Baron Growth Fund (BGRIX)

Portfolio Management

Ron Baron

Fund Manager since 1994

View All Commentary by Ron

Fund Description

Baron Growth Fund invests primarily in small growth companies.



Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 6/30/2016)

After a volatile first quarter, much of the second quarter was relatively uneventful until late June, when the U.K. voted to exit the European Union. Even with the volatility that followed “Brexit,” U.S. equity markets ended the quarter mostly higher. Positive momentum was helped by a steady increase in oil prices. Although we are still in the midst of an oil glut, production has begun to fall as tight credit markets are forcing oil companies to cancel or delay exploration and new production projects.

Persistent low oil prices over the last two years have resulted in an energy depression and industrial recession in the U.S. Corporate earnings have now declined for four consecutive quarters, largely due to declines in energy company earnings. Outside of energy and energy-related industries, we believe the U.S. economy is improving. Bank loans are up. In accord with Federal Reserve Chairman Janet Yellen’s recent commentary, we think interest rates will remain low for an extended period. Employment is strong and wages are climbing. Housing prices are increasing. Retail sales improved in the second half of the quarter and consumer confidence rose. With weak conditions abroad, international investors are turning to U.S. equity markets.

Baron Growth Fund increased in the quarter. Holdings in Financials, Information Technology (IT), and Health Care contributed the most to performance. Consumer Discretionary investments detracted. The Financials sector had a strong quarter. Performance was led by Primerica, Inc., the top contributor in the quarter. Office REIT Douglas Emmett, Inc. was a top five contributor after its shares rose on Q1 earnings that beat Street expectations and an increase in full year guidance. IT benefited from the strong performance of CoStar Group, Inc., the second biggest contributor to performance. Syndicated IT research provider Gartner, Inc. also boosted sector performance on solid financial results. IDEXX Laboratories, Inc., the third biggest contributor in the quarter, led performance of the Fund's Health Care holdings. While results among Consumer Discretionary investments were mixed, detractors outweighed contributors. The sector included the top and third biggest detractor from performance in the quarter.

While we think the domestic economy is strengthening, “Brexit,” terrorism, China’s economy, and other events abroad, as well as recent civil unrest in the U.S., are creating uncertainty. Investing for growth is investing in the future, and when the future seems uncertain, investors tend to exit growth stocks. Subdued IPO activity and negative interest rates on sovereign debt is further evidence of uncertainty. Investor flight to the perceived safety of value stocks has caused the recent contraction in the stock prices of many growth stocks, despite the strong fundamentals and continued growth of these companies. Value stocks outperformed growth in the period and growth stocks now have earnings multiples below 20-year averages while value stocks in all categories have multiples above 20-year averages. For growth investors like us, this creates investment opportunities.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 6/30/2016)
  • Primerica, Inc. provides term life insurance and third-party investment products to underserved middle income households in the U.S. and Canada. The stock price rose in Q2 due to positive financial results and improved visibility for the investment products segment in the wake of the release by the Department of Labor of finalized fiduciary standard rules for retirement accounts. Primerica reported strong financial results as sales force growth, higher sales productivity, and margin expansion offset weaker investment product sales.

  • Shares of CoStar Group, Inc., a real estate information and marketing services company, increased on outstanding financial results. Revenue growth accelerated to 25%, margins expanded 14% year over year, and earnings almost tripled. CoStar grew in its core commercial real estate market and captured share in the multifamily space. We believe CoStar is poised to generate accelerating organic revenue growth and significant margin expansion as it leverages recent investments in sales headcount, product expansion, and multifamily marketing.

  • Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. rallied in Q2 on strong financial results and multiple expansion. Competitive trends are strong and improving, highlighted by instrument placement growth of almost 25%, domestic lab growth more than twice that of its main competitor, rising sales productivity, and stability in rapid assays. We think that IDEXX’s direct go-to-market model coupled with meaningful R&D-driven product enhancements will boost revenue and earnings growth over time.

