Review and Outlook

as of 03/31/24

The bull market that started at the end of October of 2023 kept running throughout the first quarter of 2024. Even the renewed threat of "higher for longer" interest rates did not put a check on equity performance. Investors entered the new year optimistic that a soft landing was in store for the economy, in which a recession would be avoided, inflation would continue to dissipate, and the Fed would start cutting interest rates in March. The economy has not only avoided recession but has been stronger than market forecasts. Meanwhile, inflation has again turned sticky, and Fed rate cuts have been delayed to at least June.

Economic data was slightly mixed during the quarter. Strong growth in the U.S. labor supply, driven by increased labor force participation and a surge in immigration, supported job gains without higher inflation. The U.S. unemployment rate, though still low, rose slightly to 3.8%. The S&P Global US Services PMI, an index of the prevailing direction of economic trends in the U.S. service sector, pulled back modestly. Existing home sales jumped 9.5% in February 2024, the highest percentage increase in a year and above consensus expectations. At a 3.2% annualized rate, U.S. inflation, although it has yet to decline to the Fed’s stated 2% preferred level, is significantly less than the June 2022 peak of more than 9%. Looking ahead, a more normalized supply chain and moderating wage growth bode well for a continued slow decline in inflation.

Baron Partners Fund declined in the quarter. Financials, Real Estate, and Information Technology (IT) contributed the most. Investments within Consumer Discretionary, Communication Services, and Health Care detracted. Top contributor Arch Capital Group Ltd. led positive performance within Financials, while third largest contributor CoStar Group, Inc. led gains within Real Estate. IT advanced on share price gains in both portfolio holdings within the sector. Top detractor Tesla Inc. drove declines within Consumer Discretionary. Communication Services lost ground due to weakness in second largest detractor Iridium Communications Inc. IDEXX Laboratories, Inc. drove declines within Health Care. Shares of this veterinary diagnostics leader fell as foot traffic to veterinary clinics in the U.S. remained uneven, modestly hampering aggregate revenue growth.

While we are encouraged by recent signs of recovery in the markets and the U.S. economy, as long-term investors who have lived through numerous market cycles, we have learned not to try to predict the unpredictable. Instead, we focus on identifying and researching well-managed unique businesses with durable competitive advantages and compelling growth prospects and investing in them at attractive prices. We think the combination of unchanged long-term growth outlooks and attractive valuations should result in strong returns over time.

Top Contributors/Detractors to Performance

as of 03/31/24

Contributors

  • Specialty insurer Arch Capital Group Ltd. contributed to performance after reporting strong financial results that exceeded Street expectations. In the most recent reported quarter, operating ROE was 24% and book value per share rose 44% as underwriting profitability remained excellent. Pricing trends in the P&C insurance market are favorable, and elevated interest rates are driving higher investment income. Insurance stocks broadly rebounded from weakness in the prior quarter as rates stabilized. We continue to own the stock due to Arch’s strong management team and our expectation of significant growth in earnings and book value.
  • Shares of CoStar Group, Inc. contributed to performance following strong quarterly and year-end results, including 2023 revenue of $2.46 billion, a 13% year-over-year increase, and above-consensus estimates. It was CoStar's 13th consecutive year of double-digit revenue growth. We remain investors given growing traction in CoStar’s residential offering. CoStar began to monetize its new Homes.com platform in February 2024 and is targeting close to $100 million in run-rate revenue by year-end. We believe momentum can be amplified by the recent class action settlement with the National Association of Realtors, which has the potential to disrupt the residential brokerage industry and enhance the return on investment for brokers advertising on Homes.com. CoStar plans to invest almost $1 billion in its residential business in 2024, which, while a significant upfront commitment, represents the peak level of spending, in our view. We think success in the residential segment has the potential to double the size of CoStar’s overall revenue stream.

Detractors

  • Tesla, Inc. designs, manufactures, and sells electric vehicles, related software and components, and solar and energy storage products. Shares fell as the core automotive segment remained under pressure due to a complex macroeconomic environment, factory shutdowns, growing competitive risks in China, and Tesla’s price reductions throughout 2023. During the first quarter of 2024, production was negatively impacted by Red Sea maritime supply chain interferences, sabotage at a Tesla factory power supply in Berlin, and the launch of the refreshed Model 3. We remain shareholders. Tesla has started delivery of its highly anticipated Cybertruck pickup, which features new technologies within the car and its manufacturing lines. Tesla also launched version 12 of its Full Self Driving product, which features material improvements and should enhance investor confidence in Tesla's unique software and hardware capabilities. Lastly, we expect energy storage sales to continue to grow over the coming years.
  • Iridium Communications Inc. is a mobile voice and data communications services vendor offering global coverage via satellite, Shares fell during the quarter. In November 2023, Qualcomm unexpectedly terminated an agreement with Iridium to enable direct-to-device (D2D) workloads on Iridium's network. The decision shook investors' confidence in Iridium's D2D opportunity. In addition, SpaceX generated limited headwinds to Iridium's maritime segment, enhancing competitive risk. We retain conviction. Iridium remains a unique satellite asset and operator, with L-band spectrum, global coverage, years of operational experience, relatively new satellite hardware, and hundreds of partners across verticals and geographies. In addition, management announced a commitment of $3 billion in returns to shareholders between 2023 and 2030, representing a material portion of the current enterprise value.
  • Shares of FactSet Research Systems Inc., a leading provider of investment management tools, detracted from performance. While the company reported solid earnings for the second fiscal quarter of 2024, it revised its fiscal year 2024 growth in annual subscription value towards the lower end of the prior guidance range given ongoing challenges in the financial services end market. FactSet has a strong pipeline and is seeing signs of stabilization, but client caution continues to delay purchasing decisions. While there is some near-term uncertainty, we maintain long-term conviction in FactSet due to the company’s large addressable market, consistent execution on both new product development and financial results, and robust free cash flow generation.

