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 Asset Fund increased in the quarter. Holdings within Information Technology (IT), Health Care, and Financials contributed the most to performance. No sector detracted. Positive performance within IT was led by second largest contributor Gartner, Inc. Mettler-Toledo International Inc. led gains within Health Care. Shares of this provider of weighing instruments for the life sciences, food, and chemical industries increased on investor anticipation of improving financial results throughout the year due to more favorable comparisons and contributions from new products. Appreciation within Financials was led by top contributor Arch Capital Group Ltd.

As the economy stabilizes and the stock market continues its recovery, we expect the types of companies that the strategy favors to outperform – leading companies that benefit from secular growth drivers, secure competitive positions, and talented management teams. It is also worth noting that the primary mid-cap growth index has dramatically underperformed the primary mid-cap value index during the past three years. This has reduced the relative premium the market generally accords to faster growing stocks, and we believe it presents an attractive opportunity to invest in mid-cap growth stocks.

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 Gartner, Inc., a provider of syndicated research, contributed to performance. Financial results were mixed, with declines in net income and EPS for the fourth quarter, but solid increases in contract value and strong full year performance, including a 9% increase in net income and an 11% rise in diluted EPS, helped boost the share price. In addition, a 19% increase in free cash flow for the quarter and 6% for the full year underscored Gartner's operational efficiency. Gartner’s core subscription research businesses compounded at attractive rates, and we believe growth is poised to accelerate. We think Gartner will emerge as a key decision support resource for every company evaluating the opportunities and risks of AI on its business, providing a tailwind to volume growth and pricing realization. We expect Gartner’s sustained revenue growth and focus on cost control to drive continued margin expansion and enhanced free cash flow generation. The company’s balance sheet is in excellent shape and can support aggressive repurchases and bolt-on acquisitions, in our view.
  • 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

  • Bio-Techne Corporation is a leading developer and manufacturer of reagents, instruments, and services for the life sciences research, diagnostics, and bioprocessing markets. The stock detracted from performance on weak fourth-quarter financial results, including a 2% decline in organic growth, driven by a slowdown in China and ongoing biotech funding constraints. While management noted that business in China has stabilized and the funding environment has started to recover, it does not anticipate marked improvement until later in 2024. We believe these headwinds are cyclical and that Bio-Techne remains well positioned for long-term growth. 
  • ANSYS, Inc. is a leading provider of physics-based simulation software. By accurately mimicking real world physics with software, simulation tools help customers reduce costs and accelerate time to market. In December 2023, shares rose on news that several entities were interested in acquiring the company. In January 2024, Synopsys officially announced its intent to acquire ANSYS in a deal valued at nearly $35 billion, marking one of the largest software acquisitions in history. While the stock price remained above levels seen before the acquisition reports, the official announcement spurred a somewhat unfavorable market reaction given an implied price per share slightly below market expectations, a relatively long period between the announcement and anticipated closing date, heightened risk perception stemming from a substantial portion of the deal's value being proposed to ANSYS shareholders in the form of Synopsys shares, and perceived regulatory hurdles. We believe ANSYS is well positioned to benefit from multi-year contracts, its strategic relationships with its large and diversified customer base, and secular trends such as growing product complexity and the adoption of simulation technology.
  • VeriSign, Inc., a global provider of internet infrastructure and domain name registry services, manages the .com and .net domains. Shares of VeriSign declined due to continued pressure on domain growth stemming from weaker demand in China. We retain conviction in the stock given VeriSign’s strong competitive positioning and contractual ability to raise prices. Longer term, we are encouraged by VeriSign’s opportunity to win the .web domain, produce substantial free cash flow, and generate attractive capital returns as it continues to prioritize share buybacks.

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 Asset Fund (Institutional Shares) appreciated 6.00% in the first quarter, trailing the Russell Midcap Growth Index by 350 basis points due to stock selection and headwinds from style biases. The Fund was hurt most by its underexposure to securities with robust short-term momentum and elevated idiosyncratic volatility, which were strong performers in the period.

Investments in Industrials, Financials, Health Care, and Information Technology (IT) were largely responsible for the relative shortfall in the period. Stock selection in Industrials accounted for about a third of the underperformance, owing mostly to modest declines from the Fund’s sizeable positions in data and analytics vendor Verisk Analytics, Inc. and global payroll and HCM (human capital management) software leader Dayforce, Inc. Verisk’s shares fell slightly in the period, giving back all of last year’s relative gains. The company reported solid quarterly earnings, but the stock lagged as part of a broader market rotation away from steady, compounding stocks. We maintain conviction in the competitive positioning, long-term growth, margin expansion, and capital deployment prospects for the business. Dayforce shares fell on concerns that slowing employment growth will reduce the company’s growth rate in the near term. While Dayforce has some direct exposure to employment levels, it is benefiting from powerful secular trends around the modernization of HCM software and growing adoption of SaaS. We believe that Dayforce can continue to grow above 20%, helped by continued share gains, a move up-market, early international traction, and increasing success in cross-selling to existing customers. Private rocket and spacecraft manufacturer Space Exploration Technologies Corp. was another drag on performance in the sector.

Performance in Financials was hindered by FactSet Research Systems Inc., a leading provider of investment management tools. 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.

Adverse stock selection in Health Care was driven by single-digit declines from veterinary diagnostics leader IDEXX Laboratories, Inc. and life sciences tools developer Bio-Techne Corporation. IDEXX’s shares fell as foot traffic to veterinary clinics in the U.S. remained uneven, modestly hampering aggregate revenue growth. We retain conviction. IDEXX’s excellent execution has enabled the company to continue to deliver robust financial results. IDEXX’s competitive trends are outstanding, and we expect new proprietary innovations and field sales force expansion to be meaningful contributors to growth this year. We see increasing evidence that long-term secular trends around pet ownership and pet care spending have been structurally accelerated, which should help support IDEXX’s long term growth rate. Bio-Techne was a top detractor due to weak fourth-quarter financial results, including a 2% decline in organic growth, driven by a slowdown in China and ongoing biotech funding constraints. We remain shareholders.

Weakness in IT was broad based, led by disappointing performance from internet infrastructure company VeriSign, Inc. and physics-based simulation software leader ANSYS, Inc., whose shares pulled back for company-specific reasons. VeriSign’s shares declined due to continued pressure on domain growth stemming from weaker demand in China, while ANSYS stock was pressured by questions about the company’s proposed merger with Synopsys. We retain conviction in both companies. Syndicated research provider Gartner, Inc. also underperformed in the period, relinquishing a portion of last year’s strong relative gains. The company’s core subscription research businesses continued to compound at attractive rates, and we believe that growth is poised to accelerate over the next several quarters. We think Gartner will emerge as a key decision support resource for every company evaluating the opportunities and risks of AI on its business, providing a tailwind to volume growth and pricing realization. We expect Gartner’s sustained revenue growth and focus on cost control to drive continued margin expansion and enhanced free cash flow generation. The company’s balance sheet is in excellent shape and can support aggressive repurchases and bolt-on acquisitions, in our view.

Somewhat offsetting the above was solid stock selection in Communication Services, where internet advertising demand-side platform The Trade Desk bounced back during the quarter. The company delivered a solid beat and raise quarter after experiencing some macroeconomic-related softness in late 2023. The 2024 setup appears promising for Trade Desk, as the company continues to benefit from tailwinds in Connected TV, a secular growth category capturing spend at an increasing pace from linear TV, retail media, platform upgrade adoption, audio, and more. Longer term, we remain positive on the company given its technology, scale, and estimated 10% share in the $100 billion programmatic advertising market, a small and growing subset of the $700 billion global advertising market.

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.