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 3/31/2016)

Baron Fifth Avenue Growth Fund was hit hard during the January sell-off and did not come back as much when the market rallied. There were three principal culprits: reversion to mean, the re-rating of the biotech sector, and past investment mistakes. After outsized gains in 2015, Amazon, Inc., Red Hat, Inc., The Charles Schwab Corp., and Mobileye N.V. all posted double digit declines in the first quarter, while their fundamentals remained unchanged in our view. The presidential election cycle, the made-for-TV drama starring Valeant Pharmaceuticals (which we never owned), and the Treasury’s determination to stop inversions caused a widespread multiple contraction in the pharma/biotechnology space. LinkedIn Corp. gave quarterly guidance that made people question the size of its addressable market, while Twitter, Inc.’s guidance seemed to confirm investors’ fears about its market. And then of course, there was TerraForm Global, Inc., where we have clearly suffered some permanent loss of capital.

According to the MSCI GICS industry classification, just over 40% of the Fund’s assets were invested in the Information Technology (IT) sector during the first quarter. We think it is important to understand the rationale and what is really behind this number. Alphabet Inc. (formerly Google, Inc.), Facebook, Inc., Alibaba Group Holding Limited, Twitter, and LinkedIn represented more than half of these IT investments. None of these companies sell software, servers, routers, or semiconductor chips, and hence, their business fundamentals do not correlate with corporate IT refresh cycles or government budget flushes and IT infrastructure upgrades. Instead, they are part of the digital revolution that is slowly but surely sweeping across the world. The rest of the portfolio's IT investments are Visa, Inc. and MasterCard, Inc., which we think of as digital railroad companies, and Apple, Inc., which looks to us like a classic Consumer Discretionary company.

What we used to describe as volatile market conditions is starting to feel like the norm. The S&P 500 Index fell more than 10% last August and again early this year, only to regain most of its value in a matter of weeks. Interest rates, corporate earnings, China’s economy, energy prices, terrorism, politics and elections, Britain leaving the E.U., and inflation are just a few of the many issues contributing to heightened anxieties. Even the most experienced investors find this kind of volatility unsettling.

Yet, we have always lived and invested in a world full of uncertainty. The business of capital allocation (or investing) is the business of taking risk, managing the uncertainty, and taking advantage of the long-term opportunities that those risks and uncertainties create. We are confident that our process is the right one and that it will enable us to make good investment decisions over time. Our goal remains to maximize long-term returns without taking significant risks of permanent loss of capital through investing in what we believe are unique companies with sustainable competitive advantages that have the ability to compound capital at high rates of return for extended periods of time.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 3/31/2016)
  • Shares of Facebook, Inc., the world’s largest social network, rose in Q1, driven by improving consumer engagement and monetization. Facebook is the largest beneficiary of the shift in consumer engagement to mobile. Facebook is using its leadership position to provide global advertisers targeted marketing capabilities at scale. Facebook is in the early stages of monetizing online video and Instagram, which are starting to contribute to incremental revenue growth. WhatsApp and Oculus provide additional avenues for growth opportunities.

  • Shares of Brookfield Asset Management, Inc. rose in Q1 due to strong conditions in most of its business segments. The company is a global alternative asset manager with approximately $200 billion in assets under management, with a focus on real estate property, infrastructure, renewable energy, and private equity. A high quality portfolio, stable cash flows and attractive growth opportunities, global scale, a quality balance sheet, and an excellent management team with significant insider ownership support our favorable view.

  • Equinix, Inc., an operator of carrier-neutral data centers, continued to make progress on several fronts: 1) the closing of its Telecity acquisition in Europe, 2) a strong finish to 2015 with organic growth beating analyst expectations, and 3) maintaining financial flexibility and a strong balance sheet in an uncertain market. In addition, supply/demand in the data center space is favorable and price accommodative with consolidation capping supply and cloud and outsourcing lifting demand. All of those contributed to an increase in the stock price in Q1.

