Parnassus Small-Cap Fund
As of September 30, 2013, the NAV of the Parnassus Small-Cap Fund was $27.92, so the total return for the third quarter was
a gain of 8.94%. By comparison, the Russell 2000 Index of smaller companies ("Russell 2000") had a gain of 10.21%, and the
Lipper Small-Cap Core Average, which represents the average return of the small-cap core funds followed by Lipper ("Lipper
average"), had a gain of 9.26%. For the quarter, we slightly underperformed both indices.
Year-to-date, the Small-Cap Fund is trailing both indices and is up 17.46%, compared to 27.69% for the Russell 2000 and
25.48% for the Lipper average. Below is a table comparing the Parnassus Small-Cap Fund with the Russell 2000 and the
Lipper average over the past one-, three- and five-year periods and the period since inception. Although our short-term
performance has been subpar, our performance since inception has exceeded both benchmarks. Since our investment process
of identifying high-quality businesses that are temporarily out-of-favor remains the same, our goal for the Fund is to return to
outperformance in the future.
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, 2013, (as Amended and Restated September 30, 2013),
Parnassus Investments has contractually agreed to limit the total operating expenses to 1.20%
of net assets for the Fund. This agreement will not be terminated prior to May 1, 2014, and
may be continued indefinitely by the Adviser on a year-to year basis.
The company that hurt us the most was fertilizer
producer Intrepid Potash, which sank 17.7%,
from $19.05 to $15.68, slicing 15¢ off of the NAV.
Potash has historically enjoyed high prices,
because three companies in Canada and two in
Russia control 80% of the world's supply, and
they actively seek to match supply to demand.
However, during the quarter, one of the Russian
companies decided to pursue a volumemaximization
strategy, which caused the price of
potash to decline 20%. We are holding our
Intrepid Potash position because we think the
price decline is temporary. Profits are maximized
for everyone with the high-price strategy, so we
expect the Russian company to return to this
strategy in the future.
Intrepid was the only stock with a significant
negative impact, but we had four companies that
made major contributions to the Fund. Finisar
contributed the most to the NAV, as its stock soared
33.5% from $16.95 to $22.63 for a gain of 40¢ for
each fund share. The company makes optical
equipment for telecommunications networks.
Finisar's sales were much higher than expected, as
revenue from its data-communications division
increased. Demand from customers who are
upgrading their data-center equipment to handle
soaring Internet traffic accounted for most of the
increase. The data-communications division now
accounts for 70% of the company's revenue.
Shares of InterMune, a biotechnology company
focused on respiratory and fibrotic diseases,
soared 59.8% from $9.62 to $15.37, adding 37¢
to each fund share. The stock rose as sales of
Esbriet, the company's treatment for idiopathic
pulmonary fibrosis (IPF), increased. IPF is a fatal disease that reduces lung function, has a median survival of only 2-5 years and represents a significant unmet medical need.
Esbriet is approved in Europe and Canada, and the company is currently conducting a pivotal trial to receive U.S. approval.
We think InterMune has room to grow with increased use in Europe and Canada. We also think that Esbriet will win U.S.
Ciena also makes telecommunications equipment for optical networks. Its stock climbed 28.6% from $19.42 to $24.98 for a
contribution of 34¢ to each fund share. Telephone companies are increasing their purchases from Ciena to handle rapidly
increasing traffic on their networks. Ciena's equipment not only helps them add capacity, but also saves operating costs, since
new equipment is much easier to maintain than legacy products. Ciena announced a record level of order backlog, so the
stock should continue to do well.
Energy XXI, an oil- and gas-producer, surged 36.2% from $22.18 to $30.20 for an increase of 24¢ for each fund share. The
company's profits increased, as oil prices climbed 10.8% during the quarter, from $93 to $103 a barrel, because of supply
disruptions in the Middle East. The stock rallied after the company reported solid progress with its horizontal drilling
program in the Gulf of Mexico and a significant increase in its proved reserves. We believe the company's deep inventory of
oil and natural gas assets in the Gulf of Mexico provide a long runway for solid earnings growth ahead.
Outlook and Strategy
The market continued to move higher during the quarter, with the
Russell 2000 now up an amazing 27.7% for the year-to-date. During the
quarter, investors cheered the Federal Reserve's decision to continue
full-speed ahead with its stimulus program.
We remain bullish on the U.S. economy, which showed further signs of
improvement. Unemployment declined to 7.3% from 7.8% at the
beginning of the year, and annual inflation remains subdued at only
1.5%. As we predicted last quarter, interest rates have begun to move
higher, but not enough to derail the economy.
We think the housing recovery will continue, and there will be increased
demand for faster optical telecommunications networks. To benefit
from these trends, the Fund has invested in housing-related stocks and
telecom companies. 13% of our fund is invested in companies that
benefit from the nascent housing recovery. First American Financial
provides title insurance for home purchases, First Horizon National and
TCF Financial provide mortgages to their banking clients, while
PulteGroup and Toll Brothers construct new houses. New home sales of
421,000 per year remain well below the level needed to meet the
demand from population growth and immigration.
About 12% of our fund is invested in companies that benefit from
increased demand for faster optical telecommunications networks.
Ciena makes high-speed optical equipment, Finisar provides optical
modules that are installed in routers, while EZchip designs network
processing semiconductors that are the "brains" of a router. With the
proliferation of cell phones and tablets, as well as increased demand for
streaming video, we expect demand to grow for a very long time.
During the quarter we purchased three new stocks in other industries
that have strong competitive advantages, which we refer to as "moats,"
and compelling growth opportunities. Air Lease benefits from gains in
emerging market air travel, increasing demand from airlines for leasing
planes and the best CEO in the industry. Orient-Express Hotels has 44 iconic luxury hotels and benefits from improving trends in luxury travel. Thermon Group, a manufacturer of heat tracing
equipment used to prevent freezing in pipes, operates in a duopoly and benefits from increased oil production in coldclimate
Thank you for your continued investment in the Parnassus Small-Cap Fund.
Jerome L. Dodson
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.