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Parnassus Funds Report

Parnassus Funds Annual Report: December 31, 2011

February 10, 2012

Dear Shareholder:

Last year was a very difficult year for all investors, including shareholders of the Parnassus Funds. There was extreme volatility in the capital markets as stocks took heart-stopping plunges, only to be followed by remarkable recoveries. Economic problems are plaguing Europe, Asia and the Americas. Despite all this, the U.S. economy is making a slow, but steady recovery.

For 2011, three of our six funds beat their Lipper peers: the Equity Income Fund, the Mid-Cap Fund and the Fixed-Income Fund. Although the other three funds, the Parnassus Fund, the Workplace Fund and the Small-Cap Fund, all underperformed for the year, they are each substantially ahead of their Lipper peers and their market benchmarks for the three- and five-year periods.

I would like to thank all of you for investing with Parnassus. We’ll continue to work hard, investing in responsible companies that are good businesses and that are selling at attractive valuations.

Yours truly,

dodson signature
Jerome L. Dodson
President

PARNASSUS FUND

Ticker: PARNX

As of December 31, 2011, the net asset value per share ("NAV") of the Parnassus Fund was $35.23, so after taking dividends into account, the total return for the quarter was 17.33%. This compares to 11.80% for the S&P 500 Index ("S&P 500") and 10.82% for the Lipper Multi-Cap Core Average, which represents the average multi-cap core fund followed by Lipper ("Lipper average"). For the quarter, we beat both our benchmarks by substantial amounts.

If we were to look at just the quarter, I would be delighted with our performance. Unfortunately, we have to look at our quarterly returns in the context of the entire year. For the year, we show a loss of 5.01%, compared to a gain of 2.09% for the S&P 500 and a loss of 2.68% for the Lipper average. As you can see, despite the strong quarter, we are far below our benchmarks for the year. Essentially, we fell into such a deep hole during the year, that the fourth quarter results were only a start to digging ourselves out. I’ll give more details on how we fell into that hole in the first place in the company analysis section.

Below is a table comparing the Parnassus Fund with the S&P 500 and the Lipper average over the past one-, three-, five- and ten-year periods. As you can see from the table, we’re lagging the indices for the one- and ten-year periods, but we’re substantially ahead of the benchmarks for the three- and five-year periods. On page 8 is a graph showing the growth of a hypothetical $10,000 investment in the Fund over the last ten years.

parnx returns

Performance data quoted represent past performance and are no guarantee of future returns. Current performance may be lower or higher than the performance data quoted. Current performance information to the most recent month-end is available on the Parnassus website (www.parnassus.com). Investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original principal cost. Returns shown in the table do not reflect the deduction of taxes a shareholder may pay on fund distributions or redemption of shares. The S&P 500 Composite Stock Index (also known as the S&P 500) is an unmanaged index of common stocks, and it is not possible to invest directly in an index. Index figures do not take any expenses, fees or taxes into account, but mutual fund returns do. Prior to May 1, 2004, the Parnassus Fund charged a sales load (maximum of 3.5%), which is not reflected in the total return calculations. Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of the Fund and should carefully read the prospectus or summary prospectus, which contain this and other information. The prospectus or summary prospectus can be obtained on the Parnassus website, or by calling (800) 999-3505. As described in the Fund's current prospectus dated May 1, 2011, Parnassus Investments has contractually agreed to limit the total operating expenses to 0.99% of net assets, exclusive of acquired fund fees, until May 1, 2012. This limitation may be continued indefinitely by the Adviser on a year-to-year basis.

Company Analysis

As I indicated earlier, 2011 was a very disappointing year for the Fund. Most of that disappointment was caused by weak performance in three industries in which we held substantial positions: telecommunications equipment, home-building and consumer electronics. In the case of telecom equipment, I looked at the rate of growth in electronic devices and the amount of data they were sending and receiving over telecom networks. Cell phones, smart phones, iPads, personal computers and many other kinds of devices are sending more and more streams of data every day across their networks. These communications networks have only a limited capacity to handle all that traffic. At some point, the big telephone companies will have to make enormous investments in telecom equipment to keep up with the growth in that traffic. Many forecasters predicted that this increase in capital expenditures would come in the second half of 2011. Accordingly, I bought stocks that would benefit from this expected increase in telecom investments including Finisar and Ciena, both of whom make equipment used in optical networks. Unfortunately, this expected increase in capital expenditures did not occur, and Finisar and Ciena were the two stocks that hurt our performance the most in 2011.

Finisar sank 43.6% during the year from $29.69 to $16.75, slicing an astonishing $1.08 off the value of each Parnassus share. In 2010, Finisar had been one of our best-performing stocks, as sales of its optical-networking equipment skyrocketed, pushing up the stock an amazing 233% from $8.92 to $29.69 for a gain of 32¢ on the NAV. In early 2011, weakness in the Chinese telecommunications market and an inventory correction brought soaring sales to a screeching halt. "Inventory correction" is a very innocuous-sounding term, but it can mean big swings in quarter-to-quarter earnings. Because the company’s products had been so much in demand, there were long lead times between when a customer ordered and when it could get delivery. During these times of perceived shortages, customers tended to order more products than they needed for their immediate use, so they would have plenty of inventory available. When lead times are reduced, customers feel more comfortable and figure they can get more supply whenever they need it, so they reduce orders or even stop ordering completely—at least for a while. This is what happened to Finisar. The weakness in China, the inventory correction and the less-than-anticipated capital expenditures by the telecommunications service-providers all combined to wreak havoc with the company’s stock.

parnx compWe plan to continue holding Finisar’s stock, since we think there is a lot of upside potential in 2012. The inventory correction appears to be over, Finisar has great products, and at some point, the telecom serviceproviders will have to make big investments in their optical networks.

Ciena is another manufacturer of optical equipment, and its stock sank 42.5% from $21.05 to $12.10 by the end of the year, for a loss of 80¢ for each fund share. The stock did very well early in the year, climbing 23.3% from $21.05 to $25.96 for a gain of 45¢ on the NAV during the first quarter. Anticipation of stronger second-half capital expenditures by telecom service providers powered the issue, but the stock collapsed with the weak economy and the decision by the carriers not to increase capital spending.

Two of our home-builders also contributed to our disappointing performance last year. KB Homes dropped 41.9% from $13.49 at the beginning of the year to $7.84, where we sold it for a loss of 61¢ for each fund share. We sold KB because it was financially the weakest of our homebuilders. We do, however, still have three homebuilders in the portfolio: Toll Brothers, PulteGroup and DR Horton. PulteGroup dropped 16.1% from $7.52 to $6.31 during the year for a loss of 35¢ for each Parnassus share.

We’re keeping our home-builders in the portfolio despite the difficult conditions in the housing market. Here’s our rationale: last year, builders started construction on about 600,000 homes in the United States—a very low number. Each year, about 300,000 homes are demolished for various reasons. To accommodate population growth (through births and immigration, net of deaths and emigration) we need 1.2 million homes per year, so the total new construction needed is 1.5 million. As you can see, we’re building less than half the new homes needed each year. At some point, builders have to increase the number of homes under construction.

Right now, housing is very affordable. Prices have come down sharply from the peak—somewhere around 40% depending on the region. Interest rates are at historically low levels—4% or even below. Given this situation, people should be buying homes at unprecedented rates and business should be booming for home-builders. The fact is, though, that business is not booming.

