Review and Outlook

as of 12/31/22

After a brutal nine months, stocks advanced in the fourth quarter. The S&P 500 Index gained 7.56%. The economy remained resilient. It was also evident from many indicators, such as goods, energy, and rent prices, that inflation was cooling. There were signs of an economic slowdown on the horizon stemming from aggressive central bank tightening. The market rallied in October and November, as interest rates declined, and the Federal Reserve chair laid the groundwork to slow the pace of its monetary tightening. However, the market gave back some gains in December as the Fed dampened hopes of interest rate cuts in 2023 and remained unified and steadfast in its goal of reducing inflation to 2% from December’s rate of 6.5%.

Against this backdrop, Baron Durable Advantage Fund increased. Holdings within Information Technology (IT), Financials, and Health Care contributed the most. Consumer Discretionary and Communication Services investments detracted. With stock price gains in 9 out of 10 holdings, IT had a strong quarter. Mastercard Incorporated and Visa, Inc., respectively the second and third largest contributors, led positive performance within the sector. Advances within Financials were driven largely by top contributor Arch Capital Group Ltd. All five Health Care holdings appreciated, led by weighing instruments company Mettler-Toledo International, Inc., whose shares rose on solid third quarter earnings results. The portfolio’s only Consumer Discretionary holding, Amazon.com, Inc., drove declines within the sector. Amazon was the top detractor in the quarter. Communication Services lost ground on share price declines in Alphabet Inc. and Meta Platforms, Inc. Alphabet was the second largest detractor from performance.

Stock prices have always traded and fluctuated around intrinsic values at an amplitude that depends on the prevalent psychology in the market. When investors feel good about the world, they are willing to underwrite longer-term prospects, and prices tend to rise above intrinsic values. However, during times of uncertainty and stress, time horizons shrink, reducing investor appetite for long-duration assets, and prices fall below intrinsic values. In our view, this dynamic may have been behind the significant outperformance of large-cap value over large-cap growth in 2022. Over the long term, we believe stock prices will reflect the success of the businesses, or said differently, they (and we) would do well if the businesses themselves do well. We remain confident the businesses we own in this portfolio will do very well over the long term.

Top Contributors/Detractors to Performance

as of 12/31/22

Contributors

  • Arch Capital Group Ltd. is a specialty insurance company based in Bermuda. Shares increased due to favorable pricing trends in the P&C insurance market. During the quarter, the company reported earnings that beat consensus despite significant losses from Hurricane Ian. The stock also benefited from inclusion in the S&P 500 index, which prompted buying from passive funds. We continue to own the stock due to Arch’s strong management team and our expectation of strong growth in earnings and book value.
  • Shares of global payment network Mastercard Incorporated increased after reporting strong quarterly results, with 15% revenue growth and 13% EPS growth despite significant headwinds from currency movements and the suspension of operations in Russia. Payment volume grew 21% in local currency excluding Russia as consumer spending remained resilient and international travel continued to recover as border restrictions are lifted. We continue to own the stock due to Mastercard’s long runway for growth and significant competitive advantages.
  • Shares of global payment network Visa, Inc. increased after reporting strong quarterly results with 19% growth in revenue and EPS despite currency headwinds and the suspension of operations in Russia. Payment volume grew 16% in local currency excluding Russia and China with notable strength in cross-border volumes as international travel rebounds. Management also provided encouraging guidance for the next fiscal year. We continue to own the stock due to Visa’s long runway for growth and significant competitive advantages.

Detractors

  • Amazon.com, Inc. is the world’s largest retailer and cloud services provider. Shares of Amazon were down in the quarter, as the company guided to relative weakness in margins and Cloud. We believe that Amazon is well positioned in the medium term to improve profitability and sustain premium growth. Longer term, Amazon has substantially more room to grow in e-commerce, where it has less than 15% penetration in its total addressable market; and Cloud, where it is the clear leader in the vast and growing cloud infrastructure market with large opportunities in application software.
  • Alphabet Inc. is the parent company of Google, the world’s largest search and online advertising company. Shares of Alphabet were down during the quarter, with broader weakness in digital advertising demand impacting Search, YouTube, and overall margins. Long term, we retain conviction in Alphabet, as it is a quality compounder benefiting from secular growth in mobile and online video advertising accruing to its core assets of Search, YouTube, and the Google ad network. Though smaller in size, we are also encouraged by Google's investments in Cloud, AI, and other bets.
  • Brookfield Asset Management Ltd. is an asset-light alternative manager investing in real estate, infrastructure, renewable power, private equity, and credit assets globally with more than $750 billion AUM and $400 billion of fee-bearing capital. The stock was a detractor for the quarter as investors sold the “stub” security after its spin-off from Brookfield Corporation. We retain conviction given the company's diversified asset base, sustainable cash flows, strong asset management platform, and ability to deploy capital globally.

