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Parnassus Digest - April 2012

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Research Insight

Mid-cap stocks are often overlooked by investors, but they shouldn’t be. As a group, they have favorable risk-reward characteristics and have outperformed small- and large-cap issues over the long-term. Within this asset class, investors should consider the Parnassus Mid-Cap Fund (the “Fund”), which invests in quality businesses at attractive prices, and has generated higher returns than the Lipper MultiCap Core Average (“the Lipper average”) for the trailing one-, three- and five- year periods and for the period since inception.

Investors have historically sought out large- and small-cap funds for their diversified portfolios, overlooking opportunities in mid-cap funds. According to Lipper as of February 2012, in the United States there were 678 large-cap mutual funds with $946 billion in assets under management and 502 domestic small-cap funds with $241 billion in assets under management, while there were only 304 mid-cap funds with $223 billion in assets under management.

Mid-cap stocks combine the best attributes of small- and large-cap stocks. They tend to have fewer bankruptcies and more proven business models, seasoned managers, established financial relationships, and greater liquidity than small-caps. Compared to large-caps, they often have better growth opportunities and more innovative cultures. They also make good acquisition targets for larger companies looking to enhance growth. Finally, mid-cap stocks are generally less-known by the investment community, which creates opportunities for diligent investors.

The Russell Midcap Index, which measures mid-cap stock performance, generated higher returns than small- and large-cap indices in the three-, five- , ten- and twenty–year periods ending March 31, 2012. The margin over the long-term is impressive: $10,000 invested in the Russell Midcap Index on April 1, 1992 would have been worth $78,124 on April 1, 2012, versus $53,707 and $51,991 if that money had been invested in the Russell 2000 and S&P 500, respectively. The growth in value of a hypothetical $10,000 investment over the last 20 years does not reflect the deduction of taxes a shareholder would pay on fund distributions or the redemption of fund shares. An individual cannot invest directly in an index.

The Parnassus Mid-Cap Fund is actively managed with the goal of outperforming its benchmark, the Russell Midcap Index. The portfolio management team constructs a relatively small portfolio of stocks, investing in 40 to 60 companies. With this approach, the Fund has outperformed the Lipper average for the one-, three- and five-year periods and for the period since inception1, and has outperformed the Russell Midcap Index in the one- and five-year periods. During the current team’s tenure, which began on October 1, 2008, the Fund has returned 11.51% per year, versus 7.50% for its Lipper peers and 10.65% for the Russell Midcap Index.

At Parnassus Investments we choose stocks based on a rigorous, repeatable investment process that identifies businesses that are increasing their worth over time and trading at a discount to their intrinsic value. We believe a business is growing its intrinsic value when its products and services are becoming more relevant to its customers, if it is competitively advantaged, and if it has superior management and governance. We determine if a stock is trading at a discount to its intrinsic value by creating valuation models that allow us to consider a range of outcomes. In addition, all companies in the Fund have undergone extensive environmental, social and governance (ESG) reviews.

Paychex, Inc., a top-ten holding in the Fund with a market cap of $11 billion, showcases our investment process. The company provides payroll and human resources services to small- and mid-sized businesses in the United States. Paychex is increasingly relevant, because it is a leader in the growing business of helping employers manage complex and changing payroll, tax and human resources laws and regulations. Paychex’s competitive advantages are its size, extensive sales force and high customer service level. Clients rarely leave Paychex once they sign up, and the company is able to regularly raise its prices. Paychex’s board members and managers own a lot of company shares, and top executives’ compensation is tied to long-term stock price appreciation. Finally, the company pays a generous dividend, has an excellent balance sheet, generates significant cash flow, and trades at an attractive valuation.

Owning quality, attractively-valued businesses has enabled the Parnassus Mid-Cap Fund to outperform the Russell Midcap Index over the long-term by offering downside protection in falling markets and upside participation in rising markets. Since the current team assumed portfolio management responsibility on October 1, 2008, the Fund has outperformed the Russell Midcap Index in every down quarter, with the largest outperformance coming in the fourth quarter of 2008, when the Russell sank 27.28%, while the Fund lost 22.03%.

If you’re not currently an investor in the Fund, we hope this discussion has helped illuminate the benefits of the Parnassus Mid-Cap strategy. If you’re already an investor, we thank you.

1 As of March 31, 2012, for the one- three- and five-year periods and for the period since inception of the Parnassus Mid-Cap Fund finished respectively #258 of 715 funds, #80 of 620 funds, #15 of 540 funds and #41 of 424. Total returns for the Lipper Multi-Cap Core Funds Average for the one- three- and five-year periods and for the period since inception is 2.95%, 22.67%,1.21%, and 4.94% respectively.

Percentage of Parnassus Funds represented by PAYX, as of March 31, 2012 is 3.0% of the Parnassus Mid-Cap Fund, 2.6% of the Parnassus Equity Income Fund, and 1.5% of the Parnassus Workplace Fund.

The views expressed in this Parnassus Digest are subject to change at any time in response to changing circumstances in the markets and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or the Parnassus Funds. Any specific securities discussed may or may not be current or future holdings of the Funds.

