Bellingham, Wash., a picturesque seaside community near the Canadian border, is about the last place you'd expect to find a multibillion-dollar mutual fund company. Even more surprising is that the firm, Saturna Capital, runs two stock funds that have produced terrific results despite -- or perhaps because of -- a requirement that they adhere to sharia, or Islamic law.
Nicholas Kaiser, Saturna's chairman, launched Amana Income in 1986 after he was approached by a group of Muslim businessmen while he was with another firm. Kaiser, an Episcopalian, got the gig even though he knew nothing about Islamic principles. In 1994 he started Amana Growth. The funds, which are open to all, now have combined assets of $2.7 billion. Over the past ten years through August 6, Amana Income returned 5.7% annualized, and Growth gained 3.8% annualized. Over the same period, Standard & Poor's 500-stock index lost 0.8% a year.
We visited Kaiser at Saturna's headquarters. Joining the interview was co-manager Monem Salam, his adviser on Islamic matters. An edited transcript of the conversation follows:
Kiplinger's: Does the Koran specifically ban investing in companies that deal in such things as alcohol, pork and interest, or are many of these prohibitions based on scholarly interpretations?
Salam: Things like pork, alcohol and gambling are clearly mentioned in the Koran. The idea for not investing in pornography is based on the Koran's prohibition against lewdness and fornication. Tobacco is not mentioned, but the Koran says you should not harm your body, and Islamic scholars have interpreted that to mean you're not allowed to invest in tobacco.
What if a company gets only a small part of its business from prohibited activities?
Salam: There is a 5% cutoff. If a company gets less than 5% of its revenues from activities that are haram -- that is, forbidden -- we may be permitted to own it. For example, Southwest Airlines sells alcohol on its flights, but that's ancillary to its primary business of transportation.
The most intriguing rule is the prohibition against investing in a company that charges interest. Why is that?
Salam: In Islam, any loan you make is considered a charitable act. It's not a business transaction. The Koran says that if you give somebody a loan, you shouldn't expect to get any return from that person; God will reward you for it. One of the byproducts is that there can be no premium or discount on any debt obligation. So if you're trading money, which is what a debt obligation is, you trade it at par.
And that means you can't own bonds?
Salam: Zero in bonds and zero in any interest-paying cash-type investments, such as Treasury bills.
Kaiser: And that normally hurts us because it means we cannot invest our cash.
What about the notion of not being able to invest in highly leveraged companies, those that carry a lot of debt on their balance sheets?
Salam: The total debt of a company Amana invests in has to be less than one-third of its market capitalization. Because the debt carries interest, we don't want to invest in companies that heavily use debt to finance their operations.
You had a big cash position in late 2008 -- 35% in Amana Income. That's a lot of money that wasn't earning anything.
Kaiser: Zero is better than a loss of 30%. We tend to be especially cautious in the Income fund. We're not trying to beat the market in that fund. We try to beat the market in the Growth fund.
Monem, do you have veto power over the companies that Nick can invest in?
Salam: It's more of a discussion among analysts and the portfolio managers than any one person flatly saying yes or no.
Kaiser: Allegiant Travel (symbol ALGT) is a good example. The company is based in Las Vegas and flies gamblers there and to other leisure destinations at discount prices. It's one of the few successful airlines. Airlines are interesting because they can be leveraged and make a lot of money on the upside, but they are really risky. We bought some shares of Allegiant for Amana Growth, but then we investigated further and found that because of subsidies from casino operators, the company failed our 5% screen, so we had to get rid of it. We can own it in Sextant Growth, a non-Islamic fund we run, and it's actually a big possession in that fund.
How many companies qualify for the Amana Funds?
Salam: There are about 2,000 U.S.-traded companies -- plus many more foreign firms -- that are halal, or permissible, and that are reasonably liquid. From there, we screen further based on Saturna's criteria.
Kaiser: Saturna's analysts have an approved list of 225 stocks. All of our portfolios have to buy stocks from that list. Of those 225, maybe 125 are halal, meaning we can buy them for the Amana Funds. The Islamic focus helps because it forces us to really know what a company is doing.
