Parnassus Digest July 2012
PARNASSUS DIGEST July 2012
Research Insight: Evaluating Management While some debate whether it’s the horse or the jockey that wins the race, we believe that both are required to succeed over the long-term. In the context of investing, the horses we look for are high-quality businesses with sustainable competitive advantages and attractive growth prospects. The jockeys are skilled, trustworthy managers with appropriate incentives. Assessing management is tricky, especially because subjectivity can cloud one’s judgment. With this in mind, we’ve developed a repeatable process, based on objective measures, to evaluate management teams. Some of the criteria we measure include historical and current capital allocation, management strategy, and incentive schemes.
are aligned. We follow a template to ensure that all this objective information is consistently analyzed and reported to investment team members. Capital allocation is a critically important task for a management team to get right in order to increase the value of its business over the long-term. If a company has growth opportunities that offer high returns on capital, we want management to reinvest into the business. Long-time portfolio company Google (GOOG), for example, still Ian Sexsmith, CFA Senior Research Analyst has a long runway for growth, paved by the secular trend of marketing dollars moving online. With earnings and free cash flow growing at more than 15% per year, and with returns on investment that far exceed its cost of capital, we believe that reinvesting will generate the most value for Google’s shareholders.
In order to understand how a firm’s strategy has evolved over time, we analyze historical capital allocation decisions and read multiple years’ worth of annual reports. We use proxy filings to analyze compensation structure and equity ownership, since we believe that management is more likely to act in the best interests of shareholders if their incentives
TOTAL % RETURNS
3 Month
Year To Date
1 Year
3 Year
5 Year
10 Year
Parnassus Fund S&P 500 Index
-4.90
11.78
5.74
16.08
3.07
4.96
9.14
-2.75
9.49
5.45
16.39
0.22
5.32
10.60
Parnassus Equity Income Fund - Investor Shares S&P 500 Index
-0.96
6.59
5.23
13.71
4.11
7.40
9.67
-2.75
9.49
5.45
16.39
0.22
5.32
8.30
Parnassus Equity Income Fund - Institutional Shares S&P 500 Index
-0.91
6.69
5.46
13.95
4.34
7.54
6.48
-2.75
9.49
5.45
16.39
0.22
5.32
1.86
Parnassus Mid-Cap Fund Russell Midcap Index
-1.76
10.40
2.96
19.18
4.29
NA
6.64
-4.40
7.97
-1.65
19.44
1.06
NA
6.37
Parnassus Small-Cap Fund Russell 2000 Index
-7.15
8.62
-7.70
16.84
4.45
NA
7.66
-3.47
8.53
-2.08
17.80
0.54
NA
5.97
Parnassus Workplace Fund S&P 500 Index
-5.21
9.27
4.04
16.03
6.43
NA
7.97
-2.75
9.49
5.45
16.39
0.22
NA
3.91
Parnassus Fixed-Income Fund Barclays Capital U.S. Govt/Credit Bond Index
2.67
1.78
6.72
6.78
6.14
5.73
6.04
2.56
2.65
8.78
7.33
6.89
5.79
6.44
As of 6/30/12
Since Inception
Inception Date
Gross Expense Ratioa
Net Expense Ratioa
12/31/84
0.94
0.94
8/31/92
0.94
0.94
4/28/06
0.70
0.70
4/29/05
1.24
1.20
4/29/05
1.22
1.20
4/29/05
1.16
1.16
8/31/92
0.81
0.75
All returns greater than one year are annualized. a As described in Funds’ current prospectus dated May 1, 2012, 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 0.75% 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 continue until May 1, 2013, and may be continued indefinitely by the Adviser on a year-to-year basis. 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.
