As of June 30, 2018, the net asset value (“NAV”) of the Parnassus Fund – Investor Shares was $47.10, resulting in a gain of 1.03% for the second quarter. This compares to a gain of 3.43% for the S&P 500 Index (“S&P 500”) and a gain of 2.63% for the Lipper Multi-Cap Core Average, which represents the average return of the multi-cap core funds followed by Lipper (“Lipper average”).
Below is a table that summarizes the performance of the Fund, the S&P 500 and the Lipper average. The returns are for the one-, three-, five- and ten-year periods ending June 30, 2018.
Second Quarter Review
The Parnassus Fund – Investor Shares gained 1.03% for the quarter, trailing the S&P 500 by 240 basis points. (One basis point is 1/100th of one percent.) Sector allocation hurt our relative performance, as the Fund is overweight the financial services and industrials sectors, the two worst-performing sectors this quarter. Meanwhile, the energy sector was the index’s best performer, which hurt our performance because the Fund doesn’t invest in fossil fuels. While oil prices may jump from time to time because of factors such as geopolitical concerns, over the long term, we expect oil and gas stocks to underperform as renewable power sources and electric vehicles increase in relevance.
Our worst performer was Starbucks, the global coffee chain. Its stock reduced the Fund’s return by 39 basis points, as it declined 15.6% from $57.89 to $48.85. The company pre-announced weaker-than-expected sales for the quarter and lowered earnings guidance for the year. Growing competition caused revenue growth to slow in the U.S., while the company’s business in China was hurt by an interruption in delivery services. Management has numerous initiatives in place to turn around performance, such as adding loyalty members, introducing new food and beverage items and closing underperforming stores. We’re optimistic that management will be able to reaccelerate growth, and with shares trading at their cheapest valuation in eight years, we think the risk-reward for this blue-chip company is attractive.
Shares of New York City–based Signature Bank (SBNY, Financial) subtracted 29 basis points from the Fund’s return, as its shares declined 9.9% from $141.95 to $127.88. The stock fell after the bank recorded a loss on its taxi loan book and the interest rate spread between its loans and deposits contracted. After this quarter, we believe the bank’s taxi loan losses are finally in the rearview mirror. While we don’t know exactly when the bank’s loan yields will rise enough to offset its higher deposit rates, we’re confident that they eventually will, and we take comfort in the bank’s veteran management team and their exemplary track record. Despite the interest rate headwind, Signature’s revenue is expected to grow 6% this year due to the bank’s impressive loan growth, so we believe investors have overreacted and the stock is now on the bargain table.
Logistics provider C.H. Robinson (CHRW, Financial) cut the Fund’s return by 27 basis points, as its stock slid 10.7% from $93.71 to $83.66. The stock dropped due to weak earnings from its international freight forwarding division, as the integration of several recent acquisitions is proving to be costlier than initially expected. We were disappointed with the division’s results, but it’s a small part of Robinson, representing only 12% of the company’s 2017 operating income. Robinson’s domestic truck brokerage division is the driver of the company’s earnings. We expect the stock to rebound, because truck brokerage earnings are surging as the tightest truck market in over a decade is requiring shippers to pay more to access Robinson’s industry-leading network of carriers.
Two of our biggest winners this quarter, Mattel and Alliance Data Systems, were among last quarter’s biggest losers. As contrarian investors, we took advantage of the temporary weakness in their share prices and added to our positions to boost our gains when the stocks rebounded. Toy manufacturer Mattel (MAT, Financial) was the Fund’s biggest winner, contributing 104 basis points to the Fund’s return, as its stock jumped 24.9% from $13.15 to $16.42. The stock rallied as Mattel’s quarterly revenue exceeded investors’ expectations, driven by the excitement around the 50th anniversary of Hot Wheels and Barbie’s new career and role-model dolls. The stock continued to move higher on speculation that the liquidation auction for Toys“R”Us, the largest U.S. toy store chain, may yield a new owner that revives the brand. We don’t know how the Toys“R”Us saga will end, but we believe there is significant upside in Mattel’s stock as its iconic brands return to their historical levels of profitability.
Motorola Solutions (MSI, Financial), the largest provider of mission-critical communications solutions, added 54 basis points to the Fund’s return, as its shares rose 10.5% from $105.30 to $116.37. The stock moved higher after the company reported better-than-expected quarterly earnings and raised earnings guidance for the year due to broad-based global demand for Motorola’s land mobile radio systems.
