Baron Asset Fund (BARAX)

Portfolio Management

Andrew Peck

Fund Manager since 2003

View All Commentary by Andrew

Fund Description

Baron Asset Fund invests primarily in mid-sized growth companies.


Portfolio Commentary

Retail Performance

Review and Outlook (for quarter ended 12/31/2014)

After dropping in early October, most stock indexes rallied into the end of the quarter, finishing the year on a high note. Markets were buoyed by the resilient U.S. economy, as GDP grew 5% during the third quarter, the fastest rate in 11 years. In addition, job creation improved, interest rates remained near historic lows, and the housing recovery continued. The most significant economic development in the quarter was the remarkable collapse in energy prices. Although this had negative implications for our Energy sector investments, we believe the overall impact will be beneficial for several other areas of our portfolio, as domestic consumers receive an unexpected windfall in the form of lower gasoline prices.

Health Care was the best performing sector for the Fund during the fourth quarter. IDEXX Laboratories, Inc., a leader in veterinary diagnostics, rose on accelerating organic growth. The booming market for biotechnology benefited Illumina, Inc, the leader in next-generation DNA sequencing devices, and West Pharmaceutical Services, Inc., which provides sophisticated packaging solutions to the pharmaceutical and biotechnology industries. Mettler-Toledo International, Inc., the largest manufacturer of weighing instruments for laboratory applications, rose on strong results, despite a challenging economic backdrop in several of its international markets. The Information Technology (IT) sector also did well, as increased spending on subscription-based information services benefited IT research firm Gartner, Inc. and financial information firm FactSet Research Systems, Inc. A rebound in valuations across the software sub-sector benefited Guidewire Software, Inc. and ANSYS, Inc. Several of Fund’s Energy sector investments fell meaningfully, largely as a result of the aforementioned collapse in commodity prices. In contrast, the Fund’s investments in Energy MLPs that service others in the Energy sector performed relatively well, as investors continued to embrace fast-growing yield-oriented vehicles with stable cash flows and predictable growth.

We continue to believe that mid-sized growth stocks represent an attractive investment opportunity. The U.S. economy is among the world’s healthiest, its equity market multiples remain within their long-term historic averages, and interest rates remain quite low by historic standards. We believe that our portfolio of well-managed, competitively advantaged, fast growing companies will perform well in this environment.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 12/31/2014)
  • Shares of IDEXX Laboratories, Inc., a leader in veterinary diagnostics, rose in Q4 on better-than-expected earnings and progress on moving to a direct distribution model in the U.S. IDEXX’s fundamentals continue to improve, with organic growth in its core business reaching 12% in the most recently reported quarter. We believe organic revenue growth at current levels is sustainable due to recent innovations in IDEXX’s portfolio of diagnostic products, instruments, data management tools, and geographic expansion.

  • Shares of IT research firm Gartner, Inc. performed well in Q4, driven by strong financial results, accelerating contract value in its core Research business, and continued share repurchases. Gartner’s earnings exceeded expectations, helped by sustained growth in its Research segment and better-than-expected performance in its Consulting and Events segments. Growth in Research contract value, the company’s key long-term value driver, improved to 14%, and we believe will continue to accelerate over the next several quarters.

  • Shares of CarMax, Inc., the nation’s largest used car retailer, rose sharply during Q4 after reporting strong results, highlighted by accelerating sales and earnings growth. Demand for the company’s high quality, late model vehicle inventory has remained strong and coincides with resurgent new car sales and an attractive financing environment. In  addition, shares have been buoyed recently by the announcement of a large share repurchase program that we believe will be significantly accretive to earnings over the next several years.