Detractors (for quarter ended 6/30/2016)
  • Shares of athletic apparel and footwear company Under Armour, Inc. declined in Q2. The recent bankruptcy of a few sporting goods retailers and announced store closures are expected to put short-term pressure on the company’s distribution channel. Additionally, a new footwear model received mixed reviews from customers. We view these setbacks as temporary as we believe Under Armour has the potential to become a global leader in athletic apparel and footwear.

  • Shares of financial technology vendor SS&C Technologies Holdings, Inc. detracted from second quarter performance. We attribute the decline to concerns that lackluster hedge fund performance will impact SS&C’s growth. We believe a low single digit percentage of the company’s revenue is directly correlated to equity markets, far less than investors feared. We believe the company will continue to generate attractive revenue growth through market share gains, cross-sales of its expanded services portfolio into the Advent installed base, new product introductions, and share gains in the admin market.

  • Shares of Choice Hotels International, Inc., the largest hotel franchisor in the U.S., fell in Q2 due to slowed growth in revenue per available room (RevPAR) and unit growth that slightly missed Street estimates. While we agree RevPAR trends are a concern, Choice’s revenue is fee-driven and therefore less impacted by RevPAR than franchisees. We believe Choice will continue to generate strong cash flow and use it to repurchase shares, issue dividends, and invest in its new higher-end Cambria brand and vacation rental business.

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 Growth Fund rose 3.38% in the second quarter and performed in line with the Russell 2000 Growth Index. During the quarter, stock selection added value, but this positive result was mostly offset by the negative effect of the Fund’s differences in sector weights relative to the index.

Financials and Information Technology (IT) holdings were the largest contributors to relative results. Within Financials, outperformance of Primerica, Inc. and REIT holdings, led by Douglas Emmett, Inc. and Gaming and Leisure Properties, Inc., added the most value. Primerica was the largest contributor on an absolute basis, while shares of office REIT Douglas Emmett rose after the company reported Q1 earnings that beat Street expectations and raised full year guidance based on improving fundamentals across its markets. Shares of gaming REIT Gaming and Leisure increased as the company closed on the acquisition of Pinnacle Entertainment’s real estate assets and improved its balance sheet through an upsizing of the equity offering used to finance the deal. Favorable stock selection in Financials was somewhat offset by larger exposure to the lagging asset management & custody banks sub-industry, which declined 7.7% in the index. Strength in IT was partly attributable to the outperformance of Internet software & services holdings CoStar Group, Inc., the second largest contributor to absolute results, and Benefitfocus, Inc., a provider of cloud-based benefits software. Shares of Benefitfocus rose after reporting outstanding financial results as the company generated traction in new logo acquisition and cross-sales of new modules, including BenefitStore. Outperformance of syndicated IT research provider Gartner, Inc. and lack of exposure to poor performing semiconductor stocks, which fell 6.9% within the index, also aided relative performance. Shares of Gartner increased on strong financial results. We believe the company’s key forward-looking metrics look strong.

Consumer Discretionary holdings and lack of exposure to the outperforming Materials sector, which rose 7.2% in the index, detracted the most from relative results. Weakness in Consumer Discretionary was mainly due to the underperformance of Under Armour, Inc. and hotels, resorts & cruise lines investments, led by Choice Hotels International, Inc. Under Armour and Choice were two of the largest detractors from absolute performance during the quarter. The Fund’s investment in Penn National Gaming, Inc., a U.S. regional gaming company, also hurt relative performance. Penn’s stock price fell as a result of investor concerns over subdued consumer spending and leverage on the company’s balance sheet, which could become an issue in the event of an economic downturn. We believe the domestic economy and consumer spending are stable, and the company’s balance sheet is strong enough to withstand a potential downturn in the economy.

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The prospective performance of the companies discussed herein is based on our internal analysis and reflect our opinions only. We cannot promise future returns and our opinions are a reflection of our best judgement at the time of publication. Our views are not intended as recommendations or investment advise to any person and are subject to chage at any time based on market and other conditions and Baron has no obligation to update them. Investing in the stock market is always risky. Current and future portfolio holdings in the Fund are subject to risk.

Source: FactSet PA2.0 Performance Analytics Software.