As of September 30, 2023, the net asset value (“NAV”) of the Parnassus Mid Cap Growth Fund – Investor Shares (“the Fund”) was $49.59, resulting in a loss of 1.16% for the third quarter. This compares to a loss of 5.22% for the Russell Midcap Growth Index (“Russell Midcap Growth”).
Third Quarter Review
The market fell 5.22% during the third quarter, as the Russell Midcap Growth took a step back after a strong first half of the year. The Fund fell 1.16% during the third quarter, outperforming the index by 406 basis points. (One basis point is 1/100th of one percent.). The Fund rose 17.29% through the first three quarters of 2023, 741 basis points ahead of the Index's 9.88% gain.
During the third quarter, sector allocation had a negative impact on the Fund's relative performance. The Energy sector was the benchmark's bestperforming sector, and the Fund's lack of exposure to fossil fuels* hurt relative returns. Over a full business cycle, we feel confident that our collection of innovative businesses can outperform these commodity producers. Stock selection was meaningfully positive and more than offset the drag from Energy, as we generated 75 basis points or more of positive stock selection in four sectors: Information Technology, Health Care, Consumer Discretionary and Industrials.
Cyber-security provider Fortinet Inc. (FTNT, Financial) was our worst performer during the quarter, subtracting 0.8%** from the Fund's performance, as its shares fell 22.4%.
Fortinet lowered its billings guidance for the year as demand for its firewalls has slowed after growing rapidly since 2021. Now, Fortinet expects that it will take up to a year for its billings growth to return to a high-teens rate, as customers grow into their past purchases and its distribution partners work through excess inventory. We were disappointed by the setback, but Fortinet remains a competitively advantaged leader in an attractive industry. We believe the stock will return to its prior levels as growth eventually re-accelerates, so we added to the position.
Consumer data provider Equifax Inc. (EFX, Financial) reduced the Fund's performance by 0.6%, as its shares fell 22.0%. Equifax cut its financial guidance for the year because mortgage applications have fallen dramatically due to the steep rise in interest rates. Mortgage volumes in 2023 are running 40% below 2015–2019 levels and have fallen by two-thirds from their recent peak in 2021, so we don't think there is much room left to fall. Equifax's mortgage revenues have historically outperformed the mortgage market, as the company adds employment records, which increase the value of its data and allow it to gain market share. So, even if mortgage volumes remain flat with currently depressed levels, the company should generate solid growth next year. And whenever the mortgage market rebounds, Equifax should be a primary beneficiary. We took advantage of the stock's decline and added to the position.
CoStar Group Inc. (CSGP, Financial), a leading operator of online real estate marketplaces and data services, subtracted 0.5% from the Fund's return, as the stock dropped 13.6%. CoStar reduced its annual revenue guidance by 1% due to a decline in commercial real estate transaction volumes, especially in the office market. The company is diversified across property types, and the stock drop was disproportionally worse than the guidance reduction, so we added to the Fund's position.
The Fund's biggest winner this quarter was enterprise software provider Splunk Inc (SPLK, Financial). The company's shares jumped 37.9%, adding 1.6% to the Fund's return. Splunk's shares rallied after the company raised its annual financial guidance, as Splunk gained traction cross-selling its suite of data monitoring software to its loyal base of customers. Later in the quarter, the stock jumped after Splunk agreed to be acquired by Cisco (CSCO, Financial) for $157 per share. Splunk was our largest position due to our conviction that the company's revenue growth was resilient, its margins had significant room to expand and its valuation was attractive. We're pleased that Cisco agreed with our analysis.
Insurance software provider Guidewire Software Inc. (GWRE, Financial) added 0.7% to the Fund's return as its stock rose 18.3%. Guidewire finished its fiscal year with better-than-expected revenue and operating margins. The company also provided an upbeat outlook for its next two fiscal years, highlighting its predictable and durable revenue growth as well as its margin expansion opportunity.
Financial data and analytics provider Morningstar Inc. (MORN, Financial) saw its shares rise 19.7%, adding 0.5% to the Fund's performance. Morningstar has built an enviable franchise because its management team invested heavily to drive growth. After several years of margin compression, Morningstar's management team pivoted its focus to productivity enhancements and operating leverage, and investors cheered this renewed focus on profitability.
Outlook and Strategy
After a strong first half of the year, the Russell Midcap Growth fell 5.2% in the third quarter. While economic growth continued to be stronger than expected, stocks are forward looking, and a number of risks moved into focus during the quarter. First, China's economy, the second largest in the world, has been weaker than expected. Next, the Federal Reserve signaled that it expects to raise its benchmark Fed Funds rate again later this year and then hold the rate at a higher level for longer. Additionally, oil prices are rising again and ended the quarter near year-to-date highs. The combination of higher interest rates and oil prices could pressure consumer spending, impair corporate profit margins and inflate government deficits.
However, offsetting these headwinds is the revolutionary potential of artificial intelligence and an emphasis on re-shoring America's manufacturing base. The core inflation rate also continues to decelerate. And the Russell Midcap Growth still trades 26% below its late 2021 peak, so there is a lot of room for the index to recapture its lost ground. We see a wide range of outcomes and we are fundamental stock pickers, not market timers, so we aren't trying to predict what the market will do next. Over the long term, we believe that our portfolio of high-quality growth compounders— innovative companies that can gain market share with expanding moats and clean balance sheets—should outperform regardless of the economic environment.
We began 2023 with 40% of the Fund's portfolio in information technology companies, as we saw a unique opportunity to invest in the secularly advantaged software and semiconductor industries after both meaningfully underperformed in 2022. Our overweight positioning has paid off this year, as they've rallied meaningfully. While we're still overweight due to our conviction in our technology companies' growth opportunities and resilient business models, we've reduced our weighting by more than 10 percentage points since the start of the year.
