Parnassus Digest July 2011

PARNASSUS DIGEST July 2011

Research Insight Waste Management is a core holding of the Parnassus Equity Income Fund and the Parnassus Mid-Cap Fund. In this Parnassus Digest, Director of Research and Portfolio Manager Ben Allen discusses why the firm has owned the stock for nearly four years, and why it’s still a top holding for the Funds.

network of landfills in the country. It is very difficult to win a permit to build a new landfill, so owning an existing landfill is a valuable strategic asset. Another key aspect of our investment process is determining if a company’s goods or services are becoming more relevant to its customers. We consider this a necessary condition for the business to grow faster than the economy over a long time horizon. Waste Management also scores well on this measure. Management is making strategic investments to benefit from the trends in environmental services, with the most important growth areas being recycling, organics and waste-to-energy.

Waste Management is North America’s largest environmental services firm, with over $12 billion in revenue, 20 million customers and 45,000 employees. It generates more than half of its revenue from collection activities. More than a quarter of the company’s revenue comes from operating landfills and transfer stations. Recycling and waste-to-energy account for 16% of the total revenue, but this share should grow because the company is investing heavily in these businesses. Understanding the value of sustainable competitive advantages, also known as economic moats (reference the Parnassus Digest – April 2010 for insight on moats), is an essential element of our investment process. Waste Management’s moat is based on its ownership of the largest

Waste Management is the largest recycler in North America. To get a sense of their scale, consider that the company recycled enough

Benjamin E. Allen Director of Research

10 Year

Since Inception

Inception Date

Gross Expense Ratioa

Net Expense Ratioa

6.44 2.95

2.56 2.72

9.27 10.73

12/31/84

0.97

0.97

5.52 3.34

7.21 2.95

6.86 2.72

9.91 8.45

8/31/92

0.99

0.99

23.34 30.68

5.74 3.34

7.44 2.95

6.98 2.72

6.68 2.29

4/28/06

0.75

0.75

10.79 8.08

35.34 38.47

11.37 6.46

7.48 5.30

NA NA

7.25 7.74

4/29/05

1.46

1.20

-4.12 -1.61

2.05 6.21

34.40 37.41

13.80 7.77

8.84 4.08

NA NA

10.37 7.35

4/29/05

1.30

1.20

Parnassus Workplace Fund S&P 500 Index

-2.23 0.09

3.32 6.01

28.90 30.68

12.40 3.34

9.46 2.95

NA NA

8.63 4.31

4/29/05

1.25

1.20

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

2.09 2.32

2.28 2.61

3.52 3.68

6.06 6.17

5.87 6.35

5.78 5.74

6.00 6.32

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

-4.33 0.09

0.42 6.01

26.22 30.68

7.13 3.34

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

-0.74 0.09

4.46 6.01

23.10 30.68

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

-0.65 0.09

4.60 6.01

Parnassus Mid-Cap Fund Russell Midcap Index

0.10 0.42

Parnassus Small-Cap Fund Russell 2000 Index

As of 6/30/11

All returns greater than one year are annualized. 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. 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) material in 2010 to fill a train stretching from Los Angeles to New York City. The company is extending its lead in this important market by investing in single-stream recycling facilities. The benefit of singlestream is that customers aren’t required to pre-sort their recyclable waste, because the facility has magnets, screens and optical scanners to sort the recycled goods automatically. On average, customers in a single-stream program are 50% more likely to recycle than those who are required to pre-sort. As municipalities and businesses increase their recycling goals, Waste Management’s lead in single-stream will help it win and retain customers. Another great long-term opportunity for the company is the recycling of organic material. Currently, only 2.5% of food waste in the United States is being recycled, so there’s significant room to grow this business. Waste Management has made strategic investments in various companies that use organic waste as an input to their processes. Some of the valuable outputs are energy, transportation fuels and fertilizers. Investing in waste-to-energy is the third way that management is increasing the company’s role in the economy. Waste Management makes energy from waste in two ways: incineration and landfill gas capture. Incinerating waste is already very popular in Europe, and is slowly gaining traction in the United States, where the EPA states that it creates “less environmental impact than almost any other source of energy.” In addition to growing their incineration business in the United States, Waste Management is also working with partners in China and the United Kingdom to expand this operation overseas. Capturing and selling natural gas, which is created in landfills as part of the decomposition process, is a terrific way to create value in what otherwise would be an unused and environmentally harmful byproduct. The company is making new wells to increase its gas capture capacity as part of management’s goal to double its current waste-to-energy business by the year 2020. This is an ambitious but achievable goal, especially since Waste Management already generates enough energy to power over one million homes.

The benefit of Waste Management’s economic moat and increasing relevancy in the economy is predictable and growing cash flow. For 2011, management expects to generate $2.7 billion of operating cash flow. Almost half of this amount, or $1.2 billion, will be used for dividends and stock repurchases. This represents 7% of the market capitalization, an especially attractive yield considering that U.S. Treasury debt returns approximately 1% for three years and 3% for 10 years. The next big chunk of capital, or $952 million, will go towards maintenance of the company’s properties, plants and equipment. This means that operating cash flow after maintenance capital expenditures should be around $1.7 billion, or 10% of the market capitalization of the company. The remaining capital, about $475 million, will be invested into growth opportunities, such as those previously mentioned. I hope that you now have a better understanding of why we think Waste Management has a durable economic moat, increasingly relevant services and attractive valuation characteristics. It’s for these reasons that we’ve invested so much of our Funds’ capital into this unique business.

Percentage of Parnassus Funds represented by Waste Management, as of June 30, 2011 is 4.8% of the Parnassus Equity Income Fund and 4.8% of the Parnassus Mid-Cap 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 The most recent hire t o t he Parnassu s I nve s tm e n t research team is Ian Se x sm it h, Se nio r Re se arc h A n a l ys t. Ian joined in earl y 2011 , h av in g p r e v io u sly in te r ned w i t h Parnassus during hi s se co n d ye a r a s a M BA ca n d i d a t e a t the Haas School of B u sin e ss. M o r e th a n 20 0 in te r ns have passed through the Pa r n a ssu s I n ve stm e n ts I nt er ns hi p Program over the past 2 6 ye a r s. Th is p r o g r a m h a s s er ved a s an excell ent recruiting p la tfo r m a n d co n tin u e s to p r ov i d e the be st candidates fo r o u r e x p a n d in g in ve stm e nt t ea m .

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

Prior to joi ning Par n a ssu s I n ve stm e n ts, I a n wor k ed f o r Scotiabank and for TD B a n k Fin a n cia l Gr o u p in To r o nt o . When ask ed about h is d e cisio n to jo in Pa r na s s u s Investments Ian repl ie d , “ Je r r y, To d d a n d B e n h ave b u i l t a unique cul ture that co m b in e s in d e p e n d e n t a n a l ys i s w i t h team-wide col labora tio n th a t b r in g s o u t th e b es t f r o m each analyst.”



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