Review and Outlook

as of 12/31/23

The fourth quarter contributed to a strong bounce-back year in 2023. The S&P 500 Index gained 11.69% during the quarter and 26.29% during the year, recapturing all its losses from the prior year. Brushing aside ongoing macro concerns including the Federal Reserve’s continuation of its historical tightening cycle, the recession debate, geopolitical uncertainties, and poor investor sentiment following a tough 2022, the index climbed steadily through the first half of the year. After a third-quarter dip driven largely by investor concerns that rates were going to stay “higher for longer,” lower inflation data and the shifting focus to rate cuts prompted a bull run in the last two months of 2023.

Baron Durable Advantage Fund increased in the fourth quarter. Holdings within Information Technology (IT), Financials, Communication Services, and Consumer Discretionary contributed the most to performance. No sector detracted. IT had a strong quarter, with gains in all portfolio positions, led by top contributor Microsoft Corporation. Positive returns within Financials were driven largely by rating agency and data provider S&P Global Inc., whose shares increased due to higher debt issuance amid more favorable market conditions. Third largest contributor Meta Platforms, Inc. drove appreciation within Communication Services. Increases within Consumer Discretionary were attributable to second largest contributor Amazon.com, Inc., the portfolio’s only holding within the sector.

One of the biggest surprises of 2023 was the highly anticipated recession in the U.S. that has not materialized. While some were in the camp of hard landing and others were in the camp of soft landing, not many were in the camp of no landing… could that remain the case in 2024? When will the Fed start cutting rates? How aggressive will it be? What are the implications of the upcoming elections (the S&P 500 has not declined in an election year since 1940)?

Though we have a view on many of these questions we do not have the answers. The range of outcomes continues to be extremely wide, creating a challenging environment for investors. But since we are not macro investors, we stick to focusing on well-managed, high-quality businesses with durable competitive advantages for the long term. We continue to speak with company management teams as often as we can, test our investment theses, look for disconfirming evidence and measure how well our businesses are performing fundamentally.

It is our belief that investing in great businesses at attractive valuations will enable us to earn excess risk-adjusted returns for our shareholders over the long term. We are optimistic about the prospects of the companies in which we are invested and continue to search for new ideas and investment opportunities.

Top Contributors/Detractors to Performance

as of 12/31/23

Contributors

  • Microsoft Corporation is a software company traditionally known for its Windows and Office products. Over the last eight years, it has built a $100 billion-plus cloud business, including Office 365, CRM product Dynamics 365, and infrastructure-as-a-service product Azure (including Azure AI services). Shares increased after posting strong quarterly results, with a material top line beat, upside across all three operating segments, and strong margin growth, despite ramping long tail investments behind AI. We remain confident that Microsoft is one of the best positioned companies in software with its vertically integrated software stack and broad sales distribution. We believe Microsoft will continue taking share across its business, driving durable, long-term, double-digit growth and best-in-class profitability.
  • Amazon.com, Inc. is the world’s largest retailer and cloud services provider. Shares of Amazon were up in the quarter. Reported results were better than consensus, with a significant beat in North American operating profit. We believe the AWS cloud division has many years ahead of growth, with recent customer optimizations attenuating. We also believe Amazon is well positioned in the short to medium term to meaningfully improve core North American retail profitability to above pre-pandemic levels, benefiting from its new regionalized fulfillment network and its growing margin-accretive advertising business. Longer term, Amazon has substantially more room to grow in e-commerce, where it has less than 15% penetration of the total addressable market. Amazon also remains the clear leader in the vast and growing cloud infrastructure market, with large opportunities in application software, including enabling generative AI workloads.
  • Shares of Meta Platforms, Inc., the world’s largest social network, were up in the quarter due to healthy topline growth and expense guidance that beat consensus, aided by a broader tech rally. Our industry checks have also validated advertiser adoption and satisfaction, with particular improvements in monetizing Instagram Reels and click-to-message ads. Meta continues to innovate in generative AI, with a leading AI research lab and the best open-source models to date; we are beginning to see Meta's core apps incorporate generative AI in the user experience. Meta is also the megacap tech company most focused on profitability. Core app engagement remains healthy, with video and Instagram Reels incremental to user time spent. Longer term, we believe Meta will utilize its leadership in mobile advertising, massive user base, innovative culture, leading generative AI research and potential distribution, and technological scale to perform, with further monetization opportunities ahead.

Detractors

  • Shares of specialty insurer Arch Capital Group Ltd. gave up some gains in the fourth quarter after solid performance for most of the year. We believe the share price weakness was primarily due to a sector rotation away from defensive stocks to more speculative stocks following a decline in interest rates. Company fundamentals remained strong, with net premiums written growing 23%, operating ROE expanding to 25%, and book value per share rising 30% in the third quarter. Management expects favorable market conditions will persist. We continue to own the stock due to Arch’s experienced management team and our expectation of solid growth in earnings and book value.
  • LPL Financial Holdings Inc. is the largest independent broker-dealer in the U.S. Shares detracted in the quarter as the market's expectations for the number of interest rate cuts in 2024 increased. LPL invests idle client cash in both floating and fixed rate contracts. Rate cuts could reduce LPL's revenue and earnings from its floating rate contracts. LPL's interest rate exposure has also made it a favored stock for short-term traders to gain exposure to higher interest rates. We believe some of the stock weakness was a result of these investors reducing their stake as rates look set to fall. On a long-term basis, LPL's execution continues to be strong as it gains share among advisors and wins large enterprise deals.
  • The Estee Lauder Companies Inc. is a leading manufacturer, marketer. and retailer of prestige beauty products globally. Shares were challenged in the fourth quarter after management cut the company’s outlook for the fiscal year ending 6/30/24. This downward revision was mainly driven by a worsening outlook in China, business disruptions in Israel and other parts of the Middle East, and worsening FX headwinds. Lauder’s disproportionate exposure to the Chinese consumer and the travel retail channel in Asia relative to peers continues to place pressure on both growth and margins. We exited our position.

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.