Parnassus Mid-Cap Funds: Q2 2024 Investment Commentary Analysis

Parnassus Mid Cap Fund Q2 2024 Investment Commentary

The portfolio's high-quality holdings should help protect against potential market downturns and take advantage of growth opportunities as cyclical pressures ease and long-term secular trends prevail. The strategy pursues strong long-term returns by holding a concentrated portfolio of 35 to 45 high-quality U.S. mid-cap stocks with the potential for long-term growth and business resiliency. The Russell Midcap Index posted a -3.35% return during the quarter. After notching strong gains in the first quarter, markets declined in April as the likelihood that the U.S. Federal Reserve (Fed) would enact multiple rate cuts by year-end faded, overshadowing a generally positive earnings season. U.S. economic growth, as measured by GDP, decelerated to longer-term levels, and labor markets showed moderate softening. Inflation remained above the Fed's target level, although companies are finding it more difficult to pass price increases on to the consumer. Higher rates are beginning to impact interest-rate-sensitive companies and economically sensitive consumers, creating a bifurcated market and underpinning an increase in market concentration. Among mid cap stocks, Utilities and Communication Services were the top-performing sectors during the quarter, while Consumer Staples, Health Care and Materials declined the most. Stock selection in Health Care and Industrials hampered overall returns The fund (Investor Shares) returned -5.80% for the quarter, underperforming the Russell Midcap Index's -3.35% return. Stock selection within Health Care and Industrials detracted as life sciences tools and freight transportation stocks had yet to rebound. Top contributors included insurance software provider Guidewire Software (GWRE), which rose on strong fiscal third quarter earnings, and semiconductor equipment manufacturer KLA Corporation (KLAC). Detractors included bioprocessing company Repligen Corporation (RGEN), which reported uneven demand and announced a CEO transition, and trucking and logistics company J.B. Hunt Transport Services (JBHT), which suffered from soft shipping demand. Guidewire Software, the leading software provider for property and casualty insurers, reported strong fiscal third quarter earnings highlighted by accelerating growth in annual recurring revenue and structurally higher profitability. With demand increasing and a broad array of strategic partners to guide implementations and migrations, we see a long runway ahead. KLA Corporation, a provider of process control and yield management solutions for the semiconductor and related nanoelectronics industries, continued its strong run. We expect KLA will continue to benefit from the increasing complexity of chip designs. Trade Desk (TTD), a cloud-based media-buying platform for advertisement purchasers, reported a strong quarter based on increasing demand for connected TVs. The stock received another boost after the company announced a partnership with Netflix, which should accelerate Trade Desk's growth. Lam Research Corporation (LRCX) is a leading global manufacturer of innovative equipment used to fabricate integrated circuits. Like KLA, it is well positioned to capture demand driven by increasingly complex circuit designs. Bank of New York Mellon (BK), the world's largest custodian bank, reported growth in its fee revenue along with well-controlled operating expenses, providing support to management's profitability improvement plan. Repligen Corporation, a leading bioprocessing company, posted a soft first-quarter revenue result. The stock fell further after the company announced a CEO transition. We are pleased that the well-regarded outgoing CEO will remain as executive chair. We believe Repligen is well positioned to benefit once the cyclical downturn reverses. J.B. Hunt Transport Services, a leading trucking and logistics company that specializes in intermodal services, posted earnings well below expectations due to weaker-than-expected demand and higher costs. Longer-term trends should support demand for freight services and the company's strong service network. Pool Corporation (POOL), a swimming pool supply distributor, lowered its full-year earnings estimates as demand for new pool construction fell more than expected due to high interest rates impacting big ticket purchases. Most of its revenue comes from maintenance of installed pools, which should be resilient. Workday, a provider of human capital and financial management software, warned of slower growth in subscription revenue even as first-quarter revenue and earnings topped expectations. We added to our position as it fell to a valuation that we believe does not reflect its revenue growth and increasing operating margins. IQVIA Holdings (IQV) is a leading provider of clinical research services, technology solutions and analytics to the life sciences industry. Shares fell as the cancellation of a large trial affected investor sentiment. A focus on increasingly relevant companies During the quarter, we increased our overweight allocation to the Information Technology sector. In the Software industry, we initiated a new position in BILL Holdings (BILL), which runs leading payments platform Bill.com, and added to our holdings in Workday. We exited our position in Amdocs (DOX), as we saw more upside in our other Software holdings. Software has been one of our strategy's most-alpha-generative industries, driven by its increasing relevancy, network effects, mission-critical importance and the high incremental margins of the business models. We re-initiated a position in Western Digital (WDC), a manufacturer of memory semiconductor chips and hard disk drives, as we