Detractors (for quarter ended 12/31/2014)
  • Shares of Wynn Resorts Ltd., a casino operator with locations in Macau and Las Vegas, declined in Q4 due to investor concerns over the Chinese government’s anti-corruption campaign and increased visa restrictions. Concerns regarding junket liquidity also pressured the stock as the VIP segment generates half of Wynn’s earnings. We believe the market will improve in the second half of 2015 as comparisons ease, new supply starts to come online, and infrastructure improves. The opening of Wynn’s new casino in early 2016 should help as well.

  • Helmerich & Payne, Inc. is the leading land drilling contractor in the U.S. Shares fell in Q4 on investor disappointment over fiscal Q4 earnings and pessimism about the outlook for U.S. land drilling given the plunge in oil prices. We believe Helmerich is in a relatively better position to weather this downturn due to strong contract backlog, built-in fleet growth from existing contracts, and a bullet-proof balance sheet. We think the long-term trends of rig fleet renewal and Helmerich’s competitive advantages will reemerge when oil prices stabilize.

  • Shares of MRC Global, Inc. fell sharply in Q4 as a result of the significant and rapid decline in energy prices. MRC is a distributor of valves and pipes to energy and industrial customers, and we believe the company has been lumped in with the major oil producers, whose revenue is tied directly to the price of oil. Meanwhile, MRC's fundamentals improved throughout 2014, and we expect that trend to continue. We believe its shares are unusually attractive, trading at less than 10x earnings for a best-in-class and value-added industrial distributor.

Quarterly Attribution Analysis (for quarter ended 12/31/2014)

When reviewing performance attribution on our portfolio, please be aware that we construct the portfolio from the bottom up, one stock at a time. Each stock is included in the portfolio if it meets our rigorous investment criteria. To help manage risk, we are aware of our sector and security weights, but we do not include a holding to achieve a target sector allocation or to approximate an index. Our exposure to any given sector is purely a result of our stock selection process.

The Baron Asset Fund (Retail Shares) gained 6.63% in the fourth quarter and modestly outperformed the Russell Midcap Growth Index by 79 basis points, mainly due to stock selection.

The Fund’s investments within the Energy, Health Care, and Information Technology (IT) sectors were the largest contributors to relative results. Within Energy, the Fund’s lower exposure to oil & gas exploration & production stocks, which were hit hard by the sharp drop in oil prices during the quarter, and outperformance of its MLP investments aided relative results. The Fund’s MLP holdings rose 26.13% as a group and outpaced their counterparts in the index by 42.59%, led by Shell Midstream Partners, LP. Shares of Shell Midstream, an MLP spun off by Royal Dutch Shell, rose sharply post-IPO as investors sought energy companies with stable cash flows and visible growth. Within Health Care, outperformance of the Fund’s largest holding in the sector, IDEXX Laboratories, Inc., and its greater exposure to life sciences tools & services stocks, which increased 13.2% as a group within the index, contributed the most to relative results. IDEXX was also the Fund’s largest overall contributor to absolute and relative performance in the quarter. Other contributors to relative performance in the sector were Mettler-Toledo International, Inc., a global manufacturer of scales and analytical instruments, and Illumina, Inc., the leader in next generation DNA sequencing instruments and consumables. Strength in IT was mostly attributable to the outperformance of Gartner, Inc., which was also one of the Fund’s largest contributors on an absolute basis. The Fund has meaningful exposure to application software companies, and most of these holdings also outperformed, led by FactSet Research Systems, Inc. and Guidewire Software, Inc. Shares of FactSet Research Systems, Inc., which provides financial information to the global investment community, increased as the company’s organic growth rate accelerated and its customer and seat count additions exceeded expectations. Shares of Guidewire Software, Inc., the gold standard of property & casualty systems vendors, rose in the quarter, helped by strong financial performance and continued wins at top insurers.