The main problem is lack of jobs. About seven million jobs were lost since the start of the financial crisis in 2008. At the present time, new job creation is only running around 100,000 per month. If that number doesn’t pick up, it will take us around six years to get back those lost jobs. Usually when we come out of a recession, job growth surges and usually averages around 200,000 to 400,000 new jobs per month during the early part of the recovery. If we had job growth of around 300,000 per month, it would only take us around two years to make up for all those lost jobs.

parnx growthNormally, the housing market picks up after a recession, because home prices and interest rates are low. A lot of new jobs are normally created by this pick-up in housing, including industries like construction, furniture, home furnishings, building materials, landscaping and commodities. What’s different this time is that home-building has not picked up. This is partially due to competition from foreclosed homes, but there are other factors at work.

One of them is a cautious stance by lenders. After being very careless in their lending standards during the 2005-2007 period, banks and other lenders have become much more restrictive. Even though interest rates are low and housing is very affordable, people are not buying homes to any great degree. This is primarily because of the job situation. Even people who are working are reluctant to buy a new home if their neighbor lost a job or if they’re afraid of losing a job themselves.

This is truly a vicious circle. Weakness in the housing market hurts job creation, and weak job creation hurts the demand for housing. At some point, though, people will start buying homes in greater numbers, construction will pick up, new jobs will be created and this will fuel more demand for housing. This is the way it has always worked, and at some point it will happen again. Unfortunately, it’s impossible to predict exactly when this will happen. If the most recent recession were more typical, the housing market would have picked up at the end of 2009—about a year after the recession ended. By my reckoning, a housing pick-up is two years overdue. In any case, it should happen before too long, and at that point homebuilding stocks should move much higher.

There are already some glimmers of hope on the horizon, as prices seem to be firming and sales are picking up. The three housing stocks in our portfolio reflected these improved statistics. For the fourth quarter of 2011, DR Horton’s stock rose 39.5% from $9.04 to $12.61, Toll Brothers rose 41.5% from $14.43 to $20.42 and PulteGroup rose 59.8% from $3.95 to $6.31. They are still trading at very depressed levels, but they have moved much higher. It’s possible that this may signal the start of a recovery in housing.

The two stocks tied to consumer electronics that hurt the Fund during the year are Corning and MIPS Technologies. Corning makes special glass for computer screens, high-definition television sets, smart phones and other consumer electronic devices. Manufacturers reduced orders for glass, because they expected weaker sales of consumer-electronic items. At the end of November, Corning announced that it was temporarily shutting down 25% of its manufacturing capacity for special glass. The stock fell 32.8% during the year from $19.32 to $12.98, resulting in a loss of 40¢ per fund share.

MIPS Technologies designs the architecture for special semiconductors known as embedded processors and collects royalties for use of its designs in consumer products such as digital televisions, set-top boxes, WiFi access points and routers, as well as communication and entertainment products. The stock sank 41.9% from our average cost of $8.57, where we bought it during the year, to $4.98, where we sold it in the fourth quarter. Weak demand for consumer electronics sent the stock on a downward spiral. We bought the stock in hopes that its design for smart-phone processors would be accepted by a number of manufacturers who would achieve substantial sales with the MIPS design. Unfortunately, we came to the conclusion that MIPS could not break into the smart phone market in a substantial way, so we sold our shares.

The other stock that hurt the Fund during the year was Hewlett-Packard (HP), which sliced 78¢ off the NAV, as its stock dropped 38.8% from $42.10 to $25.76. In the last quarterly report, I wrote how a once-great company like HP had suffered a sharp decline, because of a dysfunctional board and weak management at the top. I indicated that we were still hanging on because the company still had some good products, and there were still some good people working there. Moreover, the stock was trading at very depressed levels. Since then, I have decided to exit the position, because there are a lot of other stocks trading at depressed levels that have better management and more upside potential.

Despite the difficult year for the Parnassus Fund, there were three stocks that each contributed 40¢ or more to the NAV. Our biggest winner was MasterCard, one of the world’s largest payment processors, whose stock soared 42.0% from $224.11 at the beginning of the year to $318.30, where we sold it late in the year. The stock added 69¢ to each fund share. At the beginning of 2011, the stock was under pressure because the Federal Reserve, acting under the Dodd-Frank Act’s Durbin Amendment, proposed reducing debit card fees from 44¢ to 12¢, a drop of 73%. In June, the Fed softened its original rule, establishing a 24¢ limit, or a 45% reduction. The Durbin Amendment also requires debit-card issuers to offer two unaffiliated networks for processing transactions, and this enables MasterCard to gain market share from Visa, the market-leader. The company reported strong earnings throughout the year.

Valeant Pharmaceuticals, a diversified drug company, added 45¢ to the NAV, as its stock climbed 33.4% from our cost of $36.80 to $49.09, where we sold it early in the year, because this equity met our target price. Earnings surged for the company, both because of strong performance in emerging markets and higher earnings in its U.S. and Canadian dermatology business.

W&T Offshore, an oil- and gas-producer, contributed 42¢ to the value of each fund share, as its stock climbed 18.7% from $17.87 to $21.21. Profits increased for W&T in 2011, as oil prices climbed from $91.38 to $99.65 a barrel, because of supply disruptions in Libya. The company also announced significant acquisitions of onshore oil assets in the West Texas Permian Basin, which diversified the company’s assets and provided significant growth opportunities.

Parnassus Fund Portfolio of Investments as of 12/31/2011

Outlook and Strategy

This section represents my thoughts and applies to the three funds that I manage: the Parnassus Fund, the Parnassus Small-Cap Fund and the Parnassus Workplace Fund. The other portfolio managers will discuss their thoughts in their respective reports.

All three of my funds underperformed this year and all three lost money. This is the first time that has happened since the Small-Cap Fund and the Workplace Fund were established in 2005. Although the quotations for the funds and the stocks in them are down, I don’t think this means a permanent loss of capital for the Fund, or for our shareholders who maintain a long-term approach to investing. I can’t control what the market will pay for a given security at a given point in time, but I can make sure that we buy good businesses at prices that are below our estimates of intrinsic value. The market value of our stocks moved higher early in the year, then dropped as the economic outlook turned bleak and the stock market became very volatile. Investors sold off our stocks at prices that I consider far below fair value. Right now, my view is that stocks in the portfolios are undervalued.

It already looks as if our stocks are making a comeback in the fourth quarter. All three funds had substantial gains in the last three months of the year, with the Parnassus Fund up 17.33%, the Small-Cap Fund up 10.53% and the Workplace Fund up 13.48%. I expect this trend to continue into 2012. Economic indicators are looking better, including more jobs and an increase in manufacturing.

Given this outlook, I don’t plan to make major changes in the portfolios. When the recovery strengthens, our portfolios should do very well.

For December, there was a net increase of 200,000 jobs added to the American economy—up from a gain of 100,000 in the previous month. If this trend continues, the housing market will improve and our homebuilders should make some strong gains. As I indicated in the company analysis section, housing and jobs are closely related. More jobs will mean more housing construction, and the vicious circle I described earlier will become a virtuous circle with new construction creating more jobs and more jobs creating demand for more housing.

The telecommunications stocks we own should also do well with an economic recovery. As the economy picks up, people will buy more electronic devices that send and receive data across the internet, and service providers will have to invest more to expand their networks. This will give a big boost to our telecommunications stocks.

