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. Gains were led by technology stocks, especially the companies seen as most likely to benefit from the artificial intelligence boom. 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 Durable Advantage Fund increased in the quarter. Information Technology (IT), Communication Services, and Financials holdings contributed the most. No sector detracted. Positive performance within IT was led by top contributor NVIDIA Corporation, while appreciation within Communication Services was led by second largest contributor Meta Platforms, Inc. Arch Capital Group, Inc. led gains within Financials. Shares of this specialty insurer rose after reporting strong financial results that exceeded Street expectations, including operating return on equity of 24% and an increase in book value per share of 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.

The outlook for 2024 continues to create 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. We believe investing in great businesses at attractive valuations will enable us to earn excess risk-adjusted returns 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 opportunities.

Top Contributors/Detractors to Performance

as of 03/31/24

Contributors

  • NVIDIA Corporation sells semiconductors, systems, and software for accelerated computing, gaming, and generative AI (GenAI). NVIDIA's stock rose in the first quarter, driven by continued strong demand for its GPUs that stand at the epicenter of the GenAI revolution. NVIDIA closed 2023 with unprecedented revenue growth at massive scale, with a fourth-quarter revenue run rate just shy of $90 billion, growing over 3.5 times year-on-year with operating margins of 67%. In addition to GenAI-driven demand, NVIDIA is benefiting from the transition to accelerated computing. NVIDIA continues to improve the performance of its chips and systems while removing hurdles for adoption through software innovation, such as the recently announced NVIDIA Inference Microservices, which make it easier for companies to adopt GenAI at scale.
  • Shares of Meta Platforms, Inc., the world’s largest social network, were up in the quarter due to robust topline growth and first-quarter guidance indicating roughly 29% year-over-year revenue growth. Our industry checks have validated advertiser adoption and satisfaction, with particular improvements in monetizing Instagram Reels and click- to-message ads. Meta continues to innovate in generative AI (GenAI), with a leading research lab and the best open-source models to date; we are beginning to see Meta's core apps incorporate GenAI in the user experience. Core app engagement remains healthy, with video daily watch time growing 25% year-over-year and the total number of monthly active users rising to 3.98 billion in the fourth quarter. We believe Meta will utilize its leadership in mobile advertising, massive user base, innovative culture, leading GenAI research and potential distribution, and technological scale to perform, with further monetization opportunities ahead.
  • Amazon.com, Inc. is the world’s largest retailer and cloud services provider. Shares increased on quarterly results that exceeded consensus expectations, particularly with a large beat in overall operating profit. We 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 fast-growing, margin-accretive advertising business. Amazon has substantially more runway in eCommerce, where it has less than 15% penetration in its total addressable market. We also believe Amazon's cloud service, AWS, has many years ahead of meaningful growth, with customer cloud optimizations attenuating, although we continue to monitor its positioning in generative AI (GenAI). It remains the clear leader in the vast and growing cloud infrastructure market, with large opportunities in application software, including enabling GenAI workloads.

Detractors

  • Adobe Inc. is a leading developer of printing, publishing, and graphics software. Shares detracted from performance after the company reported annual recurring revenue that surpassed its internal guidance but fell short of buy-side expectations by $20 to $25 million. This shortfall raised investor concerns that Adobe may need a weighted ramp in 2H to hit guidance. We believe Adobe can execute its annual objectives through: 1) addressing pricing dynamics by extending price increases to additional regions, driving increased renewals in the second half of the year, and benefiting from the dissipation of headwinds from 2022 price increases; 2) leveraging credit packs, particularly within enterprise-focused solutions like GenStudio and Firefly, which are gaining traction; and 3) introducing new solutions, including upcoming Document Intelligence add-on capabilities. We think Adobe is a top-tier franchise with an exciting innovation cycle ahead, poised to optimize its extensive user base, expand its opportunity, and benefit from generative AI trends.
  • UnitedHealth Group Incorporated is a leading health insurance company that operates across four segments: United Healthcare, Optum Health, OptumInsight, and OptumRX. Shares fell alongside other managed care organizations (MCOs) due to patient utilization of Medicare Advantage (MA) that was higher than consensus forecasts, raising concerns that MCOs had mispriced 2024 bids and could suffer margin compression as a result. In addition, the industry is facing headwinds from MA reimbursement cuts and Star Rating changes. While management said higher cost trends are mostly transitory and reflected in its bidding, and 2024 guidance was roughly in line with consensus, investors took a more cautious wait-and-see approach. We believe UnitedHealth should remain a core portfolio holding, as it is a way to play positive demographic, population health, and value-based reimbursement trends. Despite its size, we think the company should be able to grow earnings consistent with its 13% to 16% long-term EPS annual target, the fastest among major MCOs.

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.