Baron Real Estate Fund (BREIX)

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

Institutional Performance

Review and Outlook (for quarter ended 6/30/2016)

The second quarter of 2016 continued to exhibit the unusual combination of macro developments of the previous quarter. Concerns about China’s growth outlook, wild swings in oil prices, inconsistent signals and pronouncements from the Federal Reserve, interest rates at record low levels, “Brexit,” fluctuating U.S. job growth figures, and an unconventional and divisive U.S. Presidential election year are a sampling of the stunning factors that impacted the markets in the first half of the year.

While we are mindful of macro influences, we have always believed it is most prudent to prioritize the “micro” rather than the “macro.” As such, we continue to carefully research quality companies, speak to management teams, and construct a balanced and diversified quality real estate portfolio. We meet with the top management of commercial and residential real estate-related companies, attend real estate conferences, tour real estate properties in different geographic markets, and speak to equity and debt capital providers and investors.

We maintain a favorable outlook for real estate and Baron Real Estate Fund for a number of reasons. (1) The factors that have fueled the resurgence in real estate largely remain in place, including demand that continues to outstrip supply in most U.S. markets, mostly solid balance sheets, and available credit at historically low interest rates. (2) Business conditions are solid for most of our real estate companies and the outlook does not portend a recession. (3) Substantial capital is still in pursuit of real estate ownership supported by widely available debt capital at historically low interest rates. (4) Key warning signs we always monitor include increases in construction activity, a deceleration in demand, more restrictive lending policies, spikes in interest rates, and elevated valuations. Our research continues to confirm our belief that the opportunities for real estate outweigh the warning signs. (5) We continue to identify attractively valued real estate-related companies.

We expect further macro-economic, political, stock market, and bond market twists and turns in the months ahead. We believe we have assembled an excellent real estate team that is smart, hard-working, energized, and equipped to perform well over the long term. We continue to believe that the Fund, with its expansive, balanced and differentiated approach to investing in real estate, provides the flexibility to perform well over the long term in several different market environments.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 6/30/2016)
  • Shares of MGM Growth Properties LLC added to Q2 performance. MGM is a triple net gaming REIT with 11 properties in Las Vegas and other U.S. locations that went public in April 2016. Strong performance was driven by investor appetite for an attractive dividend yield, management’s detailed plan to double rental cash flow within 5 years, and the May 2016 acquisition of the Borgata casino in Atlantic City. In addition to anticipated rent escalation, we see a significant growth runway driven by accretive acquisitions of regional gaming assets.

  • Shares of data center service provider Digital Realty Trust, Inc. rose in Q2, driven by strong leasing and occupancy trends, stable pricing, and robust demand from cloud customers. Digital’s successful integration of recent acquisition Telx, with cost synergies fully realized and teams integrated, also boosted share price. Finally, its May 2016 acquisition of eight assets in Europe substantially expanded its global footprint and product offering. We think Digital will continue to benefit from strong growth in cloud adoption and IT sourcing.

  • Shares of global colocation REIT Equinix, Inc. increased on strong demand, driven by accelerating cloud adoption. Meanwhile, consolidation trends in the data center industry have kept supply in check. Together, these trends have created a strong growth and pricing environment that has benefited all players. In another positive, Equinix  closed on its acquisition of European data center company Telecity. We see these trends and others converging and benefiting this well-managed company with solid competitive moats.

Detractors (for quarter ended 6/30/2016)
  • Shares of cruise ship operator Norwegian Cruise Line Holdings, Ltd., fell in Q2 on lowered net yield guidance given lower pricing in Europe on terrorism fears following the attack in Brussels. We retain conviction. The company reiterated its 2016 net yield and EPS guidance, and forecast growth in EPS of 30% and a significant reduction in leverage by year end.

  • Jones Lang LaSalle, Inc. is a commercial real estate services company with leading positions across all of its major businesses. Shares fell over concerns that capital markets activity will slow dramatically and that the commercial real estate cycle is nearing its peak. In late June, “Brexit” further pressured the stock, given its exposure to those regions. We believe the outlook for commercial real estate is attractive and remain optimistic on the long-term prospects for Jones Lang.

  • CBRE Group, Inc. is a commercial real estate services firm with leading market positions in all of its major businesses – leasing; investment sales; outsourcing, project, and development services; advisory services; and commercial real estate investment management. The stock price fell over concerns that capital markets activity was poised to slow dramatically and that the commercial real estate cycle is nearing its peak. Towards the end of Q2, concerns that the U.K. would exit the EU further pressured the stock, given its exposure to those regions. We retain conviction as we believe the outlook for commercial real estate remains attractive.

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 Real Estate Fund rose 0.60% in the second quarter, yet underperformed the MSCI USA IMI Extended Real Estate Index by 303 basis points. During the quarter, stock selection added value, but was overshadowed by the negative effect of relative real estate category weights.

Outperformance of investments within the REITs, building products/services, and casinos & gaming categories contributed the most to relative results. Strength in REITs was mostly attributable to the outperformance of recent IPO MGM Growth Properties LLC, Douglas Emmett, Inc., and specialized REITs, led by Digital Realty Trust, Inc., Gaming and Leisure Properties, Inc., and Equinix, Inc. Favorable stock selection in the REITs category was somewhat offset by meaningfully lower exposure to these outperforming stocks, which detracted 72 basis points from relative results. Within building products/services, lower exposure to Home Depot, Inc., and outperformance of Martin Marietta Materials, Inc., added the most value. Shares of Martin Marietta, a leading supplier of crushed stone, sand, and gravel for the construction industry, rose after reporting Q1 financials results that beat Street estimates and raising 2016 guidance. Within the casinos & gaming category, MGM Resorts International aided relative performance. MGM Resort’s shares increased on strong Q1 earnings results, driven by growth in revenue per available room that exceeded Street estimates. The company also increased the amount it expects to generate from its profit growth plan.

Real estate services, hotels & leisure, and homebuilders & land developers investments were the largest detractors from relative performance. Within real estate services, larger exposure to this lagging category through investments in CBRE Group, Inc., Jones Lang LaSalle, Inc., and Kennedy-Wilson Holdings, Inc. detracted 167 basis points from relative results. The U.K.’s vote to exit the European Union weighed on these holdings given their exposure to the region. Within hotels & leisure, underperformance of cruise line holdings Norwegian Cruise Line Holdings Ltd. and Royal Caribbean Cruises Ltd. and larger exposure to this lagging category detracted the most from relative performance. Norwegian was the largest detractor on an absolute basis, while shares of Royal Caribbean fell due to lower yields in Europe and China, coupled with a large increase in capacity. Weakness in the homebuilders & land developers category was mainly due to the underperformance of Toll Brothers, Inc., a residential homebuilder focused on luxury buyers in the U.S. Although Toll reported Q1 results that beat Street expectations, the stock underperformed due to concerns that demand from luxury buyers is waning. The stock was also affected by concerns that oversupplied conditions in the NYC condo market could adversely impact Toll’s City Living high rise business, and fears that slower economic growth in China will hurt demand from Chinese buyers in California, where Toll has a significant presence.

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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.