Nothing is guaranteed, of course, but I feel much more positive about the economy and our investments than I did about three months ago.

Yours truly,

dodson signature
Jerome L. Dodson
Portfolio Manager

PARNASSUS EQUITY INCOME FUND

Ticker: Investor Shares - PRBLX
Ticker: Institutional Shares - PRILX

As of December 31, 2011, the NAV of the Parnassus Equity Income Fund-Investor Shares was $26.35. After taking dividends into account, the total return for the quarter was 11.01%. This compares to an increase of 11.80% for the S&P 500 Index ("S&P 500") and an increase of 11.82% for the Lipper Equity Income Fund Average, which represents the average equity income fund followed by Lipper ("Lipper average"). For the year, the Fund rose 3.13% versus 2.09% for the S&P 500 and 3.11% for the Lipper average.

prblx returns

The total return for the Parnassus Equity Income Fund-Institutional Shares from commencement (April 28, 2006) was 5.86%. Performance shown prior to the inception of the Institutional Shares reflects the performance of the Parnassus Equity Income Fund-Investor Shares and includes expenses that are not applicable to and are higher than those of the Institutional Shares. The performance of Institutional Shares differs from that shown for the Investor Shares to the extent that the classes do not have the same expenses. Performance data quoted represent past performance and are no guarantee of future returns. Current performance may be lower or higher than the performance data quoted, and current performance information to the most recent month-end is available on the Parnassus website (www.parnassus.com). Investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original principal cost. Returns shown in the table do not reflect the deduction of taxes a shareholder may pay on fund distributions or redemption of shares. The S&P 500 is an unmanaged index of common stocks, and it is not possible to invest directly in an index. Index figures do not take any expenses, fees or taxes into account, but mutual fund returns do. On March 31, 1998, the Fund changed its investment objective from a balanced portfolio to an equity income portfolio. Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of the Fund and should carefully read the prospectus or summary prospectus, which contain this and other information. The prospectus or summary prospectus can be obtained on the Parnassus website, or by calling (800) 999-3505. As described in the Fund's current prospectus dated, May 1, 2011, Parnassus Investments has contractually agreed to limit the total operating expenses to 0.99% and 0.78% of net assets, exclusive of acquired fund fees, through May 1, 2012 for the Investor Shares and Institutional Shares, respectively. These limitations may be continued indefinitely by the Adviser on a year-to-year basis.

The Fund had a good year, outperforming the S&P 500 and the Lipper average during a volatile market. Our investment philosophy is to own undervalued companies that sell increasingly relevant products with sustainable competitive advantages. This strategy has provided superb long-term results. Our five- and ten-year returns beat the S&P 500 by substantial margins. While the Fund has underperformed the S&P 500 over the past three years, I’m pleased with its 13.07% return, given my emphasis on risk management.

To the left is a table comparing the performance of the Fund with that of the S&P 500 and the Lipper average. Average annual total returns are for the one-, three-, five- and ten-year periods. On page 12 is a graph showing the growth of a hypothetical $10,000 investment in the Fund over the last ten years.

2011 Review

The S&P 500 had a volatile year, ranging from a year-to-date gain of 8.9% on May 2nd to a year-to-date loss of 11.3% on October 3rd. Amazingly, this tug-of-war ended with the index at the same place as a year before, with the entire annual return coming from dividends. Stocks got a boost from huge deficit spending and continued low interest rates, both of which helped corporate profits stay high. On the other hand, the European sovereign debt crisis showed that the global economy is still fragile with potentially extreme downside risks. During this turbulent year, my focus remained simple: own undervalued companies with increasingly relevant products and durable competitive advantages. I also avoided companies with excessive debt or risks that my team couldn’t accurately measure.

This strategy enabled the Fund to gain 3.13%, which beat the 2.09% return for the S&P 500. The Fund’s biggest contributor to its outperformance was the technology sector, which added 68 basis points (one basis point equals 0.01%) versus the index. It’s amazing that technology helped the Fund so much, considering that we owned Hewlett-Packard and didn’t own Apple, two decisions that reduced our return relative to the index by a combined 1.6%.

Our second biggest contributor to outperformance in 2011 was the materials sector, which added 54 basis points of outperformance. Our investments in this sector actually rose 13.3% during 2011, while the average materials stock in the S&P 500 fell 9.3%.

The Fund generated slight outperformance from the industrial, energy-utility and healthcare sectors, and was held back by the financials and telecommunications sectors. The only sector that had a significantly negative impact on the Fund was consumer staples, which trimmed our lead by 51 basis points versus the S&P 500. While we owned good companies, such as CVS Caremark, Procter & Gamble and foodservice company Sysco, our investments rose only 7.2%, much less than the 13.9% return for the S&P 500’s consumer staples category.

Company Analysis

prblx compThe Fund had four companies that reduced the NAV by at least 16¢. Our biggest loser was Hewlett-Packard (HP), which plunged 38.8% during the year from $42.10 per share to $25.76, trimming 30¢ off the NAV. Given HP’s legacy as an innovator and technology titan dating back to the 1950s, it was a deeply disappointing year for the company.

Heading into 2011, I had concerns about HP’s new CEO Leo Apotheker and the company’s struggling PC segment, but I liked its server, storage and printing businesses. I thought the company would meet its longterm goal of growing earnings from around $5.00 per share in 2011 to $7.00 by 2014. With the stock trading at six times its 2014 earnings expectation, HP seemed to have considerable upside potential. Unfortunately, what transpired in 2011 was a terrible combination of management missteps, highlighted by an over-priced $10.3 billion deal to buy U.K. software company Autonomy. In addition, HP’s competitive position worsened in 2011, especially in its PC and business services divisions.

Despite a brutal year for HP, I’ve held onto the shares. I think the tide started to turn in late September when HP’s board announced that it was replacing Mr. Apotheker with Meg Whitman, the former CEO of eBay. In mid-December, Parnassus senior analyst Lori Keith met with Ms. Whitman at HP headquarters, and left the meeting thinking that she could rebuild the company. HP still has valuable competitive advantages in hardware and infrastructure technology, which should help the company remain relevant in the server, storage and printing markets. Management is also pushing hard to build a stronger software business with enhanced cloud computing and data-analytics capabilities.

Cisco Systems, the large computer networking company, declined 10.6% during 2011 to $18.08 per share from $20.23, reducing the NAV by 24¢. The company had a very bad first half of the year, and the stock fell to a low of $13.30 per share in August. The cause of this drop was the company’s announcement that demand from governments, financial firms and telecommunications customers would be weak for several quarters. Additionally, investors worried that Cisco was losing share in its routing and core switching businesses, which comprise almost half of the company’s revenues. In response to these problems, Cisco announced a significant restructuring plan, which featured cost reduction and a scaling back of non-core businesses. These actions seem to be working, as Cisco reported promising results in the second half of 2011.

prblx growthJPMorgan’s stock fell 19.4% from $42.42 to our average selling price of $34.18, which reduced the Fund’s NAV by 21¢. While JPMorgan is one of the strongest global banks and is run by the talented Jamie Dimon, I sold the stock because of increasing risks related to the European debt crisis and regulation.

Plains Exploration and Production reduced the NAV by 19¢, as its stock fell 15.4% from our average cost of $34.78 to our average selling price of $29.41. I bought the stock because Plains has low-cost, long-lived oil reserves in California and Texas. In addition, the company has a good environmental record and a lot of acreage to fuel future growth. While these positives are still there, I sold the stock because the company may incur significant debt going forward: its cost of drilling wells currently exceeds its operating cash flow.

