Review and Outlook
The market continued its uptrend in the third quarter, recovering from the post-Brexit dip. The U.S. economy proved to be quite resilient. Job growth is solid and the unemployment rate has held at 5%. The figures are not too strong, though, so the Federal Reserve can delay raising interest rates until late this year. There is little to suggest that significantly higher inflation is in the offing. This environment of continued growth, even if muted, low interest rates, and modest inflation is a good backdrop for stocks.
Scant growth and cheap borrowing costs has led to an increase in mergers and acquisitions which have been positive for Baron Small Cap Fund. Year-to-date, six Fund holdings have been acquired (Press Ganey Holdings, Inc., FEI Company, Mattress Firm Holding Corp., ExamWorks Group, Inc., Bats Global Markets, Inc. and ITC Holdings Corp.), four by other public companies and two by private equity funds. Another holding, WasteConnections, Inc., was actually purchased in a reverse acquisition, though it is the surviving business.
The Fund increased in the quarter. Health Care, Industrials, and Consumer Discretionary were the top contributing sectors. Health Care benefited from increases in the share price of 17 out of 18 investments, including second largest contributor IDEXX Laboratories, Inc. TransDigm Group Inc., which was the Fund’s third biggest contributor, led contribution of the Industrials sector. Consumer Staples and Energy holdings detracted. Positive performance of Consumer Discretionary investments included top contributor Mattress Firm Holding Corp., which was acquired in the period. A decline in the share price of the Fund’s sole Consumer Staples investment, Chefs’ Warehouse, Inc., hurt that sector’s performance. Chefs’ was the second largest detractor in the quarter. Energy was a modest detractor as three of four sector holdings declined in the third quarter.
The negative tone of the presidential election is causing anxiety that we believe is temporarily weighing on consumer spending. Once it is over, we suspect we will revert to same fine environment for stocks, as has been the case year to date. We foresee continued moderate growth and do not fear a recession in the near future. We expect bond yields will rise, but moderately, and we believe that is already built into stock prices. Wages are increasing, which will pressure some businesses, but we still see margin expansion opportunities for companies with above average revenue growth. We are concerned that the dollar is back on the rise, since that would dampen growth somewhat and hurt earnings because of negative translation. We view the market as fairly valued, but believe multiples will stay in their present range. We think we will make our returns based on the growth of our companies’ earnings and their additive use of the cash flow their businesses generate.
Top Contributors/Detractors to Performance
Quarterly Attribution Analysis
The Quarterly Attribution Analysis for period ending September 30, 2016 is not yet available
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