Review and Outlook

as of 03/31/23

After a challenging 12 months, U.S. equities posted a second consecutive positive quarter to start 2023, with growth stocks generally outperforming after a period during which they significantly underperformed value stocks. Stocks rose on investor hopes that moderating inflation and certain weakening economic indicators might lead the Federal Reserve to end its tightening cycle, along with easing supply chain constraints, falling energy and commodity prices, and the reopening of the Chinese economy. The rebound stalled in February in the face of resilient economic data and stubbornly high inflation readings. In early March, the sudden failure of Silicon Valley Bank rattled the market, but regulators quickly intervened to prevent contagion. This episode may have resulted in the subsequent rebound, based on the belief that the Fed would moderate its pace of rate hikes to reduce the risk of a further banking crisis.

Stocks with a disproportionate amount of earnings and cash flow expected far in the future performed best during the quarter, as they stand to benefit the most from a reduction in interest rates. Although we have some exposure to these areas, much of our portfolio is comprised of slightly slower growth, solidly profitable companies in a range of industries.

Baron Asset Fund increased in the quarter. Health Care, Information Technology (IT), and Consumer Discretionary holdings contributed the most. Investments in Financials and Real Estate detracted. With top contributor IDEXX Laboratories, Inc. and third largest contributor West Pharmaceutical Services, Inc. within the sector, Health Care had a strong quarter. Second largest contributor ANSYS, Inc. led positive results within IT. Gains within Consumer Discretionary were led by Hyatt Hotels Corporation, whose shares increased on robust growth in revenue-per-available-room, driven by its strong leisure business. Weakness within Financials was driven largely by top detractor The Charles Schwab Corp. Real Estate lost ground on share price declines in three of the portfolio’s four holdings within the sector.

Although we do not base our investments on macroeconomic forecasts, we are encouraged by the growing view that domestic inflation may have peaked, likely leading to an eventual decrease in interest rates. The market also appears to have moved past the widespread fear that the Silicon Valley Bank failure could engender a broader contagion in the banking sector, causing potential ripple effects throughout the economy. As the market continues to recover and the economy stabilizes, we expect the types of companies we favor to outperform – leading companies in their industry that benefit from secular growth drivers, strong competitive positions, and exceptional management teams.

Top Contributors/Detractors to Performance

as of 03/31/23

Contributors

  • Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. contributed to performance for the quarter, helped by financial results that beat consensus and multiple expansion. The post-pandemic rate of decline of veterinary visits seems to have stabilized and is poised to return to advancement by the end of 2023. IDEXX’s competitive trends are outstanding, and we expect new proprietary innovations and field sales force expansion to be meaningful contributors to growth. We see increasing evidence that secular trends around pet ownership and pet care spending have been structurally accelerated, which should help support IDEXX’s long-term growth rate.
  • Shares of ANSYS, Inc., a leading provider of physics-based simulation software, contributed following another robust quarterly report. ANSYS benefits from strong secular trends, a broad product line, solid execution, and its strategic relationship with its customers. Together, these attributes have helped the company to generate resilient growth across revenue and cash generation that, despite foreign exchange and Russia-related headwinds, came in well above analyst expectations. In spite of general macroeconomic weakness, management described continued traction among large customers and a healthy demand environment, especially in key verticals including technology, alternative energy, automotive, and aerospace. ANSYS continues to invest in its core technology while adding new capabilities to support future growth initiatives including artificial intelligence and cloud. Its multiyear transition of its licensing model should allow for better growth predictability and further margin expansion in coming years.
  • West Pharmaceutical Services, Inc. manufactures components and systems for the packaging and delivery of injectable drugs such as rubber stoppers for vials and plungers for prefilled syringes. Shares increased after the company reported financial results that beat analyst expectations and provided solid 2023 guidance. Excluding COVID-related product revenue, organic sales growth was 14% in the fourth quarter, and management expects mid-teens base business organic growth in 2023, well above its long-term target. West's competitive pricing and favorable product mix, including products used with anti-obesity medicines, should help drive future demand. We continue to believe West operates a competitively advantaged business that is well positioned for long-term growth.

