As of June 30, 2023, the net asset value (“NAV”) of the Parnassus Value Equity Fund (Trades, Portfolio) – Investor Shares was $47.38. The Fund’s total return for the second quarter was a gain of 3.18%. This compares to a gain of 4.07% for the Russell 1000 Value Index (“Russell 1000 Value”). We lagged the benchmark by a little less than one percent this quarter, mainly because our defensive positions failed to keep up in a rising market. For the year to date period, the Parnassus Value Equity Fund (Trades, Portfolio) –Investor Shares posted a gain of 4.66%, compared to the Russell 1000 Value’s gain of 5.12%.
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. The Fund trailed our benchmark over the one-year period but remains substantially ahead over longer time horizons.
Second Quarter Review
Three of our stocks each detracted 0.3% or more from the Fund’s total return this period. Two hail from different corners of the Health Care sector, while the third posted losses due to a turbulent retail environment. Each of our top three performers contributed 0.4% or more to the Fund’s total return, with software companies accounting for two of these winners. Overall, while our technology investments boosted returns, these gains were offset by our defensive positioning within Health Care, Consumer Staples and Insurance.
Our worst performer this quarter was Target (TGT, Financial). Its stock dropped 19.8% and clipped 0.5%* from the Fund’s total return due to fears that weakening consumer demand and a highly politicized retail environment will hurt sales. In May, conservative criticism of Target’s Pride-themed merchandise exploded into a backlash that included threats of violence, ransacking of stores and a popular song calling for a boycott. Liberal groups then took issue with management’s decision to pull certain Pride items and to relocate displays to the back of the store to protect the safety and well-being of store employees. Of even more concern, Target called out a $500 million loss from shrink, which involves theft of merchandise perpetrated by organized retail crime groups. Although these problems are scary, we believe the stock reaction is overdone. Long term, the company has continued to gain share based on its inviting store network, multi-category portfolio, top-rated owned-brands and data-driven investments in customer engagement.
Moderna (MRNA, Financial) fell 20.9%, cutting 0.5% from the Fund’s total return. While the company released positive first quarter financials, negative sentiment continues to grow as the company guided to a COVID-19-delivery low in the second quarter. Uncertainty around Moderna’s COVID-19 revenues, as well as what the company’s expense profile will look like going into next year, has depressed the stock. We believe there are enough potential offsets to the declining COVID-19 business going into 2024, such as future RSV and flu vaccines. Moderna is also showing promising data in other parts of its large pipeline, such as its combination respiratory vaccines, personalized cancer vaccine and other therapeutic protein indications.
Agilent Technologies’ (A, Financial) stock dipped 12.8%, reducing the Fund’s return by 0.3%, after management cut its revenue guidance slightly. The company is not alone in seeing a slowdown in pharma spending, driven by a normalization of analytical instrument demand and a constrained biotech funding environment impacting smaller customers. Nonetheless, we believe Agilent remains a quality compounder now trading at an attractive price, as the company continues to gain market share in an industry with very high switching costs. The Agilent story still has several idiosyncratic drivers that could drive upside to earnings expectations, such as PFAS and lithium-ion battery testing, as well as RNAi oligonucleotide manufacturing. We also believe the company continues to have a long runway of consistent margin expansion as it increases the attach rate of high-margin consumables and services within its large installed base of instruments.
The largest contributor to performance this period was enterprise software company Oracle (ORCL, Financial). Oracle appreciated 28.7% in price, adding 0.8% to the Fund’s total return. The market’s narrative around Oracle has shifted from a safe harbor amid weaker enterprise IT spending to a longer-term growth story. The company has successfully begun to reaccelerate top-line growth by transitioning customers from on-premise to cloudbased services. This growth renaissance should prove more durable than the market believes-driven largely by Oracle’s Cloud Infrastructure business that can keep growing rapidly and take share in the global public cloud market.