The Fund had six stocks that each increased the NAV by at least 15¢. MasterCard, the payment processing company, rose an amazing 66.4% during 2011 from $224.11 per share to $372.82 adding 46¢ to the Fund’s NAV. The company began 2011 with a murky regulatory outlook, as the Federal Reserve had not yet released its final debit fee rules. At the time, investors worried that the Federal Reserve would cut MasterCard’s debit-card "swipe-fees" to around 12¢ per transaction from 44¢ before the rule change. We bought a significant position in MasterCard after Parnassus senior analyst Matt Gershuny convinced me that investors were anticipating a near worst-case scenario for Senator Durbin’s legislation.

MasterCard’s stock soared in June when the Federal Reserve announced its final rules, which set the swipe fee at a higher-than- expected 24¢ per transaction. The stock continued to move up in the second half of 2011 after the company reported strong earnings growth that exceeded 35% for both the May and October quarters.

Valeant Pharmaceuticals had a fantastic year, and its stock boosted the Fund’s NAV by 27¢. The stock began the year at $28.29 per share and soared 74.9% by the time we sold it in May for an average price of $49.48. The big catalysts for the stock were Valeant’s successful integration of acquisitions, superb international growth, new dermatology products and a plan to acquire drug maker Cephalon.

We repurchased Valeant shares in September for an average cost of $37.85, and the stock subsequently rose 23.4% to its year-end price of $46.69. We bought the stock after it had dropped when pharmaceuticals giant Teva outbid Valeant to win control of Cephalon. Valeant’s stock bounced back by year-end after the company reported strong third quarter results and announced another attractive acquisition.

Google, the world’s leading internet search business, rose 8.7% from $593.97 to $645.90 and added 20¢ to the NAV. The company continued to strengthen its search, mobile and display advertising businesses in 2011.

Teleflex, a maker of single-use medical devices such as catheters, added 16¢ to the Fund’s NAV as its stock rose 13.9% for the year from $53.81 to $61.29. After several years of divesting a non-core division serving the automotive, aerospace and marine industries, Teleflex finally became a pure-play healthcare company in 2011. The stock rose, as investors now see a clear path to higher margins and consistent organic growth.

Gen-Probe, a company that sells molecular diagnostic equipment to screen blood and diagnose diseases, boosted the NAV by 15¢, even though its stock price increased just 1.3% in 2011 from $58.35 to $59.12. On April 28th, a rumor surfaced that Gen-Probe might be acquired. In response, the stock jumped 13% that day and soon reached a high of $87. Given the abrupt move in the stock, we trimmed our Gen-Probe position from 3% of Fund’s assets to 1% during the second quarter, realizing an average selling price of $82.30 per share.

Questar, a Utah-based natural gas utility, pipeline operator and energy production company, also boosted the NAV by 15¢, as the stock rose 14.1% from $17.41 per share to $19.86. The company is a unique, high-return, high-growth utility that was spun off from QEP Resources in 2010. I think this utility is a great long-term investment that can generate growth and dividends for many years to come.

Parnassus Equity Income Fund Portfolio of Investments as of 12/31/2011

Outlook and Strategy

The range of possible outcomes for the economy and financial markets for 2012 is unusually wide. In the bullish scenario, the world’s central bankers will likely play an important role. Since 2009, these bankers have been able to pull various levers to help the global economy avoid a disastrous downturn. If the economy finally breaks out of its doldrums in 2012, they should get credit for keeping business moving long enough for the animal spirits in the private market to come alive again. If a robust recovery comes this year, I’d expect earnings to grow, unemployment to abate and stock markets to rise meaningfully.

If this scenario plays out, our strategy is to gain as much as possible, within the limits imposed by our risk management discipline. Going back to 2007, there have been four calendar years in which the stock market has registered a positive return. In three of those four, the Fund beat the index, including in 2009, when the stock market rallied an amazing 26.5%. I certainly hope that the stock market is up this year, and if it is, that we once again outperform a rising index.

Unfortunately, I think the more likely scenario is that business activity will remain subdued. It’s even possible that there will be a worsening of the European debt crisis, a significant slowdown in China and a stalled, zero-growth economy in North America. These factors, and many others that we can’t possibly anticipate, would impact our portfolio companies and their stocks in various negative ways. Since U.S. corporate profit margins are unusually high at the moment, if Europe enters recession and the North American economy weakens, net incomes could drop for many companies, including those in the portfolio. Because most analysts expect record margins to continue, earnings would miss expectations in this scenario, leading to a stock market correction.

If this happens, my strategy would be to limit losses as much as possible. The reason I care so much about downside protection is simple: it’s far easier to recoup small losses than large ones. In fact, a significant contributor to our outperformance for the last five years is that the Fund suffered a much smaller loss in the 2008-2009 bear market than the index, and therefore recovered from that loss much faster in the subsequent bull market.

The Fund’s three biggest underweighted sectors versus the index are financials, energy and consumer discretionary. Our major overweighted sectors are healthcare, utilities and consumer staples. This positioning is defensive, consistent with my view that there’s meaningful downside risk for stocks in 2012. Notwithstanding my views about the potential risks to the economy, I’m confident in the long-term business prospects of the 39 companies owned by the Fund. No matter what happens in 2012, my team and our process should continue to deliver attractive risk-adjusted returns over the long-term.

Thank you for your trust and investment in the Parnassus Equity Income Fund.

Highest regards,

ahlsten signature
Todd C. Ahlsten
Portfolio Manager

PARNASSUS MID-CAP FUND

Ticker: PARMX

As of December 31, 2011, the NAV of the Parnassus Mid-Cap Fund was $17.69, so after taking dividends into account, the total return for the quarter was a gain of 12.78%. This compares to a gain of 12.31% for the Russell Midcap Index (the "Russell") and a gain of 10.82% for the average multi-cap core fund followed by Lipper (the "Lipper average"). For the year, the Fund was up 3.33%, ahead of both the Russell’s loss of 1.55% and the Lipper average’s 2.68% loss. We are pleased that the Fund had a positive return in this volatile year and beat its money-losing benchmarks by such a wide margin.

Our strategy of investing in attractively valued businesses with secular growth opportunities, durable competitive advantages and quality management teams has enabled the Fund to beat its Lipper peers over the three-year and five-year periods and the period since inception. While we’ve outperformed the Russell over five years, we lag that index in the three-year and since inception periods.

Below is a table comparing the Parnassus Mid-Cap Fund with the Russell and the Lipper average for the one-, three- and fiveyear periods and for the period since inception on April 29, 2005. On page 16 is a graph showing the growth of a hypothetical $10,000 investment in the Fund since inception.

parmx returns

Performance data quoted represent past performance and are no guarantee of future returns. Current performance may be lower or higher than the performance data quoted. Current performance information to the most recent month-end is available on the Parnassus website (www.parnassus.com). Investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original principal cost. Returns shown in the table do not reflect the deduction of taxes a share holder may pay on fund distributions or redemption of shares. The Russell Midcap Index is an unmanaged index of common stocks, and it is not possible to invest directly in an index. Index figures do not take any expenses, fees or taxes into account, but mutual fund returns do. Mid-cap companies can be more sensitive to changing economic conditions and have fewer financial resources than large-cap companies. Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of the Fund and should carefully read the prospectus or summary prospectus, which contain this and other information. The prospectus or summary prospectus can be obtained on the Parnassus website, or by calling (800) 999-3505. As described in the Fund's current prospectus dated May 1, 2011, Parnassus Investments has contractually agreed to limit the total operating expenses to 1.20% of net assets, exclusive of acquired fund fees, until May 1, 2012. This limitation may be continued indefinitely by the Adviser on a year-to-year basis.

