This compact fund beats the market and provides a downside cushion in tough times

Published Sun, Jun 18 20236:59 AM EDTUpdated Tue, Jun 20 20232:21 PM EDT

Though a lot has changed in the market over the last three decades, the Parnassus Core Equity Fund still has its original principles close to heart. The fund, which was started in 1992, has aimed to give investors an actively managed strategy that's tied to the broad U.S. economy. While now considered compact with 40 holdings, portfolio manager Andrew Choi said it has become known for its cushion when the market hits a bad patch. " The things that we're thinking about and working on today is reflective of the current market environment versus, obviously, back then," said Choi, who joined the firm in 2018 and became a co-manager of the fund at the start of 2022. "But the core ethos and kind of need that this product is meeting is effectively the same." The fund's investor share class has a fee of 0.82% and minimum investment of $2,000. It has a five-star rating from Morningstar compared with other large-blend funds. It's in the 37th percentile of funds this year, according to Morningstar, and has performed basically in line with its benchmark, the S & P 500 , on the year. The fund has returned 10.9% annually since its inception, compared with a 9.9% yearly gain over the same period for the broad S & P 500. PRBLX .SPX YTD mountain The fund vs. the S & P 500 'Dancing in the right places' The fund was created in 1992, about eight years after the firm itself began. Current manager Todd Ahlsten, who is also the firm's CIO, began his role in the fund in 2001. Choi said little has changed in terms of core strategy since Ahlsten took the helm. One thing Choi highlighted was the firm's early adoption of responsible investing, which he said is Warren Buffett-esque with a focus on good businesses with good returns. It has been a quality since founding, making the firm's commitment "authentic." He said the fund has been able to perform over time without turning against these principles, even as some investors have shifted stances on environmental, social and governance guidelines amid recent rebukes from Republicans. In March, the House GOP was unable to override President Biden's veto of a ban on the investing framework. "We started in '84, and we kind of haven't changed our tune ever," he said. "And I think there has been a lot of tune changing from some of our competitors." It has also become known as a fund that can provide cushion in times of market turmoil, with Choi pointing specifically to the early 2000s and the Great Financial Crisis. But he noted a more difficult landscape in 2022, as the fund struggled with no energy exposure (that was the only positive S & P 500 sector) and as quality names got hit harder. Still, he said those unique headwinds in 2022 shouldn't detract from the fund's earned reputation. Choi said the company has been able to average around 95% upside capture and 90% downside capture over the last five years, which highlights the success of the strategy over time. "If you think of it like a dance, when the music is playing, you want to get up and you want to dance to participate in the rally," Choi said. "But the people who stay too long on the dance floor when the music stops typically have to pay for it more so than the gains that they made. So we make sure that when the music is playing, we're dancing in the right places. And we get off the dance floor before things start to turn and the music stops." How that's actually done? Choi's team does the math to ensure valuations are reasonable for what they're paying and they're not giving up too much money for a stock that is rising off speculation. Of course, the market has shifted since the end of 2022 as hopes for a better interest rate environment and excitement around artificial intelligence has sent stocks higher. Choi said his team bought Salesforce and homebuilder names at the end of last year on a bet that they could perform if the economy fared better than many expected — a prediction he said has come with rewards. Salesforce ended up being the fund's best relative performer in the first quarter, with the 50.7% gain contributing 1.4% of the fund's total return. Semiconductor names Advanced Micro Devices and Nvidia provided 0.6% and 1.1%, respectively, to the fund's return as both have surged amid growing investor excitement around AI. On the other hand, Charles Schwab and Bank of America were among the biggest detractors as financial stocks struggled amid the broader industry crisis. Apple was also a detractor, but that's because the firm was underweight on the stock, not because of how shares performed. Microsoft and Alphabet join Apple in big technology names on the top 10 holdings as of the end of the first quarter. Microsoft, its biggest holding, traded at all-time highs on Friday, underscoring the strength of Big Tech's comeback this year. But some lesser-expected names also comprise the top 10 given the fund's focus on responsible businesses and quality. Agriculture equipment maker Deere , chemical company Linde and consumer goods maker Procter & Gamble are also among the biggest holdings. The top 10 names typically account for about 40% of the fund's holdings. Looking ahead The ability to offer downside protection while also being on the more consolidated end is unusual as concentration can typically mean more volatility, according to Morningstar analyst Stephen Welch. He said the fund finds stocks that can provide downside cushion by looking at moats and management teams. And he described the responsible investing focus as two-pronged, noting the fund uses both exclusionary screeners and also looks for stocks with material risks in the ESG realm. To be sure, Choi said the firm's ESG principles have evolved over time and do not supersede all else. While the fund's underperformance in 2022 was in part due to the lack of energy holdings, Choi said it's not solely because of ESG concerns that those stocks aren't held. (The firm has made changes to ESG-related principles over time, including a move earlier this year to end a nuclear power exclusion given its role in reducing carbon use.) While his team still follows energy trends to see if there are any opportunities to make money, they see better opportunity in areas of technology such as semiconductor stocks. Semis are an example of "these kinds of secular tailwind sectors that have a lot of cyclical elements to them that lend themselves opportunities for people to become euphoric, and also manically kind of depressed," he said. "But throughout the whole period, there's all these cycles to take advantage of." Rolling returns over the past five years show the fund outperforming the S & P 500 and Russell 1000 about 60% of the time. But when looking at the five-year returns with the sharpe ratio, which measures risk-adjusted returns, the fund has outperformed closer to 90% of the time. That shows it has lower volatility and can hold up well in downturns, Welch said. Looking to the second half of 2023, Choi said he continues to like semiconductor stocks and is also watching for companies like Adobe and Salesforce that are benefiting from AI in ways that he said may not yet be fully appreciated in the stock price. Adobe has rallied this week on the back of strong earnings and guidance. And Choi is also watching the payment space, which he said still has companies with good businesses but they are becoming more attractive in terms of valuation with the industry not getting as much love as it deserves. ( Mastercard was the fund's fifth largest holding as of the first quarter.) Correction: A previous version misstated the fund's name.