As of September 30, 2020, the net asset value ("NAV") of the Parnassus Endeavor Fund (Trades, Portfolio) — Investor Shares was $38.63, so the total return for the quarter was 9.65%. This compares to a gain of 8.93% for the S&P 500 Index ("S&P 500") and a gain of 8.20% for the Lipper Multi-Cap Core Funds Average, which represents the average return of the multi cap core funds followed by Lipper ("Lipper Average").
We've been able to beat both indices for the past two quarters, but we're still behind for the year, because of our difficult first quarter. For the year to date, the Parnassus Endeavor Fund (Trades, Portfolio) — Investor Shares has a modest gain of 1.18% compared to a gain of 1.91% for the Lipper Average and a gain of 5.57% for the S&P 500. The reason for the discrepancy is that the S&P 500 is driven by a small number of large technology stocks often known as the FAANGs for Facebook, Apple, Amazon, Netflix and Google (now called Alphabet). Microsoft is the other stock associated with the group, though its initial is not included in the acronym. Those six stocks have been driving the S&P 500 higher because the S&P is weighted by market capitalization, so the big companies dominate the index. While the Parnassus Endeavor Fund (Trades, Portfolio) has modest positions in both Apple and Alphabet, those positions are not big enough to keep us up with the S&P 500. Should the FAANGs stumble, they would pull down the S&P 500, and we would probably be able to go back to beating the index.
To the left is a table showing the returns for the Parnassus Endeavor Fund (Trades, Portfolio) for the one-, three-, five- and ten-year periods. We're ahead of the Lipper Average for the one, five- and ten-year periods, but we're lagging behind the S&P 500 for the one-, three- and five-year periods, and we're about the same as the S&P 500 for the ten-year period.
Third Quarter Review
The performance of our technology stocks fell off in the third quarter. Shares of Micron Technology sank almost 9.0%, while Cisco lost 14.9%.* Those two stocks hurt the portfolio most during the quarter. Of the four issues that performed best in the quarter, Apple was the only technology stock that made the list.
Micron Technology (MU, Financial), one of the world's three largest manufacturers of Dynamic Random Access Memory chips (DRAMs), sliced 109 basis points off the NAV return, as its share price sank 8.9% during the quarter from $51.52 to $46.96. (One basis point is 1/100th of one percent.) About 10% of Micron's sales normally come from Huawei, a Chinese firm that the U.S. has barred from purchasing high-end American semiconductors. While both the political environment and short-term demand remain uncertain for the time being, Micron should be able to replace the lost sales from China with increasing demand for memory chips because of 5G, the cloud and data-center growth.
Cisco Systems (CSCO, Financial), the leading provider of enterprise-networking solutions, cut 60 basis point off the Fund's return, as its stock fell 14.9% from $46.64 to $39.39. The company reported decent results, but reduced guidance for the next quarter, and it also announced the departure of the chief financial officer. Investor sentiment has soured, as the company's enterprise sales have declined because of the current work-from-home policies. The shares are trading at a bargain price right now and should recover when spending picks up.
FedEx (FDX, Financial) added 302 basis points to the Fund's return, as its shares soared from $140.22 to $251.52 for a total return of 79.9%. The company reported a 60% increase in quarterly earnings, far exceeding investor expectations. Their domestic ground transportation division shifted into high gear during the quarter and delivered record revenues as the pandemic-induced surge in e-commerce shopping led to a sharp increase in parcel shipments. FedEx also operates the world's largest airfreight network and profits surged as its planes filled and pricing rose.
Specialty retailer The Gap (GPS, Financial) boosted the Fund's return by 141 basis points, as its stock rose from $12.62 to $17.03 for a total return of 34.9%. Gap sells clothes and accessories under the Old Navy, Banana Republic and Athleta brands among others. Despite the challenges faced by brick and mortar retailers during the pandemic, Gap's management took swift action to adapt the business. The company reduced the number of stores and increased liquidity while investing in online sales which nearly doubled from last year. Gap still has a lot of work to do, but investors liked the progress and snapped up shares while they were on sale.
Apple (AAPL, Financial) added 110 basis points to the Fund's return, as the stock went from $91.20 to $115.81 for a total return of 27.2%. The company reported much better-than-expected results, demonstrating impressive execution during the pandemic. Strong iPhone sales drove better results, and this should continue as we go into the next upgrade cycle.
Hanesbrands (HBI, Financial), a leading manufacturer of undergarments and athletic apparel, added 78 basis points to the Fund's return, as its stock rose from $11.29 to $15.75 for a total return of 40.8%. The company's key underwear category returned to strong growth trends during the quarter, with management noting that demand levels in May and June were higher than the equivalent pre-pandemic periods. The company also gained market share throughout the quarter due to larger shelf-space allocation for socks and underwear at Walmart. Finally, consumers continued to shop online, driving online sales growth of more than 70% globally, with triple-digit growth at some of the company's largest online retailers.
Outlook and Strategy
(This section was written by Jerome L. Dodson)
As I wrote in the last quarterly report, I am amazed that the stock market has made such an astonishing comeback, gaining back all it lost earlier this year. Although the stock market has recovered, the economy has not. With an unemployment rate of 7.9%, there are 18 million Americans unemployed, so times are tough. Businesses laid off 1.2 million workers in the last week of September.
Why is there such a disparity between the stock market and the real economy? The answer is that the Federal Reserve (Fed) has pumped an enormous amount of money into the system. Doing this has caused interest rates to drop to historically low levels, with banks' prime rate now at 3.25% and the Fed Funds rate at 0.25%. (The prime rate is the interest rate that banks charge its best customers, while the Fed Funds rate is the rate that banks charge when they lend to each other.) It's now possible for a financially strong borrower to get a home mortgage for less than 3%. In the 40 years that I've worked in finance, I've never seen rates this low. For consumers, the best rate I could find for a money market account was 0.60% from American Express, while most money market fund accounts are paying below 0.20%.
