Fund Fact Sheet
Parnassus Fund
Parnassus Funds Quarterly Report: September 30, 2011
As of September 30, 2011, the net asset value per share ("NAV") of the Parnassus Fund was $32.78, resulting in a loss of
19.38% for the third quarter. This compares to a loss of 13.87% for the S&P 500 Index ("S&P 500") and a loss of 16.94% for
the Lipper Multi-Cap Core Average, which represents the average multi-cap core fund followed by Lipper ("Lipper average").
For the year-to-date, the Fund is down 19.04%, compared to a loss of 8.69% for the S&P 500 and a loss of 12.04% for the
Lipper average.
These returns are very disappointing, especially considering how well we've done over the last five years. In my view, though,
these losses are quotational, and investors with a long-term approach should not lose capital. Our investment objective has
not changed, and we're picking stocks the same way we always have. What's happening is that investors have been selling off
many of our stocks at prices that I think are far below their intrinsic value, and these low quotes make our performance look
bad. At some point, I think that investors will recognize the value of the stocks in our portfolio, and prices of those shares
should rise.
The stock market as a whole has been very discouraging this year, and investors have been emotionally affected by the sell-off.
This has led to panic-selling, which frightens even more people into selling, bringing down stock quotes even further.
Unfortunately, emotion often makes people do foolish things - like selling stock at ridiculously low prices. The great investor,
Warren Buffett, once said that you don't have to be brilliant to be a good investor, but you do have to have the right temperament. What he meant was that you have
to resist the urge to sell when stocks are falling
sharply. That's the time to buy.
Human nature is such that people get scared when
the market takes a tumble. They sell their stock at
the wrong time, and this causes shares to fall even
further. That's what is happening right now. I've
noticed that in the last few months, many of our
investors have been redeeming their shares, whereas
in 2009 and 2010, we had a lot of money coming
into the Fund. I feel bad that they are taking their
money out of the Fund at just the wrong time, but
quite often, emotions outweigh rational thought.
To the left 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.
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, which contains this and other information. The prospectus
is available on the Parnassus website, or one can be obtained 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
The stock that hurt us the most was homebuilder
PulteGroup, which lost 48.4% during the quarter,
collapsing from $7.66 to $3.95 for a staggering
84¢ loss for each fund share. As most of you
know, we've been investing in homebuilder stocks
since late 2007. At first, the strategy worked well
with these stocks rising a lot in 2009 and early
2010, and making a substantial contribution to
the NAV. Unfortunately, they've been a big
disappointment since late 2010.
In previous housing recessions, homebuilding
stocks made big gains about two years after their
stocks suffered deep losses, as housing led the economy out of the recession. The housing market did not have to come back completely for stocks to move much higher,
but only had to turn up a bit, as investors bought homebuilding stocks in anticipation of a stronger housing market ahead.
This pattern repeated itself in 2009 and early 2010 with the shares moving higher. My view was that the housing market
would be much stronger sometime in 2010 at the latest. Unfortunately, I did not sell the shares at that point, since I expected
them to move even higher, as the economy made a strong recovery.
As we all know now, the economy has not made a strong recovery, and the housing market has kept getting weaker. It may have
hit bottom now, but no one knows for sure. Job growth has been weak and people without jobs don't buy houses. Even people
with jobs are reluctant to buy homes if their neighbor is out of work. The irony here is that houses are very affordable with prices
dropping around 32% nationwide from their peak, according to Case-Shiller, and interest rates are at post-World War II lows.
I've thought a lot about what to do with our housing stocks, and I've decided to hang onto what we have, but not to buy any
more despite stock prices that seem to be at rock bottom. I'm no longer confident that the housing market or the economy will
make a strong recovery any time soon. The economy and the housing market will come back, just as they always have, but it's
hard to determine when that will happen. The time to recovery could be measured in years instead of months.
