Baron Opportunity Fund (BIOPX)

Portfolio Management

MichaelLippert
Michael Lippert

Fund Manager since 2006

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Fund Description

Baron Opportunity Fund invests in innovative high-growth companies.

    

  

Fund Resources

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Michael Lippert discusses how he invests in innovative companies

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Portfolio Commentary

Retail Performance

Review and Outlook (for quarter ended 9/30/2014)

The market environment for Baron Opportunity Fund - a strategy focused on investing in higher growth, innovative businesses - remained unfavorable in the third quarter of 2014. High growth and smaller cap stocks have significantly trailed their large cap, value, and even GARP (growth at a reasonable price) peers this year. The reasons include concerns about global economic growth (weakening economies in Europe and China); the end of QE3 (quantitative easing, the Federal Reserve’s bond buying program); uncertainty around when the Fed will begin to raise interest rates; and geopolitical events, such as the Ukraine conflict, the threat of ISIS and, most recently, the spread of the Ebola virus.

We have carefully analyzed the Fund’s historical performance – both this year and further back – and are convinced that our strategy of focusing on big secular trends and innovation is sound and when well executed, should yield superior long-term performance versus generalized market indexes. We remain confident that the Baron investment philosophy and process, and our talented research team, provide differentiation versus the short-term, trading mindset that dominates Wall Street today. At the same time, with the clarity of hindsight, we have to acknowledge that we made some mistakes in the context of the market backdrop just described. Our mistakes have been ones of execution. We have made enhancements to our research and portfolio management processes to enforce even more rigor and discipline around executing our “playbook.” At bottom, we intend to be laser-focused on investing in powerful, longer term secular trends and in differentiated and special businesses – companies with significant and durable competitive advantages and high quality business models.

The Telecommunication Services and Industrials sectors contributed to Fund performance in the third quarter, while Energy, Information Technology (IT), and Health Care were the top three detractors. Shares of the Fund’s sole Telecommunication Services holding, SBA Communications Corp., rose on reports of solid Q2 results. Industrials gained largely on the performance of food equipment manufacturer The Middleby Corp., whose shares were helped by strong Q2 results. Energy had a challenging quarter due to falling commodity prices. Performance of the Fund's IT holdings was mixed. Although the sector included the Fund’s top five individual contributors, this positive was outweighed by the weak performance of other detractors within the sector.

As any student of the market knows, changes in market sentiment and direction are almost impossible to predict. Today’s headwind becomes tomorrow’s tailwind. Reversion to the mean is inescapable. We cannot predict when the market environment will do its next about-face and become more favorable for higher growth, innovative businesses. But we believe it will. We remain steadfast in our belief that the innovative, secular growth businesses in which we are invested have the potential to double in size within four to five years, with many having the further opportunity to double again after that. And long-term valuations are far more attractive than they were earlier in the year.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 9/30/2014)
  • Shares of Concur Technologies, Inc. increased in Q3. Concur is a leading provider of travel booking and expense management software.  On September 18, SAP SE announced an agreement to acquire Concur for $129 per share, a 28% premium to the closing price on September 2, the day before Bloomberg reported that Concur was exploring a sale. The $8.3 billion acquisition implied a valuation of roughly 9.7 times Concur’s estimated fiscal year 2015 revenue and confirmed our view that Concur was a valuable strategic asset.

  • Mobileye N.V. is a software and systems design leader for camera-based advanced driver assistance systems (ADAS). The share price increased after we participated in Mobileye's IPO in the quarter. We believe the company has the potential to become a multi-decade leader in the race to autonomous driving, a trend that we believe will improve transportation safety and efficiencies.

  • Mellanox Technologies Ltd. supplies semiconductor-based systems for computing, storage and communications applications that connect servers to servers and servers to storage. Mellanox's stock rose on reports of better Q2 results and Q3 guidance, as the latest generation of Intel chips spurred customer demand for high performance interconnect systems. We believe we are still in the early innings of the Mellanox growth story.

Detractors (for quarter ended 9/30/2014)
  • Shares of Benefitfocus, Inc. fell in Q3, partly due to a secondary offering in July that increased the public float by more than 30%. Benefitfocus is the leading provider of cloud-based benefits software, offering an integrated suite of solutions to help customers more efficiently shop, enroll, manage, and exchange benefits information. We think Benefitfocus serves an addressable market more than 100 times larger than its current business, which should allow it to compound revenue at more than 30% annually.

  • CARBO Ceramics, Inc., is, principally, the leading provider of ceramic proppants that are used in the hydraulic fracturing process for oil and gas wells. CARBO shares fell sharply in Q3 after one of its key clients announced it was shifting its wells to sand from ceramics and it became clearer that this shift could be imitated by other clients. CARBO's rerouting of volumes away from this client has resulted in increased price competition. We exited our position in CARBO as this transition and the resulting negative earnings effects became clearer.

  • Marchex, Inc. is a mobile advertising technology company that delivers and analyzes customer phone calls to businesses. While we believe the Marchex technology holds promise, the company recently lost a substantial piece of business from one of its largest customers, leading us to exit our position.

Quarterly Attribution Analysis (for quarter ended 9/30/2014)

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 Opportunity Fund (Retail Shares) declined 4.37% in the third quarter and underperformed the Russell Midcap Growth Index by 364 basis points. During the quarter, the positive effect from portfolio weightings was more than offset by stock selection.

The Fund’s investments within Industrials and its larger exposure to the more defensive Telecommunication Services sector, which was the top performing sector in the index during the quarter, contributed the most to relative results. Within Industrials, a combination of stock selection and the Fund’s lower exposure to this lagging sector aided relative performance. Strength in the sector was mostly attributable to the outperformance of The Middleby Corp., a leading food equipment manufacturer, and Verisk Analytics, Inc., a provider of information about risk to companies in the insurance, health care, and mortgage industries. Shares of Middleby increased after reporting solid quarterly results, allaying investors’ last quarter concerns over restaurant spending and the adverse impact of distributor acquisitions on subsidiary Viking Range’s margins. Shares of Verisk rose on slightly better-than-expected financial results and improved investor confidence in the company’s health care segment.

The Fund’s investments within the Health Care, IT, and Energy sectors were the largest detractors from relative results. Weakness in Health Care was mainly due to the underperformance of Illumina, Inc., the leading provider of next generation DNA sequencing instruments and consumables. Illumina’s shares declined in the quarter after nearly doubling over the last year on the strength of several new product introductions. The Fund’s biotechnology holdings also hurt relative performance after falling 14.3% as a group, led by Foundation Medicine, Inc., which markets a sequencing-based cancer test. The Fund exited its position in Foundation Medicine late in the quarter after the company’s shares moved sharply lower on concerns about reimbursements from third-party payors and an evolving competitive landscape. Within IT, the Fund’s Internet software & services holdings fell 9.1% as a group, with Benefitfocus, Inc. and Marchex, Inc. driving the decline. These companies were also two of the Fund’s largest detractors from absolute performance. Another detractor in the sector was Acxiom Corp., the leading provider of database marketing solutions and IT outsourcing services to large enterprise customers. Shares of Acxiom were down in the quarter due to slower customer adoption of the company’s new Audience Operating System platform. Within Energy, CARBO Ceramics, Inc. was the Fund’s second largest detractor on a relative and absolute basis due to company-specific issues, while the sharp drop in commodity prices during the quarter weighed on exploration & production holdings Oasis Petroleum, Inc. and Concho Resources, Inc.

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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