Parnassus Digest April 2011

PARNASSUS DIGEST April 2011

Research Insight Bank stocks represent less than 10% of the total market capitalization of the S&P 500 Index. However, as investors have learned over the past few years, that number understates their importance to a successful investment strategy. From steep losses in 2008 and early 2009, to a rapid rebound later in 2009 and a volatile 2010, the stocks’ performance has made for interesting conversation around many water coolers over the past few years. As such, we think it’s important to share our approach to investing in bank stocks.

least as much time to understanding the risk of an investment as we do to understanding its potential reward. This risk-based approach to investing is especially important in the banking sector. In the last three years alone, 350 banks have failed, while many others survived only by receiving capital injections from the government and/or issuing significant amounts of equity, which severely diluted their shareholders. However, while it’s important to understand the past, we’re careful not to let historical events cloud our assessment of a company’s future.

Fundamental, bottom-up research is integral to the selection of securities in the Parnassus Funds. We seek to invest in companies that have sustainable competitive moats (please reference the Parnassus Digest – April 2010 for insight on “moats”), sell increasingly relevant products and services, have quality management teams and are trading at attractive valuations. We have a three-year investment horizon and focus on risk-adjusted returns. Therefore, we will avoid stocks with a high risk of permanent loss of capital. As a result of this, we devote at

Indeed, we think many banks are trading at discounts to their intrinsic values due to lingering investor angst about the sector. Amazingly, this is true even for banks that emerged from the crisis stronger than they entered it. JPMorgan Chase & Co. (JPM) and

Ian Sexsmith Senior Research Analyst

10 Year

Since Inception

Inception Date

Gross Expense Ratioa

Net Expense Ratioa

6.00 2.63

3.60 3.29

9.55 10.83

12/31/84

1.00

0.99

6.67 2.36

7.18 2.63

7.71 3.29

10.09 8.57

8/31/92

1.00

1.00

10.54 15.66

6.89 2.36

7.40 2.63

7.82 3.29

7.17 2.39

4/28/06

0.78

0.78

10.68 7.63

23.92 24.27

10.49 7.25

6.58 4.67

NA NA

7.55 8.00

4/29/05

1.73

1.20

6.43 7.94

6.43 7.94

30.99 25.79

19.57 8.57

9.57 3.35

NA NA

11.63 7.96

4/29/05

1.47

1.20

Parnassus Workplace Fund S&P 500 Index

5.67 5.92

5.67 5.92

14.93 15.66

13.13 2.36

9.33 2.63

NA NA

9.42 4.48

4/29/05

1.36

1.20

Parnassus Fixed-Income Fund Barclays Capital U.S. Govt/Credit Bond Index

0.19 0.28

0.19 0.28

4.65 5.26

5.52 4.82

5.65 5.83

5.71 5.53

5.97 6.28

8/31/92

0.88

0.76

TOTAL % RETURNS

3 Month

Year To Date

1 Year

3 Year

5 Year

Parnassus Fund S&P 500 Index

4.96 5.92

4.96 5.92

14.36 15.66

8.54 2.36

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

5.24 5.92

5.24 5.92

10.32 15.66

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

5.28 5.92

5.28 5.92

Parnassus Mid-Cap Fund Russell Midcap Index

10.68 7.63

Parnassus Small-Cap Fund Russell 2000 Index

As of 3/31/11

All returns greater than one year are annualized. As described in Fund’s current prospectus dated May 1, 2010, Parnassus Investments has contractually agreed to limit the total operating expenses (exclusive of acquired fund fees and expenses) to 0.99%, 1.00%, 0.78%, 1.20%, 1.20%, 1.20% and 0.76% 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. 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 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.