Quarterly Attribution Analysis (Institutional Shares)

as of 03/31/24

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.

as of 03/31/24

Baron Partners Fund (Institutional Shares) fell 9.01% in the first quarter, underperforming the Russell Midcap Growth Index by 18.51% as stock-specific weakness more than offset positive impacts from active sector weights and leverage.

The Fund uses leverage to enhance returns, although this does increase the volatility of returns. As of March 31, 2024, the Fund had 116.4% of its net assets invested in securities, and the use of leverage in a rising market added approximately 140 basis points to relative performance.

The Fund’s Consumer Discretionary holdings, specifically electric vehicle manufacturer Tesla, Inc., were largely responsible for the underperformance in the period. Tesla’s shares fell as the core automotive segment remained under pressure due to a complex macroeconomic environment, factory shutdowns, growing competitive risks in China, and vehicle price reductions throughout 2023. During the first quarter, production was negatively impacted by Red Sea maritime supply chain interferences, sabotage at a Tesla factory power supply in Berlin, and the launch of the refreshed Model 3. We remain shareholders. Tesla has started delivery of its highly anticipated Cybertruck pickup, which features new technologies within the car and its manufacturing lines, and launched version 12 of its Full Self Driving product, which features material improvements and should enhance investor confidence in Tesla's unique software and hardware capabilities. We also expect energy storage sales to continue to grow over the coming years. Disappointing stock selection in Consumer Discretionary was somewhat offset by the Fund’s significantly higher exposure to this strong performing sector, which was up nearly 13% in the index.

Investments in Industrials, Communication Services, and Financials also hampered relative results. Performance in Industrials was hindered by private rocket and spacecraft manufacturer Space Exploration Technologies Corp. (SpaceX), whose shares underperformed after they remained unchanged in the period. Stock-specific weakness in Communication Services came from Iridium Communications Inc., a mobile voice and data communications services vendor offering global coverage via satellite. Iridium’s shares declined for a third consecutive quarter due to ongoing uncertainty about the company’s direct-to-device (D2D) opportunity following Qualcomm’s decision to terminate an agreement that would have enabled workloads on Iridium's network. Additionally, as SpaceX’s Starlink broadband constellation gains traction, maritime customers who previously used Iridium as a primary broadband provider are increasingly using the company as a companion service. SpaceX also launched its first D2D Starlink satellites in early January, further intensifying competition. We retain conviction. Iridium remains a unique satellite asset and operator, with L-band spectrum, global coverage, years of operational experience, relatively new satellite hardware, and hundreds of partners across verticals and geographies. Management also announced a commitment of $3 billion in returns to shareholders between 2023 and 2030, representing a material portion of the current enterprise value.

Adverse stock selection in Financials, driven by investment management tools provider FactSet Research Systems Inc., was partially offset by meaningfully higher exposure to this better performing sector. Despite reporting solid quarterly earnings, the company revised its fiscal year 2024 growth in annual subscription value towards the lower end of the prior guidance range given ongoing challenges in the financial services end market. FactSet has a strong pipeline and is seeing signs of stabilization, but client caution continues to delay purchasing decisions. While there is some near-term uncertainty, we maintain long-term conviction in FactSet due to the company’s large addressable market, consistent execution on both new product development and financial results, and robust free cash flow generation.

Apart from leverage, lower exposure to the lagging Information Technology sector was the only material contributor in the period.

Investors should consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The prospectus and summary prospectuses contain this and other information about the Funds. You may obtain them from the Funds’ distributor, Baron Capital, Inc., by calling 1-800-99BARON or visiting www.BaronFunds.com. Please read them carefully before investing.

The performance data quoted represents past performance. Past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate; an investor's shares, when redeemed, may be worth more or less than their original cost. The Fund’s transfer agency expenses may be reduced by expense offsets from an unaffiliated transfer agent, without which performance would have been lower. Current performance may be lower or higher than the performance data quoted.

Risks:All investments are subject to risk and may lose value.

The discussion of market trends is not intended as advice to any person regarding the advisability of investing in any particular security. The views expressed on this page reflect those of the respective writer. Some of our comments are based on management expectations and are considered “forward-looking statements.” Actual future results, however, may prove to be different from our expectations. Our views are a reflection of our best judgment at the time and are subject to change at any time based on market and other conditions and Baron has no obligation to update them

Portfolio holdings are subject to change. Current and future portfolio holdings are subject to risk.

The index performance is not fund performance; one cannot invest directly into an index.