2011 Review

The Russell finished 2011 down 1.55%, but this slight drop doesn’t tell the whole story. The Russell started the year strongly, rising 11.1% through early July. Investors were excited about improving domestic consumer confidence and increasing economic growth projections. They looked past global economic shocks, such as the catastrophic tsunami in Japan and destabilizing revolts throughout the Arab world.

Around the beginning of August, this optimism waned. The European financial crisis escalated, and Standard and Poor’s downgraded the United States’ credit rating, pushing the Russell down 16.2% in just twelve trading days. The market fell a few more percentage points in October, when speculation was highest that the euro zone might dissolve and reports surfaced of a Chinese economic slowdown.

Fortunately, domestic stocks recovered the bulk of their losses by year-end, driven by diminishing European debt concerns and strength in North American earnings, job creation and holiday sales. For the year, mid-cap stocks as a group performed better than small-cap stocks, but worse than largecap issues, reflecting investor wariness, and a resulting bias toward larger, more stable, dividend-paying companies.

The Fund beat the Russell for the year by almost five percentage points and its Lipper peer group by over six percentage points. The primary reason for the Fund’s outperformance was strong stock selection. We attribute this to strict adherence to our investment process, which results in owning businesses that should perform well over the long-term and regardless of the economic environment. Good stock picking in the healthcare, industrial and information technology sectors helped us the most this year, while poor stock selection in the financial and consumer staples sectors hurt the Fund.

On a sector basis, the Fund’s underweighted positions in financial and telecom services issues and overweighted position in the healthcare sector, all relative to the index, were the most positive allocation decisions for the year. We lost ground in the year due to the Fund being overweighted relative to the index in the technology sector and underweighted relative to the index in the consumer discretionary sector.

parmx compAnother reason the Fund outperformed the Russell is because of its relatively high exposure to companies with higher returns on equity (ROE), an indication of profitability and efficiency. Since these companies did better than companies with lower ROEs during the year, this factor helped our performance. The Fund was also overweighted, in comparison to the index, in larger stocks, which performed better than smaller stocks within the mid-cap universe.

Company Analysis

The Fund had three stocks that each reduced the NAV by 20¢ or more in 2011. The stock that hurt us the most was SEI Investments, the asset manager and asset administrator. The shares fell 27.1% in 2011, from $23.79 to $17.35, cutting 23¢ from the NAV. We first invested in SEI in mid-2009, when the company’s stock price was depressed, because it was managing and administering fewer assets due to the weak stock market. At the time, we also liked that management was wrapping-up its massive, multi-year investment in the Global Wealth Platform (GWP), a game-changing technology system for clients.

The stock worked well initially, reaching $25 in early 2011 due to the rising stock market. However, the shares subsequently fell given delayed GWP sales and a resulting drop in profitability at the company’s Private Banks segment. We still believe GWP will be successful, and the investment period is almost finished. In the meantime, we’re happy that the company is returning money to shareholders through buybacks and dividends.

First Horizon National, a Tennessee-based bank, cut 21¢ from the Fund’s NAV as its stock sank 23.2% from our average cost of $10.42 to $8.00. We first bought the stock in March of 2011, and the shares subsequently traded lower given the bank’s exposure to troubled national home equity loans and mortgage securities. We added to our position on this weakness, believing that eventual losses on its assets would be less than investors’ expectations. Furthermore, we thought that the stock was too cheap, given its well-capitalized balance sheet and core earnings power. This helped mitigate some of our losses, because the stock rose 34.2% in the last three months of the year.

New Jersey-based Hudson City Bancorp, a residential mortgage lender and savings bank, also took 21¢ from the Fund’s NAV, as its shares fell 40.7% from $12.74 to our average selling price of $7.55. We’re glad we sold the stock when we did, because it hit a low of $5.09 in November, and closed the year at $6.25. The shares declined throughout 2011, as historically low interest rates impaired Hudson City’s business model, curtailing loan growth and forcing management to incur large restructuring charges to extinguish high-cost borrowings. Our mistake was parmx growth not expecting mortgage rates to remain at such low levels. We sold our position because the main catalyst is higher interest rates, an outcome we currently find difficult to predict.

Our biggest winner was Valeant Pharmaceuticals, a developer and marketer of specialty pharmaceutical and branded generic drugs. Its stock rose 65.0% during 2011, from $28.29 to $46.69, adding 41¢ to the NAV. The company’s share price surged early in the year, as it beat analyst expectations for growth and profitability and issued unexpectedly bullish financial guidance. The positive results and outlook came from strong growth, synergies from its Biovail merger, and a tax-efficient corporate structure. Investors also rewarded the company during the year for its aggressive acquisition program. Normally, making a lot of acquisitions is a bad idea, but Valeant CEO Michael Pearson has done an excellent job integrating and extracting value from the companies he purchases.

Verisk, a risk management and data-analytics company serving the insurance, mortgage and healthcare industries, added 14¢ to each fund share, as its stock price rose 18.6% from our average cost of $33.83 to $40.13. Despite good operating results throughout the year, the company’s stock was flat through October. Then the stock surged after management reported betterthan- expected third quarter results and a positive outlook. This outlook is the result of a dominant competitive position, a high percentage of recurring revenue, sustainably strong margins and an aggressive acquisition and stock buyback plan.

Business analytics software company Teradata added 13¢ to each fund share this year, as its stock went up 17.9% from $41.16 to $48.51. Strong enterprise demand for its analytics solutions drove better-than-expected earnings throughout 2011, but the high point came in the second quarter, when management raised revenue guidance materially. This optimism was short-lived, though: as investors drove the stock down toward year-end, due to soft demand in Europe and delays in large enterprise deals. We added to our positions on this weakness, believing that Teradata’s business fundamentals are in good shape, and will drive better-than-expected earnings growth over the next few years.

Parnassus Mid-Cap Fund Portfolio of Investments as of 12/31/2011

Outlook and Strategy

The market has been volatile for some time now. The Russell was down 2% in 2011, up 25% in 2010, up 40% in 2009 and down 41% in 2008. These extreme swings have been driven by economic and political uncertainty, and not enough has changed to believe 2012 will bring anything different.

The uncertainty is currently driven by concern about the rates of growth for the U.S. and Chinese economies and the direction of the European financial crisis. We can see a positive scenario where the U.S. economy grows slowly, China has a soft landing and European leaders band together to solve their countries’ debt issues. It’s also possible that the U.S. and Chinese economies slow drastically and the euro zone dissolves. There is no consensus on the issues at hand, and the range of possible outcomes is wide.

Our overall bias is cautious, and our best guess is that the U.S. economy and markets will remain subdued. We continue to build the portfolio from the bottom-up, positioning it to perform well throughout the economic cycle. Our process has currently yielded a portfolio with above average returns on capital, a testament to our emphasis on companies with excellent competitive positions. While many of these stocks performed well in 2011, we think there’s more room to go, because they are still attractively valued.