Detractors (for quarter ended 3/31/2016)
  • Shares of Amazon.com, Inc., the world’s largest retailer, declined in Q1 despite reporting strong revenue growth due to retail margins being lower than anticipated. Amazon has responded by instituting substantial fulfillment and supply chain fee increases for merchants on the platform. We estimate that these fee increases should start to alleviate the recent pressure on retail margins in the upcoming quarters. Amazon’s other major business segment, Amazon Web Services (AWS) continues to gain traction with enterprise customers, and over time, we expect AWS to be the larger contributor to value creation for the company.

  • LinkedIn Corp. is the world’s largest online professional network. It has three business segments: Hiring Solutions, Marketing Solutions, and Premium Subscriptions, each serving different customers. Despite strong 4Q15 results, shares were down in Q1 due to a weak 2016 outlook. After several quarters of inconsistent results, we believe management is finding it increasingly difficult to manage the complexity of three businesses. We exited the position.

  • Shares of Alexion Pharmaceuticals, Inc. fell sharply in Q1 as a result of the massive correction in the biotech/pharma space. Alexion develops treatments for rare diseases. Its high foreign exchange exposure and high multiple also pressured the stock. Overall, we believe there have been no significant changes to the fundamentals of Alexion’s story and we retain conviction.

Quarterly Attribution Analysis (for quarter ended 3/31/2016)

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.

Baron Fifth Avenue Growth Fund declined 4.92% in the first quarter and underperformed the Russell 1000 Growth Index by 566 basis points, mainly due to stock selection.

The Fund’s Financials and Energy investments and its cash exposure as the market declined precipitously early in the quarter contributed to relative performance. Strength in Financials was mostly due to the outperformance of Brookfield Asset Management, Inc., Equinix, Inc., and CME Group, Inc. Brookfield and Equinix were two of the largest contributors on an absolute basis, while CME, which operates a derivatives marketplace, benefited as volatility drove higher trading volumes. Within Energy, outperformance of Concho Resources, Inc. added value, but this positive result was mostly offset by slightly larger exposure to this poor performing sector, which was hurt by volatile oil prices. Shares of Concho, an exploration and production company focused on the Permian basin in West Texas and New Mexico, rose after the company enhanced its position in the Delaware basin, and provided a 2017 outlook that beat expectations.

Underperformance of the Fund’s Information Technology (IT), Consumer Discretionary, and Health Care holdings and its lower exposure to the outperforming Consumer Staples sector detracted the most from relative results. Within IT, underperformance of Internet software & services holdings, led by LinkedIn Corp. and Twitter, Inc., and meaningfully larger exposure to this lagging sub-industry hurt relative results. LinkedIn was the second largest detractor from absolute results before being sold in early February, while shares of Twitter declined after the company reported an outlook for Q1 that was weaker than Street estimates.  Slowing user growth continues to be a concern, but we believe the change in senior leadership last year should lead to upcoming product enhancements. Underperformance of Mobileye N.V. and systems software holdings, led by FireEye, Inc., also weighed on relative results. Shares of Mobileye, which develops vision-based advanced driver assistance systems, declined on short seller allegations that its high valuation and competitive position are unsustainable. We retain conviction as we believe Mobileye has a dominant market position due to its solid technology and evidenced by its wins with top car manufacturers. Weakness in Consumer Discretionary was mainly due to the underperformance of Amazon.com, Inc., the largest detractor on an absolute basis. Amazon’s shares fell in the quarter after more than doubling in 2015. Health Care holdings trailed their index counterparts after falling 18.7%, with Illumina, Inc. and biotechnology holdings Alexion Pharmaceuticals, Inc. and Regeneron Pharmaceuticals, Inc. leading the decline. Shares of Illumina, a leading provider of DNA sequencing technology, fell after solid Q4 financial results were overshadowed by tempered expectations for sales of certain instruments. Shares of Alexion and Regeneron fell primarily as a result of a steep correction in the biotech/pharma space in the quarter.

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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.