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 9/30/2016)

Baron Global Advantage Fund was up 11.1% in the third quarter of 2016. We saw broad-based strength across the portfolio with 22 of our 39 investments rising over 10%.

Our core holdings performed well. This time we also received significant contributions from smaller investments with ARM Holdings rising 45% after being acquired by Softbank, and our two lesser known health care investments in Glaukos (up 29%) and Aerie Pharmaceuticals (up 115%) working out nicely as well. The third quarter was a favorable investment environment, as we undoubtedly benefited from rising tides lifting all boats, and from playing a bit of catchup after falling behind earlier in the year.

Information Technology (IT), Consumer Discretionary, and Health Care holdings were the top contributing sectors in the period. IT performance was led by second largest contributor Alibaba Group Holding Ltd.  Online food delivery marketplace JUST EAT plc also contributed to sector performance as a result of an increase in share price following the release of financial results for the first half of 2016 that exceeded Street estimates. Consumer Discretionary advanced on double digit share price increases in all five Fund holdings, led by top contributor Amazon.com, Inc. Health Care benefited from strong performance of third largest contributor Illumina, Inc., as well as the aforementioned Aerie and Glaukos. Telecommunication Services was the only sector to detract in the period, as the Fund’s two sector holdings, both of which are Indonesian tower companies, fell as telcos continued to defer network equipment upgrades.

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, material wealth, and prosperity have continued to increase everywhere in the world, 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. We believe the best strategy for long-term capital appreciation is to collect a mix of unique companies that sell into different end markets and different geographies. We will continue to focus on identifying and investing in companies that we believe have sustainable competitive advantages and the ability to reinvest excess capital at high rates of return.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 9/30/2016)
  • Shares of Amazon.com, Inc., the world’s largest retailer and cloud services provider, rose in Q3 after reporting strong revenue growth and improving margins in its core business. Amazon’s other major business segment, Amazon Web Services (AWS), continues to gain traction with enterprise customers, and had another strong quarter of growth. Over time, we expect AWS to be the larger contributor to value creation. The company continues to invest in new and potentially large business segments such as e-finance, business supplies and apparel.

  • Shares of Alibaba Group Holding Limited, the largest e-commerce company in China, performed well in Q3 following strong quarterly results. Enhanced financial disclosure helped investors to understand better the profitability of the core commerce business and thereby attribute a higher value to it. We expect that mobile monetization will continue to improve through 2016 and beyond as the company invests in new areas such as online grocery and cloud computing.

  • Shares of Illumina, Inc., the leading provider of DNA sequencing technology to academic and commercial laboratories, contributed to performance in Q3. The company reported financial results that beat Street expectations and reiterated guidance for the year. We continue to believe Illumina has a long runway for growth, driven by increasing adoption of DNA sequencing in clinical markets such as cancer screening, diagnosis, and treatment.

Detractors (for quarter ended 9/30/2016)
  • Shares of semiconductor company Mellanox Technologies Ltd. fell on disappointing Q2 results, including a slowdown in the company’s InfiniBand business and heightened competitive concerns around a new product from Intel Corp. We expect Mellanox to be a share leader at the high end of the InfiniBand business and protect its high margin business model with strong innovation and product leadership. We view Mellanox’s Ethernet business as an open-ended opportunity that is potentially much bigger than its InfiniBand business.

  • Shares of cybersecurity software vendor FireEye, Inc. fell in Q3 on disappointing guidance as new management reset expectations for 2016 in an effort to build a solid base for 2017. We believe management is building a strong foundation for future growth. The organization has been right-sized, mid-market and new subscription products are being launched, and go-to-market partnerships have been fine tuned. FireEye has best-in-class technology and is improving its delivery methodology in products (subscriptions) and go-to-market design.

  • Shares of PT Sarana Menara Nusantara Tbk., the largest independent owner of wireless telecommunication towers in Indonesia, declined in Q3 as telcos continued to defer network equipment upgrades. We believe that wireless network spending in Indonesia will eventually climb as operators contend with significant growth in wireless data consumption. Over time, we believe Sarana Menara will build a significant number of new towers for these telco tenants and have the opportunity to acquire peer tower companies as well.

Quarterly Attribution Analysis (for quarter ended 9/30/2016)

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 Global Advantage Fund rose 11.08% in the third quarter and outperformed the MSCI ACWI Growth Index by 580 basis points, due to a combination of stock selection and relative sector weights.

On a country basis, stock selection in developed markets contributed the most to relative results, mainly due to outperformance of investments in the U.S., the U.K., and Canada. Significantly larger exposure to outperforming emerging market equities, particularly those in China, also added value.

On a sector basis, Consumer Discretionary and Health Care investments, lack of exposure to the lagging Consumer Staples sector, and meaningfully larger exposure to outperforming internet software & services stocks within Information Technology (IT) added the most value. All five of the Fund’s Consumer Discretionary investments lifted relative results, led by internet & direct marketing retail holdings Amazon.com, Inc., Ctrip.com International Ltd., and The Priceline Group, Inc. Amazon was the largest contributor on an absolute basis, while both Ctrip and Priceline benefited from solid quarterly earnings results. Naspers Limited, a South Africa-based internet and media platform operator, and TAL Education Group, a leading Chinese K-12 tutoring company, were the other contributors in the sector. Within Health Care, outperformance of Illumina, Inc. and Aerie Pharmaceuticals, Inc. and lower exposure to this poor performing sector aided relative results. Illumina was the third largest contributor to absolute performance, while shares of Aerie, which is developing a novel set of eye drops to treat glaucoma called Rhopressa/Roclatan, outperformed due to success in recent clinical trials. Health care equipment holding Glaukos Corporation, which is developing products to drain intraocular (eye) fluid to relieve the symptoms of glaucoma and delay/prevent blindness, also added value after the company’s shares rose nearly 30% in the quarter.

Telecommunication Services and Financials investments were the primary detractors from relative performance. Within Telecommunication Services, underperformance of the Fund’s two holdings in the sector, Indonesia tower operators PT Sarana Menara Nusantara Tbk. and PT Tower Bersama Infrastructure, Tbk., weighed on relative results. These stocks declined in the quarter as telcos continued to defer network equipment upgrades. Weakness in Financials was largely due to the underperformance of Cetip S.A. – Mercados Organizados, which administers over-the-counter markets in Brazil for trading and registration of securities, bonds, and derivatives. Cetip’s shares relinquished some recent gains as the company awaits regulatory approval of its merger with BM&FBOVESPA SA.

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