During the quarter, we further diversified the portfolio with the proceeds of our information technology trims, initiating six new positions across four sectors while exiting one stock during the quarter.
We sold Illumina Inc. (ILMN, Financial), the largest provider of gene-sequencing instruments and related consumables. While the company enjoys an enviable leadership position, disruptive new entrants and funding pressures are reducing demand for its instruments. We used the proceeds from the Illumina sale to invest in Repligen (RGEN, Financial), an innovation leader and consistent marketshare gainer in the bioprocessing industry. Repligen's products enable drug development by making the process more efficient, so a drug can come to market faster with lower costs. The bioprocessing market is an attractive, though cyclical, industry, so we took advantage of a downturn to invest in Repligen at a discounted price. Additionally, we invested in another health care company, Alnylam (ALNY, Financial) Pharmaceuticals, Inc., that we had invested in profitably before. Its shares have meaningfully underperformed this year, but we think the company's unique RNAi technology platform should enable it to bring innovative drugs to the market in therapeutic areas like cardiomyopathy and hypertension.
We also introduced two competitively advantaged industrial businesses to the portfolio. Trane Technologies plc (TT, Financial) is a manufacturer of heating, ventilation and cooling (HVAC) systems. The HVAC industry should benefit from secular tailwinds driven by global warming and the need to reduce emissions. As the technology leader, we expect Trane to gain market share while attaching recurring, higher-margin services revenue. Copart Inc. (CPRT, Financial) operates the leading marketplace for salvage vehicles. Copart has invested heavily to attract a deep pool of sellers with its differentiated services, creating an economically resilient, highmargin and competitively advantaged business. As the costs of repairing a damaged car continue to rise alongside increasing vehicle complexity, we expect auto insurers to turn to Copart more often to minimize their claims losses.
We also invested in LPL Financial Holdings Inc. (LPLA, Financial), a wealth management platform. LPL's superior technology is gaining market share by attracting both individual registered investment advisors and entire enterprises, like Prudential Financial (PRU, Financial), to its platform. LPL is also a beneficiary of higher interest rates, as it earns a spread on its clients' cash balances.
Last but not least, we invested in off-price retailer Ross Stores Inc. (ROST, Financial). Ross should benefit as consumers increasingly seek out value. We also see meaningful upside potential to earnings if Ross's operating margins recover toward its pre-Covid levels.
We've put together a portfolio of high-quality companies that are leaders in attractive industries. We invest in stocks when they're trading at reasonable valuations relative to their growth rates, margins and financial leverage. And we move quickly to take full advantage of the opportunity when secular winners are cyclically underperforming.
Thank you for the trust you place in us to manage your investment in the Parnassus Mid Cap Growth Fund.
Yours truly,
Ian E. Sexsmith Robert J. Klaber
Lead Portfolio Manager Portfolio Manager
Mutual fund investing involves risk, and loss of principal is possible. The Fund's share price may change daily based on the value of its security holdings. Stock markets can be volatile, and stock values fluctuate in response to the asset levels of individual companies and in response to general U.S. and international market and economic conditions. The Fund invests in small and/or mid cap growth companies, which are generally riskier than larger companies, and the Fund's share price may be more volatile than funds that invest in larger companies. The adviser may be wrong in its assessment of a company's potential for growth, and the growth stocks the fund holds may not grow as the advisor anticipates. In addition, there are periods when investing in growth stocks falls out of favor with investors and these stocks may underperform. Security holdings in the fund can vary significantly from broad market indexes.
Beta measures the sensitivity of an investment to the movement of its benchmark. A beta higher than 1.0 indicates the investment has been more volatile than the benchmark and a beta of less than 1.0 indicates that the investment has been less volatile than the benchmark. Free cash flow (FCF) represents the cash a company can generate after accounting for capital expenditures needed to maintain or maximize its asset base. Forward Earnings is an estimate of a company's earnings for upcoming periods, usually the completion of the current fiscal year and often the following fiscal year. Forward Sales is an estimate of a company's expected sales over the next 12 months. Price/Book (P/B) Ratio is the ratio of a stock's latest closing price divided by its book value per share. Return on Capital Ratio (or return on invested capital) is a ratio used to measure the profitability a company relative to the amount of capital invested by shareholders and other debtholders.
ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) GUIDELINES: The Fund evaluates financially material ESG factors as part of the investment decision-making process, considering a range of impacts they may have on future revenues, expenses, assets, liabilities and overall risk. The Fund also utilizes active ownership to encourage more sustainable business policies and practices and greater ESG transparency. Active ownership strategies include proxy voting, dialogue with company management and sponsorship of shareholder resolutions and public policy advocacy. There is no guarantee that the ESG strategy will be successful.
The Parnassus Funds are fossil fuel-free funds, meaning they do not invest in companies that derive significant revenues from the extraction, exploration, production or refining of fossil fuels; the Funds may invest in companies that use fossil fuel–based energy to power their operations or for other purposes.
The Russell Midcap® Growth Index is a widely recognized index of common stock prices. The Russell Midcap Growth Index measures the performance of the mid cap growth segment of the U.S. equity universe. It includes those Russell Midcap® Index companies with higher price-to-book ratios and higher forecasted growth values. An investor cannot invest directly in an index. Index performance includes the reinvestment of dividends and capital gains. An index reflects no deductions for fees, expenses or taxes.
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The Parnassus Funds are distributed by Parnassus Funds Distributor, LLC.
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.