What does this mean for the stock market? In short, it means that investors have nowhere else to put their money. If they earn almost nothing when they put their money in a bank account or a money market fund, they look for somewhere else to invest. The place with the most liquidity is the stock market, and money looking for a home is driving the market averages much higher.
Right now, the market is very overvalued compared to historic ratios. For example, the current price/earnings ratio is 22, compared to a normal range of 15 to 18.** At some point, that ratio will have to come back down, but it's impossible to know when this will happen. There are two ways the ratio could correct—either earnings go up or stocks go down. Let's hope it's the former and not the latter.
There's another wild card in the equation, and that's called inflation. The only thing that's surprised me more than the big move up in the stock market has been the absence of inflation. What I learned in economics class as an undergraduate is that if more money chases the same amount of goods, prices go up, and that's what causes inflation. Well, as we've seen, the Federal Reserve is creating enormous amounts of new money, and there hasn't been much inflation. In fact, the Fed has been trying to boost the inflation rate up to 2%, and it stubbornly stays below that figure.
What's happening to us? Has someone repealed the laws of economics? No one knows for sure, but let me take a guess. The late 1970s and early 1980s saw an enormous amount of inflation. At the beginning of 1977, the inflation rate was 5.2%, in 1978 it hit 6.8%, in 1979, it was 9.28%, and in 1980 it hit an amazing 13.91%. On April 2 of 1980, the prime rate hit 20%, and the economy went into a terrible recession. Paul Volcker had just been named Chairman of the Fed on August 6 of 1979, and he proceeded to raise interest rates to historic heights. That hit the economy hard, but it stopped the runaway inflation. The rate dropped to 11.83% in 1981, and by 1983 it was down to 3.71%.
Although Volcker stopped inflation, the country paid a terrible price. In 1979, the unemployment rate was 6.0%, in 1980 it went to 7.2%, and it went to 8.5% in 1981, before topping out at 10.8% in 1982. It did not fall below 6% again until 1987, when it hit 5.7%.
Because of that experience, the Fed has kept inflation in check since that time. So, part of the reason for low inflation is monetary policy.
Another reason, in my view, is that consumers have much more knowledge about prices now than we did then. It's much harder for businesses to raise prices than it was in the 1970s, since consumers can go right online and comparison shop. The Internet has been a major force in keeping inflation in check. Although I am not an admirer of Amazon's businesses practices and I try not to shop there, it has been a great force in keeping pricesdown and controlling inflation. Other online merchants have helped to keep down costs as well.
Finally, the other element in the equation is the unemployment rate. With unemployment so high and the economy struggling, prices cannot move too much higher in a short time frame. At some point, though, things will change. No one can predict when that will happen, but my guess is it will be sometime next year. Once the current 7.9% unemployment rate hits 5% or below, I think the dynamics will change. Of course, you could argue that the unemployment rate hit 3.6% in January, and there were still no signs of inflation. What's different now? The difference is that trillions of dollars have been pumped into the American economy, and that will eventually stoke inflation. Even with watchful consumers all shopping for bargains, too much money chasing a limited amount of goods will, at some point, mean more inflation.
In the meantime, you can be confident that we will do our best to manage your money wisely. Thank you for investing with Parnassus Endeavor Fund (Trades, Portfolio).
Yours truly,
Jerome L. Dodson
Lead Portfolio Manager
Billy Hwan
Portfolio Manager
1As of Sept. 30, 2020.
2As of Sept. 30, 2020.
3As a percentage of total net assets.
The average annual total return for the Parnassus Endeavor Fund (Trades, Portfolio) – Institutional Shares from commencement (April 30, 2015) was 10.43%. Performance shown prior to the inception of the Institutional Shares reflects the performance of the Parnassus Endeavor Fund (Trades, Portfolio) – Investor Shares and includes expenses that are not applicable to and are higher than those of the Institutional Shares. The performance of the Institutional Shares differs from that shown for the Investor Shares to the extent that the classes do not have the same expenses. 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. Current performance information to the most recent month end is available on the Parnassus website (www.parnassus.com). Investment return and principal value will fluctuate, so an investor's shares, when redeemed, may be worth more or less than their original principal cost. Returns shown in the table do not reflect the deduction of taxes a shareholder may pay on fund distributions or redemption of shares. The S&P 500 is an unmanaged index of common stocks, and it is not possible to invest directly in an index. Index figures do not take any expenses, fees or taxes into account, but mutual fund returns do. The estimated impact of individual stocks on the Fund's performance is provided by FactSet. As described in the Fund's current prospectus dated May 1, 2020, (As Amended and Restated Effective as of August 5, 2020), Parnassus Investments has contractually agreed to limit total operating expenses to 0.95% of net assets for the Parnassus Endeavor Fund (Trades, Portfolio) – Investor Shares and to 0.71% of net assets for the Parnassus Endeavor Fund (Trades, Portfolio) – Institutional Shares. This agreement will not be terminated prior to May 1, 2021, and may be continued indefinitely by the Adviser on a year-to-year basis. *For this report, we quote total return to the portfolio, which includes price change and dividends.
Before investing, an investor should carefully consider the investment objectives, risks, charges and expenses of a fund and should carefully read the prospectus or summary prospectus, which contain this and other information. The prospectus or summary prospectus can be found on the website, www.parnassus.com, or by calling (800) 999-3505.
