Baron Opportunity Fund (BIOIX)

Portfolio Management

MichaelLippert
Michael Lippert

Fund Manager since 2006

View All Commentary by Michael

Fund Description

Baron Opportunity Fund invests in innovative high-growth companies.

    

  

Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 9/30/2016)

Baron Opportunity Fund performed well during the third quarter, continuing a steady improvement from a challenging start to the year. In January and February, investors appeared to put significant weight on macro downside risks: a sharp economic slowdown in China, the end of the U.S. economic recovery, persistent low and even negative sovereign interest rates, collapsing oil prices, etc. As we have progressed through the year, concerns over those fears have turned more optimistic and the market environment has been more favorable for the Fund. But macro uncertainties always exist. Today they involve such issues as whether the Federal Reserve will raise interest rates before the end of the year, the outcome of one of our nation’s most troubling presidential elections in recent history, the persistent challenges in the Middle East (Syria, Iraq, ISIS, etc.) and the seemingly ever-present threats of terrorist attacks, and, of course, what the next move in the stock market will be. While we try to stay abreast of all these issues, we remain focused on what we can control: our industry and company research and portfolio construction decisions.

The consistent strategy of the Fund has been to invest in high growth, innovative businesses capitalizing on powerful secular trends. This is how we strive to distinguish ourselves from a passive index or ETF, as well as generalized growth funds, and to provide our investors with what we believe is a unique investment vehicle in today’s increasingly passive, index-driven investment mindset. In a world and market concerned about where growth will come from, we aim to differentiate not by trying to figure out the next bend in the cyclical growth curve, but by identifying powerful secular trends–generational, paradigm or tectonic shifts across industries and society–that will drive robust long-term growth regardless of the short-term fluctuations of the underlying economy. These trends are visible, impactful, and persistent. They are where the world’s going, not where it’s been (paraphrasing the great hockey player Wayne Gretzky). We believe many of the businesses that emerge as winners will possess significant growth opportunities, considerable moats to sustain their leadership and capture large profit pools from the legacy way of doing things.

Some of the powerful secular themes in which we invest include 1) cloud computing and software-as-a-service, 2) mobile, 3) big data and analytics, 4) digital (internet-delivered) media, 5) e-commerce, 6) genetics, 7) electronic medical records, 8) immuno-oncology, 9) targeted digital advertising, 10) cybersecurity, 11) electric drive vehicles and autonomous driving, and 12) electronic payments.

We believe wholeheartedly in the strategy for the Fund: growth based on powerful, long-term, innovation-driven secular growth trends. In the highly uncertain world we live in, we believe non-cyclical, sustainable, and resilient growth should be part of investors’ portfolios.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 9/30/2016)
  • Shares of Amazon.com, Inc., the world’s largest retailer and cloud services provider, rose in Q3 after reporting strong revenue growth and improving margins in its 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. The company continues to invest in new and potentially large business segments such as e-finance, business supplies and apparel.

  • Alphabet Inc. is the world’s largest search and online advertising company. Shares of Alphabet were up in Q3, driven by quarterly results that surpassed Wall Street expectations. We continue to believe that even 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.

  • Acxiom Corporation is a leader in marketing data services and identity management for enterprises. Shares of Acxiom were up in Q3, driven by rapid growth in the company’s cloud-based connectivity and identity business. We believe that Acxiom is benefiting from a streamlining of operations and a focus on returning the core business to profitable growth while accelerating the growth of its new LiveRamp business.

Detractors (for quarter ended 9/30/2016)
  • Bristol-Myers Squibb Company is a large diversified pharmaceutical leading the development of immune stimulating therapies for oncology. These efforts are spearheaded by its product Opdivo, now approved to treat several types of cancer. After positive data was released on a rival drug to treat first-line advanced non-small-cell lung cancer, Bristol-Myers revealed that Opdivo did not meet the primary endpoint in a Phase III trial in the same indication, and shares fell. We are analyzing the competitor’s trial results and Bristol-Myers data sets.

  • Shares of Gartner, Inc., a provider of syndicated IT research, relinquished some gains due to tougher comparisons and slightly more challenging macro conditions. We believe Gartner’s key metrics are solid. The company has significant financial flexibility, and we think it will aggressively deploy capital for repurchases or mergers and acquisitions. Over time, in our view, Gartner will generate accelerating top line growth, significant growth in earnings and free cash flow, and persistent return of capital.

  • Shares of cloud computing pioneer salesforce.com, inc. decreased in Q3. The company reported mixed bookings results due to execution issues in the domestic market. We believe that salesforce’s addressable market is more than 10 times larger than its current run rate revenue, giving it ample opportunity to compound revenue in excess of 20% annually. We believe the company is highly innovative, and has a strong track record of disrupting legacy environments with next-generation software.

Quarterly Attribution Analysis (for quarter ended 9/30/2016)

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 Opportunity Fund increased 6.47% in the third quarter and outperformed the Russell 3000 Growth Index by 155 basis points due to relative sector weights. Larger exposure to outperforming small cap stocks, which rose more than 10% within the index, also added value.

Consumer Discretionary, Financials, and Health Care investments and lack of exposure to the lagging Consumer Staples sector, which fell 4.8% in the index, contributed the most to relative results. Within Consumer Discretionary, outperformance of internet & direct marketing retail holdings Amazon.com, Inc. and The Priceline Group, Inc. and larger exposure to this better performing sub-industry, which rose 15.5% in the index, added the most value. Amazon was the largest contributor to absolute results, while shares of online travel agency Priceline rose on solid Q2 results and a robust outlook for Q3. Strength in Financials was mainly due to the outperformance of brokerage firm The Charles Schwab Corp. and electronic trading platform company MarketAxess Holdings Inc. Schwab’s shares appreciated on strong asset growth, while shares of MarketAxess rose on robust trading activity as average daily volume grew 34% in Q3 compared to the year-ago period. MarketAxess also reported excellent Q2 results with 28% revenue growth and 36% EPS growth, both exceeding Street estimates. Within Health Care, outperformance of Illumina, Inc. and Sage Therapeutics, Inc. and lower exposure to poor performing pharmaceutical stocks, which fell 7.4% within the index, lifted relative results. Shares of DNA sequencing company Illumina increased after the company reported financial results that beat Street expectations and reiterated guidance for the year. Shares of Sage, which is developing treatments for central nervous system disorders, rose sharply after the company announced positive top-line results from its Phase II trial with SAGE-547 for the treatment of severe postpartum depression.

Underperformance of Information Technology (IT) investments detracted from relative results, but this negative effect was somewhat offset by significantly larger exposure to this strong performing sector, which increased double-digits in the index. Weakness in IT was mostly attributable to the underperformance of Gartner, Inc. and application software investments, led by Guidewire Software, Inc. and salesforce.com, inc. Gartner and salesforce were two of the largest detractors on an absolute basis, while shares of P&C insurance software vendor Guidewire fell on earnings guidance slightly below Street expectations due to an accounting-related deferral that we expect will reverse next year. Semiconductor holding Mellanox Technologies Ltd. also weighed on relative performance after the company reported disappointing Q2 results.

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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 advice to any person and are subject to change 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 PA