As of March 31, 2023, the net asset value (“NAV”) of the Parnassus Value Equity Fund (Trades, Portfolio) – Investor Shares was $45.92. The total return including dividends for the quarter was a gain of 1.44%. This compares to a gain of 1.01% for the Russell 1000 Value Index (“Russell 1000 Value”). We ended the quarter narrowly ahead of our benchmark after overcoming a major loss of one of our portfolio’s holdings, discussed within. The fact that we kept up with the benchmark despite the setback is a good example of why diversification remains an essential tool for risk management for the Fund.
On the left is a table that summarizes the performance of the Parnassus Value Equity Fund (Trades, Portfolio) and the Russell1000 Value over multiple time periods. The Fund trailed our benchmark over the one-year period, but remains substantially ahead over longer time horizons.
First Quarter Review
Two of our stocks detracted over 115 basis points each from the Fund’s total return this period. We’re disappointed to report that the equity of one of them, Signature Bank (SBNY, Financial), was wiped out completely in the regional banking crisis in March. On the other hand, our winners slightly more than made up for our losses. Each of our best performers contributed 37 basis points or more to the Fund’s return.
The Fund’s worst performer was our only regional bank stock, Signature Bank. It fell a shocking 100%, meaning the entire value of the company vanished in an instant when regulators seized the bank on a Sunday afternoon last month. The unexpected closure cost the Fund’s return 153 basis points (One basis point is 1/100th of one percent).
Signature’s stock plunged after Silicon Valley Bank (SIVBQ, Financial), a regional bank focused on start-up companies, failed suddenly on the morning of March 10 after massive losses on its bond portfolio caused a run on the bank. While Signature did not have the same investment losses or industry concentration as Silicon Valley Bank, its deposits were also concentrated in accounts that were above the federal $250,000 insurance limit. Signature’s client base of successful businesses and high net-worth individuals was highly attractive, as their deposit balances accumulated quicker, they used multiple products and they had less credit risk. Signature’s superior customer service earned them this client base, which had provided shareholders with faster growth and lower credit losses than most regional banks. Unfortunately, it also meant their desirable clients had other banking options and could move their money quickly in a crisis.
After the failure of Silicon Valley Bank, contagion spread to Signature and other banks, as their customers’ fear of losing money in a similar bank run created one. Signature disclosed as recently as March 9 that its deposits were increasing and that it was repurchasing its own stock thanks to its strong capital position, before a bank run on March 10 led regulators to close Signature on March 12. We do not have any remaining exposure to regional banks, as we are concerned that deposit outflows and rising deposit rates will reduce their future earnings power.
Relatedly, shares of Charles Schwab (SCHW, Financial) declined 36.9% in the quarter, cutting 115 basis points from the Fund’s total return. Typically, Schwab benefits as interest rates rise, as the company earns more interest on the cash clients hold in brokerage accounts. However, this time was different, as the accelerated arc of interest rate hikes from the Federal Reserve meant that it needed to find external sources of funds. This substantially reduced interest income. Later in the quarter, as regional banks became stressed, investors became concerned about the company’s holdings of mortgagebacked securities and Treasuries and the corresponding losses. We reduced our position in Schwab by nearly one-third early in the quarter on expectations that the first half of the year would be turbulent. We believe the stock will improve when earnings normalize and investors refocus on the company’s enduring franchise. The company’s net new asset growth accelerated during the regional banking crisis, demonstrating that the company has a trusted and differentiated platform.
Shares of vaccine and biotechnology company Moderna (MRNA, Financial)a fell 14.5%, reducing the Fund’s return by 34 basis points. The company’s financial and clinical results were mixed, which has increased uncertainty among investors as they try to weigh the magnitude of COVID-19 revenues rolling off. The company reported worse-than-expected flu data and is taking longer to readjust its pandemic-era cost base as it transitions to an endemic COVID-19 vaccine market. Despite these challenges, we continue to believe that Moderna’s pipeline is undervalued and see several catalysts, such as upcoming releases of RSV, influenza and rare disease data, that could drive the stock higher.
Our biggest winner was health care company Align Technology (ALGN, Financial). Its stock soared 58.4%, contributing 94 basis points to the Fund’s total return. Sales volume for Align’s product picked up for the first time in a year, prompting the company to reinstate quarterly guidance. The move eased investor concerns about a worst-case scenario for 2023 and caused the stock to jump by 27% that day. Looking ahead, we remain optimistic about Align’s ability to dominate its large markets, thanks to its focus on reinvesting in its strong competitive position through differentiated research and development "R&D". The company is undergoing its largest new product cycle in its 25-year history, which we think is a testament to the strength of its innovation.
