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Parnassus Fund 2nd Quarter Commentary

As of June 30, 2019, the net asset value ("NAV") of the Parnassus Fund - Investor Shares was $48.68, resulting in a gain of 4.26% for the second quarter. This compares to an increase of 4.30% for the S&P 500 Index ("S&P 500") and a gain of 3.67% for the Lipper Multi-Cap Core Funds Average, which represents the average return of the multi-cap core funds followed by Lipper ("Lipper average"). Year-to-date, the Parnassus Fund - Investor Shares posted a gain of 20.08% versus a return of 18.54% for the S&P 500 and a return of 17.26% for the Lipper average.


Below is a table that summarizes the performance of the Parnassus Fund, the S&P 500 and the Lipper average. The returns are for the one-, three-, five- and ten-year periods ended June 30, 2019. We are pleased to report the Fund outperformed the Lipper average for all periods.

Second Quarter Review

The Fund gained 4.26% for the quarter, trailing the S&P 500 in a photo finish by 4 basis points. (One basis point is 1/100th of one percent.) We were disappointed to trail this quarter, but we're pleased to maintain a healthy lead over the index in 2019: 20.08% to 18.54%. Stock selection had a modestly positive impact on our relative performance this quarter, while sector allocations had a slightly negative impact, with our most meaningful detractor being our 3% average cash position.


Our worst performer was Alliance Data Systems (NYSE:ADS), the leading private-label credit card issuer. It subtracted 102 basis points from the Fund's performance, as the stock's total return was a loss of 19.6%. (For this report, we will quote total return to the portfolio, which includes price change and dividends.) The shares fell after the company sold its marketing segment, Epsilon, for net proceeds of $3.5 billion, which was below investors' expectations. The stock fell again later in the quarter after the company's long-time CEO, Ed Heffernan, abruptly retired. We're excited that Melisa Miller has been promoted to CEO, and we believe she can reinvigorate the company. We expect the stock to move significantly higher as Alliance Data repurchases stock with proceeds from the Epsilon sale and its loan growth accelerates, thanks to recent partnership wins with Sephora, Burlington Stores and IKEA.


Industrial conglomerate 3M (NYSE:MMM) reduced the Fund's performance by 41 basis points, as the total return to our average selling price was negative 14.1%. 3M's stock fell after the company reported weak quarterly earnings and significantly reduced its financial guidance for the full year, due to a slowdown in China and its automotive and electronics businesses. This was the fourth consecutive reduction in annual guidance, and the deepest cut yet, which led us to re-evaluate our investment thesis. We also became concerned that 3M's environmental liabilities for its historical production of per- and polyfluorinated substances (PFAS) could be significant, so we exited our position.


Information technology consultant Cognizant (NASDAQ:CTSH) recorded a negative total return of 12.2%, subtracting 39 basis points from the Fund's return. The company reported disappointing quarterly earnings, and meaningfully reduced its financial guidance for the full year as a result. Cognizant didn't win enough new business in the quarter to offset the loss of several large contracts due to client consolidation in health care and in-sourcing in financial services. We attribute the disappointing performance to the distraction caused by a leadership transition, as co-founder and CEO Francesco D'Souza announced his retirement on February 6. New CEO Brian Humphries, who joined the company from Vodafone Business, didn't start until April 1. We expect performance to improve now that the leadership transition is complete.


Our biggest winner this quarter was Motorola Solutions (NYSE:MSI), the leading global provider of mission-critical communications solutions. The stock contributed 86 basis points to the Fund's performance, as its total return was 19.2%. The stock rose after the company reported quarterly earnings that exceeded expectations and raised its annual guidance, as Motorola's land mobile radio systems, command center software and video security products continue to gain market share and attract new clients.


Health care information technology provider Cerner (NASDAQ:CERN) added 80 basis points to the Fund's return, as its total return was 28.5%. The shares moved higher after activist firm Starboard Value announced an investment in the company. Cerner reached an agreement with the activist, promising to increase its operating margins, repurchase $1.5 billion of stock and add four new directors to its board. We're pleased management is unlocking value, and we believe that Cerner remains well positioned to be a long-term winner in the health care sector.


Thomson Reuters (NYSE:TRI) provides information and data for legal, tax and accounting professionals. The stock generated a total return of 9.5% for the quarter and contributed 53 basis points to the Fund's performance. The company reported earnings that exceeded expectations due to higher profit margins, as the recent acceleration in organic revenue growth is flowing through to the bottom line.