Research Insight (continued) Wells Fargo & Co. (WFC), two of our holdings, exemplify this point. Their conservative balance sheets and shrewd strategic decisions enabled them to grow their businesses while competitors shrank. Both companies are expanding their already best-in-class franchises, are well capitalized and are led by strong management teams. The Federal Reserve has given both its vote of confidence, as each recently received approval to raise dividends and repurchase shares. Despite all of these positive factors, the companies are trading at less than nine times next year’s expected earnings. Two other holdings, Pinnacle Financial Partners (PNFP) and First Horizon National Corporation (FHN), are examples of banks that were hit hard by the recession, but are addressing their problems responsibly. Pinnacle’s loan portfolio had a heavy weighting in high risk construction and development loans, and the bank suffered along with the construction market. However, management has since reduced the riskiness of its loan portfolio. Pinnacle has a unique franchise, based on the idea that a good workplace will encourage employees to provide customers with exemplary service. This strategy has worked, as the bank consistently adds new clients, and its superior customer relationships provide it with access to the most attractive loan opportunities in its market. First Horizon National is returning to its roots after a failed national expansion strategy. The new management team is committed to growing its core businesses, which include a leading Tennessee-based regional bank and a fixed income capital markets group that services community bank treasury departments. These two businesses have long histories and excellent customer relationships, and both generate high returns on capital. The transformation of First Horizon has reached an inflection point, where management can now concentrate on improving their already strong franchises instead of minimizing the losses from the non-core businesses they are exiting. We believe that the shares of both Pinnacle and First Horizon will increase in value as their high quality management teams continue to execute on their strategies.

Another Parnassus Investments bank holding is Royal Bank of Canada (RY), the largest Canadian bank. The Canadian banking market is highly consolidated, which helps to create higher returns on capital than are available in the more fragmented and competitive US market. A powerful national regulator has made it difficult for foreign banks to enter the market and firmly restricts risky loans; the latter point explains why Canada emerged from the recent global credit crisis without a single bank failure or bail-out. We believe that this stock will perform well as the company continues to gain share in Canada and builds out its wealth management and capital markets divisions internationally. We appreciate your investment with us.

This Digest draws on data and commentary from the Federal Deposit Insurance Corporation’s (FDIC) Failed Bank List. The list includes banks which have failed from January 1, 2008 – March 25, 2011. Percentage of Parnassus Funds represented by the companies in this article, as of March 31, 2011: JPM is 4.56% and 4.07% of the Parnassus Equity Income Fund and the Parnassus Fund, respectively; WFC is 3.26%, 3.11%, 1.12% and 1.04% of the Parnassus Fund, Parnassus Workplace Fund, Parnassus Fixed-Income Fund and Parnassus Equity Income Fund, respectively; PNFP is 1.70% of the Parnassus Small-Cap Fund; FHN is 1.99%, 1.72%, 1.00% and 0.19% of the Parnassus Small-Cap Fund, Parnassus Workplace Fund, Parnassus Mid-Cap Fund and Parnassus Fund respectively; RY is 2.32% of the Parnassus Equity Income 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.

I n si d e P a r n a s s u s Ryan Wilsey to m anage Parnassu s Sm all-C a p F un d with J erome Dodson E f f e c t ive May 2 , 2011 . Rya n W i l s ey has been work ing clo se ly with Je r o m e D o d so n o n t he Parnassus Small -Cap Fu n d sin ce jo in in g th e tea m a s a senior research analyst in 20 09 . E ffe ctive M ay 2, 2011, Ryan Wil sey wil l man a g e th e Pa r n a ssu s Sm a ll-C a p F u nd along wi th current po r tfo lio m a n a g e r, Je r o m e D od s o n.

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

This move refl ects th e g r owin g p r o m in e n ce o f t he F u nd within Parnassus In ve stm e n ts. “ I ’ m d e lig h te d t o have Ryan Wi lsey joi n m e a s a p o r tfo lio m a n a g e r o f t he Parnassus Smal l-Cap Fu n d , ” sa id Je r o m e D o d so n . “ S i nc e Ryan started wi th us a s a se n io r r e se a r ch a n a lyst , he ha s made a signi fi cant con tr ib u tio n to th e m a n a g e m e nt o f t he Fund, and I’m l ooking fo r wa r d to a su cce ssfu l p a rt ner s hi p with him.” When ask e d a b o u t h is n e w r o le, W ilse y r ep l i ed “Jerry has been a gr e a t m e n to r, a n d I lo o k for wa r d t o providing value to o u r sh a r e h o ld e r s in my n e w r o l e a s portfoli o manager.”



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