Baron Growth Fund (BGRIX)

Portfolio Management

Ron Baron

Fund Manager since 1994

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Fund Description

Baron Growth Fund invests primarily in small growth companies.



Fund Resources

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Ron Baron on investing in small companies.

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Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 6/30/2015)

U.S. stock markets made little progress during the three months ended June 30, 2015. Most indexes achieved modest gains. The Russell 2000 Growth Index gained 1.98%.

Numerous cross currents impacted the economy and markets during the second quarter of 2015. The U.S. economy continued to steadily improve. Consumer and business confidence rose, unemployment fell, wages increased at an accelerating pace, housing prices continued to rise, automobile sales remained strong, and central banks worldwide implemented “easy” monetary policies to stimulate their economies. With our economy growing and reported inflation increasing in the U.S., interest rates, while still quite low, began to increase. This impacted interest-sensitive stocks, including REITs, MLPs and utilities. Continued strength in the dollar negatively impacted U.S. industrial and export-dependent businesses, whose stocks lagged in the period. Stocks in transport companies, whose results are closely correlated to industrial businesses, also lagged. Energy prices stayed low, to the benefit of consumers and energy-dependent businesses. A cutback in capital expenditures by energy companies partially offset the favorable impact of lower energy prices.

Baron Growth Fund declined in the quarter. Consumer Discretionary, Information Technology (IT), and Health Care were the top contributors. Consumer Staples, Industrials, and Utilities detracted the most. Contribution of the Consumer Discretionary sector was led by the Fund’s leisure facilities, education services, and casinos & gaming holdings. IT gained on strong performances by certain Internet software & services and application software holdings, including the fourth biggest contributor in the second quarter, Benefitfocus, Inc. The strong stock performance of top contributor Community Health Systems, Inc. drove performance of the Health Care sector. A drop in the stock price of United Natural Foods, Inc., the third biggest detractor in the quarter, negatively impacted the performance of the Consumer Staples sector. Low oil prices and a strong dollar weighed on the Industrials sector. Industrials holding Genesee & Wyoming, Inc., a leading short line railroad, was the Fund’s top detractor. ITC Holdings Corp., the second biggest detractor in the quarter, negatively impacted performance of the Utilities sector.

While it is not possible to predict stock markets over the short term, over the long term, stock prices and our economy are inextricably linked. For the past 55 years, GDP has grown 6.6% a year and stock prices have grown 6.6% a year. Taking dividends into account, stocks have doubled every 10 years. We have every reason to believe that our economy and stock markets will continue to achieve these historic results over the long term. We see many opportunities.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 6/30/2015)
  • Shares of U.S. hospital operator Community Health Systems, Inc. surged with the U.S. Supreme Court decision to uphold subsidies under the Affordable Care Act, insuring that Community Health will continue to experience lower bad debt, higher volumes, and better payer mix under the law. Q1 results beat expectations as a strengthening macro environment and management initiatives helped drive improvements in core organic operating metrics, including admissions, surgeries and ER visits. We believe synergies from the Health Management Associates acquisition will exceed initial guidance, and we maintain our positive outlook for the company.

  • Shares of The Middleby Corp., a leading food equipment manufacturer, rose in Q2 on the company’s announcement that it was in preliminary discussions to acquire AGA Rangemaster Group plc, a U.K.-based residential kitchen equipment manufacturer. While there is no certainty that this deal will close, the potentially accretive acquisition highlighted Middleby’s acquisition acumen as well as its commitment to grow the residential kitchen equipment business through brand and geographic expansion.

  • Arch Capital Group Ltd. is a specialty insurance and reinsurance company based in Bermuda. The company reported solid Q1 financial results with 15% growth in book value per share. Despite a soft reinsurance pricing environment, underwriting profitability remains strong, catastrophe losses remain benign, and the company continues to experience favorable reserve development. The share price has also benefited from M&A activity and speculation in the P&C insurance industry.

Detractors (for quarter ended 6/30/2015)
  • Shares of leading shortline railroad Genesee & Wyoming, Inc. declined in Q2 for three reasons: 1) exposure to Australia, where mining carload volumes have been impacted by weaker commodity prices; 2) soft U.S. coal and steel shipments; and 3) foreign currency headwinds. We maintain a positive long-term view on the company and believe valuation is attractive. Barriers to entry are substantial and we think that, as the only public shortline, Genesee is well positioned to execute on its growth strategy.

  • Shares of ITC Holdings Corp., the nation’s largest independent transmission company, fell in Q2 along with most of the utility sector over interest rate concerns. Company-specific issues, including a potential regulatory cut to the allowed return on equity and questions around ITC’s ability to execute on the development portion of its five-year capital expenditure plan, also weighed on the stock. We continue to hold the stock as we believe ITC has robust growth prospects and will execute on its growth strategy and capital expenditure plan.

  • Shares of United Natural Foods, Inc., the largest distributor of natural, organic, and specialty products to North American supermarkets, declined in Q2 on a slight deceleration in sales growth that we believe will prove temporary. The natural and organic food sector is one of the brightest categories within grocery, and United Natural has been the leader in getting these products to market. We are also excited about a recent acquisition that we believe could double the company’s addressable market opportunity in fresh and perishable foods.

Quarterly Attribution Analysis (for quarter ended 6/30/2015)

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 declined 1.11% in the second quarter and trailed the Russell 2000 Growth Index by 309 basis points. During the quarter, the Fund’s stock selection and, to a lesser extent, relative sector weights detracted from relative performance.

The Fund’s lower exposure to the lagging Materials and Energy sectors and outperformance of its Consumer Discretionary investments contributed the most to relative results. Strength in Consumer Discretionary was partly attributable to the outperformance of the Fund’s education services holdings, led by Bright Horizons Family Solutions, Inc., a leading provider of corporate sponsored childcare. Shares of Bright Horizons increased on solid quarterly results, driven by rising center count, a mix shift to higher margin consortium centers, greater capacity utilization, and international expansion. Other contributors to relative performance in the sector were timeshare company Marriott Vacations Worldwide Corp. and regional casino operator Penn National Gaming, Inc. Shares of Marriott rose after strong sales led management to increase EBITDA and free cash flow guidance for fiscal year 2015, while Penn National’s shares increased on an upturn in visitation and spending levels boosted gaming revenue at its casinos.

The Health Care, Financials, and Consumer Staples sectors were the largest detractors from relative performance. Within Health Care, meaningfully lower exposure to biotechnology stocks, which rose 12.7%, detracted 119 basis points from relative results. Sector weakness was also due to the underperformance of IDEXX Laboratories, Inc., a leader in veterinary diagnostics. IDEXX’s stock price decline was partly attributable to greater-than-expected foreign exchange headwinds. Separately, the company noted increased competition and lower prices impacting around 3% of revenue. We believe that management will successfully react with pricing programs, creative diagnostic bundles, and an expanded inside sales force to better serve these customers in the future. Within Financials, larger exposure to REITs, which suffered in a rising interest rate environment during the quarter, and underperformance of Primerica, Inc. and Cohen & Steers, Inc. detracted the most from relative results. Shares of Primerica, a provider of term life insurance and third-party investment products, declined due to potential negative implications of the Department of Labor’s new fiduciary rules for advisers servicing Individual Retirement Accounts. Consumer Staples investments trailed their index counterparts, falling 7.8%, with United Natural Foods, Inc. and TreeHouse Foods, Inc. leading the decline. United Natural was the third largest detractor on an absolute basis, while shares of TreeHouse declined after the company lowered guidance for 2015 due to competitive challenges in single-serve coffee and customer delays in the roll-out of snack nut merchandising displays.

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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.