Quarterly Attribution Analysis (Institutional Shares)

as of 12/31/22

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 12/31/22

Baron Durable Advantage Fund (Institutional Shares) appreciated 4.65% in the fourth quarter, yet trailed the S&P 500 Index by 291 basis points due to stock selection and headwinds from style biases, notably overexposure to the weak performing Beta and Growth factors along with underexposure to the strong performing Leverage, Earnings Yield, Value, and Dividend Yield factors.

Information Technology (IT) investments were the only material contributors to relative performance. Strength in the sector was largely due to the outperformance of global payment networks Mastercard Incorporated and Visa, Inc., whose shares increased after reporting strong quarterly results despite significant headwinds from currency movements and the suspension of their respective operations in Russia.

Investments in Industrials, Consumer Staples, Health Care, Communication Services, and Consumer Discretionary combined with lack of exposure to the top performing Energy sector were responsible for much of the underperformance in the period. Within Industrials, lower exposure to this better performing sector coupled with the underperformance of electronics company HEICO Corporation accounted for about a third of the relative shortfall. HEICO’s shares lagged despite reporting strong quarterly results, with EPS coming in slightly ahead of consensus estimates and total organic growth of 11%. One area of concern was a modest decline in organic sales growth in the Electronic Technologies Group segment, as the company continued to face headwinds from defense supply chain constraints. Weakness in Consumer Staples came from membership warehouse operator Costco Wholesale Corporation, whose shares declined despite reporting solid quarterly results as comparable store sales growth slowed due to inflation and weaker bigger-ticket discretionary purchases. Within Health Care, lack of exposure to biotechnology and pharmaceutical stocks was a major headwind to performance, as these sub-industries were up 19.5% and 13.1%, respectively, in the index. Science and technology innovator Danaher Corporation and health care and well-being company UnitedHealth Group Incorporated also weighed on performance in the sector. The Fund’s holdings in Communication Services, search and online advertising company Alphabet Inc. and social network owner Meta Platforms, Inc., trailed their peers in the index. Alphabet’s shares were down in response to broader weakness in digital advertising demand impacting Search, YouTube, and overall margins, while Meta’s shares were pressured by investor concerns about rising expenses in a difficult macroeconomic environment. Adverse stock selection in Consumer Discretionary, related to share price weakness from retailer and cloud services provider Amazon.com, Inc., was somewhat offset by the Fund’s lower exposure to this lagging sector. Amazon was the largest detractor after guiding to relative weakness in margins as well as the Cloud segment.

as of 12/31/22

Yearly Attribution Analysis (for year ended 12/31/2022)

Baron Durable Advantage Fund (Institutional Shares) fell 24.81% for the year, underperforming the S&P 500 Index by 670 basis points due to stock selection and, to a lesser extent, differences in sector weights and headwinds from various style biases.

Underexposure to the lagging Consumer Discretionary and Real Estate sectors together with favorable stock selection in Information Technology (IT) and cash exposure in a down market were the lone sources of strength in the period. Positive stock selection in IT, owing mostly to the outperformance of fabless semiconductor leader NVIDIA Corporation, was somewhat offset by the Fund’s significantly higher exposure to this poor performing sector. NVIDIA was a top contributor during the period held due to resiliency in the company's Data Center segment. Global payment networks Mastercard Incorporated and Visa, Inc. also performed well after reporting solid financial results throughout the year as strong payment activity has persisted despite high inflation.

Lack of exposure to the top performing Energy sector proved costly, accounting for almost a third of the underperformance in the period. Investments in Consumer Staples, Health Care, Communication Services, Industrials, and Financials also weighed heavily on performance. Beauty products leader The Estee Lauder Companies Inc. and membership-only retail chain Costco Wholesale Corporation were a drag on performance in Consumer Staples. Estee Lauder’s stock was down as sales growth was hurt by lockdowns in China, causing management to materially lower full-year guidance. Costco’s shares were negatively impacted by disappointing earnings results from fellow big-box retailers Target and Walmart along with ongoing concerns about persistently high inflation and rising costs. Stock-specific weakness in Health Care, owing to the poor performance of Iqvia Holdings Inc. and Stevanato Group S.p.A, was partly offset by the Fund’s higher exposure to this outperforming sector. Shares of Iqvia and Stevanato were down sharply early in the year after being caught up in the rotation out of growth stocks in the life sciences tools & services space. We exited our positions in both companies late in the first quarter. Performance in Communication Services was hindered by social network owner Meta Platforms, Inc. and search and online advertising company Alphabet Inc., as both companies were hurt by macroeconomic weakness impacting digital advertising demand. Meta was also negatively impacted by Apple's new privacy changes in iOS mobile devices, which are making it more difficult for Facebook to measure the effectiveness of its advertising across its mobile apps. Within Industrials, lower exposure to this outperforming sector coupled with share price weakness from information services provider IHS Markit Ltd. hampered performance. IHS Markit shares declined prior to the closing of the company’s merger with S&P Global Inc. Broad-based weakness in Financials related to substantial declines from BlackRock Inc., Brookfield Corporation, Moody's Corporation, CME Group, Inc., S&P Global Inc., and MSCI, Inc. was partially mitigated by the Fund’s significantly higher exposure to this outperforming sector.

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.