Inside Parnassus

Parnassus Mid-Cap Fund added to Schwab’s Income Mutual Fund Select List.The Parnassus Mid-Cap Fund (PARMX) was added to Charles Schwab’s Income Mutual Fund Select List™ in the first quarter of 2012. The Income Mutual Fund Select List (IMFS) is a list of no-load and no-transaction fee mutual funds that have passed rigorous screening for performance, risk, expenses, style consistency and diversification by the Charles Schwab Investment Advisory, Inc. The List exists to help investors achieve an income-producing portfolio with growth potential.

More information on the Charles Schwab Income Mutual Funds List, as well as the full list of funds, can be found on the Mutual Funds Research page of the Charles Schwab website under Income Mutual Funds Select List. The Income Mutual Fund Select List is provided for informational purposes and should not be considered as an individualized recommendation. Schwab produces the list quarterly to help investors navigate the vast number of funds available through the Schwab Income Mutual Funds List and identify funds that might be appropriate for their portfolios.

Total % Returns as of 3/31/2011
3 Mo. YTD 1 Yr. 3 Yr. 5 Yr. 10 Yr. Since
Expense Ratio
Grossb Netb
Parnassus Fund 17.54 17.54 6.37 24.97 5.82 3.46 9.43 0.97 0.97
S&P 500 Index 12.58 12.58 8.51 23.38 2.01 4.11 10.74 NA NA
Parnassus Equity Income Fund
Investor Shares
7.62 7.62 5.46 20.44 5.74 6.76 9.85 0.99 0.99
S&P 500 Index 12.58 12.58 8.51 23.38 2.01 4.11 8.56 NA NA
Parnassus Equity Income Fund
Institutional Shares
7.66 7.66 5.73 20.67 5.97 6.89 6.93 0.75 0.75
S&P 500 Index 12.58 12.58 8.51 23.38 2.01 4.11 3.40 NA NA
Parnassus Mid-Cap Fund 12.38 12.38 4.91 26.78 5.96 NA 7.16 1.46 1.20
Russell Midcap Index 12.94 12.94 3.31 29.10 3.02 NA 7.30 NA NA
Parnassus Small-Cap Fund 16.98 16.98 -4.69 28.39 7.37 NA 9.11 1.30 1.20
Russell 2000 Index 12.44 12.44 -0.18 26.88 2013 NA 6.74 NA NA
Parnassus Workplace Fund 15.28 15.28 7.32 27.79 9.07 NA 9.12 1.25 1.20
S&P 500 Index 12.58 12.58 8.51 23.38 2.01 NA 5.05 NA NA
Parnassus Fixed-Income Fund -0.86 -0.86 6.12 6.87 5.67 5.75 5.97 0.83 0.75
Barclays Capital
U.S. Govt/Credit Bond Index
0.08 0.08 8.53 7.08 6.25 5.91 6.39 NA NA

All returns greater than one year are annualized.

a The inception date for the Parnassus Fund is December 31, 1984. The inception date for the Parnassus Equity Income Fund and Parnassus Fixed-Income Fund is August 31, 1992. The inception date for the Parnassus Mid-Cap Fund, Parnassus Small-Cap Fund and Parnassus Workplace Fund is April 29, 2005. The inception date for the Institutional Shares of the Parnassus Equity Income Fund is April 28, 2006.

bAs described in the Fund’s current prospectus dated May 1, 2011, Parnassus Investments has contractually agreed to limit the total operating expenses (exclusive of acquired fund fees and expenses) to 0.99%, 0.99%, 0.77%, 1.20%, 1.20%, 1.20% and 0.75% of the net assets of the Parnassus Fund, the Parnassus Equity Income Fund–Investor Shares, the Parnassus Equity Income Fund–Institutional Shares, the Parnassus Mid-Cap Fund, the Parnassus Small-Cap Fund, the Parnassus Workplace Fund, and the Parnassus Fixed-Income Fund, respectively. These limitations may be continued indefinitely by the Adviser on a year-to-year basis. Without these fee waivers and/or expense reimbursements, the Funds’ returns would have been lower.

Performance shown for the Parnassus Equity Income Fund – Institutional Shares prior to the inception date of April 28, 2006 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.

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 the most recent month-end performance is available on the Parnassus website (www.parnassus.com). Investment return and principal will fluctuate, so that an investor’s shares, when redeemed, may be worth more or less than their original principal cost. The S&P 500 Index, the Russell Midcap Index, and the Russell 2000 Index are widely recognized indexes of common stock prices. The Barclays Capital U.S. Government/Credit Bond Index is a widely recognized index of fixed-income security prices. An individual cannot invest directly in an index. An index reflects no deductions for fees, expenses or taxes. Returns shown for the Funds do not reflect the declaration of taxes a shareholder would pay on the fund distributions or the redemption of fund shares. Prior to March 31, 1998, the Parnassus Equity Income Fund was a balanced fund. Prior to May 1, 2004, the Parnassus Fund charged a sales load of a maximum of 3.5%, which is not reflected in the total return figures.

Common stock prices fluctuate based on changes to a company’s financial condition and on overall market and economic conditions. Small- and mid-cap companies can be particularly sensitive to changing economic conditions and have fewer financial resources than large-cap companies. Investments in fixed-income securities are subject to interest rate risk, credit risk and market risk, each of which could have a negative impact on the value of the Fund’s holdings.

The Parnassus Funds are underwritten and distributed by Parnassus Funds Distributor, a subsidiary of Parnassus Investments and a FINRA member.

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 contains this information. A prospectus or summary prospectus can be obtained on the website, www.parnassus.com, or by calling (800) 999-3505.