believe earnings expectations are far too low. Semiconductors have been another of our most-alpha-generative industries, thanks to the industry's secular tailwinds and our in-house expertise. Our biggest reduction in sector weighting was in Consumer Staples, as we exited Sysco (SYY) due to its persistent market share losses. We also reduced our exposure to Health Care, exiting BioMarin Pharmaceutical (BMRN) because we're skeptical that the new CEO's plan to reduce expenses and streamline the pipeline will generate outperformance. Within industrials, we exited CNH Industrial (CNH) following the CEO's surprise resignation. We used the capital to add to our position in J.B. Hunt Transport Services, the dominant intermodal freight transportation provider. In Financials, we exited Block (SQ) due to regulatory concerns surrounding its Cash App business. The common theme in our trades this quarter was to concentrate the portfolio into stocks that we believe are increasing in relevancy. We exited structurally slow growers, turnaround stories focused on profitability instead of growth or companies that faced regulatory hurdles to growth. Looking toward eventual improvement in end markets While headline economic growth and employment numbers remain positive, and the excitement of artificial intelligence is pushing a concentrated group of stocks to all-time highs, there are crosscurrents under the surface. Less affluent consumers and small and medium-sized businesses are grappling with the effects of persistently high interest rates. The economy seems to be in a rolling recession, where certain industries-such as freight transportation, life sciences tools and housing-are mired in a downturn despite the positive headline numbers. However, the Fed is expected to cut interest rates later this year, and we expect fiscal spending to remain at elevated levels. Once the uncertainty of the election passes, "animal spirits" may return and help the economy to re-accelerate, potentially broadening the stock market's gains. In this environment, we're maintaining our balanced positioning. We're overweight freight transportation, life sciences tools and housing. While this positioning detracted from our relative returns, we've held on to or increased our investments in these industries due to our confidence in their prospects. Even if overall economic growth slows, these industries are already experiencing a downturn, which we believe should limit further downside. Our portfolio contains competitively advantaged, secularly growing businesses with strong balance sheets and increasing market share. As demand in their respective end markets eventually improves, we anticipate meaningful upside for our holdings. Matthew Gershuny, Portfolio Manager, Senior Analyst Lori Keith, Director of Research, Portfolio Manager

Parnassus Mid Cap Growth Fund Q2 2024 Investment Commentary

We remain enthusiastic about our portfolio's thematic overweights to advantaged industries like semiconductors, software, life sciences tools and housing. The strategy pursues long-term outperformance by owning a concentrated portfolio of 35 to 45 high-quality U.S. mid-cap stocks with the potential for long-term growth and business resiliency. The Russell Midcap Growth Index posted a -3.21% return during the quarter. Markets declined in April as the likelihood of the U.S. Federal Reserve (Fed) enacting multiple rate cuts by year-end faded, overshadowing a generally positive earnings season. U.S. economic growth, as measured by GDP, decelerated to longer-term levels, and labor markets showed some moderate softening. Inflation remained above the Fed's target level although companies are finding it more difficult to pass price increases on to the consumer. Higher rates are beginning to impact interest rate-sensitive companies and economically sensitive consumers, creating a bifurcated market and underpinning an increase in market concentration. Among mid cap growth stocks, Utilities and Communication Services were the top-performing sectors during the quarter, while Materials and Consumer Staples declined the most. Stock selection in Information Technology, the Fund's largest sector weight, aided relative returns The Fund (Investor Shares) returned -3.20% (net of fees) for the second quarter of 2024, approximately in line with the Russell Midcap Growth Index's -3.21% return. Stock selection in the Information Technology and Industrials sectors contributed to relative results, while selection within Real Estate and Health Care detracted. The top contributors to relative performance included Teradyne (TER), Guidewire Software (GWRE) and KLA Corporation (KLAC). Notable detractors include CoStar Group (CSGP), Pool Corporation (POOL) and Align Technology (ALGN). Teradyne, a provider of advanced testing solutions for semiconductors, electronic systems and wireless devices, delivered first-quarter revenue and earnings per share that topped expectations. Management cited artificial intelligence-driven (AI-driven) demand in memory and computing as a significant performance driver. Guidewire Software, the leading software provider for property and casualty insurers, reported strong fiscal third quarter earnings highlighted by accelerating growth in annual recurring revenue and structurally higher profitability. With demand increasing and a broad array of strategic partners to guide implementations and migrations, we see a long runway ahead. KLA Corporation, a provider of process control and yield management solutions for the semiconductor and related nanoelectronics industries, continued its strong run. We expect KLA will continue to benefit from the increasing complexity of chip designs. Monolithic Power Systems (MPWR), a power management chip designer, rallied after its