Baron Emerging Markets Fund (BEXFX)

Portfolio Commentary

Review and Outlook (for quarter ended 3/31/2013)

Last quarter, we remarked on the positive effects of various important international developments: progress towards fiscal and banking union in Europe and the related stabilization of the European Union’s (EU’s) financial system; clear signs of a bottoming in China’s economic cycle; and the likely impact of a greater level of developed world quantitative easing, particularly in Japan subsequent to an abrupt shift in political leadership. These trends, which support international equities, remained largely in place through much of the first quarter of 2013. Late in the quarter, however, international markets, particularly emerging markets, began to underperform as signs of policy backtracking emerged.

In particular, Chinese authorities introduced several measures designed to curb speculation in real estate and slow lending in the lightly regulated “wealth management” markets. India’s finance minister disappointed market expectations for business-friendly fundamental reforms in unveiling a populist-leaning fiscal budget, leading to a complete reversal of the stock market’s fourth quarter gains. We fully expect India’s complex political fabric to drive this sort of “two steps forward, one step back” progress, and we remain enthusiastic towards our varied investments in unique and entrepreneurial Indian companies.

In Europe, the bailout of Cyprus bears mentioning given the precedent set regarding uninsured bank deposits. While Cyprus is indeed a special case and the financial impact itself is not significant, we will monitor the potential resumption of deposit and capital flight, as greater stress in the EU financial system would ultimately impact emerging market economies and capital flows.

Japan was the standout international equity market during the first quarter, as a new head of the Bank of Japan was confirmed and expectations for aggressive quantitative easing and a weaker yen continued to build. While this policy shift has benefited Japanese equities, Japan's gain represents a loss of export competitiveness for many neighboring Asian countries and companies, particularly in a relatively slow growth global economy. We believe recent events in Japan are at least partially responsible for the relative weakness in certain emerging market equities, though our relative performance has benefited, as we favor companies driven by local consumption rather than export-driven businesses. A good example is our significant exposure to consumer and domestically-driven companies in the ASEAN countries of Indonesia, Thailand, and the Philippines. These companies are largely insulated from Japanese yen depreciation, Chinese economic volatility or weak European demand, and as a group were strong performers in the first quarter.

We note the unusual divergence between global equity and commodity prices. This trend, if sustained, signals a multi-year downturn in the global commodity cycle, which would have lasting implications for future value creation. Such an outcome would favor commodity consuming countries (and industries), such as the U.S., China, India, and Japan, while creating headwinds for exporters such as Australia, Brazil/Latin America, and Russia. We believe the shift in China from an investment-led to a consumption-led economy, as well as the firming U.S. dollar, support such a phenomenon; given our general lack of exposure to commodity driven or cyclical businesses, we further believe the Fund is well positioned over the long term for such a scenario.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 3/31/2013)

• L.P.N. Development PCL is a leading homebuilder and condominium developer in Thailand with an impressive track record of growth, profitability, cash generation and return on capital. The stock was strong during Q1 as management revealed plans to increase condo launches this year by 50% over the prior year’s level.

• NQ Mobile, Inc. was up 49.2% in Q1. NQ Mobile is the #1 mobile security provider in China, and has a growing international presence, with over 50% of its revenues now from outside of China. Performance in Q1 was driven by a large deal with America Movil, the 4th largest telecom provider in the world, with over 250 million subscribers in Latin America. NQ Mobile also reported strong Q4 results, with year-over-year revenue growth of 134%.

• Shares of Biostime International Holdings Ltd. rose sharply in Q1. China-based Biostime produces baby food, and its primary product is infant formula. The outperformance during Q1 can be attributed to above-consensus financial performance. Sales of infant formula are growing rapidly in China, and Biostime has strong brand positioning and is gaining market share in its key markets.