Outlook and Strategy


The momentum from the start of the year continued during the second quarter, as the S&P 500 gained 4.30%. The market moved higher because investors believe the Federal Reserve will cut interest rates during the second half of the year to offset slowing economic growth. Stocks were also supported by optimism that the U.S. and China would move past their differences and resume trade negotiations.


While we're pleased the market is up more than 18% through the first half of the year, we're seeing a disconnect between the market's return and global growth. According to FactSet, Europe's GDP growth is expected to slow from 1.9% in 2018 to just 1.4% in 2020, while U.S. GDP growth is projected to moderate from 2.9% in 2018 to 1.9% in 2020.


We're not seeing signs of an imminent recession in the U.S., but we're aware that many economic indicators, such as consumer sentiment and employment, are at or near peak levels. While stocks have largely looked past this, the bond market is concerned. The 10-year Treasury note yield fell 41 basis points during the quarter to 2.00%, reflecting bondholders' belief that economic growth and inflation will be lackluster.


In this environment of rising valuations but decelerating growth, our portfolio became more defensive as we invested in a number of industry-leading companies with wide moats and strong balance sheets.


In the information technology sector, we purchased Microsoft (NASDAQ:MSFT), the number-one provider of business productivity software and a leader in cloud computing services. The company is gaining market share with its comprehensive portfolio of technology offerings across infrastructure and software. The enterprise transition to the cloud is still nascent and as it matures, Microsoft should benefit greatly. We also invested in Monolithic Power Systems, an analog semiconductor company. The company is uniquely positioned to benefit from the increasing relevance of energy efficiency in integrated circuits. We believe that Monolithic's moat is widening as the problems it solves become more complex.


We added two companies in the real estate sector. We invested in AvalonBay (NYSE:AVB), an owner of upscale apartment buildings in supply-constrained high-growth markets. The company's high-quality portfolio generates durable same-store revenue growth, which is boosted by its industry-leading development pipeline. AvalonBay's downside should be protected by its conservative financial leverage and attractive dividend yield. Next, we added Howard Hughes Corporation (NYSE:HHC), an owner, operator and developer of real estate across the United States. The company's portfolio includes distinctive assets in desirable locations, such as the South Street Seaport in Manhattan. In late June, the company announced its intention to explore strategic alternatives to maximize value for shareholders. We're in favor of this decision because we believe the assets trade at a large discount to their underlying net asset value.

In the financials sector, after a period of recent underperformance, we invested in CME Group (NASDAQ:CME), the world's largest derivatives exchange. CME is a wide-moat business that benefits from economic and market volatility. We also re-initiated a position in auto insurer Progressive. The company continues to do a remarkable job gaining market share through its data-driven approach to insurance pricing, yet the stock is trading at a discount to the market.


Finally, we purchased shares of Nike (NYSE:NKE), the global leader in athletic footwear and apparel. The company is executing on its Triple Play strategy to double innovation, speed to market and direct connections to consumers, which will enable it to gain market share and grow margins. Given its tremendous long-term growth potential from emerging markets and a robust e-commerce presence, we're excited to invest behind one of the world's strongest brands.


Our sales during the quarter can be bucketed into three groups. The first group of stocks was sold because they were being acquired. Zayo Group, a fiber-optic communications network owner, announced it was being acquired for $35 per share, while luxury hotel operator Belmond was bought for $25 per share. The next group of companies was sold for ESG reasons. As mentioned above, we exited 3M due to the potential environmental liabilities related to PFAS. We eliminated our position in Mattel after the company recalled all 4.7 million Rock 'n Plays on the market because of its link to infant deaths. We're disappointed the company didn't react faster to address the Rock 'n Play safety concerns, and we believe it could tarnish the Fisher Price brand. The third group of stocks was sold for company-specific reasons. We sold online broker Charles Schwab based on our view that the company will be adversely impacted by lower interest rates. We exited our position in measurement company Nielsen because we didn't think the range of outcomes for its strategic review was favorable. Lastly, we moved on from coatings company Axalta, as we believe that our new purchases offer more upside. The changes made during the quarter result in a more defensively positioned portfolio. Nonetheless, we expect the Fund to perform well if the market continues to climb due to our overweight positioning in the cyclical information technology and industrial sectors, as well as the collection of highly innovative businesses we own across the Fund. Yours truly,


Robert J. Klaber

Portfolio Manager

Ian E. Sexsmith

Portfolio Manager

This article first appeared on GuruFocus.