Baron Growth Fund (BGRIX)

Portfolio Commentary

Review and Outlook (for quarter ended 3/31/2013)

The Fund's best performers included investments in the Information Technology, Consumer Discretionary, Financials, and Industrials sectors. We continue to be excited about our holdings in an area we call information business services. These businesses pair highly valuable proprietary data assets with robust analytical tools. Examples include Gartner, Inc., SS&C Technologies Holdings, Inc., CoStar Group, Inc., and Advent Software, Inc.

A new addition to the portfolio this quarter is a company well-known to us, casino operator Pinnacle Entertainment, Inc. We remain positive about its plan to acquire Ameristar Casinos, Inc. and the synergies of the combined company. In our view, the company's management team is strong and they are creating value for customers, employees, and shareholders.

Equity investors continued to be rewarded during the first quarter, as several major U.S. market indexes reached all-time highs. Fourth quarter earnings results were generally positive, and the U.S. economy continues to improve. Existing home prices and new home construction activity are increasing, automobile sales are rebounding, and natural gas prices and electricity costs remain low, which positively impact industrial activity. These factors appeared to offset fears surrounding consumer deleveraging, government fiscal restraints, higher taxes, and the economic impact of sequestration. In addition, positive money flows continued into equity investments, indicating that investors' long-awaited shift away from cash finally might be beginning.

From December 1999 to December 2012, our economy grew 4.1% per year on a nominal basis and the S&P 500 Index was down .23% (up 1.66% including dividends). This is an anomaly in our opinion. We were subject to a terrorist attack and participated in two wars; and we experienced the worst financial crisis in our history, followed by a deep recession, consumer deleveraging, fiscal restraints, and higher taxes, all coupled with global uncertainty.

The U.S. stock markets and the U.S. economy have been inextricably linked over the long term. For example, from 1960, when John F. Kennedy became President, to the end of last year, the nominal GDP of our economy rose from $524 billion to $15.9 trillion. Over the same time period, the S&P 500 Index rose from 58.11 to 1,426.19. While GDP grew at an annualized rate of 6.75% per year, the S&P 500 Index advanced 6.35%, or 9.71% including dividends, per year, for the past 52 years.

We think our economy will continue its measured recovery and eventually return to about 6% growth per year in nominal dollars, and the U.S. stock markets will continue their measured advance. We believe growth will be propelled by new technologies in unconventional energy and resource development and low natural gas prices, agricultural transformation, advancements in IT, software and online commerce, and the housing recovery. We continue to find many investment opportunities in these areas and many others across all sectors of our economy. Of course, we continue to expect our competitively advantaged, well managed, growth companies to outperform markets by 300 to 500 basis points per year over the long term, although we cannot assure that will be the case.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 3/31/2013)

• Rural hospital provider Community Health Systems, Inc.’s shares rose 54.2% in Q1 and are up over 114.9% in the last 12 months. The primary driver of performance has been the anticipation of health care reform. Improving admission trends are also contributing to Community Health’s multiple expansion from historically depressed levels.

• Shares of Genesee & Wyoming, Inc., a leading short line railroad, rose 22.4% during Q1, after completing a transformational acquisition of its primary competitor for $2 billion. The combined entity makes Genesee & Wyoming the dominant regional rail operator in the U.S., adding revenue diversity and cementing barriers to entry. In addition, private equity firm The Carlyle Group acted as a strategic equity partner, making a $350 million investment and advising on future acquisitions.

• Arch Capital Group Ltd. is a specialty insurance and reinsurance company. The stock rose during Q1 due to better than expected earnings results and an improving insurance market. Arch also announced an acquisition that would allow it to enter what we believe to be an attractive new business line.

Detractors (for quarter ended 3/31/2013)

• Shares of United Natural Foods, Inc., the largest distributor of natural and organic products in North America, detracted from Q1 performance despite continued strong fundamentals. The company’s largest customer is Whole Foods, which is experiencing robust, though moderating, growth in the face of tough comparisons. We believe United Natural Foods will continue to benefit from a greater focus on health, growth of organics from less than 10% of grocery today, and conventional supermarkets devoting more space to the category.

• Agrinos AS declined 46.3% in Q1. Agrinos is a green technology company with a unique microbial product that enhances crop yields. Performance in Q1 was weak because a delay in receivables collection led to a change in accounting policy, with no revenue booked for Mexico in Q4. We continue to hold Agrinos because we believe it has disruptive technology and exciting long-term growth prospects.

• Cia. Hering SA, a leading Brazilian retailer, experienced a tough operating environment last year, and its weak earnings report for Q1 kept pressure on the stock. While we are concerned about the slowed same-store-sales-growth and margin declines, we are cautiously optimistic that the company can continue its penetration of retail in Brazil and realize the potential upside of its nascent Kids business.

Quarterly Attribution Analysis (for quarter ended 3/31/2013)

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 Growth Fund (Institutional Shares) increased 13.45% in the first quarter and performed in line with the Russell 2000 Growth Index. During the period, the negative effect of relative sector weightings was more than offset by the Fund’s favorable stock selection.

Outperformance of the Fund’s investments within Information Technology (IT) and Energy and its meaningfully larger exposure to the Financials sector, one of the best performing sectors in the benchmark, were the primary contributors to relative performance. Strength in IT was mainly attributable to the outperformance of the Fund’s application software investments, led by ANSYS, Inc., the market leader in simulation-driven product development, and SS&C Technologies Holdings, Inc., a leading provider of mission-critical software products and services for the financial services industry. Shares of ANSYS performed well in the period after reporting better than expected quarterly results. Additionally, the company’s shares benefited from multiple expansion as investors anticipated accelerating growth driven by improving global manufacturing trends. Another contributor within IT was MAXIMUS, Inc., a leading provider of outsourced government health and human services. The company’s shares rose 26.7% in the quarter on strong earnings and the tailwind provided by the Affordable Care Act’s expansion of Medicaid and the creation of in-state health insurance exchanges. Within Energy, the majority of the Fund's investments outperformed, led by Core Laboratories N.V., the leading provider of products and services used to characterize and model reservoir properties through the analysis of rock and fluid samples. Shares of Core Laboratories rose in the quarter following better than expected earnings results. Key trends that benefited the company were continued demand from emerging deep-water and international oilfield developments, the positive impact of new products/technologies, and strength in shale oil & gas developments in the U.S. and overseas. Another contributor in the sector was Targa Resources Corp. which is the general partner of Targa Resources Partners L.P. (LP), a growth-oriented master limited partnership, and is a direct beneficiary of the LP’s distribution growth. We believe that Targa is uniquely positioned to benefit from hydrocarbons’ volume growth through its asset footprint, including pipeline and terminal systems, natural gas gathering and processing operations, and hard-to-replicate fractionators. Within Financials, the Fund’s larger exposure to this outperforming sector, and in particular to asset management and custody banks, contributed to relative results. This sub-industry outpaced the broader market during the quarter, rising close to 26%.

The Fund’s lower exposure to Health Care, particularly to biotechnology stocks, and its larger exposure to the underperforming Consumer Discretionary sector were the largest detractors from relative performance. During the period, the Health Care sector in the benchmark meaningfully outperformed the benchmark, largely due to outperformance of biotechnology stocks. As a result, the Fund’s lower exposure to this sub-industry detracted, overshadowing the significant outperformance of the Fund’s largest holding in the sector, Community Health Systems, Inc.

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