Detractors (for quarter ended 3/31/2013)

• Financial Technologies Ltd. operates financial exchanges and owns 26% of MCX, the largest commodity exchange in India. In March, India’s government announced a new tax on commodity transactions to take effect in June. This news has led to uncertainty about the effect on commodity-related trading volumes and, given Financial Technologies interest in MCX, the stock sold off. We believe investors ascribe little to no value to the company’s other fast growing and profitable exchanges. Despite a weak local equity market, we retain conviction in the company due to its business model and high returns on capital.

• Delta Corp Ltd. , an operator of casinos in India, was a detractor in Q1. The company continued to make progress on the construction and openings of their casinos in Daman and Goa; however the macro environment in India has deteriorated, which presents a headwind to profit growth. We still like the long-term prospects for the company, and we believe its profit growth will improve when its two new casinos are operating.

• Agrinos AS declined 46.3% in Q1. Agrinos is a green technology company with a unique microbial product that enhances crop yields. Performance in Q1 was weak because a delay in receivables collection led to a change in accounting policy, with no revenue booked for Mexico in Q4. We continue to hold Agrinos because we believe it has disruptive technology and exciting long-term growth prospects.

Quarterly Attribution Analysis (for quarter ended 3/31/2013)

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 Emerging Markets Fund (Retail Shares) gained 2.29% in the first quarter, outperforming the MSCI EM IMI Growth Index, which finished the period down 0.17%, by 246 basis points.

While emerging market equities overall were roughly flat for the quarter, the Fund generated a modest gain and meaningfully outperformed its benchmark. This was primarily the result of favorable stock selection. Stock selection was positive across a number of countries within Asia-Pacific (ex-Japan), led by China, overshadowing weakness from investments in India, which is also part of this region. The Fund’s significant exposure to companies in the ASEAN countries of Indonesia, Thailand, and the Philippines, which were the standout emerging markets countries in the quarter, also added to relative results.

On a sector basis, the Fund's investments within the Financials, Consumer Staples, and Telecommunication Services sectors were the largest contributors to relative results for the quarter. Strength within the Financials sector was largely attributable to outperformance of the Fund’s two real estate development investments, L.P.N. Development PCL and Lippo Karawaci Tbk PT. L.P.N. Development PCL is a leading homebuilder and condominium developer in Thailand with an impressive track record of growth, profitability, cash generation, and return on capital, while Lippo Karawaci Tbk PT is a real estate developer based in Indonesia. Another relative contributor in the sector was Bank Rakyat Indonesia (Persero) Tbk PT, a leading commercial bank in Indonesia. Within Consumer Staples, all but one of the Fund’s investments in the sector outperformed, led by Biostime International Holdings Ltd., a leading Chinese infant formula distributor. Shares of Biostime outperformed in the quarter driven by above-consensus financial performance as well as speculation regarding the easing of China’s one child policy. Another relative contributor in the sector was Universal Robina Corp., a leading packaged food and beverage company based in the Philippines. Favorable stock selection within Telecommunication Services was attributable to the outperformance of the Fund’s two investments in the sector, Sarana Menara Nusantara Tbk PT and Tower Bersama Infrastructure Tbk PT, the two largest independent owners of wireless towers in Indonesia. These companies have experienced increased leasing revenue and cash flow from colocation activity as a result of the high growth of data traffic in Indonesia.

Underperformance of the Fund’s investments within the Information Technology (IT) sector, and the Fund’s lower exposure to Utilities, the best performing sector in the benchmark, detracted from relative performance. Weakness in IT was mostly due to underperformance of Financial Technologies Ltd. which operates financial exchanges and owns 26% of the Multi Commodity Exchange of India Ltd. (MCX), the largest commodity exchange in India. The company’s shares suffered a meaningful correction in response to the surprise imposition of a new commodity trading tax by India’s government. Additionally, underperformance of Ireland-based Velti plc, a leading global mobile marketing company, detracted from relative results. Shares of Velti declined sharply in the period after the company missed quarterly expectations and lowered its 2013 outlook. The Fund exited its position due to the lack of cash flow visibility.

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