Review and Outlook

as of 12/31/23

Early in the fourth quarter, an increasingly restrictive rise in real-yields and slowing employment and inflation momentum triggered a re-evaluation of likely U.S. Federal Reserve policy, which was confirmed by Fed comments suggesting its hiking cycle was complete. The Fed then surprised markets by communicating that rate cuts would likely occur sooner and in larger magnitude than expected. Bond yields and financial conditions reacted swiftly, pricing in rate cuts and easing liquidity conditions. The Fed’s pivot meaningfully increased the likelihood of a soft landing, in effect declaring it was shifting its attention from pure inflation fighting to a dual-mandate and a desire to balance growth and inflation. While markets cheered the news, we believe this event also likely foreshadows the end of the 14-year U.S. dollar bull market and will usher in a cycle of relative outperformance by non-U.S. equities. Although we suspect financial markets may have moved a bit too far, too fast, and expect some consolidation of gains and market volatility, we believe the time has come for investors to rebalance portfolios in favor of Asian emerging markets.

We expect the Asian emerging markets in general, and particularly those economies and companies most geared to the improvement in domestic growth, consumption, and investment that we expect to result from declining interest rates and appreciating currencies, to benefit most from this inflection point in financial conditions and capital flows. We anticipate a sustainable period of enhanced relative earnings growth potential in Asian EM – essentially a mean reversion or mirror image of the past several years.

Historically, the interest-rate and bond-yield sensitive markets such as India and Southeast Asia are disproportionate beneficiaries in the current environment, and we believe our portfolio is well positioned to benefit, given our overweight position in India and our structural and thematic bias towards domestic consumer, financial, and industrial leaders. We believe India, our largest overweight exposure, has reached escape velocity after years of productivity-enhancing reforms and stands out as a material beneficiary in the evolving global geopolitical environment.

Recent Asian EM performance and sentiment have been masked by ongoing skepticism toward China. Consistent with our view that global markets have reached an important inflection point, we note that the MSCI EM Asia ex-China Index outperformed the S&P 500 Index from the recent market low on October 27 through year end. Yet, China remains the elephant in the room. While inconsistent policy signals and geopolitical developments have been frustrating for investors -- and a key reason for our significant underweight exposure to China -- we believe China’s policymakers have the tools and capacity to engineer a recovery, and we remain cautiously optimistic that ongoing incremental efforts will render current valuation and skepticism as too conservative.

Top Contributors/Detractors to Performance

as of 12/31/23

Contributors

  • Semiconductor giant Taiwan Semiconductor Manufacturing Company Limited contributed in the fourth quarter due to investor expectations for a cyclical recovery in semiconductors heading into 2024 and significant incremental demand for AI chips. We retain conviction that Taiwan Semi’s technological leadership, pricing power, and exposure to secular growth markets, including high-performance computing, automotive, 5G, and IoT, will allow the company to sustain strong double-digit earnings growth over the next several years.
  • Shares of Trent Limited contributed to performance during the quarter. Trent is a leading retailer in India that sells direct-to-consumer private label apparel through its proprietary retail network. Share price appreciation was driven by strong quarterly sales performance as well as continued footprint expansion of its Zudio value fashion franchise. We believe the company will generate over 25% revenue growth in the near to medium term, driven by same-store-sales growth and outlet expansion. In addition, we believe operating leverage and a growing franchisee mix will lead to better profitability and return on capital, driving more than 30% EBITDA CAGR over the next three to five years.
  • Shares of South Korean conglomerate Samsung Electronics Co., Ltd. increased during the quarter due to an improving outlook for memory semiconductors in 2024, driven by supply discipline, DRAM and NAND inventory normalization, and an increase in AI-related demand. We are confident Samsung will remain a global leader in semiconductors and 5G smartphones.

Detractors

  • Yum China Holdings Inc. is the master franchisee for the YUM brands in China and operator of the KFC and Pizza Hut restaurant networks in that market. Shares detracted after the company reported a negative surprise on margins for the third quarter and hinted that increased competition and cost-consciousness among Chinese consumers could cause that margin compression to continue through the first quarter of 2024. Although in-year margins are volatile at Yum China, its pristine balance sheet, cumulative investments in technology, unmatched scale, and successful pivot to higher-ROI, smaller footprint stores in recent years should drive continued 8% to 10% store growth at attractive returns and capital returns to shareholders in excess of earnings over the next several years. We remain shareholders.
  • Alibaba Group Holding Limited is the largest retailer and e-commerce company in China. Alibaba operates shopping platforms Taobao and Tmall and owns 33% of Ant Group, which operates Alipay, China's largest third-party online payment provider. Shares of Alibaba were down in the fourth quarter due largely to the delay of the previously announced spin off of its cloud division. Quarterly results were roughly in line with Street expectations, with strength in profitability. We retain conviction that Alibaba is well positioned to benefit from the ongoing growth in online commerce and cloud in China, though competitive market concerns remain.
  • Shares of Bajaj Finance Limited, a leading non-bank financial company in India, detracted from performance largely due to regulatory restrictions imposed on certain lending products during the quarter, which negatively impacted investor sentiment. We retain conviction in Bajaj due to its best-in-class management team, robust long-term growth outlook, and conservative risk management frameworks. We think the company is well positioned to benefit from growing demand for consumer financial services such as mortgages and personal and credit card loans, among other related products.