Throughout the year, we increased our information technology exposure, taking advantage of volatility to buy high-quality businesses at good prices. We sold off some of our healthcare stocks because of valuation concerns and a belief that the government may cut spending in this area. We are most overweighted in the industrial and information technology sectors, owning businesses that are well-positioned to capture an increasing share in attractively growing end-markets. We remain underweighted in the consumer discretionary sector, where very few companies meet our competitive moat criterion.

Even in these volatile times, our overall strategy has resulted in excellent long-term results for investors. Since we began managing the Fund in October of 2008, its annualized total return is 8.48%, ahead of the Russell’s 7.42% and the Lipper’s 4.33%. While there will be up-years and down-years going forward, we’re confident that our strategy will yield attractive riskadjusted returns in the long-run.

Thank you for your investment.

Yours truly,

gershuny signature allen signature keith signature

Matthew D. Gershuny
Portfolio Manager

Ben Allen
Portfolio Manager

Lori A. Keith
Portfolio Manager

PARNASSUS SMALL-CAP FUND

Ticker: PARSX

As of December 31, 2011, the NAV of the Parnassus Small-Cap Fund was $20.08, so after taking dividends into account, the total return for the quarter was 10.53%. This compares to a return of 15.47% for the Russell 2000 Index ("Russell 2000") of smaller companies and 15.15% for the Lipper Small-Cap Core Average, which represents the average small-cap core fund followed by Lipper ("Lipper average"), so we underperformed both indices.

For the year, the Fund was down 13.29%, compared to a loss of 4.18% for the Russell 2000 and a loss of 3.41% for the Lipper average. I’ll talk about the reasons for the Fund’s poor performance in the company analysis section.

Below is a table comparing the performance of the Parnassus Small-Cap Fund with that of the Russell 2000 and the Lipper average over the past one-, three- and five-year periods and the period since inception. While our one-year number is very disappointing, we’re substantially ahead of both benchmarks for the three- and five-year periods and for the period since inception. On the following page is a graph showing the growth of a hypothetical $10,000 investment in the Fund since inception.

parsx returns

Performance data quoted represent past performance and are no guarantee of future returns. Current performance may be lower or higher than the performance data quoted. Current performance information to the most recent month-end is available on the Parnassus website (www.parnassus.com). Investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original principal cost. Returns shown in the table do not reflect the deduction of taxes a shareholder may pay on fund distributions or redemption of shares. The Russell 2000 Index is an unmanaged index of common stocks, and it is not possible to invest directly in an index. Index figures do not take any expenses, fees or taxes into account, but mutual fund returns do. Small-cap companies can be particularly sensitive to changing economic conditions and have fewer financial resources than large-cap companies. Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of the Fund and should carefully read the prospectus or summary prospectus, which contain this and other information. The prospectus or summary prospectus can be obtained on the Parnassus website, or by calling (800) 999-3505. As described in the Fund's current prospectus dated May 1, 2011, Parnassus Investments has contractually agreed to limit the total operating expenses to 1.20% of net assets, exclusive of acquired fund fees, until May 1, 2012. This limitation may be continued indefinitely by the Adviser on a year-to year basis.

Parnassus Small-Cap Fund Portfolio of Investments as of 12/31/2011

Company Analysis

parsx compositionThree stocks hurt the performance of the Small-Cap Fund the most, with each slicing 40¢ or more off the NAV. There was no pattern to the three biggest losers. The most damage was caused by Artio Global Investors, an asset manager that invests in international equities, whose price dropped an astonishing 68.1% from our average cost of $15.29 to $4.88 by the end of the year. This sliced 64¢ off each fund share. The firm posted an impressive investment record from 1996 through 2008, beating the market in 12 out of 13 years, but has underperformed since then. We bought the stock this year, when it appeared that investment performance was improving, but returns fell off toward the end of the year.

The firm experienced significant redemptions and the stock fell further. We think the firm’s investment performance should improve, since the same team has been in place from the 1996-2008 period.parsx growth

Finisar sank 43.6% during the year from $29.69 to $16.75, while slicing 49¢ off the value of each Parnassus share. In 2010, Finisar had been one of our best-performing stocks, as sales of its opticalnetworking equipment skyrocketed, pushing up the stock an amazing 233% from $8.92 to $29.69 for a gain of 75¢ on the NAV. However, in early 2011, weakness in the Chinese telecommunications market and an inventory correction brought soaring sales to a screeching halt. "Inventory correction" is a very innocuoussounding term, but it can mean big swings in quarter-to-quarter earnings. Because the company’s products had been so much in demand, there were long lead times between when a customer ordered and when it could get delivery. During these times of perceived shortages, customers tend to order more products than they need for immediate use, so they will have plenty of inventory available. When lead times are reduced, customers feel more comfortable and figure they can get more supply whenever they need it, so they reduce orders or even stop ordering completely—at least for a while. This is what happened to Finisar. The weakness in China, the inventory correction and the less-than-anticipated capital expenditures by the telecommunications service-providers all combined to wreak havoc with the company’s stock.

We plan to continue holding Finisar’s stock, since we think there is a lot of upside potential in 2012. The inventory correction appears to be over, Finisar has great products, and at some point, the telecom serviceproviders will have to make big investments in their optical networks.

Natural gas-producer Quicksilver Resources dropped 54.5% in 2011 from $14.74 to $6.71, slicing 44¢ off the NAV. Natural gas prices fell 32% during the year from $4.44 to $2.98 per million BTU’s—a two-year low. Unusually mild temperatures, weak industrial demand and an excess supply of natural gas caused the drop. The stock is very depressed right now, and should move higher in 2012.

There were no stocks that made a really significant positive contribution to the Small-Cap Fund. The company that added the most was Salix Pharmaceuticals, which rose 46.0% from our average cost of $32.78 to $47.85 by year-end, adding 15¢ to the NAV. The stock moved higher because of increased prescription growth for Xifaxan, a treatment for hepatic encephalopathy (a liver disease) and traveler’s diarrhea. The stock rose further on anticipation that Xifaxan would be approved by the FDA for use in irritable bowel syndrome.

Yours truly,

dodson signature
Jerome L. Dodson
Portfolio Manager

PARNASSUS WORKPLACE FUND

Ticker: PARWX

As of December 31, 2011, the NAV of the Parnassus Workplace Fund was $19.64, so after taking dividends into account, the total return for the quarter was 13.48%. This compares to a return of 11.80% for the Standard & Poor’s 500 Index ("S&P 500") and 11.04% for the Lipper Large-Cap Core Average, which represents the average large-cap core fund followed by Lipper ("Lipper average"). We beat both indices by substantial amounts for the quarter, but unfortunately, it was not enough for the Fund to beat the benchmarks for the year.

For the year, the Fund was down 1.62%, compared to a gain of 2.09% for the S&P 500 and a loss of 0.66% for the Lipper average. I’ll talk about what caused our underperformance in the company analysis section of the report.