The stock of Ciena Corporation sank 39.1% from $18.38 to $11.20 for a loss of 78¢ for each Parnassus Fund share. The
company makes optical equipment used in telecommunications, and the stock dropped after the company reported
disappointing sales, particularly from Europe and the Middle East. Investors are concerned that carriers will not be investing
as much in optical equipment as anticipated. We're holding the stock and adding to our position, because we think it is
undervalued. Part of the decline was due to weak revenue forecasts, but much of the drop was not based on fundamental
factors, but on the general market sell-off and the weak economy. Ciena has excellent products and appears to be gaining
market share in the optical equipment market.
Oil- and gas-producer W&T Offshore saw its stock fall 47.3% from $26.12 to $13.76 while slicing 71¢ off the NAV. Crude oil
prices dropped sharply during the quarter from $95 to $79 a barrel and the company's drilling costs have not dropped as much
as the price of crude oil. We're holding the stock since we expect oil prices to rise again and drilling prices to drop.
Technology-giant Hewlett-Packard's stock fell 38.3% from $36.40 to
$22.45, chopping 71¢ off the NAV. Operating results were good for the
company as both revenue and earnings beat analyst expectations. What
torpedoed the stock were not the fundamentals, but intrigue in the
boardroom and weak performance in the CEO suite.
The decline of HP over the past decade has been a deep disappointment
for me. Fifteen years ago, the company was a great place to work, one of
the most admired corporations in the country and an example of how
innovation could produce great products. The company still has some
great products and most of its employees are capable, dedicated and
hard-working. The problem has not been with the workers of HP, but
rather with the board and the CEO. For years now, the directors have
been feuding and spying on one another, and they've made a series of
terrible decisions. The trouble began about 12 years ago, when the
board departed from the company's tradition of promoting from within
for the CEO job, and passed over company veteran Ann Livermore to
hire Carly Fiorina, a vice president at Lucent. Fiorina made an ill-advised
move to buy Compaq Computer for $25 billion dollars. The move
divided shareholders, caused dissension within the company and
resulted in Walter Hewlett, son of a company founder, leading a
shareholder revolt that lost by a small margin. Hewlett left the board
soon after the fight. In an ironic footnote, the board recently revealed
plans to divest the personal computer business because of low
profitability.
The company made something of a comeback when the board hired
Mark Hurd in 2005 to replace Carly Fiorina. Hurd succeeded in getting the company back on track, as its operations improved along with earnings. In a move that was inconceivable to me, the
board fired Hurd in 2010, and hired Leo Apotheker, who had very little experience in the industry and had been terminated
after only ten months as CEO of software maker SAP. Apotheker made a series of bad decisions including announcing the sale
of the PC business before there had been a thorough review. There was also a deal to buy software-company Autonomy for
the incredible price of $10.3 billion and a move to shut down HP's webOS tablet division. The board soon realized its
mistake and fired Apotheker after less than a year in office.
Its next decision was to hire Meg Whitman, former CEO of eBay, to replace Apotheker without doing a thorough search to
find other candidates. Although Whitman had some success at eBay, her record there was mixed. She had no experience with
a company as big as Hewlett-Packard and no history with a company that had a large hardware, software and services
business.
Given this strange history, you may be wondering why I'm still holding onto the stock. There are two reasons. First, it's
incredibly cheap at only five times earnings. Second, the company provides some great products and services, and it has a
talented and dedicated workforce that deserves better corporate governance from the board of directors.
Despite the downward movement in most of our stocks, there was one that made a substantial contribution to the NAV.
MasterCard, the big debit- and credit-card processor, added 13¢ to each fund share, as the stock climbed 5.3% from $301 to
$317 during the quarter. The stock moved higher in August after the company reported excellent quarterly financial results,
including higher purchase volume and transaction growth with international transactions especially strong. The stock's rally
continued, when management affirmed its long-term performance targets and reported gains in market share at the expense
of Visa.
Parnassus Fund Portfolio of Investments as of 9/30/2011
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.