Shares of Alliance Data Systems (ADS, Financial), a leading digital marketing firm and credit card issuer, contributed 49 basis points to the Fund’s return, as its shares increased 9.6% from $212.86 to $233.20.
Alliance Data’s shares rallied as its credit card loss rates stabilized during the quarter, and the company guided for loss rates to fall next quarter. We believe there is significant upside in the stock, as Alliance Data’s industry-leading profitability and growth rate shine through now that the cloud of rising credit losses has passed.
Outlook and Strategy
The S&P 500 posted a solid gain during the second quarter, increasing 3.43%. The market rose steadily through mid-June, as the U.S. economy posted strong GDP growth and the unemployment rate fell to 3.8%, an 18-year low. However, stocks ended the quarter on a weaker note, as investors worried about an escalating trade war between the world’s two largest economies, the U.S. and China.
We’re closely following President Trump’s trade actions, and we’re hopeful that cooler heads will prevail. Not only do the U.S. and China have a lot to lose if they pursue protectionist policies, but the global economy does as well. Trade tensions are coming at a time when we’re beginning to see cracks in the synchronized global growth that has benefited the market in 2017 and so far in 2018. Recent economic data has pointed to decelerating growth in Europe, while earnings growth for S&P 500 companies is expected to peak during the third quarter and meaningfully decelerate thereafter.
Despite the prospect of slower future growth, the S&P 500 Growth Index rose 7.4% during the quarter, continuing to outperform the S&P 500 Value Index, which increased just 2.9%. Growth has now outperformed Value for a rare sixth consecutive quarter. The S&P 500 Growth Index ended the quarter with a valuation of 19.1x forward earnings estimates, a 5.5x premium to the S&P 500 Value Index at 13.6x. This valuation gap is nearly the widest it’s been in the past 10 years, and more than double its 10-year average of 2.5x. We believe that valuations will revert toward their mean and that Value will rotate back into favor. When it does, we expect to benefit.
During the quarter, we were excited to initiate positions in three well-run businesses that we believe have great long-term potential. The first new holding is 3M (MMM, Financial), a leading global provider of diversified industrial products. We had the opportunity to buy this blue-chip company after a rare 20% drop, as investors panicked after 3M slightly reduced its 2018 earnings guidance due to weakness in the dental and automotive refinish markets. We aren’t fazed by the short-term blip, as 3M’s innovation engine and manufacturing expertise will be applied globally to diverse end markets to generate enviable long-term returns for shareholders.
We also invested in Zayo Group (ZAYO, Financial), a fiber-optic communications network owner. Zayo’s fiber network provides its customers with dedicated high-capacity, low-latency bandwidth. Zayo’s infrastructure is uniquely positioned to benefit from the unrelenting growth in data consumption.
The last newcomer to the Fund is telecommunications carrier T-Mobile (TMUS, Financial). This disruptive company has done a great job gaining market share and growing its free cash flow, and now it has an additional opportunity to create substantial value if its announced merger with Sprint is approved by regulators. We believe the future is bright at T-Mobile whether the company remains independent or merges with Sprint.
To make room for our new holdings, we sold several stocks during the quarter. We said goodbye to Expeditors International (EXPD, Financial), a logistics company specializing in international air and ocean deliveries, and semiconductor equipment manufacturer KLA-Tencor, primarily for valuation reasons after both stocks had big runs. We sold two dental businesses, Patterson Companies and Dentsply Sirona, as both have been dealing with a sluggish dental market. Additionally, Patterson has struggled with ongoing market share losses, while Dentsply Sirona faces an uncertain turnaround plan. Finally, we sold Nutrien, a fertilizer manufacturer, due to our concern that it would take longer than expected for fertilizer prices to rebound.
At quarter-end, the Fund remains underweight the technology sector because of the sector’s high valuation and elevated expectations. As a reminder, we do not have exposure to the energy and utility sectors due to our fossil-fuel-free mandate. We’re overweight the industrials, materials and telecommunication services sectors because we’ve been able to identify a number of competitively advantaged and increasingly relevant businesses whose stocks are currently on sale. The Fund remains overweight financials, as rising interest rates and less regulation should benefit the sector.
The first half of 2018 has been marked by increasing volatility and rising global trade tensions. We’re not market forecasters, so we don’t know the market’s next move, but we believe the Fund is well-positioned for the future. We remain focused on investing in socially responsible companies, and we’re confident that our time- tested stock selection strategy is poised to outperform.
Yours truly,
Robert J. Klaber Portfolio Manager
Ian E. Sexsmith
Portfolio Manager
