Parnassus Digest April 2010

PARNASSUS DIGEST April 2010

Senior Research Analyst Insight

Unfortunately, all too often investors mistake a temporary advantage or even a fad as a moat, and end up paying too much for a company. At Parnassus Investments, we have a strict process for analyzing moats, which fall into one of the following six categories: Brand, Customer Switching Costs, Low-Cost Producer, Network Effects, Patents, and Regulatory License. Following are six examples of current Parnassus Investments portfolio companies that best demonstrate these moats.

The future is unpredictable but, by investing in high-quality companies, Parnassus Investments believes it can outperform the market over the long-term. Our analysts look for companies that have “economic moats,” a term that was coined by Warren Buffett, perhaps the greatest investor alive. Ryan Wilsey, Senior Research Analyst, offers insight into how the investment team identifies and incorporates moats in our investment process.

Brand: Nike’s (NKE) brand is unmatched in sportswear, which causes customers to choose Nike products over its competitors’ products. This allows Nike to charge more for its products than if it had no moat.

An economic moat is a long-term competitive advantage that allows a company to earn returns on capital well in excess of its cost of capital. Typically when a company earns outsized returns, new competitors enter, and the average return on capital for the industry falls to the marginal cost to produce the product. However, economic moats help prevent competitors from entering, and allow our portfolio companies to enjoy outsized returns over the course of our expected holding period.

Ryan Wilsey Senior Research Analyst

10 Year

Since Inception

Inception Date

Gross Expense Ratioa

Net Expense Ratioa

5.75% 1.92%

-0.21% -0.65%

9.36% 10.65%

12/31/84

1.02%

0.99%

4.35% -4.17%

7.03% 1.92%

6.09% -0.65%

10.08% 8.18%

8/31/92

1.02

1.01

50.32% 49.77%

4.57% -4.17%

7.21% 1.92%

6.18% -0.65%

6.33% -0.74%

4/28/06

0.81

0.80

6.02% 8.67%

56.75% 67.71%

0.91% -3.30%

NA NA

NA NA

4.49% 4.96%

4/29/05

2.26

1.21

11.61% 8.85%

11.61% 8.85%

69.51% 62.76%

4.55% -3.99%

NA NA

NA NA

8.05% 4.66%

4/29/05

1.88

1.21

Parnassus Workplace Fund S&P 500 Index

3.86% 5.39%

3.86% 5.39%

69.21% 49.77%

7.76% -4.17%

NA NA

NA NA

8.33% 2.35%

4/29/05

2.34

1.21

Parnassus Fixed-Income Fund Barclays Govt/Credit Bond Index

2.06% 1.55%

2.06% 1.55%

9.90% 7.51%

5.86% 5.84%

5.57% 5.17%

6.18% 6.22%

6.04% 6.34%

8/31/92

0.90

0.77

TOTAL RETURNS

3 Month

Year To Date

1 Year

3 Year

5 Year

Parnassus Fund S&P 500 Index

7.12% 5.39%

7.12% 5.39%

60.45% 49.77%

2.94% -4.17%

Parnassus Equity Income Fund - Investor Shares S&P 500 Index

3.87% 5.39%

3.87% 5.39%

50.15% 49.77%

Parnassus Equity Income Fund - Institutional Shares S&P 500 Index

3.88% 5.39%

3.88% 5.39%

Parnassus Mid-Cap Fund Russell Midcap Index

6.02% 8.67%

Parnassus Small-Cap Fund Russell 2000 Index

As of 3/31/10

All returns greater than one year are annualized. As described in Fund’s current prospectus dated May 1, 2009, Parnassus Investments has contractually agreed to limit the total operating expenses (exclusive of acquired fund fees and expenses) to 0.99%, 0.99%, 0.78%, 1.20%, 1.20%, 1.20% and 0.87% 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. a

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

Senior Research Analyst Insight (continued) We find brand moats the most challenging to identify because most brands can only generate high returns on capital temporarily and, therefore, do not have moats. The investing landscape is littered with formerly high-flying brands that turned out not to have a moat such as Krispy Kreme doughnuts and Crocs shoes. Investors should proceed with caution when searching for brand moats! Customer Switching Costs: With over 1,200 branches, Royal Bank of Canada (RY) has the largest branch network in Canada. These branches make it very easy for new customers to open an account. Once customers deposit money at the Royal Bank of Canada, they are unlikely to go through the hassle of switching to a competing bank, even if it offers a better interest rate. The reason is that switching banks requires a customer to fill out time-consuming forms and go through the hassle of changing all of his or her direct-deposit and automatic bill-pay relationships. Low-Cost Producer: Compass Minerals’ (CMP) salt mine has the cheapest extraction cost in the country because its salt vein is 3-4x thicker than its competitors. This natural advantage allows Compass to use a cheaper mining technique, which is not feasible for its competitors. Because Compass has the lowest costs, it can either price cheaper than its competitors to gain market share or price the same as its competitors and earn a larger profit margin.

