Baron Focused Growth Fund (BFGFX)

Portfolio Commentary

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

Equity investors continued to be rewarded during the first quarter, as several major U.S. market indexes reached all-time highs. Fourth quarter earnings results were generally positive, and the U.S. economy continues to improve. Existing home prices and new home construction activity are increasing, automobile sales are rebounding, and natural gas prices and electricity costs remain low, which positively impact industrial activity. These factors appeared to offset fears surrounding consumer deleveraging, government fiscal restraints, higher taxes, and the economic impact of sequestration. In addition, positive money flows continued into equity investments, indicating that investors' long-awaited shift away from cash finally might be beginning.

A shift to equities may benefit our investments in asset managers and information services companies, whose businesses are tied to the equity markets. Examples include Eaton Vance Corp., The Carlyle Group, MSCI, Inc., and FactSet Research Systems, Inc.

The Fund's best performers included investments in the Industrials, Consumer Discretionary, and Financials sectors. Seventeen of the Fund’s 28 investments achieved double-digit returns in the quarter. Only four investments, American Campus Communities, Inc., Booz Allen Hamilton Holding Corp., C.H. Robinson Worldwide, Inc., and Agrinos AS, declined during the quarter. We believe the long-term growth prospects for these businesses remain favorable.

A new addition to the portfolio this quarter is a company well-known to us, Vail Resorts, Inc. Vail is the largest operator of ski resorts in North America. It owns and operates seven world class ski resorts: Vail, Breckenridge, Keystone, and Beaver Creek in Colorado; and Heavenly, Northstar, and the Kirkland property in Lake Tahoe.

Outlook

From December 1999 to December 2012, our economy grew 4.1% per year on a nominal basis and the S&P 500 Index was down .23% (up 1.66% including dividends). This is an anomaly in our opinion. We were subject to a terrorist attack and participated in two wars; and we experienced the worst financial crisis in our history, followed by a deep recession, consumer deleveraging, fiscal restraints, and higher taxes, all coupled with global uncertainty.

The U.S. stock markets and the U.S. economy have been inextricably linked over the long term. For example, from 1960, when John F. Kennedy became President, to the end of last year, the nominal GDP of our economy rose from $524 billion to $15.9 trillion. Over the same time period, the S&P 500 Index rose from 58.11 to 1,426.19. While GDP grew at an annualized rate of 6.75% per year, the S&P 500 Index advanced 6.35%, or 9.71% including dividends, per year, for the past 52 years.

We think our economy will continue its measured recovery and eventually return to about 6% growth per year in nominal dollars, and the U.S. stock markets will continue their measured advance. We believe growth will be propelled by new technologies in unconventional energy and resource development and low natural gas prices, agricultural transformation, advancements in IT, software and online commerce, and the housing recovery. We continue to find many investment opportunities in these areas and many others across all sectors of our economy. Of course, we continue to expect our competitively advantaged, well managed, growth companies to outperform markets by 300 to 500 basis points per year over the long term, although we cannot assure that will be the case.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 3/31/2013)

• Shares of Genesee & Wyoming, Inc., a leading short line railroad, rose 22.4% during Q1, after completing a transformational acquisition of its primary competitor for $2 billion. The combined entity makes Genesee & Wyoming the dominant regional rail operator in the U.S., adding revenue diversity and cementing barriers to entry. In addition, private equity firm The Carlyle Group acted as a strategic equity partner, making a $350 million investment and advising on future acquisitions.

• Shares of Verisk Analytics, Inc., which provides information about risk to companies in the insurance, health care, and mortgage industries, outperformed the market as the company announced better than expected earnings for Q4. For Q1, the company grew earnings 26%, with particularly robust results from the company’s expanding portfolio of health care-related analytical and fraud prevention tools. We believe that increasing insurance rates, coupled with product enhancements and extensions, will help to accelerate revenue growth from Verisk’s insurance customers over the next few years.

• Choice Hotels International, Inc., the largest hotel franchisor in the U.S., increased 26.4% in Q1 as investors recognized the company’s strong pipeline of new domestic hotel development contracts signed. Its increase in signed contracts should set the company up for future unit growth. We believe this unit growth, combined with lower discount royalty rates and continued improvement in RevPAR, should result in stronger revenue and margin growth in the future.

Detractors (for quarter ended 3/31/2013)

• 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.

• Shares of Booz Allen Hamilton Holding Corp. were down slightly in Q1, but they performed well given the confusion surrounding the current defense budget. Near the end of Q1, the company completed a $154 million acquisition of a small division of another defense contractor that specializes in high-end engineering and prototyping. Its most recent earnings report beat expectations, as the company managed its workforce around shifting demand for particular services and new opportunities.

• Shares of the leading U.S. truck broker, C.H. Robinson Worldwide, Inc., detracted from performance during Q1, declining 5.4% after reporting disappointing earnings. Although truckload freight volumes are improving, C.H. Robinson is experiencing temporary margin pressure as cost of capacity increases faster than its ability to pass pricing to shippers. We believe this issue will be resolved as 2013 unfolds and gross volumes accelerate.

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 Focused Growth Fund (Retail Shares) gained 10.92% in the first quarter, yet underperformed the Russell 2500 Growth Index by 128 basis points. During the quarter, the Fund’s above average exposure to cash (almost 8% in a market rally) and unfavorable stock selection detracted from relative results.

The Fund’s investments within the Industrials, Consumer Discretionary, and Utilities sectors were the largest contributors to relative results for the quarter. Strength in Industrials was largely attributable to outperformance of the Fund's two largest holdings in the sector, Genesee & Wyoming, Inc., a leading short line railroad, and Verisk Analytics, Inc., which provides information about risk to companies in the insurance, health care, and mortgage industries. Favorable stock selection in the Consumer Discretionary sector was mainly attributable to the outperformance of Choice Hotels International, Inc., the largest hotel franchisor in the U.S. Shares of Choice Hotels increased 26.4% in the quarter as investors recognized the company’s strong pipeline of newly signed domestic hotel development contracts, which should set the company up for future unit growth. Another contributor in the sector was recent addition Manchester United plc, an English Premier League professional sports team. Within Utilities, a combination of outperformance of the Fund’s only holding in the sector, ITC Holdings Corp., and the Fund’s larger exposure to the outperforming sector contributed to relative performance. Shares of ITC, the nation’s largest independent transmission company, rose 16.6% in the quarter as investors’ concerns regarding a potential dividend tax hike and changes in the company’s regulatory structure began to subside, investors increasingly recognized ITC’s superior growth prospects relative to other regulated utilities, and the short interest in ITC substantially declined.

Underperformance of the Fund’s investments within the Information Technology (IT) and Materials sectors were the largest detractors from relative performance in the quarter. The majority of the Fund’s IT investments underperformed during the quarter, led by Booz Allen Hamilton Holding Corp., which provides information technology consulting services to the federal government, as well as commercial and foreign customers. Shares of Booz Allen were down slightly during the quarter, dampened by the confusion surrounding the current defense budget. Unfavorable stock selection in Materials was largely attributable to underperformance of Agrinos AS, a green technology company with a unique microbial product that enhances crop yields. Performance in the quarter was weak because a delay in receivables collection led to a change in accounting policy, and no revenue was booked for Mexico in the fourth quarter. The Fund’s meaningfully lower exposure to Health Care, one of the better performing sectors in the benchmark, also detracted from relative results.

Back to Top