One of the most prominent trends recently in fund investments has been a focus on sustainable, responsible and impact investing (SRI) – an investment discipline that uses environmental, social and corporate governance (ESG) metrics to produce long-term portfolio returns and a positive impact on society. According to the Forum for Sustainable and Responsible Investment, SRI assets reached $6.57 billion in the U.S. in 2014, about 18 percent of the total assets under management. Evidence supporting the link between ESG criteria investing and corporate financial performance (CFP) is also growing. A 2015 study by Deutsche Asset & Wealth Management Investment and the University of Hamburg, Germany, has shown a positive correlation in 90 percent of the 2,200 individual studies analyzed. Mutual funds are particularly active in the ESG space, with the number growing to more than 450 and assets under management close to $2 trillion. Parnassus Investments is a long-established fund company that adopts the ESG investment principles in all of its six funds. Its flagship fund, the Parnassus Fund (PARNX), incepted on December 31, 1984, has done well by doing good, outperforming the S&P 500 Total Return Index and large-growth peers on a five-year, 10-year and 15-year basis according to Morningstar.
Overview
PARNX, the investor shares of the Parnassus Fund, invests across all capitalizations with almost 40 percent in medium, small and micro caps, holding around 40 stocks. Its stocks’ average market capitalization was $25 billion compared with the Russell 1000 Growth Index of $62 billion. About 88 percent was allocated to U.S. stocks, 5 percent to non-U.S. stocks and 6.8 percent to cash as of July 31, 2016. It has a four-star Bronze rating and the highest sustainability rating from Morningstar. Total assets reached $726.9 million on June 30, 2016. The minimum investment is $2,000, while the expense ratio is 0.84 percent, about 30 basis points lower than the Morningstar large-growth category average.
The fund invests across all the sectors but has traditionally been overweight in the technology sector compared with the benchmark and underweight in the utilities and energy sectors. This is not only because its headquarters are near Silicon Valley in San Francisco, but also because the fund’s technology companies lead many others in providing a good working environment.
Investment Strategy
Under lead manager Jerome Dodson’s stewardship, the fund has the stated objective of seeking capital appreciation, aiming to beat the S&P 500 Index with a high active share. The team first narrows down the investable universe using strict proprietary ESG criteria covering environment, governance, workplace, community and customers. As a result, the fund has had no stocks of companies related to alcohol, gaming, weapons, tobacco or nuclear power since 1984, and no fossil-fuel stocks since 2015.
The team also has a robust stock selection process, seeking companies that have strong competitive advantages for the long haul that allow them to make outsize profits (Warren Buffett’s “wide moats”); quality management teams that work for the shareholders’ best interests; and attractive valuation, usually contrarian.
The portfolio is concentrated with a stated position limit of 5 percent at cost. Each position is given a “core allocation” and “opportunistic capital” so that the fund dynamically adds to and subtracts from the stock position when the target price is reached or a better opportunity arises. The fund holds cash in the range of 1 to 10 percent.
Stock Selection
PARNX has outperformed its peers and the S&P 500 Index over the long term due to sector and individual security selections. The fund has traditionally focused on the technology sector with a significant overweight allocation of 34 percent in information technology compared with 20 percent in the S&P 500 Index, and a significant underweight allocation of zero percent in both energy and utilities compared with 7 percent and 4 percent, respectively, in the S&P Index as of June 30, 2016. It allocated only 3 percent to consumer discretionary compared with the index of 12 percent. The technology sector has become the largest sector in the S&P 500 Index and includes some of the world’s most valuable companies, such as Apple, Alphabet, Microsoft and Facebook.
With the cumulative outperformance of the S&P Growth Index by 33 percent and the S&P Information Technology Sector Index by 73 percent in the past 10 years over the S&P 500 Index, the PARNX fund has fared well against its peers and the benchmark. While this is a risk to the fund when the technology sector turns down relative to the index, the fund’s rigorous stock-picking discipline with strict ESG criteria may help mitigate this risk. One stock holding is Alphabet (GOOGL), which according to Dodson has a great moat, a good social story and model employee treatment, with generous maternity leave, fitness centers and time off for charitable events. While year-to-date the stock has trailed the S&P, it has a huge cash cushion, stable revenue, and an innovative and smart workforce, and it continues to be a long-term holding in PARNX.
Management Team
PARNX’s management team consists of Jerome Dodson, the founder of Parnassus Investments and portfolio manager of the fund since 1984; Ian Sexsmith, a portfolio manager since 2013; and Robert Klaber, a portfolio manager since 2016. The fund’s investment style is set by Dodson, who is a well-known technology analyst and has a career background that includes working in a nonprofit organization serving minority-owned businesses and at a bank that designed innovative products for depositors to invest in solar energy projects. While the other two portfolio managers have shorter tenure at the fund, they have both been senior research analysts with the firm since 2011 and 2012, respectively, with overlapping responsibilities across other funds’ teams. Given that Dodson is expected to retire as CEO in 2018 and to change some of his fund responsibilities, there appears to be enough lead time to mitigate the succession risk in this fund.
Performance
Based on Morningstar, year-to-date to August 26, 2016, PARNX has returned 6.07 percent per annum compared with the S&P 500 Total Return Index’s 7.67 percent and its large-growth peers’ 3.00 percent. The fund has underperformed the S&P 500 Index by 5.76 percent and 0.54 percent per annum on a one-year and three-year basis, but has outperformed its peers by 0.69 percent and 0.81 percent per annum in the respective periods. The fund has outperformed both the S&P 500 Index and its peers on a five-year, 10-year and 15-year basis, with a per annum return of 18.57 percent, 10.23 percent and 6.4 percent, respectively. The fund was rated Morningstar’s top-performing ESG fund in the 10-year period to June 30, 2016. The fund also ranks within the top 1 percent of the large-cap growth fund category during that period.
For the past five years to July 31, 2016, the fund has a 1.21 beta to the S&P 500 Index, with a higher standard deviation of 15.81 percent as compared with S&P’s 12.08 percent. While the fund has greater volatility, its 10-year upside capture ratio against the S&P 500 Index is 121 compared with 102 for its peers, according to Morningstar, which leads to the fund’s positive performance rating.
Conclusion
The Parnassus Fund (PARNX) combines ESG investment principles, portfolio concentration and value investing in Warren Buffett’s style, delivering outstanding long-term returns against the S&P 500 and its ESG and large-growth peers. It has one of the longest investment records – over 25 years – among ESG funds. The fund has navigated between the growth and blend styles with a traditional overweight in the technology sector given the manager’s expertise. Its sector concentration, higher volatility and potential succession issue are some of the risks to monitor. However, the firm’s investment philosophy of picking ethical and good social businesses with long-term competitive advantages that deliver good corporate performance at an undervalued price will help mitigate the risks mentioned above.