Baron Real Estate Fund (BREFX)

Portfolio Management

JeffreyKolitch
Jeffrey Kolitch

Fund Manager since 2009

View All Commentary by Jeffrey

Fund Description

Baron Real Estate Fund invests in securities of real estate and real estate related companies of all sizes.

  

Portfolio Commentary

Retail Performance

Review and Outlook (for quarter ended 12/31/2015)

Despite the strong performance of Baron Real Estate Fund for the six years since inception, we are disappointed with its 2015 performance, in which we made a few key investment mistakes (particularly in senior housing and hotel investments). We have spent considerable time reviewing 2015 and documenting “lessons learned,” and believe we are well positioned to avoid these missteps in the future.

We have been taking advantage of the recent, largely indiscriminate market sell-off to upgrade the quality of the holdings and overall structure of the Fund.

  • We are buying what we view as best in class companies that are now “on sale” (e.g., CBRE Group, Inc., Mohawk Industries Inc., Boston Properties, Inc.)
  • We have lowered overall leverage by trimming or exiting positions in companies with more highly leveraged balance sheets.
  • We are minimizing our exposure to smaller and less liquid companies.
  • We are de-emphasizing complex companies that may have a narrower investor audience and are less likely to receive full credit for intrinsic value.
  • We are trimming exposure to geographic markets that may face headwinds due to low oil prices (Houston), elevated real estate construction activity (e.g., New York City hotels), or unfavorable international exposure (e.g., Brazil).
  • We are increasing exposure to REITs. Near-term prospects for REITs appear relatively attractive. Most REITs are largely domestic, have average dividend yields of about 4%, may continue to benefit from low interest rates, should benefit from occupancy growth and increased rents at a time of limited new construction activity, and have stronger balance sheets and access to low cost capital and accretive investment opportunities, in our view. We are also positioning the Fund with a larger yield and a defensive orientation. Our view is that targeting a 30-40% REIT allocation is prudent, given current economic and market conditions.
  • Other real estate categories we are prioritizing include commercial real estate service companies, cruise line operators, data center companies, and building product/services companies. We are de-emphasizing hotels, timeshare operators, international gaming companies, and senior housing operators.

While the near-term outlook for real estate is a bit more cautious than a few years ago, we maintain a favorable bias because we believe the positive considerations outweigh the negative ones. We believe the factors that have fueled the real estate recovery largely remain in place. Demand continues to outstrip supply in many markets, most balances sheets are in solid shape, and credit remains available at low interest rates. Absent a recession, our sense is that business prospects for many categories of real estate will remain positive.

We recognize that in the months ahead, there may be periods of continuing market weakness. Nevertheless, we believe that the overall prospects for real estate and the Fund remain promising.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 12/31/2015)
  • Shares of quartz countertop manufacturer CaesarStone Sdot-Yam Ltd. contributed in Q4, recapturing some of the ground it lost in Q3 that resulted from Q2 financial results that, while impressive, fell short of Street expectations. A negative report by a short seller also pressured the stock in Q3. We remain positive on our investment in CaesarStone, as earnings growth continues to accelerate from successful new product launches and quartz market share gains over other countertop materials such as granite and marble.

  • Shares of MGM Resorts International, an operator of casinos mainly in Las Vegas and Macau, increased in Q4 as the company generated strong Las Vegas Strip revenue per available room and indicated robust forward bookings for conventions, especially at its new Mandalay convention space. In addition, the announcement that MGM will be spinning off some assets into a REIT and issuing an IPO for the REIT in early 2016 boosted the stock price as investors viewed the spin off as a smart way to reduce balance sheet leverage for the holding company.

  • Equinix, Inc. is a carrier-neutral data center and Internet exchange provider. Share prices rose in Q4 after Equinix announced the closing of its acquisition in Japan and the approval of its Telecity acquisition in Europe. We expect both deals to strengthen Equinix’s leading global position. We like Equinix's growth prospects and think it has a clear and sensible plan to keep growing at a higher pace than its peers while improving business efficiencies and demonstrating margin leverage.

Detractors (for quarter ended 12/31/2015)
  • Despite earnings that met Street expectations, shares of global hotelier Hilton Worldwide Holdings, Inc. decreased in Q4 as revenue per available room decelerated, raising concerns that the current lodging cycle was ending. Concerns that Airbnb was taking away pricing power during peak times also affected sentiment on the stock. The company continues to consider spinning off its owned assets into a REIT and spinning off or selling its timeshare business, all of which could create more value in the stock, in our view.

  • Shares of Builders FirstSource, Inc. fell in Q4. Builders FirstSource is a leading distributor of building products, mostly for the new residential construction industry in the U.S. Despite impressive financial results for Q3, shares declined as a result of relatively high debt levels amidst concerns that macroeconomic growth is slowing. Following its merger with ProBuild, we retain conviction, as residential construction levels are still depressed, the company is gaining market share, and management’s merger synergy targets appear conservative.

  • Shares of ClubCorp Holdings, Inc., an operator of golf courses and business clubs across the U.S., declined in Q4 due to concerns over the effect of slumping oil prices on the Texas economy, where 26 of its 150 golf clubs are located. In addition, a decline in the number of golf rounds played in Q4 as a result of bad Texas weather affected sentiment. However, golf rounds played comprise just 15% of the revenue and retention rates have not been affected, nor do we expect them to be, since members historically stay on 85% of the time.

Quarterly Attribution Analysis (for quarter ended 12/31/2015)

The Quarterly Attribution Analysis for period ending December 31, 2015 is not yet available

Yearly Attribution Analysis (for year ended 12/31/2015)

The Yearly Attribution Analysis for period ending December 31, 2015 is not yet available

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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.