So what gets a stock on the approved list?
Kaiser: We're basically GARP [growth-at-a-reasonable-price] investors. We look at five years of earnings. We look back more than we look forward because, to be honest, nobody knows what the future holds. Apple (AAPL), which we hold in Amana Growth, is our perfect stock. It has delivered five years of consistent earnings growth and five years of consistent surprises in earnings growth. And Apple's price-earnings multiple, at about 18 or 19 today, certainly looks reasonable. We like Google (GOOG), which is also in the Growth fund.
What is the main difference between the Growth and Income funds?
Kaiser: The holdings in Income must pay a dividend. We try to buy stocks that yield at least as much as the S&P 500.
Of the 125 stocks on your approved list that are considered halal, how many pay dividends?
Kaiser: Maybe 75% to 80% -- we like dividends. The Income fund is the harder of the two funds to manage because we can't own many of the companies that pay dividends. They're often big banks or utilities, which carry a lot of debt. We end up looking at a lot of cyclical companies. They may want to have debt, but banks don't like to lend to firms with cyclical earnings streams. So we've invested a lot in big mining companies. They have cyclical earnings, pay dividends and meet our debt requirements.
Does Teck Resources mine for gold?
Kaiser: Gold, copper, coal -- coal is what we were after in this case. Another big natural-resources company in Growth is Potash Corporation of Saskatchewan (POT).
All of the resources companies are based outside the U.S.
Kaiser: Yes, Amana Growth and Amana Income each have about 20% of assets in foreign stocks. That has generally helped our performance in recent years.
Do you meet with company officials, or do you mostly study documents?
Kaiser: Both, but mostly it's based on studying all the publicly available information -- press releases, SEC filings, all the stuff that's available on the Internet in some shape or form. And we join in on analyst calls.
What edge do you and your relatively small company have over the fund industry's giants?
Kaiser: I've been doing this a long time, and I guess I'm a careful investor. Another edge is that we don't spend a lot of effort studying leveraged capital structures because we're not allowed to invest in those kinds of companies. So we really know what the business is.
Salam: Because of our Islamic criteria, we're forced to look closely into the revenue sources and balance sheets of companies.
Has your inability to invest in financial companies helped the performance of the Amana Funds?
Kaiser: It certainly helped over the past decade, although it hurt in the '90s because financial stocks did very well then.
What's an example of a stock you've added lately?
Kaiser: Church & Dwight (CHD), the maker of Arm & Hammer products, is one. It's got a strong balance sheet and good growth. The company has had a sleepy history and is starting to wake up, and its products are beginning to move. At 18 times earnings, the stock is reasonably valued, given a 20% return on equity and annual earnings growth of 20%. Plus, the stock pays a nice dividend.
Your portfolio turnover is extremely low, in some years as little as 2%. What prompts you to sell a stock?
Kaiser: For starters, it's against Islamic tenets to speculate or gamble. We're looking for cyclical-type growth, maybe as long as a product cycle. Let's say it's a tech company that has developed a leadership product before its competitors are able to enter the same space. The company will have a couple of quarters or even years of strong competitive advantage. We'll sell when actual developments don't meet our expectations for the business.
What are your views on the economy?
Kaiser: We don't see corporate earnings improving much a year from now, but they'll be no worse, either. Companies have already cut a lot of expenses, and that has boosted earnings. We still don't know what will happen to income-tax rates in this country and in European countries, which have so much debt. The world is now learning that eventually you have to pay for all that debt. We are no longer going to have the debt-fueled growth that has been a hallmark of Western economies since World War II. The recession we just went through was the biggest since the '30s, and it's going to take a few years to work itself out.
Given what's happened since 9/11, has either of you taken flak for being involved with the Amana Funds?
Kaiser: No, though I believe our regulators have examined us diligently.
Salam: It's important to remember that Amana is not an Islamic fund company. We're a fund company that employs Islamic values. Anybody can buy our funds. If you like our values and you like our returns, buy our funds.
Kaiser: We believe the majority of our investors are not Muslim.