If people buy this expecting to get 20 percent returns every year, they're almost certain to be disappointed."

"That's nothing against the fund manager, because I think Nick Kaiser has done a really good job, but that kind of performance is just not sustainable," he added. "I think Nick would agree that it's not going to happen every year--he's been very lucky, in addition to being skilled, but investors need to keep their expectations in check."


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