Review and Outlook
U.S. stock markets experienced significant volatility in the first quarter, driven by concerns over the potential for increased interest rates, declining oil prices, the strong dollar, mixed domestic economic data, and corporate earnings disappointments. While overall gains were moderate, mid caps did better than large caps. The Russell Midcap Growth Index gained 5.38%, while large cap indexes were flat to slightly up.
Performance of Baron Asset Fund in the quarter was driven more by stock-specific earnings results than by broader industry trends. The best-performing stocks generally included companies with predominantly domestic businesses, and modest exposure to weaker foreign economies and the strengthening U.S. dollar. Several of the Fund’s investments in companies that sell proprietary data and analytics, such as Verisk Analytics, Inc. and FactSet Research Systems, Inc., performed particularly well. Travel-related companies with a largely domestic focus, including holdings Vail Resorts, Inc. and Choice Hotels International, Inc., benefited from improved travel spending. Towers Watson & Co. demonstrated its long-term opportunity to build a large business helping corporations create private healthcare exchanges for their employees and retirees.
Although energy prices stabilized at their recent, much lower levels during the quarter, several companies that sell products to energy end-markets fell after reporting disappointing results. These included pump manufacturer Colfax Corporation, and industrial distributors MRC Global, Inc. and Fastenal Company. Luxury retailers Ralph Lauren Corp. and Tiffany & Co. both suffered from the impact of the rising U.S. dollar, which led to reduced spending by foreign tourists in their U.S. stores, as well as the negative impact that foreign exchange had on their earnings results.
We believe that mid-sized growth stocks continue to represent an attractive investment opportunity. The U.S. economy remains among the world’s healthiest, its equity market multiples remain within the range of their long-term historic averages, and interest rates continue to be quite low by historic standards. The recent drop in energy prices should generate ongoing corollary benefits for many domestic companies. We believe that our portfolio of well-managed, competitively advantaged, fast growing companies will continue to perform well in this environment.
Top Contributors/Detractors to Performance
Quarterly Attribution Analysis
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) increased 3.44% in the first quarter, yet trailed the Russell Midcap Growth Index by 194 basis points due to stock selection.
Outperformance of the Fund’s only holding in the Utilities sector, solar power company TerraForm Power, Inc., and its Industrials investments contributed the most to relative results. Shares of TerraForm increased more than 20% on news that the company and its parent, SunEdison, had closed a transformational acquisition of First Wind Energy for $2.4 billion. The news provided confidence that TerraForm would meet its dividend-per-share growth rate of 24% through 2019. Strength in Industrials was mostly attributable to the outperformance of Towers Watson & Co., an employee benefits consultant, and Verisk Analytics, Inc., two of the Fund’s largest contributors on an absolute basis. Shares of Towers Watson rose on robust results, including 10% growth in its core Benefits segment and 40% growth in Exchanges.
The Fund’s investments within the Health Care, Information Technology (IT), and Consumer Discretionary sectors were the primary detractors from relative performance. Within Health Care, the Fund’s meaningfully lower exposure to biotechnology and pharmaceutical stocks, which rose 23.9% and 14.1%, respectively, within the index, detracted the most from relative results. Additionally, the Fund’s largest holdings in the sector, Illumina, Inc. and IDEXX Laboratories, Inc., struggled to keep pace with their index counterparts after significantly outperforming last year. Within IT, the Fund’s lack of exposure to strong performing semiconductor stocks and underperformance of its largest holding in the sector, Gartner, Inc., weighed the most on relative results. Shares of IT research firm Gartner fell after management lowered guidance for 2015 due to foreign currency headwinds. We remain encouraged by Gartner’s performance on a constant currency basis, as growth in Research contract value, the company’s key long-term value driver, continues to improve. Weakness in Consumer Discretionary was mostly due to the underperformance of Ralph Lauren Corp. and Tiffany & Co., which were also the Fund’s two largest detractors on an absolute basis. Casino operator Wynn Resorts Ltd. and global lodging company Hyatt Hotels Corp. also hurt relative performance in the sector. Shares of Wynn declined as a result of the Chinese government’s anti-corruption campaign, which has resulted in a slowdown in Macau and lower spending at casinos there. We believe increased hotel capacity will eventually draw visitors back to Macau. Wynn continues to generate strong cash flow which, in our view, supports its 5% dividend yield. Hyatt’s shares fell slightly as the company generated lower-than-expected unit growth in its fiscal fourth quarter. Supply concerns at two of its international hotels also hurt margins and EBITDA at its owned properties. We believe Hyatt will benefit from its strong pipeline of new hotel room growth and increases in revenue per available room given the low supply growth in many of its markets. We think these factors, combined with its strong balance sheet, will result in solid long-term growth for the company.
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