first-quarter revenue exceeded expectations on strong demand for AI servers. The company's fabless business model allows it to take advantage of increased AI spending without high capital expenditures. Trane Technologies, a provider of heating, ventilation and air conditioning (HVAC) solutions, reported first-quarter earnings that topped estimates and provided strong full-year guidance. We believe that Trane's long-term growth prospects look promising because it provides innovative, energy-efficient solutions. CoStar Group, a leading provider of online real estate marketplaces, has been investing heavily in Homes.com, its residential marketplace, and 2024 is expected to be the peak investment year. We think the investments will pay off, as the company has followed a similar investment profile before, ultimately delivering strong returns. Pool Corporation, a swimming pool supply distributor, lowered its full-year earnings estimates as demand for new pool construction fell more than expected due to high interest rates impacting big ticket purchases. Most of its revenue comes from maintenance of installed pools, which should be resilient. Align Technology, the manufacturer of leading dental aligner Invisalign, logged solid first-quarter earnings. Yet shares fell over concerns of weakening consumer sentiment since orthodontic costs are often not covered by insurance. We believe that Align, a leader in the clear aligner category, will take market share from metal braces. Adyen (OTCPK:ADYEY)(OTCPK:ADYYF), a global payments processing solutions provider, detracted after the company reported earnings that met expectations on higher transaction volume but signaled increased competitive pressure in the U.S. We maintain our view that secular growth trends should support a continued rise in Adyen's transaction volume. Workday (WDAY), a cloud-native provider of human capital and financial management software, warned of slower growth in its subscription revenue this year even as first-quarter revenue and earnings topped expectations. We added to our position as it fell to an all-time-low valuation, which does not reflect its sustainable mid-to-high-teens revenue growth and increasing operating margins. Parnassus Mid Cap Growth Fund | Investment Commentary 2Q 2024 We continue to see opportunities in semiconductors, software, life science tools and housing Our portfolio positioning remains consistent with last quarter, as we maintained our overweight position in the semiconductor, software, life sciences tools and housing industries. Our semiconductor overweight was our most significant contributor this quarter, and our exposure increased as our holdings appreciated. We also re-initiated a position in Western Digital, a memory semiconductor and hard disk drive manufacturer, as we believe earnings expectations are far too low. We increased our exposure to the software industry during the quarter, adding a new position in payments provider BILL Holdings (BILL)(Bill.com). Some software stocks have underperformed due to concerns about slowing economic growth and enterprise technology spending on AI crowding out spending on software. However, we have high conviction in our software holdings because they provide mission-critical technology and we believe their network effects, high switching costs and culture of innovation will drive strong long-term performance. We also increased our exposure to the life sciences tools industry, adding a new position in West Pharmaceutical Services, a leader in packaging for injectable therapies. The industry is going through a cyclical downturn, but drug development continues, ensuring quality control remains as important as ever; we think it's a matter of time before the cycle turns. We exited both of our biotech investments, BioMarin Pharmaceutical and Alnylam Pharmaceuticals, as we believe the life sciences industry offers more durable growth and wider competitive moats without the idiosyncratic risks of individual drug trials. We maintained our overweight exposure to the housing market. While we haven't yet seen a recovery in the housing market, as existing home sales volume remains at multi-decade lows due to a structural undersupply, we believe that we are well positioned to benefit when volumes improve. We own a number of best-in-class companies tied to the housing market, including Equifax, Sherwin-Williams and Pool Corporation. We maintain balanced positioning in an uncertain environment While headline economic growth remains positive and the excitement of AI is pushing a concentrated group of stocks to all-time highs, we discern crosscurrents under the surface. Less affluent consumers are struggling with elevated prices, and persistently high interest rates are negatively impacting some consumers and small and medium-sized businesses. However, the Fed is expected to cut interest rates later this year, and we expect fiscal spending to remain at elevated levels. Once the uncertainty of the election passes, "animal spirits" may return and help the economy to reaccelerate, potentially broadening the stock market's gains. In this uncertain environment, we're retaining the portfolio's overall balanced positioning and focusing on our thematic overweights to semiconductors, software, life sciences tools and housing. Three of those four thematic overweights- software, life sciences tools and housing-are in industries that are out of favor with investors. We think each of them is a coiled spring. When demand in their end markets eventually improves, the upside for these companies should be meaningful. Portfolio Activity Ian Sexsmith, CFA, Portfolio Manager, Senior Analyst Robert Klaber, Director of ESG Research, Portfolio Manager Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.