An Islamic Investment Fund Is ‘Serendipitously’ Well Positioned

With $3.1 billion in assets under management, accounting for about half of the AUM of Bellingham, Washington-based Saturna Capital Corp., the Amana Growth Fund is among the biggest U.S. mutual funds managed according to the sharia principles of Islamic finance. It has ridden a wave of growing interest in the strategy: Islamic mutual fund assets totaled $120 billion at year-end 2021 and increased by 84% (13% annualized) over five years, according to Fitch Ratings.

Prohibiting investments in such businesses as liquor, pornography, gaming and banking has been “serendipitous” with delivering results, says Scott Klimo, vice president and chief investment officer of Saturna and portfolio manager of Amana Growth, which is thriving at the top of its Morningstar peer group. (The family also includes the Amana Income, Amana Developing World and Amana Participation funds, and some $5 billion of Saturna-managed funds are sharia-compliant.)

“I don’t think there’s anything that particularly distinguishes the banking industry in terms of a risk profile, but it is something that tends to get a little more beaten up in a downturn,” comments Klimo, who is also portfolio manager of the Saturna Al Kawthar Global Focused Equity UCITS ETF. “This year, people are worried about recession, so they’re worried about the quality of loan books.”

Scott Klimo, CIO, Saturna Capital

A graduate of Hamilton College and a Chartered Financial Analyst, Klimo spent nine years with Security Global Investors in San Francisco and was director of research before its parent company’s 2010 acquisition by Guggenheim Partners. In 2012 he joined Saturna, a firm founded in 1989 to cater to Muslim students who had been arriving in the U.S. and finding that no available mutual funds were acceptable under Islamic standards.

Initially Saturna’s director of research, Klimo has been CIO since 2016, overseeing funds that the firm’s website describes as taking a value-oriented approach and “favor[ing] companies with low price-to-earnings multiples, strong balance sheets and proven businesses.”

Providing further detail in a recent interview, Klimo notes that “risk management is to a large extent driven by the guidelines that we apply to our portfolio – our stock selection under Islamic rules. Perhaps the most significant of those is simply debt. We’re not permitted to invest in companies that have greater than 33% total debt to market capitalization.”

Does avoiding certain industries simply remove risks that would otherwise have to be managed?

I don't think it’s entirely true to say it that way. We are long-term investors. We buy and hold, often for a decade or more. That forces you to take into consideration less quantitative aspects and look at more qualitative issues such as, Who are the people managing the business? Do these people have a track record of positive execution, of competence, of integrity? Is the way that they pay themselves aligned with my interests as a minority shareholder? What is their treatment of employees?

Those sorts of things contribute to the type of companies that we can feel comfortable being in a partnership with as investors for two decades or more. We look at all of these and other potential risk factors and build a portfolio of companies that we believe are an attractive tradeoff of potential return versus how we evaluate that risk.

How would you describe the difference between Islamic and conventional asset management?

I worked at a very, very different firm before coming to Saturna, where we would look at things like expected value at risk (VaR) at different confidence levels. We don’t do any of that here. Our risk control is entirely built up stock by stock, and we’re aware of what our exposures are in different sectors and different industries. We’re always going to be benchmark-agnostic.

Even if we wanted to, we couldn’t “closet benchmark” because there are large segments of any benchmark that are simply off limits to Saturna. So we have to take risk seriously on a stock-by- stock basis.

What financial metrics do you take into consideration?

One ratio that we look at is accounts receivable to total assets, which is pretty straightforward. If you’re a company, and you’re making something or selling a service, you would like to get paid for it. If you have supposedly sold things that you haven’t received any earnings or income for, that can be a bit of a red flag.

To what extent have you borrowed from the language of socially responsible investing?

The principles and philosophies that we’re applying were aligned with SRI from the get-go. The members of our board are all accomplished Muslim businesspeople, authors and educators who had value-added qualitative guidance to offer.

Do you see a future for Islamic finance in digital currencies or tokenization?

We’re pretty adamant that that’s not going to be sharia-compliant, and not something that we will invest in. It’s a form of speculation, that which cannot be seen. What is a bitcoin? Its value is assigned utterly randomly by a collection of people who say to themselves, “Yeah, this is something I'd like to have a piece of.”

What are the demographics of your investor base?

A portion of investors are clearly attracted by the Islamic aspect, and a portion are attracted by the fact that the fund is in the top decile over one year and three years, and the top quartile over 15 years. If you don’t self-identify as Muslim, we don’t ask. But we have run a variety of quantitative programs using names and the appearance of various letters in certain combinations. We estimate that it’s split roughly 50-50 between Muslim investors and other investors.

What stocks or sectors are the funds concentrated in?

The portfolios have something of a mix. In Amana Growth, for example, we have companies that anybody would consider a growth stock, don’t pay a dividend, and turn everything into either buybacks or reinvestment in the business – typical type of growth. And then we have companies that have nice growth profiles but also pay a big dividend.

After technology, our second largest sector exposure in the growth fund would be healthcare, primarily large pharma.

We’ve owned Apple since 1994, which has given us a return of 200 times, and Novo Nordisk, a Danish multinational pharmaceutical company, which is up 6,000% since we bought it in 1997.

How do you feel about the rest of the year in capital markets?

One of the things that defines us is that we are not driven by market movement. We’re very low turnover: mid-single-digit annualized turnover, versus anywhere from 50% to 80% for the universe. Admittedly, a big part of that universe includes quantitatively driven, 400-position, factor exposure-modifying portfolios. That’s really where you have the tail risk when an algorithm says, “This is the type of thing you want.” And all of a sudden you get destroyed – which we saw in 2000 with the dot-com crash, and we’re seeing again in some hedge fund returns this year.