3rd generation wireless networks, Qualcomm benefits tremendously from the increasing adoption of data-intensive smart-phone users. Regulatory License: The government has granted VeriSign (VRSN) the exclusive rights to manage the domain registry for .com and .net websites. The government requires a domain registry provider with the competence to ensure that web-users reach the appropriate website when they enter a domain name into their web browsers. VeriSign has earned the government’s trust through over ten years of operation with zero domain registry downtime. Hopefully, you now have a better idea of how and why Parnassus Investments seeks to identify companies that have economic moats. Analyzing moats is at the core of our fundamental investment process. We think it has helped us generate strong long-term returns in the past, and we expect it to continue to generate value for our shareholders in the future. If you would like to learn more about moats, I recommend reading The Little Book that Builds Wealth by Pat Dorsey. It is a quick read, provides numerous real-life examples and is well worth your time.

Network Effects: eBay (EBAY) exhibits strong network effects. As more sellers list products for sale on eBay, the value to new buyers increases because they are more likely to find the product they are looking for. Similarly, as more buyers come to the site, the value to sellers increases because they are able to sell their products at higher auction prices.

Percentage of Parnassus Funds represented by the companies in this article, as of March 31, 2010: NKE is 3.0% and 1.8%, of PRBLX and PARWX, respectively; RY is 2.0% of PRBLX; CMP is 1.8% of PARSX; EBAY is 0.7% and 4.3%, of PARNX and PARWX, respectively; QCOM is 5.0%, 5.7% and 7.2%, of PARNX, PRBLX and PARWX, respectively; VRSN is 3.5%, 1.3% and 3.1%, of PARNX, PRBLX and PARSX, respectively.

Patents: Qualcomm’s (QCOM) more than 10,000 patents on Code Division Multiple Access (CDMA) technology make it virtually impossible for a competitor to develop a wireless standard based on its technology. Since CDMA is currently the only technology available for today’s high-speed

The views are subject to change at any time in response to changing circumstances in the market 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 Fund.

I n si d e P a r n a s s u s Pa rn a ssus I nve stm ent s i s h on ored t o be rec og ni z e d a s t h e #1 E quity Fund G roup i n t h e S ma l l G roup ca t e g o r y by t h e U S Lipper Fun d Awa rds 2010. T h i s i s Pa r na s s u s In ve s t me nts’ fir st ti me rec ei v i n g t h e L i pper awa r d ; the f i rm ranke d 1 st out of 162 c ompa n i es, ba s ed o n t hr e e ye a r h istor y. T he Par na s s us Work pl a c e F un d, w h i c h i nve s t s i n c o m panies that h ave f avora bl e work en v i ro nm e nt s, re c e i ve d the awar d f or bes t U .S . mul t i - c a p c ore f u nd ; i t ra n k e d 1 st out of 6 5 8 U .S . mul t i - c a p c ore f un ds. In c a l culatin g the aw a rd s, L i pper c o n s i d e red a ll o p e n-e nd f u n ds reg is tered fo r s a le i n t h e U n i t e d S t a t es i n q u a l i f y i ng c l a ssi f i catio n s. Aw ard s we re g i v en t o f u n d s wi t h a 3 - , 5- a nd 10 - y e a r his to r y as o f t h e en d o f t h e e v a lu a t i o n y e a r L i p p e r U . S . C las s ificatio n s wi t h a t lea s t 10 d i s t i n c t p o r t fo l i o s. B o t h g ro up an d fun d a wa rd s were c a lc u la t e d u s i n g L i p p e r ’s c o n si st en t retur n s co re.



For more information: Parnassus Investments 1 Market Street, Suite 1600 San Francisco, CA 94105 (800) 999-3505 www.parnassus.com

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