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An Attractive Choice Among ESG Funds

Bronze-rated Parnassus Fund’s record of excellent stock-picking and a strong environmental, social, and governance focus outweigh succession questions.

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The following is our latest Fund Analyst Report for Parnassus Fund (PARNX). Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

An experienced lead; a proven process; a strong environmental, social, and governance focus; and a record of excellent stock-picking give this fund an edge. It has generated a strong long-term record, but succession questions remain. The fund earns a Morningstar Analyst Rating of Bronze.

Firm founder Jerome Dodson has guided the fund since 1984, and his importance can't be understated. He has built a robust team at Parnassus and has a good track record launching funds and developing managers to run each portfolio. Silver-rated funds  Parnassus Core Equity (PRBLX) and  Parnassus Mid-Cap (PARMX) exemplify this. But Dodson's retirement is a possibility, and the additional managers on this fund, Ian Sexsmith and Robert Klaber, are light on tenure. That said, the duo owns day-to-day management of the fund, including the sell decisions. Dodson still serves as sounding board and mentor on new stock ideas, which is sensible given his experience. Sexsmith and Klaber have done a fine job over a short period, demonstrating increased responsibility for the investment process and increasing personal ownership in the fund--both positives.

The team narrows its investable universe using a rigorous ESG research process. Then it invests based on company fundamentals, valuation, and perceived long-term competitive advantages. The resulting portfolio has about 40 stocks, so a few names can have a significant impact on performance. The fund also carries sector-specific risk, being traditionally overweight in technology stocks. But strong stock-picking and a robust process have offset both risks.

Parnassus has carved out an attractive niche in the ESG space. In a peer group of socially conscious large-growth and large-blend funds, the firm's large-cap offerings have top-tier long-term performance and fair fees. There aren't competitors with similar conviction and portfolio concentration that compete with the funds on every front. The fees on the institutional shares of Parnassus are competitive even with some socially conscious index funds.

Process Pillar: Positive | Wiley Green 07/24/2017
This fund doesn't hug a benchmark. It resides in the large-growth Morningstar Category, but 32% of its holdings are mid- or small-cap stocks. Its average market cap of $30 billion is less than half the benchmark Russell 1000 Growth's. The fund owns stocks in all nine sections of the Morningstar Style Box and has roamed between growth and blend over time. Sector weightings are limited to 3 times the S&P 500's, but there is no minimum. The managers have given perpetual underweightings to utilities and energy and an overweighting to technology.

The team narrows the investable universe with proprietary ESG criteria that have made the firm a leader in the growing ESG space. The managers check firms in five areas: environment, governance, workplace, community, and customers. This process uncovers consciously managed companies instead of just identifying known rotten eggs. As a result, this fund has an above-average Morningstar Sustainability Rating. The fund has avoided fossil fuel stocks since February 2015.

Next, the team seeks companies with strong competitive advantages, exemplary management teams, and attractive valuations. The latter shines through in the value measures, all of which are well below the Russell 1000 Growth's. Further, the fund's P/E and price/book ratios are lower than the S&P 500's. Most of its stocks' Morningstar Stewardship Ratings are Standard or Exemplary.

This fund's managers invest with conviction. Positions have a stated limit of 5% at cost, but this was eclipsed when the team added to a 6% position in Altera before a published acquisition by  Intel (INTC), and a quarter later the position had grown to 9%. This type of weighting is anomalous, but stock-specific exposure is high. Comanagers Ian Sexsmith and Robert Klaber have demonstrated conviction through stock sells as well. Since July 2017, the pair has shed names like  Applied Materials (AMAT),  Qualcomm (QCOM), and  American Express (AXP), which are still owned in firm founder Jerome Dodson's solo-managed fund,  Parnassus Endeavor (PARWX).

Every holding in the fund has a "core allocation" and "opportunistic capital," the latter of which may be adjusted when market prices change or a better investment arises. Management's treatment of the  eBay (EBAY) spin-off of  PayPal (PYPL) in 2015 is a good example of both types of allocation. Post-split, the team has retained its position in PayPal with little adjustment, but it sold out of eBay a month after the deal. EBay's stock depreciated meaningfully, reaching a bottom in February 2016. The team reinitiated a "core allocation" to the stock in March 2016 and added opportunistically in April. It was a smart move--eBay has since appreciated handsomely.

