Parnassus Digest January 2012

PARNASSUS DIGEST January 2012

Research Insight The actions of policymakers and their perceived effectiveness by investors have become an increasingly important driver for financial markets. As such, understanding policymakers’ macroeconomic frameworks is critical to assess the future direction of economic policies and financial markets. In this Parnassus Digest, I present the currently prevailing macroeconomic framework, as well as alternative schools of economic thought. My goal is to have this discussion give you a better picture of the rationale behind the various economic solutions discussed in the financial media.

a more limited government role, because they generally believe that markets are better off without outside interventions. The second and more important distinction between the two schools relates to credit cycles. Heterodox economists put a strong emphasis on the influence of credit cycles on the economy. They point out that debt tends to accumulate across business cycles, eventually leading to unstable and excessive credit growth. They believe that this inherent feature of creditbased capitalist systems is the primary cause of boom-bust cycles. Mainstream economists don’t emphasize this debt accumulation dynamic. There are no such concepts as leveraging, deleveraging, and balance sheet recessions to them. They assume that the economy is for the most part in equilibrium, Minh T. Bui whereas heterodox economists believe Portfolio Manager & that credit-based economic systems are Senior Research Analyst inherently cyclical and unstable.

Mainstream and Heterodox Economics There are basically two main concepts that separate mainstream and heterodox economics. First, most mainstream economists view the government as an important agent, especially during economic downturns. This usually implies heavy fiscal and monetary stimuli to help an ailing economy, with the hope that money injected into the economy stokes animal spirits. On the other hand, heterodox economists prefer

10 Year

Since Inception

Inception Date

Gross Expense Ratioa

Net Expense Ratioa

2.64 -0.25

1.55 2.92

8.87 10.36

12/31/84

0.97

0.97

13.07 14.11

4.92 -0.25

6.18 2.92

9.57 8.01

8/31/92

0.99

0.99

3.40 2.09

13.30 14.11

5.15 -0.25

6.31 2.92

5.86 1.41

4/28/06

0.75

0.75

3.33 -1.55

3.33 -1.55

18.67 20.17

3.74 1.41

NA NA

5.58 5.64

4/29/05

1.46

1.20

10.53 15.47

-13.29 -4.18

-13.29 -4.18

19.29 15.63

4.09 0.15

NA NA

6.92 5.14

4/29/05

1.30

1.20

Parnassus Workplace Fund S&P 500 Index

13.48 11.80

-1.62 2.09

-1.62 2.09

21.68 14.11

5.92 -0.25

NA NA

7.16 3.39

4/29/05

1.25

1.20

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

0.98 1.18

7.24 8.74

7.24 8.74

7.11 6.60

6.01 6.54

5.93 5.85

6.10 6.47

8/31/92

0.83

0.75

TOTAL % RETURNS

3 Month

Year To Date

1 Year

3 Year

5 Year

Parnassus Fund S&P 500 Index

17.33 11.80

-5.01 2.09

-5.01 2.09

17.93 14.11

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

11.01 11.80

3.13 2.09

3.13 2.09

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

11.05 11.80

3.40 2.09

Parnassus Mid-Cap Fund Russell Midcap Index

12.78 12.31

Parnassus Small-Cap Fund Russell 2000 Index

As of 12/31/11

All returns greater than one year are annualized. a As described in 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 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. 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.

Research Insight (continued) Economic Downturns

more debt than they can sustain, they need to deleverage their balance sheets. This can be done through reduced consumption and increased savings to rebuild capital, debt restructuring, or defaults. Austrians also favor going back to the gold standard because a fiat money system perpetuates a vicious cycle of malinvestments and asset bubbles.

Mainstream economists didn’t predict the current credit crisis, primarily because they don’t focus on the importance of credit cycles. Both Keynesians and Monetarists view aggregate demand as the primary economic driver. Aggregate demand includes personal consumption, private investment, and government spending. They assume that downturns are due to a shortfall in aggregate demand, which is caused by an external shock that could not have been anticipated.

MMTs agree with the Austrians on the need for deleveraging. However, they believe that a combination of austerity and deleveraging needs to be offset by some forms of government support. Left unbalanced, austerity and deleveraging could push an economy into a depression, lead to social unrest, and encourage economic nationalism. As opposed to Austrians, MMTs embrace a fiat money system, because it allows for fiscal stimulus through government deficit spending.

While heterodox economists didn’t predict the exact timing of the current credit crisis, they warned about the inherent fragility of a debt-based economy. Both Austrian and Modern Monetary Theory (MMT) schools recognize the inevitable problem of excessive debt under a fiat money system. Increasing the money supply and artificially lowering interest rates distort capital and investment allocation decisions. This means that riskier investments are undertaken and more money is borrowed than is prudent. Debt-fuelled consumptions and investments merely bring future spending to the present. Therefore, credit growth must be sustained through lower interest rates to bring forward even more spending. This scheme eventually comes to an end when credit flow stops and the bubble bursts.

Conclusion While economists are often ridiculed for their forecasting prowess, I find that much of the value is derived from understanding the macroeconomic backdrop rather than the actual forecasts. I think that this is especially useful now, as the mainstream framework has so far been inadequate to address the current crisis. I believe that the alternative schools of economic thought are worth considering, because they provide a good framework to understand the economy and assess future economic policy choices.

Economic Policy Prescriptions Our economic policy prescriptions therefore come from two main camps: Keynesians and Monetarists versus Austrians and MMTs. As discussed above, both sides have their distinct economic framework. However, each of them have significantly different views when it comes to economic policy prescriptions. Keynesians argue for both fiscal and monetary interventions. This implies tax cuts, increased government spending, and lowering interest rates to increase aggregate demand. Monetarists also call for government interventions. However, they claim that fiscal policy is rather ineffective and therefore should be limited. Instead, they argue that increasing the money supply through interest rates is the most effective way to stimulate aggregate demand.

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.

Austrians suggest that the best way to deal with a bust is to let it take its natural course. Because the financial and household sectors end up with

I n si d e P a r n a s s u s Distribution Informat io n

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

Long Term Capital Gains, Payable Date:  November 18, 2011 Rate

NAV Price Per Share

Parnassus Fund

$3.0190

$34.35

Parnassus Equity Income Fund Investor Shares

$0.4465

$25.50

Parnassus Equity Income Fund Institutional Shares

$0.4465

$25.56

Parnassus Mid-Cap Fund

$1.0007

$17.23

Parnassus Small-Cap Fund

$0.6831

$19.96

Parnassus Workplace Fund

$0.7648

$19.34

Parnassus Fixed-Income Fund

$0.2365

$17.46

For more information on distributions please visit our website. www.parnassus.com/parnassus-mutual-funds/DividendInfo.aspx



PARNASSUS INVESTMENTS

®