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Why a Fund's Piety
Is Now Paying Off? By: Carolyn Cui The little-known mutual fund Amana Income Fund is
one of this year's top performers. It can thank Islamic law for that. The Amana fund is a specialized fund that invests
based on Islamic religious principles. That means it must avoid, among other
things, investing in banks or other firms that earn money by charging interest.
Nor can it invest in companies carrying lots of debt. This year these restrictions are paying off. The
fund, which seeks well-established companies paying dividends, has largely
avoided the mortgage-related carnage hitting the markets since the summer. The
Amana Income Fund has returned 13% since the start of this year, and is ranked in
the top 2% of its category. With shares of many banks and brokerage houses
having plunged amid concerns over losses on mortgage-related securities, the
average stock income fund is up only 3.6%, according to fund tracker Lipper
Inc. "It's good that you don't have [banks and
financial companies] in periods like this year," says Nicholas Kaiser of
Saturna Capital Corp., Bellingham, Wash., which manages the Amana funds.
"It's great to be out of it." Indeed, most mutual funds that invest based on
Islamic principles have largely weathered the recent credit turmoil. Two
Islamic funds offered by Azzad Asset Management, smaller than the Amana and its
$333.1 million of assets, also are beating the Standard & Poor's 500-stock
index since the start of this year, after trailing the broad market for several
years. Dow Jones Islamic Fund is up 13.3% year to date,
which ranks it in the top 4% of its category of large- market-capitalization
stocks. The fund, managed by Allied Asset Advisors, tracks the Dow Jones
Islamic Market Index, which is a product of Dow Jones & Co., publisher of
The Wall Street Journal. A sister Amana fund, Amana Growth Fund, isn't
doing quite as well. The fund has $680 million of assets and invests in
companies whose earnings are expected to rise faster than the broader market.
It has returned 11.5% this year. While that beats the broader market, it still
trails its growth-type peers by 1.4 percentage points. Mr. Kaiser says the fund is basically looking for
growth stocks that have such "value" characteristics as
"reasonable" share price-to-earnings multiples, but this year the
best performers were highflying stocks like Google Inc. "So some of our
stocks didn't do well this year," he says. Apart from financial stocks, Islamic funds, like
other faith-based funds, also screen out so-called sin stocks, including
alcohol, tobacco, gambling and weapons makers. They also must shun companies in
pork-processing businesses and companies with a debt level higher or equal to
33%. These rules eliminate from consideration about
half of all the publicly traded stocks in the U.S. Out of the Russell 3000
Index -- which includes the 3,000 largest U.S. companies based on market
capitalization and represents about 98% of U.S. stocks -- Amana has about 1,500
companies to choose from. By comparison, KLD Research & Analytics, a
social-investing research firm, contains 2,100 stocks in its broad index. Faith-based or socially conscious mutual funds --
there are numerous varieties -- tend to under-perform the broader market. That
is often because their blanket prohibition of certain sectors means they
automatically rule out some good-performing stocks. At the same time, the added
stock-picking research required by their social or religious criteria increases
the cost of running such funds. Amana funds have been a powerful rebuttal to this
notion. In the past five years, both are among the top-returning funds in their
respective categories, returning about 20% on an annualized basis. Some of Amana's investment rules -- for instance,
low turnover in buying and selling stocks, and aversion to debt -- make
investing sense for long-term investors, says David Kathman, an analyst with
Morningstar Inc. Because of the low-debt restriction, Amana has
found some good investments. Its growth fund started buying Washington Group
International Inc., a construction firm, in January 2006 at $55 a share after
Mr. Kaiser spotted its zero-debt level. "This looks good for us," he
recalls saying. Amana recently sold the stock at $91.50 after the shares
rallied on a takeover offer. ¥ The News: One of the top-performing mutual funds
this year is Amana Income Fund, a little-known fund that adheres to Islamic
principles. ¥ Behind the Scenes: Because Amana must avoid
companies that earn money by charging interest or those with large debt loads,
it has been largely spared fallout from the credit crunch. ¥ Bottom Line, for Now: Amana's returns belie the
tendency of faith-based or socially conscious mutual funds to under-perform the
broader market. The Islamic rules have helped Amana dodge some
bullets. Enron Corp., which then fit growth-fund criteria, was ruled out from
Amana Growth Fund's holdings -- before the scandal was exposed -- because its
debt level exceeded the 33% threshold, Mr. Kaiser says. Saturna Capital uses guidelines set up and
endorsed by the Fiqh Council of North America, an organization of religious
scholars dealing with issues concerning Muslims in North America. Islamic law also forbids frequent trading of
shares, since that is seen as a form of gambling. As a result, the turnover in
the portfolios at Amana funds averages around just 10% each year, compared with
50% or more at a typical mutual fund. Lack of turnover is a contributor to
performance, since shareholders are taxed for capital gains when managers sell
stocks and make gains, and because of lower trading fees. The 61-year-old Mr. Kaiser, who isn't Muslim
himself, is concerned about the sub-prime spillover to his funds. As a big part
of the U.S. economy "is based on home buying and loans -- that's going to
drop off quite a bit," he says, leading people to cut consumption in
retails and gasoline. "We have a lot of [those] stocks in our portfolios.
If we have a major recession, I don't think we are immune from it just because we
are not in those [financial] sectors," he said. Amana's consistent performance appears to be
attracting more non-Muslim investors. In the past 18 months, the two funds have
increased from $288 million in assets to more than $1 billion combined. Of
course, it is impossible to know for certain the religious persuasion of any
given investor in a mutual fund, but by their names "we can pretty much
tell they are non-Muslims," Mr. Kaiser says. "They just went for
performance." Write to Carolyn Cui at carolyn.cui at wsj dot
com http://www.iviews.com/Articles/articles.asp?ref=WS0711-3427 |
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