Underperformance of the Fund’s investments within the Consumer Discretionary and Industrials sectors detracted the most from relative performance. Underperformance of Wynn Resorts Ltd., The Priceline Group, Inc., and Hyatt Hotels Corp. hurt relative results the most within Consumer Discretionary. The Fund’s larger exposure to the lagging casino and gaming sub-industry through its investment in Wynn and its 2.2% average weight in Priceline, which declined slightly and is not a benchmark constituent, also detracted from relative performance. Wynn was also the largest detractor from absolute performance. Shares of Hyatt, a global hospitality company, fell slightly due to lower margins at two Asian properties. Weakness in Industrials was mainly due to the Fund’s lack of exposure to airline stocks and the underperformance of MRC Global, Inc. and Colfax Corp. MRC Global was the Fund’s third largest detractor from absolute performance, while shares of industrial machinery company Colfax fell on reports of weaker-than-expected quarterly earnings and below-consensus 2015 guidance.

Yearly Attribution Analysis (for year ended 12/31/2014)

The Baron Asset Fund (Retail Shares) increased 9.48% for the year, yet trailed the Russell Midcap Growth Index by 242 basis points, due to differences in sector weightings and stock selection.

The Fund’s investments within the Energy and Health Care sectors were the largest contributors to relative performance. The Fund’s Energy investments gained 6.2% amid the sharp drop in oil prices in the second half of the year and significantly outperformed their counterparts in the index by 26.5%. All three of the Fund’s MLP investments rose sharply during the year, led by Phillips 66 Partners LP and Shell Midstream Partners, LP. Shares of Phillips 66 Partners nearly doubled as the company continued to grow significantly faster than its peers. The Fund’s lower exposure to oil & gas exploration & production stocks, which were hurt by declining oil prices, also aided relative performance. Within Health Care, the outperformance of Illumina, Inc. and IDEXX Laboratories, Inc., which were also the Fund’s two largest contributors to absolute performance, added the most value. Other contributors on a relative basis in this sector were Mettler-Toledo International, Inc., a global manufacturer of scales and analytical instruments, and Universal Health Services, Inc., a leading operator of acute care hospitals.

The Fund’s investments within the Industrials, Consumer Discretionary, and Consumer Staples sectors were the largest detractors from relative results. Weakness in Industrials was largely due to the underperformance of MRC Global, Inc., the Fund’s largest detractor on an absolute basis; Colfax Corp.; Verisk Analytics, Inc.; and Nielsen N.V. Colfax, an industrial machinery company, had a weak second half. Shares of Verisk, which provides information about risk to companies in the insurance, health care, and mortgage industries, moved lower after earnings fell slightly short of expectations. Shares of Nielsen, a global information and measurement company, fell slightly due to concerns about competition for the company’s Watch business and slower revenue growth in other product lines. The Fund’s lack of exposure to airline stocks, which benefited from the drop in oil prices, also hurt relative performance. Within Consumer Discretionary, Wynn Resorts Ltd., a leading company in the gaming industry, and the Fund’s larger exposure to the underperforming casinos & gaming sub-industry, detracted the most from relative results. Underperformance of the Fund’s Internet retail and specialty stores investments, led by HomeAway, Inc. and Dick's Sporting Goods, Inc., respectively, also hampered relative performance in the sector. Shares of HomeAway, the #1 player in the online vacation rentals space, were weak due to concerns that increased marketing spending to support its new pay-per-booking product would weigh on margins. Shares of Dick’s, a sporting goods retailer, declined due to an earnings shortfall in its hunting and golf businesses. Discovery Communications, Inc., a leading global cable network programming operator, also detracted from relative results. Its shares fell in 2014 (along with other cable programmers) due to a weaker domestic TV ad environment and concerns around the loss of market share to digital video.

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The prospective performance of the companies discussed herein is based on our internal analysis and reflect our opinions only. We cannot promise future returns and our opinions are a reflection of our best judgment at the time of publication. Our views are not intended as recommendations or investment advice to any person and are subject to change at any time based on market and other conditions and Baron has no obligation to update them. Investing in the stock market is always risky. Current and future portfolio holdings in the Baron Funds are subject to risk.