This year, the funds that I manage have not done very well, and that's the first time that has happened in a long time. The
market has dropped quite a bit, but our funds have dropped even more. Our approach is still the same, but our stocks are
currently even more out of favor than the market as a whole. Investors have been selling off the stocks in our portfolios, so
that now most of them are priced far below their intrinsic values. Given this situation, our strategy is to change nothing. We'll
hang onto the stocks we have. There will be some fine-tuning, such as selling stocks that have higher valuations and buying
others that have lower valuations, but there won't be any wholesale changes.
This has happened to us before, with investors selling off our stocks at very low prices. What we found was that the best
strategy was just to hold what we already own if they were good companies. At some point, the market will recognize the
value in our securities and they will appreciate. Unfortunately, we don't know when that will happen.
That's the strategy part of this report. How about the outlook?
As most of you know, I tend to be an optimist. Right now, though, I can't find much to be optimistic about. We've been out
of the recession for two years now, but the recovery has been very weak. Normally, when the economy comes out of a deep
recession such as the one we had in 2008, the recovery is very strong, with housing and new job creation leading the economy
higher.
This time, both housing and job creation are very weak. Of course, one affects the other. People without jobs don't buy
houses, and if there are not many houses being constructed, there are fewer jobs around. We seem to be caught in a vicious
circle.
The irony here is that corporations have a lot of cash on their balance sheets, but they aren't willing to use that cash to invest
and create new jobs. They're concerned about the demand for their products and services, and without demand, there's no
reason to invest. Another irony here is that housing is more affordable than at any time in recent memory. Housing prices are
cheap and interest rates are low. It's a great time to buy, but people just aren't buying.
Also casting a pall over economic activity is the situation in Europe. Their banks are not well capitalized, and some
governments have spent so much and borrowed so much, that they're financially very shaky. No one wants to lend them any
more money. If governments default on their bonds, this will affect the banks, since they hold a lot of debt issued by
European governments. If Europe were to go into another deep recession, this would definitely have a very negative effect on
the American economy. It seems that the American stock market is trading off the debt situation in Europe. Our stock market
drops when it looks as if the Europeans will default, then it moves sharply higher when it appears that their financial
problems will be resolved.
The Greek economy is a small one, and it shouldn't have much effect on the rest of the world. Somehow though, headlines
from Greece are driving our stock market. For decades, the Greek government has spent far more than it took in as revenue,
and tax-evasion is a national sport. The government has hired far more civil servants than it needs or can afford. It's clear that
Greece has to raise taxes and reduce government spending, which means reducing its number of government workers and
cutting pensions. This seems like a common-sense approach, but when the Greek prime minister announced this policy, it
resulted in public worker strikes and violent protests. It's as if a big part of the Greek population has an economic death wish.
Because of Greece's small size, all this should not affect the overall European or North American economy. Nevertheless, it
unnerves investors.
At some point, though, our economy will get better. It always has and it will again. Some economic activity will provide a
catalyst for the broader economy. With housing now so affordable, people might start buying homes again, since the
population is growing faster than houses are being constructed. This would lead to more jobs in construction, home
furnishings and general retail. A vicious circle would turn into a virtuous circle. Another possibility would be for corporations
to invest some of the cash on their balance sheets to hire more people and invest more. This would also stimulate economic
activity and start the virtuous circle.
Eventually, this will happen, but right now, there are no signs on the economic horizon of something that will jump-start the
economy. Both the Obama administration and the Federal Reserve have tried to stimulate the economy, but thus far, their
efforts have fallen short. I think both entities are doing the right thing, and it's a mystery why the economy hasn't responded.
In the meantime, there's nothing we can do as investors except wait. We have good companies in the portfolios of our funds,
and they will do well when the economy recovers, but there's no way of telling when that will happen.
The only consolation in our current situation is that stocks are very cheap. At quarter's end, the S&P 500 traded at just 10.6
times consensus earnings estimates for the next twelve months. This is well below the fifteen-year average of 17.0 times, and
close to the low of 8.9 times reached during the market sell-off in late 2008. When stocks are this cheap, it is possible that we
could have a rally.
Yours truly,
Jerome L. Dodson
Portfolio Manager
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.