Baron Fifth Avenue Growth Fund (BFTIX)

Portfolio Management

AlexUmansky
Alex Umansky

Fund Manager since 2011

View All Commentary by Alex

Fund Description

Baron Fifth Avenue Growth Fund invests in large growth companies.

    

Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 9/30/2014)

This quarter was very similar to the one ended in March, where a good earnings season combined with solid economic data (steadily improving unemployment, low inflation, rising business and consumer confidence) led the market  higher until mid-September. Then signs emerged that Europe was deteriorating, the growth in emerging markets continued to slow (growth recession they called it), crude oil WTI broke $90, and the outbreak of the Ebola virus was no longer contained to West Africa. In a two week swoop, the market erased earlier gains with mid cap and small cap stocks getting hit particularly hard. The decline persisted into early October, with the S&P 500 Index giving up all of its gains year-to-date and the Russell 2000 Growth Index sporting double-digit declines. “Is this just a correction or is the bull market finally over? Is this the time to buy or is this the time to sell?” the talking heads were asking. Separating the noise from valuable perspectives and looking for and developing unique insights is what we try to do at Baron Funds.

Conceptually, we find it more stressful when the market is running straight up than when the stock prices are coming down. As capital allocators we are always looking for mispriced opportunities, which are easier to find when stocks are on sale. Our conviction is always highest when we can buy at sizable discounts to the business’ intrinsic values and we worry less about figuring out exactly when that dynamic might change.

The Information Technology sector included the four top individual contributors to the Fund, which helped boost sector performance in the quarter. Financials and Consumer Staples contributed modestly to performance as well. Financials gained ground primarily on the strength of CME Group Inc., the world's largest and most diversified derivatives marketplace. A solid quarter for the Fund’s sole Consumer Staples position, big box retail chain Costco Wholesale Corp., boosted performance of that sector. Consumer Discretionary, Materials, and Energy were the top sector detractors. While Consumer Discretionary holdings had a mixed quarter, the sector was weighed down by the weak performance of three of the top five individual detractors. Materials fell on weakness by the Fund’s sole sector holding, Monsanto Company. The Energy sector was hurt by falling commodity prices in the quarter.

While we expect the markets to remain volatile, we remain positive on the overall environment. Over the last 50 years, despite the doubling of the population, average global income per capita has tripled, life expectancy has risen by a third, and child mortality is down 70%. Literacy rates are up meaningfully, and average IQs are considerably higher, even after adjusting for inflation and better nutrition. All predictions of doom have repeatedly proved wrong. Despite disasters and reverses, quality of life and material wealth and prosperity have continued to increase everywhere in the world (although, not equally distributed), and we think that’s unlikely to change.

Our goal remains to maximize long-term returns without taking significant risks of permanent loss of capital.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 9/30/2014)
  • Facebook Inc. is the world's largest social network. Shares of Facebook were up in Q3 on reports of continued improvements in consumer engagement and mobile monetization. We believe that Facebook is in the early innings of building out its global advertising business while investing in newer synergistic offerings such as Instagram and WhatsApp.

  • Twitter, Inc. is an online social networking and micro-blogging service that enables users to send and read short messages. Shares of Twitter performed well in the quarter as investors saw signs of greater consumer engagement and improved monetization on the platform. We believe Twitter is in the early stages of its overall growth and has substantial runway ahead of it.

  • Shares of Apple, Inc. increased in Q3 as investors purchased the stock ahead of the new iPhone 6 launch. Lines, both virtual and physical, were longer than any other launch in Apple’s history, and 10 million devices were sold in the first weekend. Apple also introduced a payment system and a watch, which helped shift investor sentiment around new product innovation and categories in the post-Jobs era. Being the most valuable company on earth makes it harder to grow but so far, Apple is proving the naysayers wrong.

Detractors (for quarter ended 9/30/2014)
  • Shares of Las Vegas Sands Corp., which operates casinos in Las Vegas, Singapore and Macau, fell in Q3 as China's corruption crackdown and more stringent visa restrictions dampened growth in Macau. In addition, the junkets which bring in VIP rollers, lend them money, and settle their debts, are proving less willing to extend generous credit terms, as it has become harder to collect debts. Despite these setbacks, we believe that as new supply comes online and infrastructure improves, Las Vegas Sands will continue to grow in this underpenetrated market.

  • Shares of Illumina, Inc. declined in Q3. Illumina is the leading provider of next generation DNA sequencing instruments and consumables. There was no specific reason for the decline. The shares are up significantly over the past year, driven by strong momentum following the announcement of multiple new product introductions. We believe Illumina has further distanced itself from its competitors and holds an effective monopoly on DNA sequencing at a time when demand is accelerating, and our conviction in the long-term investment thesis remains unchanged.

  • Shares of leading seed and traits company Monsanto Co. fell in Q3, driven down by weak grain prices, which has dampened investor enthusiasm across the agricultural complex. Monsanto also issued lower-than-expected guidance following its biennial investor event in August. Monsanto is not immune to lower grain prices, but we continue to own the stock as we believe it is a highly cash generative franchise with dominant market share, high barriers to entry, and compelling long-term global growth prospects.

Quarterly Attribution Analysis (for quarter ended 9/30/2014)

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 Fifth Avenue Growth Fund (Institutional Shares) rose 0.59% in the third quarter, yet modestly underperformed the S&P 500 Index by 54 basis points. During the quarter, the Fund’s relative sector weights added value, but this positive effect was offset by stock selection.

The Fund’s investments within the Information Technology (IT) sector and its lower exposure to the lagging Energy and Utilities sectors contributed the most to relative results. Within IT, outperformance of the Fund’s Internet software & services holdings and its meaningfully larger exposure to this sub-industry, which rose 6.5% as a group in the index, aided relative performance. Strength in Internet software & services was largely attributable to the outperformance of Facebook Inc. and Twitter, Inc., which were also the Fund’s two largest contributors on an absolute basis. Another contributor in the sub-industry was LinkedIn Corp., the leading online professional networking platform. Shares of LinkedIn increased in the quarter due to strong second quarter results, with revenue growth of 47% year-over-year and its Marketing Solutions business showing revenue acceleration.

The Fund’s investments within the Consumer Discretionary, Health Care, and Materials sectors were the primary detractors from relative results. Within Consumer Discretionary, underperformance of the Fund’s casinos & gaming and restaurant holdings and its larger exposure to these lagging sub-industries hurt relative results. Shares of Las Vegas Sands Corp. and Wynn Resorts Ltd. declined in the quarter after China's corruption crackdown and more stringent visa restrictions slowed growth in Macau. YUM! Brands, Inc., the parent company of fast food chains Taco Bell, KFC, and Pizza Hut, also weighed on relative performance in the sector. The Fund decreased its position in YUM! after the company’s shares fell on negative publicity surrounding accounts of improper food handling practices by a former local supplier in China, where the company generates about half its revenues. We consider this setback to be temporary and believe YUM! will continue to grow units and profits at a rapid pace in China and other emerging markets. Within Health Care, the underperformance of the Fund’s largest holding in the sector, Illumina, Inc., overshadowed the positive effect of its larger exposure to biotechnology stocks, which rose 17.5% as a group in the index. Illumina was also one of the Fund’s largest detractors from absolute performance. Weakness in the Materials sector was due to the underperformance of Monsanto Co., which was also one of the Fund’s largest detractors on an absolute basis.

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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 judgement 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. Investing in the stock market is always risky. Current and future portfolio holdings in the Fund are subject to risk.

Source: FactSet PA.