As of December 31, 2023, the net asset value (“NAV”) of the Parnassus Mid Cap Growth Fund – Investor Shares was $55.57, resulting in a gain of 35.60% for 2023. This compares to a gain of 25.87% for the Russell Midcap Growth Index (“Russell Midcap Growth”).
Below is a table that summarizes the performance of the Parnassus Mid Cap Growth Fund and the Russell Midcap Growth Index. The returns are for the one-, three-, five-and ten-year periods ended December 31, 2023.
Year in Review
The Parnassus Mid Cap Growth Fund – Investor Shares gained 35.60% in 2023, outpacing the Russell Midcap Growth by 973 basis points. (One basis point is 1/100th of one percent.) The seeds of our strong performance in 2023 were sown in 2022, when investors were concerned with rising inflation, a rapid series of interest rate hikes by the Federal Reserve targeted to slow the economy and a land war in Europe that caused commodity prices to spike. Against this backdrop in 2022, innovative, secularly growing and competitively advantaged stocks were punished disproportionately due to their higher valuations. We took advantage of a steep price decline in leading software providers, semiconductor companies and other innovative, best-in-class businesses by adding to our positions, as we thought the market's focus on near-term valuations was overlooking their long-term earnings potential. Over the course of 2023, the economy grew faster than expected as consumer spending was resilient due to a robust employment market and excess savings from the COVID pandemic years. Inflation decelerated as supply chains normalized and commodity prices fell. Against this backdrop, investors refocused on long-term earnings potential and business quality, and our Fund reaped the rewards.
The vast majority of our outperformance in 2023 came from strong stock selection. Sector allocation also added to our performance, with our overweight of the Information Technology sector being the largest contributor. For the year, Information Technology, Health Care and Consumer Discretionary drove our returns, as each contributed more than 250 basis points to performance. The Financials sector was our most significant detractor.
Our worst performer this year was First Republic Bank (FRCB, Financial). First Republic fell a shocking 73.0% from its average price, subtracting 2.2%* from the Fund's relative return. First Republic plunged during the regional bank crisis in early March, after Silicon Valley Bank's sudden failure caused contagion. First Republic's concentrated client base of successful businesses and high net-worth individuals in a select few coastal markets fled in a bank run to larger, more-diversified banks. We exited First Republic before it ultimately failed.
Fertilizer manufacturer Nutrien (NTR, Financial) reduced the Fund's relative return by 1.1% as its stock returned a -20.2%. Nutrien's stock price fell along with their earnings as fertilizer prices declined. Lower crop prices reduced fertilizer usage, and supply was less constrained than anticipated as Russian and Belarussian potash exports continued despite economic sanctions. Nutrien is the world's largest producer of potash, a commodity whose supply is controlled by only a handful of key global producers. We're holding onto our position because we believe Nutrien will be a major beneficiary when the commodity cycle inevitably recovers.
Call center software provider Five9, Inc. (FIVN, Financial) reduced the Fund's relative return by 0.9% as the stock dropped 24.1% from its average price. The stock declined as investors became concerned that Five9 could be negatively impacted by new artificial intelligence (AI) technology, as Five9 lacks a proprietary AI solution, and the number of call center agents could decline over time if AI-enabled chat bots are widely adopted. We were unable to disprove these concerns, so we exited our position.
Our best performer in 2023 was enterprise software provider Splunk (SPLK, Financial). Splunk's shares soared 70.6%, adding 2.9% to the Fund's relative return. Splunk's shares outperformed as it gained traction from cross-selling its suite of data monitoring software to its loyal base of customers and its management team dramatically improved the company's profitability. Splunk's impressive financial performance also caught the eye of technology giant Cisco (CSCO, Financial), which announced it would acquire Splunk for $157 per share.
Insurance software provider Guidewire (GWRE, Financial) boosted the Fund's relative return by 1.9% as its stock rose 74.3%. Guidewire delivered better-than-expected revenue and operating margins and provided an upbeat outlook for its next two fiscal years. Guidewire ended the year in our largest position, due to its predictable and durable revenue growth as well as its margin expansion opportunity.
MercadoLibre (MELI, Financial), the leading online consumer marketplace and payments platform in Latin America, contributed 1.8% to our relative return as it gained 85.7%. MercadoLibre's earnings estimates for 2023 rose by over 50% during the year as the company exceeded sales and profitability expectations. MercadoLibre's e-commerce business continues to gain market share, driven by its strong value proposition centered around a broad assortment of products, compelling price points and fast delivery speeds. The company's payments business is becoming a one-stop shop for financial services, as it now offers a full suite of products, ranging from payments to credit, insurance and savings.
Outlook and Strategy
2023 was a good year for equity markets, and a great year for our Fund. We're pleased with our performance in 2023, and our goal is to deliver consistent outperformance relative to the Russell Midcap Growth over a business cycle.
