Parnassus Small-Cap Fund
As of December 31, 2013, the NAV of the Parnassus Small-Cap Fund was $28.72, so after taking dividends into account, the
total return for the year was 28.33%. This compares to a return of 38.82% for the Russell 2000 Index (“Russell 2000”) of
smaller companies and 36.74% for the Lipper Small-Cap Core Average, which represents the average return of the small-cap
core funds followed by Lipper (“Lipper average”).
Usually, we would be thrilled to report a 28.3% gain for the year. However, we trailed the Russell 2000 by over ten percentage
points. Although we are never proud to trail our benchmark, it is not surprising to us this year. Our goal is to outperform
during down years and attempt to keep up during boom years by buying high-quality, competitively-advantaged businesses.
Although this approach of focusing on lower-risk companies contributed to our underperformance this year, it has served our
investors well in the past.
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. Although our short-term performance has been weak, our performance for the last five
years and since inception has exceeded both
benchmarks. Further down is a graph showing the
growth of a hypothetical $10,000 investment in
the Fund since inception. Our investment process
of identifying high-quality businesses that are
temporarily out-of-favor remains the same, so our
goal is to return to outperformance in the near
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.
Five companies in the portfolio each accounted
for a gain of 32¢ or more for the year, while only
two accounted for a loss of 20¢ or more. The
company that hurt us the most was fertilizer
producer Intrepid Potash, which sank 26.5%,
from our average cost of $19.56 to where we sold
it at $14.38, slicing 23¢ off of the NAV. Potash has
historically enjoyed high prices, because five
companies control 80% of the world’s supply, and
they manage production to match demand.
However, one of the companies decided to steal
market share from the others, which caused the
price of potash to decline 20%. We had not
expected production to jump while demand was
stable, and since our investment thesis was proven
wrong, we exited our position.
EZchip Semiconductor, a designer of
semiconductors used in data centers, enterprise
networks and telecommunications equipment,
dropped 25.6% during the year, from $33.07 to
$24.61, cutting 20¢ from each fund share. The
stock plunged early in the year, when a large
customer, Huawei, decided to design its own
network processing chips rather than purchasing
them from EZchip. The issue sank further when its
largest customer, Cisco, also announced plans for
a new chip, but the stock rebounded somewhat, when Cisco clarified that its new semiconductor would not replace that
of EZchip. We’ve had a lot of ups and downs with this stock, but we’re
hanging on to it, because of its best-in-class technology and its
undisputed leadership in network-processors.
Turning to the winners, the biggest contributor was Gentex, a
manufacturer of auto-dimming car mirrors. Gentex soared 75.3%
during the year, from $18.82 to $32.99, contributing 61¢ to each fund
share. Thanks to its superior technology, Gentex supplies 90% of all
auto-dimming car mirrors around the world. The company benefited
from increasing new car sales, as well as adoption by additional car
models. We are holding our shares because we expect this important
safety feature to expand downward from luxury cars to mid- and lowerpriced
The Fund’s second best performer was Ciena, a manufacturer of optical
equipment used in telecommunications networks. The stock climbed
52.4%, from $15.70 to $23.93, for a gain of 53¢ per fund share. During
the year, telecommunications carriers increased their purchases from
Ciena to accommodate rapidly increasing traffic on their networks, and
Ciena’s order backlog hit record levels. The company’s innovative
products gained market share, and we expect further share gains in
2014, so the stock should continue to do well.
Finisar also manufactures optical equipment for telecommunications
networks and data-centers. Its stock rose 46.8%, from $16.30 to $23.92,
adding 49¢ to the NAV. The company’s data-center division, which
accounts for 70% of the firm’s revenue, had robust sales because
customers upgraded equipment to handle increasing Internet traffic. We
see further upside to the stock, as Internet traffic continues to grow,
driving strong demand for Finisar’s equipment.
VCA Antech, the largest veterinary laboratory and animal hospital
operator in the country, jumped 49.0%, from $21.05 to $31.36, for an
increase of 42¢ for each fund share. The company’s laboratory segment
operates in a market with only two suppliers, which allowed it to
increase prices, while its hospital segment benefited from improving
pet-care spending. Additionally, management announced the
company’s first share buyback in April.
Shares of InterMune, a biotechnology company focused on respiratory
diseases, shot up 52.0%, from $9.69 to $14.73, contributing 32¢ to the
NAV. The stock rose as sales of Esbriet, the company’s treatment for
idiopathic pulmonary fibrosis, grew more than 160%. During the year,
the company won additional approval for Esbriet in the United
Kingdom and Italy. Having only recently launched in these two new
countries, Esbriet should have significant room to grow.
Parnassus Small-Cap Fund Portfolio of Investments as of 12/31/2013
Outlook & Strategy
The market continued to climb a wall of worry in 2013, with the Russell 2000 reaching a new, all-time high at the end of the
year. The strong stock market gains were propelled by an improving economy, as well as very low interest rates, which made
equities more attractive to investors than other asset classes. The economy showed clear signs of improvement throughout the
year, with unemployment declining from 7.8% to 7.0%, while GDP growth increased to 4.1% – up from no growth at the
end of last year. The Federal Reserve maintained ultra-low interest rates in order to stimulate the economy, forcing investors
to seek greater returns from higher-risk assets, which led to more than $300 billion of global equity inflows.
Unfortunately, because of the significant equity
inflows, stock prices appreciated faster than
profits, and valuation multiples have increased.
Since valuations are less compelling than at the
beginning of the year, we sold stocks that hit our
intrinsic value targets and redeployed the cash
into our remaining undervalued companies. As a
result, the number of stocks we own has declined
from 40 at the beginning of the year to only 34,
the lowest number since 2005.
We remain bullish on the U.S. economic
recovery, but we are concerned that valuation
multiples may pull back once the Federal
Reserve reduces monetary stimulation and
interest rates return to historically average levels.
Therefore, we have reduced our exposure to
interest-rate sensitive sectors such as utilities and
have purchased competitively-advantaged
businesses that benefit from long-term secular
trends. Each of our ten new investments made in
2013 fits this profile:
Air Lease, the fastest growing airplane leasing company, is run by what we believe is the best CEO in the industry and benefits
from increasing air travel in emerging markets.
Blount International, the largest manufacturer of saw chains, operates in a market with only two suppliers and benefits from
increased chainsaw sales in emerging markets.
Dominion Diamond, the lowest-cost North American diamond miner, benefits from increased demand for diamond
engagement rings in China and India.
Harman International offers the best car infotainment systems and benefits from increasing adoption of these systems in midand
Micros Systems, the largest provider of point-of-sale systems for restaurants, hotels and retailers, benefits from increasing
adoption of its systems.
MRC Global, the largest distributor of valves to the U.S. energy sector, operates in a market with only two suppliers and
benefits from increased domestic oil and gas production.
Orient-Express Hotels has 45 iconic luxury properties and benefits from improving luxury travel trends.
Regal-Beloit, the leader in energy-efficient motors, benefits from increased demand for energy saving products.
Thermon Group, the second largest manufacturer of heat-tracing equipment used to prevent freezing pipes, operates in a
market with only two suppliers and benefits from increased oil production in cold-climate regions.
UTi Worldwide, a leading global logistics company, benefits from increasing global trade.
Thank you for investing in the Parnassus Small-Cap Fund.
Jerome L. Dodson
Lead 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.