Baron Global Advantage Fund (BGAIX)

Portfolio Management

AlexUmansky
Alex Umansky

Fund Manager since 2012

View All Commentary by Alex

Fund Description

Baron Global Advantage Fund invests in growth companies of all sizes anywhere.

  

Portfolio Commentary

Institutional Performance

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

The Baron Global Advantage Fund declined approximately 2% in the third quarter and is up 4% year-to-date, both roughly in-line with its benchmark. We continue to maintain a healthy lead over the benchmark over the last 12 months and since inception. While we would characterize the quarterly result as somewhat uneventful, we had a number of sizable winners as well as portfolio holdings that got hit unusually hard. We did very well with investments in China, large cap U.S., and in the Information Technology sector, with TAL Education Group, Baidu, Facebook, Mellanox Technologies, and Mobileye all posting at least double digit gains and making meaningful contributions to quarterly returns. On the other hand, we gave up most of last quarter’s gains in Brazil, took it on the chin in Europe, and saw most of our small cap investments decline precipitously with Coupons.com, Benefitfocus, AO World, Grifols, and Acxiom all posting substantial stock price declines. We think this is a favorable environment for managers who are looking to invest in businesses at substantial discounts to their intrinsic values. We have continued to find new ideas and our “pipeline” of compelling investment candidates is the largest it’s ever been. One place we will not be finding them any time soon is Russia.

We have generally been very bullish on the emerging markets, especially China, India, and Indonesia. The emergence of the middle class has allowed these countries to develop their own economic eco-systems. The emerging markets economies, in aggregate, did not suffer a down year in 2008 or 2009, and the three countries mentioned above did not post even a single down quarter! In many respects, the global financial crisis of ’08-’09 was a wonderful stress test that the emerging economies passed with flying colors. These countries tend to have younger populations, high local savings rates, and infrastructure needs that are new in nature (rather than rehab projects like highways and airport renovations that last forever but do not really lead to new efficiencies or opportunities). This being a global fund, looking for competitively advantaged companies that could also benefit from these beneficial long-term trends is always high on our priority list.

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. People are healthier, smarter, and more prosperous than they have ever been. 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)
  • Shares of leading Chinese tutoring services provider TAL Education Group rose significantly in Q3. Performance was driven by strong reported results, with 45% revenue growth and improved gross margins on a favorable mix-shift towards small classes. The company also expanded into three new cities, bringing its physical presence to 19 cities. Given its strong reputation in math and science, high barriers to entry, and strong margin and cash flow characteristics, we think TAL is well positioned for solid growth over the next few years.

  • 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.

  • Mellanox Technologies Ltd. supplies semiconductor-based systems for computing, storage and communications applications that connect servers to servers and servers to storage. Mellanox's stock rose on reports of better Q2 results and Q3 guidance, as the latest generation of Intel chips spurred customer demand for high performance interconnect systems. We believe we are still in the early innings of the Mellanox growth story.

Detractors (for quarter ended 9/30/2014)
  • Shares of Coupons.com Incorporated, a leading digital couponing platform, declined sharply on news of disappointing Q2 results. Digital coupons represented less than 1% of total U.S. consumer packed goods (CPG) coupon distribution volume in 2012, but accounted for almost 7% of all U.S. CPG coupon redemptions. We believe that, as a market leader, Coupons.com has considerable room for expansion going forward.

  • Shares of Benefitfocus, Inc. fell in Q3, partly due to a secondary offering in July that increased the public float by more than 30%. Benefitfocus is the leading provider of cloud-based benefits software, offering an integrated suite of solutions to help customers more efficiently shop, enroll, manage, and exchange benefits information. We think Benefitfocus serves an addressable market more than 100 times larger than its current business, which should allow it to compound revenue at more than 30% annually.

  • AO World plc is the leading online seller of major domestic appliances in the U.K., with a 10% market share. Shares fell in Q3 due to contractions in valuations for the online sector in the UK over the past several months. We think AO's unique supply chain and customized software give it a strong competitive advantage, and we believe it can be several times larger over the next few years as it expands into new product categories and continental Europe. It took its first step overseas with its September 30 launch of a website in Germany.

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 Global Advantage Fund (Institutional Shares) decreased 1.94% in the third quarter and slightly underperformed the MSCI ACWI Growth Index by 23 basis points.

Outperformance of the Fund’s two investments in Israel and its holdings in China added the most value. This positive effect was more than offset by underperformance of the Fund’s developed markets investments in the U.S. and Spain and its meaningfully larger exposure to emerging market equities, particularly in Brazil, which lagged their developed market counterparts during the quarter.

On a sector basis, outperformance of the Fund’s investments within Energy, its lower exposure to the lagging Materials sector, its lack of exposure to Industrials, and its meaningfully larger exposure to Information Technology, which gained 1.4% in the index, contributed the most to relative results. Within Energy, the outperformance of Tallgrass Energy Partners, LP, an MLP formed in 2013 to acquire, develop, and operate midstream energy assets, added the most value. Shares of Tallgrass increased after the company closed on its first equity stake in the Pony Express pipeline. Favorable stock selection in Energy was partly offset by the Fund’s larger exposure to the sector, which fell approximately 10% in the index.

The Fund’s investments within the Health Care, Financials, and Consumer Discretionary sectors detracted from relative results. Weakness in Health Care was mostly attributable to the underperformance of Grifols SA, which manufactures and sells plasma derivative health care products, and Illumina, Inc., the leading provider of next generation DNA sequencing instruments and consumables. Shares of Grifols sold off after the company reported a weak second quarter, including one-time expenses in conjunction with the integration of its recently acquired Novartis diagnostics unit, and incremental price competition in a small commoditized product line. Illumina’s shares declined in the quarter after nearly doubling over the last year on the strength of several new product introductions. Within Financials, the underperformance of Cetip SA - Mercados Organizados, which operates the largest fixed income exchange in Brazil, detracted the most from relative results. Following significant outperformance in the first half of the year, Cetip’s stock price was adversely impacted by the depreciation of the Brazilian real against the U.S. dollar, as well as uncertainty surrounding the Brazilian presidential elections. Within Consumer Discretionary, the Fund’s Internet retail holdings fell 13.4% as a group, with Coupons.com Incorporated and AO World plc leading the decline. These companies were also two of the Fund’s largest detractors from absolute performance. Another detractor in Internet retail was MakeMyTrip Ltd., an online travel company that provides travel products and solutions in India and internationally. Shares of MakeMyTrip underperformed in the quarter due to more volatile market conditions and concerns about the impact Ebola could have on the travel industry.

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