Below is a table comparing the Parnassus Workplace Fund with the S&P 500 and the Lipper average for the one-, three- and five-year periods and the period since inception. While we’re lagging our benchmarks for the one-year period, the Fund is way ahead of the indices for the three- and five-year periods and for the period since inception. On the following page is a graph showing the growth of a hypothetical $10,000 investment in the Fund since inception.

parwx returns

Performance data quoted represent past performance and are no guarantee of future returns. Current performance may be lower or higher than the performance data quoted. Current performance information to the most recent month-end is available on the Parnassus website (www.parnassus.com). Investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original principal cost. Returns shown in the table do not reflect the deduction of taxes a shareholder may pay on fund distributions or redemption of shares. The S&P 500 Index is an unmanaged index of common stocks, and it is not possible to invest directly in an index. Index figures do not take any expenses, fees or taxes into account, but mutual fund returns do. Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of the Fund and should carefully read the prospectus or summary prospectus, which contain this and other information. The prospectus or summary prospectus can be obtained on the Parnassus website, or by calling (800) 999-3505. As described in the Fund's current prospectus dated May 1, 2011, Parnassus Investments has contractually agreed to limit the total operating expenses to 1.20% of net assets, exclusive of acquired fund fees, until May 1, 2012. This limitation may be continued indefinitely by the Adviser on a year-to-year basis.

Parnassus Workplace Fund Portfolio of Investments as of 12/31/2011

Company Analysis

parwx compositionThree companies each accounted for a loss of 20¢ or more on the NAV. The stock of Hewlett- Packard (HP) hurt the Fund the most, swooning 38.8% from $42.10 to $25.76, and subtracting 49¢ from the value of each fund share. I discussed HP at length in our last quarterly report, saying that a once-great company had deteriorated because of a dysfunctional board and weak upper management. I indicated that we would still hang onto the company because its stock price was so depressed. Since then, I’ve sold the stock, because there are many other stocks trading at depressed levels that have better management and more upside potential.

Corning makes special glass for computer screens, high-definition television sets, smart phones and other consumer electronic devices. Manufacturers reduced orders for glass last year, because they expected weaker sales of consumer electronic items. At the end of November, Corning announced that it was temporarily shutting down 25% of its manufacturing capacity for special glass. The stock fell 32.8% during the year from $19.32 to $12.98, resulting in a loss of 33¢ per fund share.parnx growth

SEI Investments is an asset-manager and also provides services and support to other assetmanagers. The stock dropped 27.1% during the year from $23.79 to $17.35 for a loss of 25¢ on the NAV. Assets under management and administration dropped because of the volatile stock market and SEI’s stock dropped as well. Profitability is also down, because the company is having a hard time selling its latest investment services system, the Global Wealth Platform.

MasterCard, one of the world’s largest payment processors, saw its stock soar 52.7% from $224.11 at the beginning of the year to $342.15, where we sold it late in the year. The stock added 30¢ to each fund share. At the beginning of 2011, the stock was under pressure because the Federal Reserve, acting under the Dodd-Frank Act’s Durbin Amendment, proposed reducing debit card fees from 44¢ to 12¢, a drop of 73%. In June, the Fed softened its original rule, establishing a 24¢ limit or a 45% reduction. The Durbin Amendment also requires debit-card issuers to offer two unaffiliated networks for processing transactions, and this enables MasterCard to gain market share from Visa, the market-leader. The company reported strong earnings throughout the year.

Nike, the global footwear, sports equipment and apparel company, boosted the Fund’s NAV by 24¢ during 2011, as its stock jumped 12.8% from $85.42 to $96.37. The company exceeded expectations for growth throughout the year and ended 2011 on a high note. In December, the company announced that orders for the Nike brand were up 13% from the previous year, including an amazing 27% jump in China.

Intel added 21¢ to the NAV, as its stock rose 15.3% from $21.03 to $24.25. The company consistently beat quarterly earnings expectations in 2011, leading up to its highest-ever revenue and earnings in the third quarter. The record results were driven by improved pricing and increased demand from businesses for computers, as well as higher demand from consumers in emerging markets. Intel also raised its dividend by 15% and repurchased 6% of its shares.

Yours truly,

dodson signature
Jerome L. Dodson
Portfolio Manager

PARNASSUS FIXED-INCOME FUND

Ticker: PRFIX

As of December 31, 2011, the NAV of the Parnassus Fixed-Income Fund was $17.53, producing a total return for the quarter of 0.98% (including dividends). This compares to a gain of 1.18% for the Barclays Capital U.S. Government/Credit Bond Index ("Barclays Capital Index") and a gain of 1.31% for the Lipper A-Rated Bond Fund Average, which represents the average return of all A-rated bond funds followed by Lipper ("Lipper average"). For the year, the Fund was up 7.24% compared to a gain of 8.74% for the Barclays Capital Index and a gain of 6.80% for the Lipper average.

Below is a table comparing the performance of the Fund with that of the Barclays Capital Index and the Lipper average. Average annual total returns are for the one-, three-, five- and ten-year periods. The 30-day SEC yield for the Fund for December 2011 was 0.95%. On the following page is a graph showing the growth of a hypothetical $10,000 investment in the Fund over the last 10 years.

prfix returns

Performance data quoted represent past performance and are no guarantee of future returns. Current performance may be lower or higher than the performance data quoted. Current performance information to the most recent month-end is available on the Parnassus website (www.parnassus.com). Investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Returns shown in the table do not reflect the deduction of taxes a shareholder may pay on fund distributions or redemption of shares. The Barclays Capital U.S. Government/Credit Bond Index is an unmanaged index of bonds, and it is not possible to invest directly in an index. Index figures do not take any expenses, fees or taxes into account, but mutual fund returns do. Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of the Fund and should carefully read the prospectus or summary prospectus, which contain this and other information. The prospectus or summary prospectus can be obtained on the Parnassus website, or by calling (800) 999-3505. As described in the Fund's current prospectus dated May 1, 2011, Parnassus Investments has contractually agreed to reduce its investment advisory fee to the extent necessary to limit total operating expenses to 0.75% of net assets for the Parnassus Fixed-Income Fund. This limitation continues until May 1, 2012, and may be continued indefinitely by the investment adviser on a year-to-year basis.

2011 Review

If you didn’t follow U.S. financial markets over the past year, you might think that not much happened, as the S&P 500 closed the year up a modest 2.09% including dividends and the Nasdaq was down a mere 0.79%. These returns betray nothing of the drama that went on during 2011.

A series of shocks roiled global financial markets in 2011. The intensification of the euro zone sovereign debt crisis was one of the most significant events, but the fallout from the Japanese earthquake, the Arab spring upheavals, and higher energy prices also weighed on the global economy. The performance of U.S. equity markets was a surprising exception. For the year, the global stock market capitalization sank 12.1% to $45.7 trillion, according to Bloomberg data.

Faced with these shocks, U.S. economic growth ended up 1.80% for the year, but below the projected growth rate of 2.60% that most economists expected at the beginning of the year. As a result of this slower growth and a flight to safety, U.S. Treasuries enjoyed a stellar year, returning 9.81%. The interest rates at the long-end of the yield curve (10-year to 30-year) declined the most, driving long-dated bond prices higher.

While U.S. Treasuries outperformed other fixedincome securities for the year, they trailed riskier bonds during the fourth quarter. Corporate bonds and commercial mortgage-backed securities (CMBS) performed much better, as some economic indicators were better than expected. During the fourth quarter, corporate bonds returned 1.93% and CMBS gained 3.11%, compared to an increase of 0.89% for U.S. Treasuries.

prfix growthDuring the fourth quarter, the Fund’s performance trailed the Barclays Capital Index by 20 basis points (one basis point equals 0.01%), because we had less exposure to the corporate bond market. As of the end of the fourth quarter, corporate bonds represented 29.9% of the Fund’s total net assets, compared to 38.2% for the Barclays Capital Index.

