Baron Partners Fund (BPTIX)

Portfolio Management

RonBaron
Ron Baron

Fund Manager since 1992

View All Commentary by Ron

Fund Description

Baron Partners Fund invests in all-cap companies with significant growth opportunities.

   

   

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 Partners Fund increased in the quarter. Holdings in Information Technology (IT), Financials, and Health Care contributed the most to performance. Consumer Discretionary and Industrials investments detracted. IT benefited from the strong performances of Zillow Group, Inc. and CoStar Group, Inc., the two biggest contributors to performance in the quarter. Positive performance of the Financials sector was led by two top five contributors, Gaming and Leisure Properties, Inc. and FactSet Research Systems Inc. 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 two detractors from performance in the quarter. Weak performance of the Industrials sector was led by aircraft leasing company Air Lease Corp. In the wake of “Brexit,” the stock traded lower over concerns that higher travel barriers will impact passenger demand.

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)
  • Zillow Group, Inc. is the leading real estate website in the U.S. In addition to information on rentals and homes for sale, the company owns the Zillow Mortgage Marketplace and Street Easy, New York City’s leading real estate site. Zillow continues to invest in its brand as the leader in an $8 billion real estate advertising market. Shares were up in Q2, based on improving fundamentals and the favorable settlement of a lawsuit with Move, Inc. We think Zillow is well positioned to grow its share of the real estate advertising market.

  • 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 electric vehicle company Tesla Motors, Inc. fell during Q2, driven down by concerns over dilution from recent equity financing and the complex Model X ramp and execution risk. The market also appeared skeptical of Tesla’s announced intent to buy Solar City. We feel good about the brand Tesla has built and its execution on two top-of-the-line cars. Tesla has received over 370,000 reservations for the Model 3, representing nearly $18 billion in backlog. We are still evaluating the potential implications of a Tesla/Solar City deal.

  • AO World plc is the leading online seller of major domestic appliances in the U.K. AO sets itself apart through optimization of proprietary software and logistics and its focus on customer service. Shares of AO were down in Q2 as its expansion into Germany progressed more slowly than expected. The U.K. business continues to execute on its domestic plan and take share from competitors. We expect the German business to expand but at a more modest pace, while AO works to improve terms with vendors in advance of further volume expansion.

  • Shares of DNA sequencing company Illumina, Inc. fell in Q2 on first quarter revenue that missed Street expectations and a lowered forecast for 2016 due to weak first quarter sales of its HiSeq instrument line and a lower forecast for Europe. Management believes the issues are short-term, fixable, and unrelated to fundamental market demand. We continue to believe Illumina has a long runway for growth driven by increasing adoption of DNA sequencing in clinical markets such as cancer screening, diagnosis, and treatment.

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 Partners Fund gained 3.27% in the second quarter and outperformed the Russell Midcap Growth Index by 171 basis points. During the quarter, stock selection added value and overshadowed the negative effect of the Fund’s relative sector weights.

The Fund may use leverage and is especially likely to do so when we believe prospects for businesses are favorable and stock prices of those businesses do not reflect those prospects. As of June 30, 2016, Baron Partners Fund had 129.6% of its net assets invested in securities, and this use of leverage in an up market contributed 52 basis points to relative performance.

Aside from leverage, outperformance of Information Technology (IT) investments and larger exposure to strong performing REIT and specialized finance stocks within the Financials sector contributed the most to relative results. Within IT, outperformance of Internet software & services holdings Zillow Group, Inc. and CoStar Group, Inc. and significantly larger exposure to this better performing sub-industry added the most value. Zillow and CoStar were the two largest contributors on an absolute basis. Strength in the sector was also attributable to the outperformance of Gartner, Inc., a provider of syndicated IT research, and Mobileye N.V., a vision-based advanced driver assistance systems software company. Gartner’s shares increased on strong financial results, while Mobileye recouped losses suffered in the first quarter after management allayed investor concerns regarding competitive threats by announcing two autonomous program wins.

Consumer Discretionary, Health Care, and Industrials investments, and lack of exposure to the outperforming Consumer Staples sector detracted the most from relative results. Favorable stock selection in the Consumer Discretionary sector resulting from the outperformance of  Manchester United plc, Vail Resorts, Inc., and recently re-purchased Under Armour, Inc. was outweighed by the negative effect of significantly larger exposure to the poor performing hotels, restaurants & leisure sub-industry. Weakness in Health Care was mainly due to the underperformance of Illumina, Inc., the third largest detractor from absolute results, and Inovalon Holdings, Inc., a health care data and analytics vendor. Inovalon’s shares declined after the company’s financial results fell short of Street expectations. Within Industrials, underperformance of Air Lease Corp., which leases commercial aircraft to airlines around the world, and Fastenal Co., an industrial supplies distributor, hurt relative results. Shares of Air Lease traded lower on concerns that "Brexit" would result in higher travel barriers and negatively impact passenger demand. Fastenal’s stock price declined due to choppy monthly sales performance as a sharp decline in demand in oil and gas-impacted regions and the impact of a stronger dollar on multinational industrial customers weighed on 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.