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Nick Kaiser, Saturna Capital

Nick Kaiser's Amana funds, which invest according to Islamic law, are trouncing their large-cap competition.

David Kathman, 01/30/2009

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The trip up Interstate 5 from Seattle to Bellingham, Wash., features some of the most glorious scenery in the Pacific Northwest. Nick Kaiser grew up in Bellingham, and he founded Saturna Capital here in 1989 after selling his previous investment firm in Indianapolis. As we enjoy a seafood lunch at an outdoor café overlooking Bellingham Bay and Kaiser regales his guests with stories about the history of the bay and the nearby islands, it's not hard to see why he came back. "You can put a crab trap in the water, and an hour later, you have dinner," he says. Kaiser is an avid boater and a student of maritime history, and a few years ago, he built his dream house in Bellingham, with a study full of books and a winding path down to a boat dock.

Bellingham may seem to be an unlikely setting for one of the world's leading centers of Islamic finance, but that's what Saturna has become under Kaiser's leadership. In an unassuming building downtown, Kaiser manages the $750 million Amana Trust Growth AMAGX and the $500 million Amana Trust Income AMANX, by far the largest mutual funds that invest according to Islamic law. Although Muslims living in the United States are the funds' target audience, lots of non-Muslims attracted by the funds' stellar track records have jumped on board over the past few years. Both funds have trounced the S&P 500 Index over the past decade and rank among the best performers of any large-cap stock funds during that period.

A Tight-Knit Group
Kaiser's journey to the top of the Islamic finance world began in Indianapolis, where he and a partner were running Unified Management, a publicly traded investment firm. Their clients included service organizations such as the Islamic Society of North America, headquartered in a suburb of Indianapolis. Eventually, a group of local Muslim businessmen asked Unified to start an investment fund for them. Although Kaiser is not himself Muslim and knew little about Islamic investing at the time, he readily agreed and soon became well versed in this highly specialized field. "I said I could manage an Islamic mutual fund for them if they would teach me about Islamic investing," he says. "It worked out well for both sides."

His clients were so pleased with Kaiser that they stayed with him when he went west to start Saturna. Now, Saturna has $1.5 billion in assets under management, up more than tenfold since the beginning of 2005. Most of that is invested according to Sharia (Islamic law), though Kaiser also manages the secular Sextant Growth SSGFX and Sextant International SSIFX funds, which are small but growing. A tight-knit group of fewer than 50 employees has helped the firm expand into such areas as retirement planning and education savings accounts. Most recently, the firm launched the Saturna Trust Co., which helps American Muslims manage their estates in accordance with Sharia.PAGEBREAK

Kaiser's right-hand man in Bellingham is Monem Salam, who joined Saturna in 2003 as its director of Islamic investing. Salam is in charge of making sure that the Amana funds are Sharia-compliant. At first glance, the two men could not seem more different. The 62-year-old Kaiser speaks rapidly in his soft but gruff-sounding voice, with an unmistakable dry wit. Salam is a devout Muslim, more than 25 years younger than Kaiser, with a somewhat more intense, deliberate manner, but also an adventurous streak. He grew up in Texas as the son of a pilot, and his pursuit of a private pilot's license as a Muslim was recorded in a documentary recently shown on PBS.

Despite their different demeanors, Kaiser and Salam are very much at ease together, and both of them become more animated when talking about Islamic investing principles and doing right by their clients. "A mutual fund is actually the ideal vehicle for investing according to Sharia," Salam says, "because everybody is treated equally."

That equality extends to things like brokerage commissions. Saturna doesn't use any soft dollars, and a few years ago, the firm started doing all portfolio trades for free through its in-house broker-dealer, Saturna Brokerage Services. The Amana funds have "good, tough board members who keep us on our toes," Kaiser says. "They ask the right questions, and the tougher they are, the better I like it."

Principles and Profits
On the surface, many principles of Islamic investing are similar to those found in other socially responsible funds. The Amana funds can't invest in companies that get a significant amount of their revenue (generally more than 5%) from alcohol, tobacco, gambling, or pornography. The funds extend this restriction to companies that produce pork products. Kaiser and Salam work with a board of Islamic scholars, which gives advice on what is halal (permitted) and haram (forbidden). They tend not to allow much leeway. A few years ago, Kaiser sold Target TGT after discovering that the discount retailer had started selling alcohol in its stores; he sold grocer Albertson's for similar reasons.

The most obvious difference between the Amana funds and secular SRI funds is that the Amana offerings are prohibited from paying or receiving riba (interest), which is forbidden in the Quran. That eliminates essentially all financial stocks from the portfolio, as well as conglomerates that have significant financial arms, such as General Electric GE. An ultrastrict interpretation might also eliminate companies with any debt on their balance sheets, leaving very few options to invest in. But Sharia scholars agree that the Quran allows some debt in certain circumstances, as long as it's not excessive and it's part of a greater good. The Amana funds can hold companies with debt up to 33% of their market capitalization, though in practice the funds generally invest in more conservative companies than that.PAGEBREAK

All these restrictions stem from broader principles of Sharia, which is ultimately an ethical system designed to promote social and economic justice. The prohibition on riba is actually a prohibition on all unwarranted gains, meaning those in which risk or ownership is not shared. Speculation is also forbidden by Sharia; not only does this eliminate gambling stocks from consideration, but scholars also say that it prohibits excessive trading in a portfolio, which is one reason why the Amana funds have extremely low turnover, averaging under 10% annually. Muslims are also required by Sharia to pay a certain amount of their income (up to 10%) in zakat (charitable contributions). Saturna provides statements for its Muslim clients to make it easier to calculate the zakat they owe.

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
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 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.PAGEBREAK

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
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 squeaky-clean management," Kaiser says.

As the stellar performance of the Amana funds shows, good investment results and strong principles can definitely go hand in hand.

David Kathman is a mutual fund analyst with Morningstar. 

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