The Fund lagged the Lipper average by 28 basis points in the fourth quarter, as our large investments in U.S. Treasuries couldn’t keep up with the stronger returns of corporate bonds and CMBS. Most of our peers also had a greater exposure to the CMBS market and corporate bonds than we had.

Despite this fourth quarter setback, the Fund returned 7.24% for the year, as all asset classes in the portfolio contributed positively to the NAV. Our investments in U.S. Treasuries were the biggest winners, adding 89¢ to the NAV. Corporate bonds increased the NAV by 43¢ and our convertible bonds added 3¢.

For the year, the Fund lagged the Barclays Capital Index by 150 basis points, due to our lower exposure to U.S. government bonds and corporate bonds. On the other hand, the Fund outpaced the Lipper average by 44 basis points, as we benefited from our greater exposure to the strong U.S. Treasury bond market. prfix ocmp

Parnassus Fixed-Income Fund Portfolio of Investments as of 12/31/2011

Outlook and Strategy

The consensus view that the U.S. will muddle through another year of slow growth and that Europe will find an orderly solution for its debt crisis is certainly possible. However, I’m still concerned about downside rather than upside risks to those scenarios. In my opinion, many of the problems that have undermined global economic growth are unresolved, with both public and private sector debt levels still too high. While some investors think that these issues will be solved quickly, deleveraging is a long-term process that hampers economic growth for many years.

I think that the situation in Europe remains a major risk factor. There are significant amounts of European government and bank debt that come due in 2012, at a time when the funding costs of Europe’s peripheral countries remain at near record highs. According to research by Goldman Sachs, there is a total of about €1 trillion of European government debt due to be refinanced or repaid in 2012, with more than €360 billion just in the first quarter.

Furthermore, the combination of slowing economic growth and global fiscal austerity measures has the potential to create an environment prone to political turmoil. At the same time, several countries, including the U.S., France, Russia and China, will appoint new political leaders or reappoint existing ones in 2012. It is unclear how these political transitions will impact economic growth, but they will surely increase uncertainty and volatility in financial markets.

While U.S. equity markets managed to decouple from the rest of the world in 2011, I think that it is precarious to assume that the U.S. economy can do the same. In my view, the global economy is now much more fragile and vulnerable to external shocks than it was a year ago. As such, I prefer to maintain a defensive investment strategy given the potential for downside risk.

As of the end of 2011, the Fund is positioned for slow economic growth and continued low interest rates. U.S. Treasuries should perform well in a slowing economy and provide downside protection to external economic shocks. These securities continue to be our largest holding, representing 58.1% of the Fund’s total net assets. The rest of the portfolio consists of corporate bonds (29.9%), cash and short-term securities (10.6%), and convertible bonds (1.4%).

As always, I remain vigilant to changes in the economic and financial outlook and will position the portfolio accordingly.

Thank you for your trust and investments in the Parnassus Fixed-Income Fund.

Yours truly,

bui signature
Minh T. Bui
Portfolio Manager

Responsible Investing Notes

By Milton Moskowitz

Reading the Financial Times on the last day of 2011, I came across a letter to the editor from Mr. Leonard S. Hyman of Sleepy Hollow, New York. He said:

So far this year we have seen the Arab spring, the Russian awakening and the Occupy movement. How about a "Stockholder spring" next, to wrest control of corporations from self-perpetuating boards of directors who overpay their chief executive pals to produce random results and overpay them even more when they screw up and have to be removed from office?

That rallying cry followed three mind-blowing blunders by corporations heretofore regarded as upstanding citizens with regard for their customers, employees and communities where they operate:

• First, the wildly successful movie rental company Netflix arbitrarily changed its pricing plan, touching off a stampede of exiting customers. More than 800,000 members fled. Netflix stock once sold for $304 a share; it ended 2011 at $69.29.

• Then Bank of America, which became the largest bank in America via a string of acquisitions, announced that it would charge debit cardholders a monthly fee of $5. Customer outrage forced the bank to abandon this plan.

• Verizon Wireless, the nation’s largest cellphone provider, decided to slap a $2 charge on customers who pay their bills online or over the phone. Negative reaction was immediate, with more than 100,000 customers signing an online petition for Verizon to drop the fee, which they did one day after announcing it.

In some 50 years of business reporting I can’t remember a comparable consumer revolt, one that shamed companies into reversing a course of action so quickly. On the other hand, I could hardly believe that companies, in this day and age, would move ahead with new fees without doing some serious research on how their customers would react.

"The primary reason we get up in the morning to go to work is not to make money. The primary reason is to serve customers; the result is you make money." This declaration comes from John Stumpf, CEO of Wells Fargo, in an interview appearing in the fall issue of DiversityInc, a magazine devoted to exploring diversity issues in business. Wells Fargo is the nation’s fourth largest bank and a major holding of the Parnassus Fund and the Parnassus Workplace Fund. In this candid interview, Stumpf laid out the position Wells holds: "We are the largest home lender to persons of color. We do more than anyone else with low- and moderate-income customers. Our portfolio, after all of this difficult time, has performed better than any of the large underwriters. In fact, it might come as a surprise to you that 93 percent of our borrowers are current on their mortgages, 5 percent are past due and about 2 percent are in some area of foreclosure. These numbers are better than the industry’s by 50 percent and better than some of our large bank competitors by maybe 100 percent."

Good news also came at the end of the year from IBM, another holding of the Workplace Fund, when the information technology leader announced the selection of Virginia Rometty as CEO, succeeding Sam Palmisano, who said: "Ginni got it because she deserved it. It’s got zero to do with progressive social policies." Rometty has been with IBM since 1981. Women account for 30% of the workforce at IBM and hold 29% of manager and executive positions. Only 11 other Fortune 500 companies have female CEOs. They are: Wellpoint, Xerox, Sunoco, Avon (Andrea Jung will soon be replaced), DuPont, TJX, KeyCorp, PepsiCo, Kraft, BJ’s Wholesale Club and Archer Daniels Midland.

In November, Cisco Systems, provider of switches and routers connecting computers to the internet, completed a challenging public-private partnership project in the state of Karnataka in southwest India. Karnataka is India’s 9th largest state, with a population of 61 million. The rural Raichur district in the state was ravaged by floods in 2009 — and Cisco contributed $10 million to relief efforts. The company then marshaled resources to construct houses in five villages and build a primary healthcare center. Using Cisco technology, the local government was able to bring healthcare services to an area that previously had none. Cisco also set up computer labs in 11 schools, donated 110 computers and used solar power to keep them running. D.V. Sadananda Gowda, chief minister of Karnataka, acknowledged what he called a "remarkable achievement," praising Cisco for its commitment.

Milton Moskowitz is the co-author of the Fortune magazine survey, "The 100 Best Companies to Work For," and the co-originator of the annual Working Mother magazine survey, "The 100 Best Companies for Working Mothers." Mr. Moskowitz serves as a consultant to Parnassus Investments in evaluating workplaces for potential investments by the Parnassus Workplace Fund. Neither Fortune magazine nor Working Mother magazine has any role in the management of the Funds, and there is no affiliation between Parnassus and either publication.

The information above represents the Letter from Parnassus Investments, management's discussion and analysis of fund performance, and Responsible Investing Notes as excerpted from the Report. Please click on the "Full Report" link above to view the Report in its entirety.