As of December 31, 2022, the net asset value (“NAV”) of the Parnassus Value Equity Fund (Trades, Portfolio) - Investor Shares was $45.27, so after taking dividends into account, the total return for the year was a loss of -13.81%. This compares to loss of -7.54% for the Russell 1000 Value Index (“Russell 1000 Value”). It was a challenging year for the Fund, because we avoided energy stocks, which soared, and held technology stocks, which slumped. The double whammy caused the Parnassus Value Equity Fund (Trades, Portfolio) - Investor Shares to lag our primary benchmark by 627 basis points. (One basis point is 1/100th of one percent.) The Fund’s well-timed pivot into healthcare stocks significantly enhanced returns, but it was not enough to offset losses.
On the left is a table that summarizes the performance of the Parnassus Value Equity Fund (Trades, Portfolio) and the Russell 1000 Value over multiple time periods. While we trailed our benchmark last year, the Fund’s returns remain highly competitive over the three-year and longer periods.
Year in Review
Each of our three largest detractors reduced the Fund’s return by 1.0% or more. These stocks suffered a bust in consumer demand coming off stimulus-driven highs. Our three biggest contributors each added 0.6% or more to the Fund’s return. Pharmaceutical and biotechnology companies, just added in 2021, dominated the winners list.
Our biggest loser was Western Digital (WDC, Financial), a memory semiconductor company. Its stock sank -51.6% subtracting -1.5%* from the Fund’s total return. Rapid decline in demand for consumer electronics post COVID-19 and inventory buildup at customers significantly depressed pricing for memory chips. We increased our position, as we believe that the industry glut will turn to shortage and lift pricing once inventories have been depleted and demand growth returns. The company is undervalued and stands to benefit if the trend of industry consolidation continues.
Hanesbrands (HBI, Financial) slipped -58.5% cutting -1.4% from the Fund’s total return. The company is a leading provider of basic apparel, including underwear, socks, T-shirts and activewear under various brands including Hanes, Champion, Playtex, Bali and Bonds. This year’s extraordinarily difficult retail environment buffeted Hanesbrands, which was also felled by a ransomware attack that crippled operations. Investors fled the stock following slowing customer demand, higher costs to reduce excess inventory and the negative impact of the strong U.S. dollar on global sales. We sold our shares over concerns that the company’s high debt load would force management to cut the dividend or raise additional capital.
VF Corp. (VFC, Financial) sank -60.4%, detracting -1.3% from the Fund’s total return. The apparel and footwear company owns a portfolio of lifestyle brands, including North Face, Timberland, Vans and many others. Shares suffered their worst annual performance in over 20 years due to company missteps amid heightened macro uncertainty. Management lowered their outlook three times in three months, as U.S. sales slowed with the end of stimulus payments, inflation waylaid European consumers and Chinese sales collapsed under COVID-19-lockdowns. Moreover, an inventory glut, unfavorable foreign exchange, and an impairment charge on the company’s earlier purchase of streetwear brand Supreme all weighed on profitability, culminating in the retirement of the company’s long-time CEO. We held our shares, encouraged by the company’s efforts to revitalize Vans and by evidence that problems related to inventory, freight and inflation are beginning to abate.
Our top position and biggest winner was global biopharmaceutical company Merck (MRK, Financial). Its stock surged 44.8%, contributing 1.8% to the Fund’s total return. Merck’s steady cash flow and consistent execution made it a defensive haven this year among large capitalization pharmaceutical stocks. We remain confident in the company’s current pipeline and its ability to extend cancer drug Keytruda’s patent protection, HPV vaccine Gardasil’s growth and M&A capabilities. Moreover, Merck trades at a reasonable valuation while offering a healthy 2.5% dividend yield.
Vertex’s (VRTX, Financial) share price climbed 31.5%, adding 0.7% to the Fund’s total return. Vertex’s cystic fibrosis business continues to grow nicely, with the company gaining approval in new geographies and for treatment of younger age groups. Vertex is in late-stage trials for its next-generation triple-combination therapy for cystic fibrosis, as well as for a potential mRNA delivery mechanism with Moderna. Vertex also had positive pipeline news on its sickle cell and beta thalassemia partnership with CRISPR and phase II acute pain data. We continue to think Vertex is an innovative biotechnology company with a strong management team and attractive cash position. The stock’s valuation should move higher given the company’s dominant cystic fibrosis franchise and diversified pipeline.
Gilead Sciences (GILD, Financial) jumped 23.6% last year, boosting the Fund’s total return by 0.8%. The biopharmaceutical company has dominant franchises in HIV and hepatitis C medicines. Gilead’s PrEP market for preventative care is driving growth for the company’s monopolistic HIV franchise. Additionally, Gilead had a positive readout in its growing oncology franchise. Although oncology remains a highly competitive therapeutic area, we believe it represents an attractive option for the company at its current low valuation. Given today’s uncertain macro environment, we like Gilead’s steady execution, dividend yield and cash flow.
Outlook and Strategy
Inflation hammered stocks and bonds in 2022. Massive pandemic stimulus by the U.S. government, mixed with disrupted global supply chains, lit the flame of inflation, but Russia’s war on Ukraine set it ablaze through higher energy prices. The Federal Reserve responded to inflation belatedly, but forcefully, and raised interest rates higher and faster than at any point since the 1980s. Higher rates make borrowing more expensive for businesses and consumers. They depress the real economy with a lag, yet they take down the value of financial assets immediately. Fortunately, recent economic data indicate that the pace of inflation is moderating. One of the biggest investor debates today is whether the Fed will be able to tame inflation without causing a deep recession, the so-called “soft landing.”
In this highly uncertain investing backdrop, we adhere to our disciplined process of bottom-up, fundamental stock selection. We begin with what the market is already telling us. We focus our attention on areas with the biggest mis-pricings or misunderstandings. We look deeply at companies to understand what the key debates are, and home in on where quality may be overlooked. Finally, we invest for the long term. The current sell-off in stocks is unpleasant, but we are cautiously optimistic, because the seeds of the next market rally are likely being planted today.
To that end, the Fund initiated four new positions in the fourth quarter. Citigroup is a leading U.S.-based commercial and investment bank. CEO Jane Fraser has been restructuring the bank for years, including scaling back international operations to improve profitability. International Flavors & Fragrances makes the key ingredients that define hundreds of the world’s most beloved foods and scents. Under new management, the company is also divesting underperforming assets in pursuit of higher future returns. We bought shares in Target Corp., a major U.S. retailer, and Align Technologies, maker of Invisalign braces. Both companies’ stocks fell due to worries about a recession that could dent consumer spending. We believe these issues are short-term in nature, and that these businesses are poised to take share in their respective end markets longer term.
To fund these purchases, we sold Discover Financial at a substantial gain, as well as Becton Dickinson, which outperformed the broader market. We harvested tax losses with the sale of Hanesbrands, as previously discussed. Our continual aim is to recycle capital from our outperformers to undervalued stocks. When the market is down, as it is now, there are fewer outperformers and more undervalued stocks, and the number of positions tends to increase slightly.
This year is likely to carry forward several cross currents from the past year and present new macroeconomic uncertainties. We remain confident that our time-tested process and deeply committed investment team position us well to navigate these challenging times. Your portfolio managers have over 25 years of combined value-investing experience, which we bring to bear every day with the goal of generating attractive risk-adjusted returns for our long-term shareholders.
Thank you for your investment in the Parnassus Value Equity Fund (Trades, Portfolio).
Billy J. Hwan
Lead Portfolio Manager
Krishna S. Chintalapalli
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. Returns would have been lower if certain of the Fund’s fees and expenses had not been waived.
