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 6/30/2016)

The heightened market volatility has remained a constant over the last few years, and this quarter was no exception. The outcome of the ill-conceived idea of the U.K.’s referendum on leaving the E.U. seemed benign just a few days before the June 23 vote. The predictions markets showed a 90% probability that “BRemain” would win and global equities were rallying nicely in anticipation of a positive resolution to yet another risk and uncertainty. Instead, the U.K. voted to leave the E.U., producing a sharp global sell-off.

Within two days, market participants appeared to realize that this new risk and uncertainty will likely cause the U.S. Federal Reserve to delay its planned policy rate hikes until later this year or possibly until 2017 and that the negotiations over a formal withdrawal from the E.U. are likely to take a couple of years. Within three days, the market erased the prior two-day losses, and we have been grinding higher ever since.

Baron Global Advantage Fund had many big winners during the quarter with eight investments rising over 20%. Unfortunately, only two of the eight (Amazon.com and TAL Education Group) were owned in a large enough size to be in the top 10 at the start of the quarter. We had a medium size position in Cetip SA, whose agreement to be acquired by BM&FBOVESPA caused the stock to rise 24%. Glaukos Corp., Mobileye N.V., Aerie Pharmaceuticals, and TerraForm Global all bounced back from meaningful declines in the prior quarter. Largely offsetting those gains were double-digit declines in Pacira Pharmaceuticals, EPAM Systems, Illumina, Mellanox Technologies (the Fund’s top contributor last quarter), and Allergan.

Our investments in China have continued to make significant positive contributions to returns. At over 15% of the Fund (on average) compared to just about 2% in the benchmarks, China is by far our largest geographic overweight. With GDP of $11.4 trillion in 2015, China is the second largest economy in the world. After decades of torrid growth, China now represents 15.5% of global GDP. Until a few years ago the Chinese economy was dominated by manufacturing, mining, and construction businesses. Today, services industries are over 50% of China’s GDP and rising, accounting for 87% of total GDP growth in 2015. The Chinese middle class is continuing to emerge with urban disposable income per capita rising to 23% of total income. While shortcomings in transparency and corporate governance need to continue to improve, we believe China offers an unusually fertile ground for long-term investment opportunities.

We are excited about the long-term prospects of the companies that comprise this portfolio. 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 6/30/2016)
  • Shares of Amazon.com, Inc., the world’s largest retailer and cloud services provider, rose in Q2 on strong revenue growth and improving margins in the 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. Amazon continues to invest in new and potentially large business segments such as e-finance, business supplies, and apparel.

  • TAL Education Group is a leading Chinese K-12 tutoring company, operating over 360 learning centers in 24 cities. Shares of TAL appreciated in Q2, driven by growth in enrollments of over 55%. We see significant opportunity for growth as TAL expands existing learning centers, opens new learning centers in existing cities, and enters new cities, while generating strong cash flow. The new hybrid class initiative in which classes are webcast to distant learning centers has the potential to improve teacher utilization and increase margins.

  • Glaukos Corporation is developing products to drain intraocular (eye) fluid to relieve the symptoms of glaucoma and delay/prevent blindness. Improved sales of its lead product, iStent, drove strong revenue growth in the quarter. We see several drivers of future growth. iStent offers an alternative to daily eye drops, which require long-term patient compliance. A recent real-world study produced good results that exceeded clinical trial results. The company is also planning to expand internationally. 

Detractors (for quarter ended 6/30/2016)
  • Pacira Pharmaceuticals, Inc., a pharmaceutical that makes pain control drug EXPAREL, had a watershed event in mid-December 2015 when it won a favorable settlement of a marketing dispute with the FDA. Pacira received broad, definitive labeling for many major surgical uses. Shares peaked earlier in 2016, but have since dropped due to broader concerns in the pharma sector as well as growth guidance biased toward the second half of 2016. We believe Pacira has the potential for 25-35% top line growth for years to come.

  • Alphabet Inc. is the world’s largest search and online advertising-related company. Shares of Alphabet were driven down by Q1 results that missed Street expectations. We believe that while desktop search is becoming a more mature business for the company, Alphabet is well positioned to benefit from substantial growth in mobile and online video advertising.

  • EPAM Systems, Inc. provides outsourced software development using highly skilled, low-cost employees primarily in Eastern Europe and Russia. EPAM reported strong quarterly results that exceeded management guidance, with 32% revenue growth and 26% EPS growth. However, shares fell following “Brexit” as EPAM has meaningful exposure to European customers (36% of revenue), especially European banks whose IT budgets could come under pressure. We believe customer demand will remain robust and that EPAM has a long runway for growth in a large market.

Quarterly Attribution Analysis (for quarter ended 6/30/2016)

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 1.05% in the second quarter and outperformed the MSCI ACWI Growth Index by 31 basis points, mainly due to stock selection.

On a country basis, stock selection in emerging markets added the most value, mainly due to outperformance of investments in China, Brazil, and South Africa. Larger exposure to outperforming equities in Brazil, South Africa, and Indonesia also contributed to relative results. These positive effects were somewhat offset by underperformance of developed market investments in the U.S. and Canada.

On a sector basis, outperformance of Consumer Discretionary and Financials investments contributed the most to relative results. Consumer Discretionary holdings contributed 339 basis points, driven by the outperformance of the Fund's largest sector holdings, Amazon.com, Inc., TAL Education Group, and Naspers Limited. Amazon and TAL were the two largest contributors on an absolute basis, while Naspers, a South Africa-based Internet and media platform operator, benefited from its large ownership position in Tencent Holdings Ltd., whose shares increased sharply in the quarter. Strength in Financials was mainly due to the outperformance of Cetip SA - Mercados Organizados, which administers over-the-counter markets in Brazil. Cetip’s stock price rose on good financial results, shareholder approval of the merger with BM&FBOVESPA, and appreciation of the Brazilian Real.

Information Technology (IT) and Health Care investments and lack of exposure to the outperforming Consumer Staples sector detracted the most from relative results. Within IT, underperformance of Internet software & service holdings, led by Alphabet, Inc. and Baidu, Inc., and significantly larger exposure to this lagging sub-industry hurt relative performance. Alphabet was the second largest detractor from absolute results, while shares of China-based Internet search engine Baidu fell sharply after the government launched an investigation into online medical advertisements following the death of a student who had sought cancer treatment at a hospital that had advertised on the search engine. Underperformance of ethernet company Mellanox Technologies Ltd. and the Fund’s systems software and IT consulting & other services investments, led by Check Point Software Technologies Ltd. and EPAM Systems, Inc., respectively, also weighed on relative results. Weakness in Health Care was mostly attributable to the underperformance of pharmaceutical holdings Pacira Pharmaceuticals, Inc. and Allergan plc. Pacira was the largest detractor on an absolute basis, while shares of Botox manufacturer Allergan declined after the U.S. Treasury disallowed the Pfizer-Allergan inversion. The Fund’s investment in DNA sequencing company Illumina, Inc. also hampered relative performance after the company reported Q1 revenue that missed Street expectations and lowered its forecast for 2016 due to weak sales of its HiSeq instrument line.

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