D.R. Horton’s (DHI, Financial) stock surged 24.9%, adding 0.7% to the Fund’s total return as the second-largest contributor. The largest home builder in the United States delivered better-than-expected earnings, driven by solid demand and strong pricing for new homes. The company saw an encouraging start to the spring selling season and limited home inventory nationwide, benefiting new home sales relative to existing ones. We remain excited about the company’s long-term growth prospects, as it benefits from its significant scale, additional share gains, a strong balance sheet and a long runway to consolidate smaller builders.
Finally, the share price of Microsoft (MSFT, Financial) increased 18.4%, boosting the Fund’s return by 0.4%. Positive sentiment around generative AI’s capacity to drive future growth continued to outweigh near-term concerns over decelerating Azure growth. Microsoft remains the dominant global enterprise software platform providing both an offensive and defensive role for the portfolio. The company’s technological leadership and breadth of its productivity suite enable it to not only win in secular growth areas like cloud, but also benefit from vendor consolidation in this environment of weaker IT spending.
Outlook and Strategy
As measured by the S&P 500, U.S. stocks have fully recovered their losses after the Fed began raising interest rates over a year ago. The much-anticipated recession from higher borrowing costs hasn’t arrived yet. Consumer spending remains resilient as unemployment is at multi-decade lows and wage growth is robust. Advances in generative AI are fueling investor optimism about a new era of worker productivity and corporate opportunity. The current macroeconomic backdrop is in stark contrast to earlier expectations for a severe downturn from potential impacts of higher interest rates, supply chain disruptions and high energy prices. While inflation is gradually moderating and economic growth is indeed slowing, it is far from certain whether the so-called hard-landing or soft-landing scenario is the more likely outcome over the coming months.
This divergence in macroeconomic outcomes from prior expectations is a reminder of two important decisions investors face-timing and time horizon. As stewards of your capital, we remain vigilant about macroeconomic risks, but our fundamental bottom-up driven investment process avoids undue reliance on timing macroeconomic changes. We invest with a longterm time horizon that helps us tide over short-term changes in the economy, and resist waiting for the perfect time to buy and sell stocks, as that is often only obvious in hindsight. We buy stocks when we find bargains and sell when the risk-reward is no longer attractive.
As active managers, we’re focused on assessing whether portfolio companies are prudently planning for a range of economic scenarios, not just a specific one. At the portfolio level, we’ve applied a similar measure of risk management in our positioning. We are overweight select Financials and technology stocks, which should do well if the economy avoids a hard landing, while our overweight positioning in Health Care and telecommunications stocks should hedge capital in the event of a major economic downturn.
In the second quarter, we initiated new positions in Fidelity National Information Services (FIS) and Adobe. FIS is a financial transaction technology provider. The company’s stock took a hit due to concerns about exposure to regional banks and weak performance in its payments processing business. However, the company’s revenue from regional banks is highly recurring and should continue to grow as regional banks invest more in technology to defend market share. FIS is also divesting its payments processing business, which should help strengthen its balance sheet.
Adobe is the world’s largest maker of design software. Concerns about the impact of generative AI on its business provided us the opportunity to buy this quality franchise trading off-price. We believe Adobe should be a leading beneficiary of generative AI adoption due to its strong incumbent position and early investments in AI that should be even more evident in upcoming product releases.
We also reinitiated a position in the semiconductor company Intel. The company slashed its dividend to reduce cash burn as it invests to regain competitiveness, and new management’s turnaround plans are showing early signs of success. Intel should also benefit from a recovery in demand for PC and Server CPUs next year, which slumped coming out of the pandemic.
To fund these purchases, we sold Apple at a substantial gain, and booked profits in Paychex and Accenture. These companies now trade at elevated valuations, which reflect high investor expectations relative to fundamentals.
Finally, our benchmark, the Russell 1000 Value, is reconstituted every year in June. Meta (formerly Facebook), Alphabet, Home Depot and Starbucks are well-known companies that exited the benchmark. Union Pacific, Nike and Estee Lauder are notable new additions. Changes in the benchmark, however, do not affect our time-tested investment process. We look for bargains across the entire universe of investable stocks to generate attractive, long-term, risk-adjusted returns for our 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.