All high-quality, well-managed companies eventually grow to a size where they generate more cash than they can reinvest in their core business. When this happens, the temptation to invest in non-core opportunities can be tempting. Unfortunately, this destroys shareholder value more often than not, because the non-core investments don’t share the competitive advantages that characterize the core business. Good management teams, however, realize that the excess cash provides them with the ability to provide shareholders with a built-in return: a dividend. An example of a company that has allocated its capital wisely is Shaw Communications (SJR), a cable company based in Western Canada. Shaw has paid 2/3 of its free cash flow over the past five years in dividends, while reinforcing its moat with strategic investments and occasional acquisitions. Its dividend yield is a healthy 5%, and we believe there is potential for the dividend to grow along with free cash flow in the future. Increasing a company’s intrinsic value is a continuous process, and it requires a long-term vision that is sometimes at odds with the prevailing view of the market. This is why a consistent strategy is also an important driver of shareholder value. Charles Schwab (SCHW), the San Franciscobased discount brokerage, is continuing to gather new customers despite the pressure on profitability from extremely low interest rates. We believe that Charles Schwab’s focus on customer acquisition is increasing its intrinsic value, and that it will be rewarded for its longterm vision when the interest rate environment normalizes. Reviewing compensation schemes is an important tool that we use to determine if management’s incentives are aligned with shareholders’. We like structures that incentivize management to increase shareholder value, not just the size of the company. And while the dollar amount of compensation matters, what matters more is if it was earned. Waste Management (WM), North America’s largest comprehensive waste and environmental services firm, determines its annual cash bonuses using a unique formula that incorporates a pricing improvement target. This protects the long-term value of the franchise by encouraging management to focus on price, as lower prices generally lead to lower margins and lower earnings. We also like that the formula, the targets and the results are available for all to see. We like situations where we can invest alongside management, as we
believe that equity ownership is the ultimate alignment of interest. We view insider buying as a positive signal. Management invests their hardearned money when they believe that business will improve and the stock will move higher, and they know their business better than anyone. Tracy Krohn, the founder and CEO of W&T Offshore (WTI), an oil- and gas-producer, added more shares to his already sizable holdings earlier this year. W&T is a long-time investment of Parnassus and we hold Mr. Krohn in high regard. Because he’s invested alongside us, his conviction in the outlook for his company increases our own. Analyzing management is an important part of our fundamental investment process. By using the criteria described above, we believe that we can evaluate management objectively and add value for Parnassus Funds shareholders. We appreciate your investment with us.
Percentage of Parnassus Funds represented by GOOG as of June 30, 2012 is 3.2%, 3.6% and 3.7% of the Parnassus Equity Income Fund, Parnassus Fund and Parnassus Workplace Fund, respectively. Percentage of Parnassus Funds represented by SJR as of June 30, 2012 is 3.0% and 1.9% of the Parnassus Mid-Cap Fund and Parnassus Equity Income Fund, respectively. Percentage of Parnassus Funds represented by SCHW as of June 30, 2012 is 3.0% 1.2%, 1.2%, 1.0% and 2.8%of the Parnassus Equity Income Fund, Parnassus Mid-Cap Fund, Parnassus Fund, Parnassus Fixed-Income Fund and Parnassus Workplace Fund, respectively. Percentage of Parnassus Funds represented by WM as of June 30, 2012 is 4.3%, 4.1% and 2.6% of the Parnassus Equity Income Fund, Parnassus Mid-Cap Fund and Parnassus Fixed-Income Fund, respectively. Percentage of Parnassus Funds represented by WTI as of June 30, 2012 is 3.2%, 2.9% and 1.3% of the Parnassus Small-Cap Fund, Parnassus Fund and Parnassus Equity Income Fund, respectively. 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 Parnassus Investments Office Undergoes Construction. Jerome Dodson founded Parnassus Investments from his home in 1984. As the assets of the firm slowly grew, he moved the organization to the Financial District of San Francisco. We have called One Market Plaza our home since 1995.
Parnassus Investments 1 Market Street, Suite 1600 San Francisco, CA 94105 (800) 999-3505 www.parnassus.com
Over the long-term, the Parnassus Funds have done a good job of meeting their objectives and have continued to see inflows. In early June of this year, Parnassus Investments started renovation to meet the growing needs of the firm. The expansion includes the creation of two new conference rooms and six new offices. If your travels ever bring you to San Francisco, we welcome the opportunity to show you around our renovated space and introduce you to our growing team.
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