Our strategy is to invest in high-quality growth compounders. To us, these are innovative companies that are market-share gainers in secularly growing markets with competitive advantages and seasoned management teams. Our sweet spot is to build positions in shares of these high-quality businesses when they fall due to transitory issues, but the longterm opportunity remains intact. Transitory issues could include a business model transition, like shifting from selling software on-premise by a license to a cloud-based subscription (Splunk and Guidewire), or a cyclical downturn within a secularly growing market (MercadoLibre). We've also learned that we should avoid turn-around situations, disruptive companies that have yet to develop a sustainable financial model and highly levered businesses. We don't believe that our method of analyzing moat, relevancy, management, environmental, social and governance (ESG) and downside risk lends itself well to these unproven and risky businesses. We believe that doubling down on what we do best, and avoiding our weaknesses, is the best recipe to deliver long-term outperformance.
We feel fortunate to invest in the mid cap growth asset class. Mid cap growth companies are large enough to have proven financial models, seasoned management teams and access to capital. However, they're small enough that they still have a long runway for growth and new products can result in growth inflections. Mid cap stocks often focus on niche markets, where they can build long-term relationships with their customers as they partner to solve complex problems. Niche markets are typically more defensible than large markets, which invite competition and make partnering with customers difficult. Over the past 10 years, mid cap growth stocks have traded at an average price-to-earnings that is approximately 10% higher than that of large cap growth stocks due to the durability of mid cap earnings growth rates.
However, mid cap growth stocks are currently trading at parity to large cap growth, as the “Magnificent Seven”6 have captured the imagination of investors due to their seemingly infinite growth opportunities. At some point, however, the law of large numbers may apply. For a $1 trillion market cap company to generate a 15% annual shareholder return, it must generate $150 billion in value—that's more than the entire market value of any of our holdings! We believe that the valuation of mid cap growth stocks should return to its historical premium to large cap growth, especially if inflation continues to decelerate and the Federal Reserve reduces interest rates to limit the pressure it's putting on the economy.
We've observed that equity markets have become more volatile. Volatility creates opportunity, and we look for opportunities that present themselves for long-term investors when a stock's price diverges from its intrinsic value. Since the COVID-19 epidemic in 2020, the Russell Midcap Growth has endured five corrections deeper than 10%, and each correction has been followed by a sharp rally of more than 20%. During the preceding five-year period, from 2015– 2019, there were only two market corrections. We believe that flows into thematic exchange traded funds (ETFs), the increasing use of equity options, the Federal Reserve's interest rate and balance sheet management decisions, and the federal government's budget deficits and partisanship have all likely contributed to the increased volatility. Our firm has continued to build its research team, enabling us to uncover the best opportunities in these fast-moving markets.
During the year, we steadily reduced our exposure to the Information Technology sector as we took some profits after the sector's impressive gains. We began the year with 38% of the Fund invested in Information Technology stocks, and we ended the year at 28%. We still have an overweight to the sector, but to a smaller degree, as we own a collection of secularly growing and competitively advantaged businesses in the software and semiconductor industries.
In the fourth quarter, we initiated five new positions and sold three. We initiated positions in two software companies. Datadog (DDOG, Financial) has built a leading cloud-based observability and application monitoring platform and is growing rapidly as enterprises shift their workloads from on-premises servers to the cloud. Procore Technologies (PCOR, Financial) is building a cloud-based software platform for the construction industry that digitizes project, invoice and bid management to improve collaboration and efficiency. We believe that both companies have a long runway of growth in front of them as they solve complex problems for their customers. They could also be meaningful beneficiaries from artificial intelligence due to their plethora of data.
We also initiated positions in two payments companies. Adyen (XAMS:ADYEN, Financial) is gaining market share among the largest enterprises due to its unique full-stack technology, allowing multinational corporations to seamlessly process global transactions by any method. We re-initiated a position in Block (SQ, Financial), which operates the Cash App consumer finance network and the Square merchant payment processing business, which is popular among small- and medium-sized businesses. Block's Founder and CEO Jack Dorsey has stepped in to run the Square business and is focused on increasing the company's profitability and accelerating market share gains. We believe investors are underestimating the long-term earnings power of both innovative businesses.
Last but not least, we invested in Mettler-Toledo (MTD, Financial), a leading manufacturer of instruments such as scales and pipettes. Mettler-Toledo is famous for its instruments' precision and its customer service, and the companyis positioned as the #1 or #2 player in most of its fragmented markets. We had the opportunity to buy Mettler-Toledo at a cyclical low, as demand from China and from pharmaceutical companies was weak. We expect demand to eventually recover, and Mettler-Toledo to lead its markets higher.
We sold three software businesses to make room for our new additions. We exited the remainder of our Splunk
position, after the company announced it was being acquired by Cisco. We exited communications software
provider Twilio (TWLO, Financial), as we believe that Procore and Datadog have more defensible businesses and higher growth
potential. We also sold life sciences software provider Veeva Systems (VEEV, Financial), as the upcoming entrance of Salesforce (CRM, Financial) into its market will increase the industry's competitive intensity and could reduce the company's future growth profile.
We're excited about the mid cap growth asset class and the opportunities presented by volatile markets. Our goal is to build a diversified portfolio of stocks that can outperform our benchmark over the full business cycle, and we feel good about our portfolio heading into 2024.
Thank you for your investment in the Parnassus Mid Cap Growth Fund.
Yours truly,
Ian E. Sexsmith, Lead Portfolio Manager
Robert J. Klaber, Portfolio Manager
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.