FedEx (FDX, Financial) climbed 32.7% this quarter, contributing 56 basis points to the Fund’s total return. The transportation company provides a variety of forwarding and logistics services across its Express, Ground, Freight and Services segments. FedEx’s price increases and cost-cutting measures began to bear fruit, resulting in better-than-expected profitability in Ground. Freight was also a bright spot, with continued volume and margin expansion. This gave investors more conviction that FedEx can employ the same margin-accretive measures in Express, which is FedEx’s biggest segment by sales and a sore point among investors. As FedEx continues to raise prices and cut costs, we are looking for more stability in profits and resiliency in operations.
Microsoft’s (MSFT, Financial) shares appreciated 20.5%, adding 37 basis points to the Fund’s total return. Positive sentiment around generative artificial intelligence (AI)‘s capacity to drive future growth and expand Microsoft’s moat outweighed weaker-than-expected deceleration in Azure growth guidance during the quarter. Microsoft remains the dominant global enterprise software platform—offering a unique mix of offense and defense. Technological leadership and the sheer breadth of of its productivity suite enable the company to not only win across secular IT growth spaces like cloud, but also benefit from vendor consolidation when budgets contract.
Outlook and Strategy
During the first quarter, stocks continued their strong recovery from the lows of last year. The pace of inflation is moderating while consumer spending remains resilient. This has boosted investor sentiment, but gains in stock prices have not been uniform across the market. Growth stocks significantly outperformed their value peers, driven by expectations for interest rate cuts. The crisis in regional banks has made investors question the Fed’s resolve in keeping rates higher for longer. It’s likely the Fed may disappoint investors counting on an imminent fall in interest rates, as inflation is still well above the Fed’s 2% target while the unemployment rate is at multi-decade lows. The Fed’s actions to tame inflation could eventually also impact consumer spending and corporate earnings. In this uncertain environment, the Value Equity Fund is taking a balanced approach and positioning the portfolio for both downside protection and upside capture.
The Fed’s tightening cycle so far has had two primary casualties: unprofitable growth companies and banks with low-yielding bond portfolios. While there is much debate about the next shoe to drop, the Value Equity Fund is navigating the current investing landscape with a playbook that has served us well since the Fund’s inception in 2005. We focus on identifying and owning companies with a track record of emerging stronger from different market environments. Periods of uncertainty, like the one we’re facing today, also present value investors with bargain opportunities that are harder to come by during bull markets.
To that end, the Fund initiated new positions in CME Group and Baxter International. CME is the world’s largest derivative exchange. CME should benefit from increased demand for interest rate hedging spurred by the recent banking crisis and ongoing uncertainty around the direction of rates. Additionally, the company is expanding globally, is launching new products and helps the Value Equity Fund with commodities exposure through its commodity futures trading business. Baxter International, established in 1931, makes products to treat kidney diseases and sells a variety of injectable therapies. Their products have durable market positions and are essential treatments with low cyclicality. The company’s stock took a hit due to an ill-timed acquisition and execution missteps amplified by supply disruptions in 2022. Management has announced plans to split the business and sell assets to simply operations and bring down leverage. We believe these steps should improve execution and sentiment on the stock over time.
We completely exited two stocks, including Signature Bank, and significantly reduced our positions in several others. In January, we sold our shares in Vertex Pharmaceuticals at a profit of over 50%. We were attracted to the company’s net cash balance sheet and core cystic fibrosis franchise, so were delighted to buy in after a series of drug development failures sent the stock to bargain levels in June 2021. Investors now assign full value to both Vertex’s robust pipeline and core businesses, so we exited the stock at a price close to its all-time highs. Among our trims, we pared our holding in Schwab by approximately 33% prior to its dramatic sell off, as previously discussed. We stayed invested in, but at lower levels, our top winners—including Align and FedEx due to their cyclicality and outperformance.
We manage the portfolio according to a set of principles, which the above examples are intended to demonstrate. First, we are bottom-up fundamental stock pickers at heart. Added to that is a layer of risk management that balances the trade-offs between concentration and diversification. Finally, there is scaffolding around process designed to highlight our portfolio’s exposures and positioning relative to our benchmark. As we saw in this quarter, no process is foolproof. However, we believe the risks of investing, if managed by experienced professionals, can handsomely reward the patient investor over the long term.
Thank you for your investment in the Parnassus Value Equity Fund (Trades, Portfolio).
Billy J. Hwan, Lead Portfolio Manager
Krishna S. Chintalapalli, Portflio 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.
