Review and Outlook
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
Quarterly Attribution Analysis
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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