In this type of market, many portfolio managers can take on the genius role simply by exposing themselves to beta. After all, despite some big issues over the past decade, owning the market has been a safe bet. Concrete example: the Vanguard 500 Index Fund (VFINX), a proxy for the S&P 500, produced a compound annual growth rate (CAGR) of 15.39% over the 10 years ending August 31. This is not to be despised, especially in light of its cost. VFINX can only be owned for 14 basis points (0.14%) per year.
Vanguard founder, the late John Bogle, has often decried alpha research as a futile and expensive endeavor. For the most part, it has proven itself over the years. It’s hard to consistently beat the market. But it is not impossible. To witness it: The Parnassus Core Equity Fund (PRBLX), a large cap portfolio that beat VFINX’s performance over periods of 3, 5, 10 and 20 years. PRBLX, with $ 31 billion in assets, is America’s largest ESG-focused fund.
OK, I hear you say, PRBLX beats the index fund but at what cost? Among large-cap core mutual funds, the average expense ratio is 1.03%, well above the cost of the passive Vanguard product. PRBLX is priced lower by 84 basis points (0.84%). The question remains whether the 70bp outperformance of the Parnassus fund is justified by its outperformance. The answer, in a nutshell, seems to be “yes”.
Just compare how PRBLX has performed against its peers and against the Vanguard portfolio over the past 10 years.
PRBLX’s annual growth rate exceeds that of the Vanguard Index Fund by 33 basis points. By dividing the excess growth rate by the excess cost of PRBLX, you can get the fund recovery ratio, a measure of compensation for additional holding costs. The Parnassus fund has consistently produced positive recovery ratios, as well as positive alpha, over all the periods described below:
PRBLX recovery ratios and alpha coefficients
Todd Ahlsten, chief investment officer of Parnassus Investment and portfolio manager of the PRBLX fund, says his fund is deliberately monitoring costs. “We want the fees to be competitive and reasonable, and believe that we offer unique value in principle and performance,” he says. “The expense ratio is 0.84% for the Investor share class, although most advisors use the Institutional share class at 0.62%.”
Ahlsten’s ran the PRBLX fund for two decades and had to adjust the portfolio’s price to maintain his advantage. “Over the past 20 years, the makeup of the stock market has changed to be more tech-driven and less brick-and-mortar focused. It has changed the benchmark itself and we are actively aware of the bets we are making, ”he says. “With more government intervention and dominant secular trends, we had to become more aware of the broader market environment. “
Ahlsten and his co-director Ben Allen have responded by creating sector teams that look broadly at market drivers. The result is a portfolio with decided sectoral inclinations but which still remains strongly correlated to the market. Relative to VFINX, PRBLX’s returns indicate underweightings in consumer discretionary, utilities and energy as well as overweightings in industrials and real estate.
“We are primarily a bottom-up stock picking business,” says Ahlsten. “To outperform over a market cycle, we are investing in an artisan basket of around 40 high-quality companies. These companies, in which we invest after extensive research, have sustainable competitive advantages, offer increasingly relevant products and services and are well managed by well-motivated management teams.
“ESG has been and will be a key part of our investment process as well,” adds Ahlsten. “The end result is a high conviction, highly active, low turnover portfolio that investors can use as their core portfolio. Hence the name of the fund.
Style-wise, the returns of the Parnassus fund simulate modest exposure to the dampening effect of long- and medium-term T-bill volatility – apparently at the expense of the large-cap growth allocation – even if no bond is actually held in the portfolio.
“We don’t use too quantitative a process for low volatility stocks,” says Ahlsten. “We also do not go into high cash positions, nor do we use derivatives. We manage volatility using the same process and philosophy that we have used for years, including in 2008 when we outperformed the S&P 500 by over 14%.
For the Ahlsten team, the ESG objective makes stock selection easier. Ahlsten says: “This has been a key part of our process since the inception of the fund. For us, ESG is a quality marker. Companies that score high on environmental, social and governance characteristics generally have a culture of avant-garde, innovative management and workforce teams. This mindset is useful for improving the value of the company, which informs the stock price. ”
Significantly, ESG is also a risk management tool. Paying attention to companies that are concerned about their material and reputational risks tends to produce more predictable and positive investment results, Ahlsten says.
It is difficult to argue against the approach of Parnassus.
“Investors come to us for long-term investments over a market cycle,” says Ahlsten. “Our aim is to offer more advantages than disadvantages. Achieving this asymmetric return profile helps to argue in favor of active management. “
Brad Zigler is the editor of alternative investments at WealthManagement. Previously, he was responsible for marketing, research and training for the options market of Pacific Exchange (now NYSE Arca) and the iShares complex of exchange-traded funds.