Positions may be taken and adjusted aggressively, and cash reserves are volatile within a band of 0% to 10% of assets.

Performance Pillar: Positive | Wiley Green 07/24/2017  
The fund has good long-term performance. It beats the Russell 1000 Growth Index and nearly all its large-growth category peers in the five- and 10-year periods. The fund's risk-adjusted performance is less convincing but still solid. It lands in the category's top quartile over the long term but lags the benchmark in the three- and five-year periods. The fund has been more volatile than its category peers and has fared a bit worse in downdrafts, but it has more than offset that with strong gains in buoyant markets. Its 10-year upside capture ratio against the S&P 500 is 124, compared with 103 for the typical fund in the large-growth category. The fund earns a Positive Performance rating.

It doesn't closely track its prospectus benchmark, the S&P 500. Both individual stock selection and sector weightings drive the performance of the fund relative to that benchmark. Individual stock selection is the primary driver of returns, but the fund has benefited over the past 10 years from a favorable environment for its growth style and technology sector overweighting. Since July 2007, investable proxies for the U.S. growth market and the technology sector have beaten the S&P 500.

People Pillar: Positive | Wiley Green 07/24/2017  
Jerome Dodson has been running the fund since its 1984 inception. He also manages Parnassus Endeavor and eats his own cooking--his ownership level in the funds he manages is over $1 million.

Dodson has a capable but relatively new pair of comanagers. Ian Sexsmith began managing the fund in May 2013. He has held the role of senior research analyst at Parnassus since 2011 and was previously a Parnassus intern. Robert Klaber joined as a manager in May 2016. He also holds the title of senior research analyst and has been a member of the Parnassus research staff since 2012, working primarily on the Parnassus Core Equity. Before 2012, he was also a Parnassus research intern. Since July 2016, both managers have increased their ownership into the $100,000-$500,000 range, a positive.

Sexsmith and Klaber demonstrate full command of the portfolio. They divide it in two parts, each of which is managed for opportunistic adjustment. Dodson still advises on new ideas, but Sexsmith and Klaber own the decision to sell stocks.

Klaber and Sexsmith's strong start and Dodson’s record creating successful teams help offset Dodson's succession risk and justify a Positive People rating. Diversification of analyst duties across the various fund teams and collaboration between those teams is positive and manifests itself in portfolio overlap between the various funds.

Parent Pillar: Positive | Wiley Green 07/20/2017  
Change is under way at Parnassus Investments. Jerome Dodson, who founded the company in 1984, announced in February 2017 that Ben Allen had succeeded him as the firm’s president. Dodson remains the chief executive officer, but Allen is expected to assume that role in 2018. Dodson will continue to manage money at Parnassus indefinitely. Allen embodies the Parnassus approach to recruiting and retaining investment talent. He joined the firm as a research intern, a rite of passage for members of the research team, and worked his way from senior research analyst to director of research to portfolio manager. The transition is not cause for panic. Allen is talented and experienced, the plan is thoughtful, and the firm retains all its high-caliber research leaders.

Parnassus has six funds, the newest of which is an Asia-focused fund launched in April 2013. A foreign fund is a first for the company, but the firm has not grown recklessly; the last time it had launched a new fund was in 2005. The funds invest only in securities that pass its environmental, social, and governance screens. From there, the managers find companies with relevant products, sustainable competitive advantages, quality management, and ethical practices, and it buys when the stock is undervalued. The fixed-income fund also uses equity research for security selection. A well-defined wheelhouse combined with a strong culture of investment excellence adds up to a Parent rating of Positive.

Price Pillar: Positive | Wiley Green 07/24/2017 
The fund has below-average expense ratios on an asset-weighted basis compared with its peer group, which earns it a Positive Price rating. The addition of an institutional share class in 2015 that sports a below-average expense ratio of 0.71% is attractive to large investors, though that class carries a small percentage of fund assets.

The fund's expenses have crept closer to the fee group medians thanks to high pressure on cost driving the average expense ratio down, so Parnassus may need to lower fees soon to remain competitive.

Wiley Green does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.