"Consequences, schmonsequences, as long as I'm rich," Daffy Duck observed famously.

Even for investors concerned about "ethical investing" -- a seeming oxymoron to some -- few are getting rich these days. This makes the ( PRBLX) Parnassus Equity Income , a "socially responsible" fund, a gem of an offering.

Yes, it's one of those funds. Socially responsible funds take their lumps from the media. The two big criticisms: 1. "Social responsibility" is a Rorschach term that means varied things to different people. 2. Any way you define socially responsible, this batch of funds doesn't always beat the market. However, the Parnassus Equity Income has managed a 10.09% average annual return for the past five years, trouncing 99% of its large-cap peers and the S&P by nine percentage points. Surely, the fund's holders feel good about doing good.

Todd Ahlsten, the fund's manager since May 2001 and director of research since 1995, chatted with us about what socially responsible means to his fund, how he has beat the market and what he likes now. Here's a teaser: Financials, pharmaceuticals and semiconductors -- Intel ( INTC) among them.


Good Guys Are in the Black
The Parnassus Equity Income Fund has trounced the S&P since its inception in September 1992

1. The Parnassus Equity Income fund is classified as a "socially responsible" mutual fund. How do you define that elusive term?

We don't invest in alcohol, tobacco, gambling, defense contractors, or companies that are bad polluters. We stay away from companies that have any ethical problems or have done business dealings that we don't feel are appropriate. We try to invest in a portfolio of companies that are known to treat their employees well, are active in their communities, contribute to charity, have positive products for the economy or sell things that have a positive social benefit.

2. How does your definition differ from peers?

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There are minor differences. Some folks will screen out animal testing. We screen out animal testing for cosmetics, but not for pharmaceuticals. I think we have pretty stringent screens when it comes to a lot of the quality-of-life products. For instance, we won't invest in Coca-Cola ( KO) even though it's a good company, because we don't think it's necessarily a healthy product for society. Whereas, let's say, the ( DSEFX) Domini (Social Equity) has Coke because they are a great charity-giving company and they've been active in minorities and community development. Some companies own Wal-Mart ( WMT) for example, where as we see them destroying the downtown areas of Middle America. It's a judgment call.

3. What other stocks would you never own?

We wouldn't own Microsoft ( MSFT) because of their competitive dynamics. We stay away from defense contractors, such as Boeing ( BA) and Northrop Grumman ( NOC). Even though they play an important role in our country right now, we feel that there is too much allocation toward national defense.

4. Socially responsible funds take heat from the media like in Friday's Wall Street Journal article. How do you respond to such criticism?

Coming into this year, our one-, three-, five- and 10-year number beat the S&P by a hundred in every period. Its five-year return is the No. 1 return out of 154 funds in its peer group. We do very good screens in terms of social responsibility, but we also stringently look at the financial aspects of each investment. We've merged these two concepts together and I think we do a pretty good job of it. Our peers sometimes will focus too much on investing in a company with a great social profile and the investment merits might not be there.

5. What sort of impact have recent incidents of corporate malfeasance had on your investment strategy and the way you evaluate stocks?

Jerry Dotson, our president, and I agree that we'll never look at an auditor's signature the same again. We've taken an even more stringent stance on the accounting. We focus even more on cash flows. Even though we've always had a strong focus on cash flow, we're even more stringent on what's the cash in, what's the cash out and essentially looking at cash flow as much as we look at earnings. You might be able to manipulate what's going on with the earnings of a business, but the cash in and the cash out are much harder to manipulate. Cash is either there or it's not there.

From a corporate governance and management trust standpoint, we're just trying to be invested in companies where not only does management have a big stake, but regarding executive compensation, we're looking at how their benefits are aligned with the shareholders of the company, and their performance. Also, we examine how stable the board of directors is.

6. Do you think the market has overreacted to these issues?

We do. We think there are some phenomenal investment opportunities out there. In the same way things got crazy in 1999 and 2000, I think they're excessively pessimistic now. In the S&P 500, a few of the companies go in the bad category -- the WorldComs, the Global Crossings, the Enrons, probably a few others. Out of those 500 companies, every company manages earnings and any CFO who says he doesn't is not being truthful. It's a matter of what's within the realm of reason. Most of the companies are good companies with ethical management teams that will within their own discretion try to make numbers based on what the expectations are to Wall Street.

Todd Ahlsten,
Manager, Parnassus Equity Income
Assets: $159 Million
One-Year Return:
-8.77%
Five-Year Average Annualized Return: 10.09%
Expense Ratio: 1.00%
Top Three: AIG, Cardinal Health and Intel
Sources: Morningstar, Parnassus.

7. Your cash levels have changed considerably. Would you fill us in?

We started the year with 46% of the portfolio in cash and we were underweight in technology. By the time June rolled around, we started to see some bargains as the Nasdaq was hitting new multi-year lows. Currently, we are only about 3% cash.

8. What values are you digging up in technology?

We found value in Intel ( INTC), LSI Logic ( LSI), Cisco ( CSCO) Applied Materials ( AMAT) and Novellus ( NVLS).

We think these are great companies that have good balance sheets, good cash flow, we trust the accounting. We trust management, and they're businesses that have bright futures at cheap prices. We've added to those aggressively.

9. Where are you putting your cash to work now?

We found increasing opportunities in semiconductors and semiconductor capital equipment, which have come way down in valuation. We found great opportunities in pharmaceuticals and pharmaceutical distribution. One of my favorite investments is the No. 2 holding: Cardinal Health ( CAH), the big drug distributor. They were a former client of Arthur Andersen. About a month ago, when they were going through a transition to their new auditor, there wasn't a partner to sign their previous documents because Andersen was being dissolved. As a result, the stock traded down $15 a share on that. Cardinal is a remarkable company with remarkable cash flow, so we used that as an opportunity to aggressively buy Cardinal shares.

I also like Eli Lilly ( LLY), Merck ( MRK), Johnson & Johnson ( JNJ) and McKesson ( MCK). These are big names that we significantly added to in pharmaceuticals and healthcare.

10. Fannie Mae (FNM) and Freddie Mac (FRE) were among your top-five holdings about a month ago. Where are they now?

We've unwinded those positions significantly. They went from being 3% and 4% positions to slightly under 1% positions. We bought those stocks at very cheap prices a couple of years ago and they had some pretty good moves. But with all these rumblings in Washington with regulation, it got to the point where they would go down when the market went down and they wouldn't go up when the market went up. Even though they're great companies and they're cheap, they're always going to trade at a multiple discount because every time you pick up the Journal, somebody else is pissed off. So we dramatically lowered our exposure.

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