Quarterly Attribution Analysis (Institutional Shares)

as of 12/31/23

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 12/31/23

Baron New Asia Fund (Institutional Shares) was up 6.07% in the fourth quarter, performing essentially in line with the MSCI AC Asia ex Japan Index.

On a country level, lower exposure to lagging Chinese equities and significantly higher exposure to better performing Indian stocks added the most value in the period. Active exposure to Japan was another material contributor thanks to sharp gains from the Fund’s digitization and automation/robotics/AI-related holdings. Mostly offsetting the above was poor stock selection in Taiwan and Korea coupled with lower exposure to these countries, which were the top performers in the Asian equity universe during the period. The Fund’s cash position in a market rally also adversely impacted relative results.

From a sector or theme perspective, stock selection was positive overall due to strength in Consumer Discretionary, Real Estate, and Health Care, where the Fund’s Indian holdings in the digitization, Asia consumer, and best-in-class/high-quality growth themes contributed the vast majority of relative gains. Favorable stock selection in Consumer Discretionary, owing mostly to strong gains from digitization leader Zomato Limited and a few of the Fund’s Asia consumer holdings (Trent Limited, Titan Company Limited, and Mahindra & Mahindra Limited), was partly offset by higher exposure to this lagging sector. Performance in Real Estate was bolstered by Indian real estate development company Godrej Properties Limited, which is part of the Fund’s Asia consumer theme. Strength in Health Care was largely due to outperformance from Japanese digitization company Hoya Corporation and best-in-class/high-quality growth holdings Max Healthcare Institute Limited and Apollo Hospitals Enterprise Limited, the latter of which are leading hospital operators in India.

Somewhat offsetting the above was adverse stock selection in Information Technology (IT) coupled with lower exposure to this top performing sector, which was up nearly 18% in the index. Cash exposure and weak stock selection in Industrials were the other material detractors. Performance in IT was hindered by China value-added holdings Glodon Company Limited and Venustech Group Inc., whose shares were down 24.8% and 1.6%, respectively, in the period. The Fund’s China value-added holdings also played a role in the underperformance in Industrials, where Jiangsu Hengli Hydraulic Co., Ltd., Estun Automation Co., Ltd., and NARI Technology Co. Ltd. were among the largest detractors.

as of 12/31/23

Yearly Attribution Analysis (for year ended 12/31/2023)

Baron New Asia Fund (Institutional Shares) appreciated 5.79% for the year, performing in line with the MSCI AC Asia ex Japan Index. The Fund managed to keep pace with the index despite headwinds from the general outperformance of value-oriented securities, as Book-to-Price, Dividend Yield, and Earnings Yield were the best performing style factors during the year.

On a country level, favorable stock selection in India coupled with meaningfully higher exposure to this better performing country added the most value. Indian stocks meaningfully outperformed the broader Asia equity universe due to a combination of resilient corporate earnings growth and the abrupt shift to risk-off in China during the latter half of the year. We remain excited about the long-term investment opportunities within India driven by several productivity enhancing economic reforms implemented by the Modi administration that are kickstarting a virtuous investment cycle and positioning the country to become the fastest growing large economy in the world. Active exposure to Japan through select positions in digitization (Tokyo Electron Limited and Hoya Corporation) and automation/robotics/AI (Keyence Corporation) also stood out as contributors during the year. Somewhat offsetting the above was adverse stock selection in China and Hong Kong, where several of the Fund’s China value-added and consumer holdings were material detractors. Lower exposure to Taiwan and Korea also proved costly as these were the best performing countries in the Asia equity universe during the year.

From a sector or theme perspective, stock selection was an overall tailwind to performance thanks to solid gains from several of the Fund’s Indian holdings in the Consumer Discretionary, Real Estate, and Communication Services sectors. Strength in Consumer Discretionary came from an assortment of themes, notably Asia consumer (Trent Limited and Titan Company Limited), digitization (Zomato Limited), and global security/supply chain diversification (Amber Enterprises India Ltd. and Dixon Technologies Ltd.). Within Real Estate, lower exposure to this lagging sector combined with strong performance from Indian real estate development company Godrej Properties Limited added value. Positive stock selection in Communication Services was driven by Indian digitization holdings Tata Communications Limited and Bharti Airtel Limited, whose share prices were up in excess of 30% for the period.

Partially offsetting the above was disappointing stock selection in Information Technology (IT) coupled with lower exposure to this outperforming sector. Weakness in IT was partly due to declines from China value-added holdings Glodon Company Limited, Kingdee International Software Group Company Limited, and Silergy Corp. Lower exposure to SK hynix Inc. and MediaTek Inc. also weighed on performance, as these AI beneficiaries were up sharply alongside other semiconductor stocks in the period. Another drag on performance was adverse stock selection in Consumer Staples combined with higher exposure to this lagging sector. Performance was hindered by China consumer investments Budweiser Brewing Company APAC Limited, China Mengniu Dairy Co. Ltd., and Wuliangye Yibin Co., Ltd., whose shares underperformed as China's "reopening" recovery coming out of COVID lockdowns in late 2022 has been weaker than investors anticipated.