Detractors

  • Shares of online brokerage firm The Charles Schwab Corp. declined during the quarter following the bankruptcy of Silicon Valley Bank (SVB) and the resulting weakness in financials generally and particularly in regional banks. Despite running a much different business than SVB, Schwab is facing deposit pressure through cash sorting in the wake of the collapse. As investors continue to move uninvested cash balances into higher-yielding money market funds, with the assets remaining at Schwab, the company must raise high-cost external funding in the short term. Although this is pressuring earnings estimates and contributing to near-term weakness in shares, we retain long-term conviction given accelerating net inflows year-to-date, with Schwab gathering over $75 billion in new assets in just the first two months of 2023. We are encouraged by the firm’s exceptional client loyalty levels, robust organic growth, and industry-leading operating expense per client assets. Schwab is well positioned to retain clients and increase long-term earnings growth, in our view.
  • CoStar Group, Inc. is the leading provider of information and marketing services to the commercial real estate industry. After two straight quarters of robust performance, shares detracted during the quarter, likely due to profit taking. The company is generating robust financial performance, with net new sales growing 15% in the quarter, and margins expanding by 200 basis points excluding growth investments. We expect the company’s core businesses to continue to benefit from the migration of real estate market spend to online channels. CoStar has begun to invest aggressively in building out its residential marketing platform. We estimate CoStar invested around $230 million in this initiative in 2022, and its initial 2023 guidance implies a total investment approaching $500 million. While this is a significant upfront commitment, we believe the residential market represents a transformative opportunity. The company’s proprietary data, broker-oriented approach, and best-in-class management position it to succeed in this endeavor, in our view.
  • First Republic Bank provides banking and wealth management services. The share price collapsed after the failures of Silicon Valley Bank and Signature Bank ignited investor fears that First Republic could face a similar fate. A majority of First Republic's funding base is comprised of large, uninsured deposits from a small number of wealthy clients and businesses. Despite a historically loyal customer base, we believe many of these deposits were withdrawn from the bank and replaced with higher-cost funding, leading to earnings pressure. We concluded that the bank’s competitive position and earnings potential had likely been permanently impaired, so we exited the position.

Quarterly Attribution Analysis (Institutional Shares)

as of 03/31/23

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 03/31/23

Baron Asset Fund (Institutional Shares) appreciated 5.34% in the first quarter, yet trailed the Russell Midcap Growth Index by 380 basis points principally due to stock selection and headwinds from style biases, notably underexposure to the strong performing Beta and Residual Volatility factors.

Adverse stock selection in Financials, Information Technology (IT), Industrials, and Communication Services was largely responsible for the relative shortfall during the quarter. Within Financials, online brokerage firm The Charles Schwab Corp. and banking and wealth management services provider First Republic Bank weighed heavily on performance after their shares were negatively impacted by the bank runs and failures of Silicon Valley Bank (SVB) and Signature Bank. While Schwab is not a regional bank, the company did experience some deposit pressure related to cash sorting, which undoubtedly weighed on its share price. We retain long-term conviction given accelerating net inflows year-to-date, with Schwab gathering over $75 billion in new assets in just the first two months of 2023. We are encouraged by the firm’s exceptional client loyalty levels, robust organic growth, and industry-leading operating expense per client assets. Schwab is well positioned to retain clients and increase long-term earnings growth, in our view. First Republic’s shares collapsed given investor concerns that the company could face a similar fate as SVB and Signature Bank. Prior to the crisis, First Republic’s funding base was mostly comprised of large, uninsured deposits from a small number of wealthy clients and businesses. Despite a historically loyal customer base, we believe many of these deposits were withdrawn from the bank and replaced with higher-cost funding, leading to earnings pressure. We concluded that the bank’s competitive position and earnings potential had likely been permanently impaired, so we exited the position. Aside from stock selection, the Fund’s higher exposure to this lagging sector, which was hurt by severe declines from regional banks, also hampered performance.

Weakness in IT and Industrials was driven by declines from syndicated research provider Gartner, Inc. and real estate data and marketing platform CoStar Group, Inc., respectively. Gartner gave back a modest portion of last year’s significant gains due to softening business conditions, as the company’s IT vendor customer base is being negatively impacted by layoffs and cost reductions across the sector. Despite this headwind, Gartner is still generating attractive double-digit growth in research contract value. We expect sustained revenue increases and renewed focus on cost control to drive margin expansion and enhanced free cash flow generation over time. CoStar was a top detractor after earnings and guidance fell short of Street expectations due to aggressive investment in the company’s residential real estate segment. We estimate CoStar invested around $230 million to build out its residential marketing platform in 2022, and its initial 2023 guidance implies a total investment approaching $500 million. While this is a significant upfront commitment, we believe the residential market represents a transformative opportunity. The company’s proprietary data, broker-oriented approach, and best-in-class management position it to succeed in this endeavor, in our view. Within Communication Services, underperformance of marketing solutions provider ZoomInfo Technologies Inc. coupled with lower exposure to this top performing sector hampered relative results. ZoomInfo’s shares declined as the broader software and technology spending environment, to which the company is disproportionately exposed, continued to show weakness. We are closely monitoring customer intent and spending patterns with ZoomInfo during this trickier macroeconomic time. Longer term, we believe that ZoomInfo can become a much larger company as it grows into its ever-expanding $70 billion-plus total addressable market and potentially expands into adjacencies like marketing and talent acquisition software.

Partially offsetting the above was favorable stock selection in Health Care attributable to sharp gains from veterinary diagnostics leader IDEXX Laboratories, Inc. and pharmaceutical packaging manufacturer West Pharmaceutical Services, Inc. IDEXX was the largest contributor in response to better-than-expected financial results and multiple expansion. The rate of decline in veterinary visits appears to have stabilized, and we believe increased pet ownership and pet care spending remain long-term secular trends. West’s financial results surpassed Street expectations and management provided solid guidance for fiscal year 2023. Excluding COVID-related product revenue, the company’s organic sales growth was 14% in the fourth quarter, and management expects mid-teens base business organic growth in 2023, well above its long-term target.

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.