Review and Outlook

as of 12/31/20

2020 was unlike any other year in recent memory. If one had to guess where the market would trade during a global pandemic with millions of jobs lost globally, entire cities and countries shut down for extended periods of time, and a highly polarized election culminating with a shocking riot on Capitol Hill, few would guess the market would reach record highs. And yet, despite the extreme uncertainty and a significantly wider range of possible outcomes throughout the year, markets kept rallying.

This was especially true for the high-growth segment of the market, which significantly outperformed. High-growth companies enjoyed especially high multiples during the periods of monetary stimulus and with interest rates near zero the discounted value of their future cash flows was higher. The companies that we target for Baron Durable Advantage Fund tend to be more mature, and hence, have a lower percentage of their intrinsic values derived from terminal cash flows. Nevertheless, our businesses also accrued benefits from this accommodating environment, and we believe that most experienced considerable increases in their intrinsic values.

Against this backdrop, Baron Durable Advantage Fund increased in the fourth quarter. Information Technology (IT), Health Care, and Communication Services contributed the most. No sector detracted. IT had a solid quarter, with gains in 11 out of 12 investments. Appreciation was led by third largest contributor Accenture plc. Health Care’s performance was led by Iqvia Holdings Inc., a leading contract research organization focused on the combined industries of health IT and clinical research. Communication Services advanced largely on the strength of top contributor Alphabet Inc.

Our goal is to invest in large-cap companies with, in our view, strong and durable competitive advantages, proven track records of successful capital allocation, high returns on invested capital, and high free cash flow generation, a significant portion of which is regularly returned to shareholders in the form of dividends or share repurchases. 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 12/31/20

Contributors

  • Alphabet Inc. is the parent company of Google, the world’s largest search and online advertising company. Shares of Alphabet were up in the quarter given continued recovery in ad spend, strong cloud revenue growth, and improved cost controls. We remain highly convicted in Alphabet's merits as it continues to benefit from growth in mobile and online video advertising, which accrues to its core assets of search, YouTube, and the Google ad network. We are further encouraged by Alphabet's investments in AI, autonomous driving (Waymo), and life sciences (Verily, Calico).
  • Shares of MSCI, Inc., a leading provider of investment decision support tools, contributed to performance. The company reported solid third quarter earnings despite the challenging COVID-19 backdrop, and management is continuing to proactively manage its cost base. MSCI's asset-based fee revenue has also positively contributed due to strong underlying market conditions and inflows. We retain long-term conviction as the company owns strong, "all weather" franchises and remains well-positioned to benefit from a number of prominent tailwinds in the investment community.
  • Accenture plc provides consulting and technology services to corporate clients around the world.  Shares increased as client spend recovered from the pandemic faster than analyst forecasts with 25% bookings growth in the most recent quarter.  Revenue and earnings beat consensus, leading management to raise full-year guidance.  We believe Accenture is well equipped to help its clients adapt to the changing economic environment and will continue gaining share in a very large global market.

Detractors

  • S&P Global Inc. provides credit ratings, indices, data, and analytics to the financial and commodities markets. The company reported strong financial results due to continued growth in debt issuance. The stock declined on investor expectations that issuance will moderate next year due to tough comparisons. The company’s announced acquisition of IHS Markit received a mixed reaction, perhaps due to the size and complexity of the combined company. We continue to own the stock as we see a long runway for growth and significant competitive advantages for the company.
  • AstraZeneca PLC is a multinational pharmaceutical company developing drugs across multiple therapeutic areas such as oncology and respiratory diseases. Shares were impacted by news of AstraZeneca's joint development with Oxford University of a viral-based COVID-19 vaccine. Given a mixed data set due to an unforeseen error in dosing that occurred in the Brazilian market, the vaccine timelines slipped, hurting share performance. Our investment thesis on AstraZeneca is not dependent on COVID-19 but rather its best-in-class large-cap growth profile, and we retain conviction.
  • Fidelity National Information Services, Inc. provides software to financial institutions and enables merchants to accept electronic payments. The stock detracted due to pandemic-related revenue headwinds, as declines in travel and spending activity led to lower transaction volumes.  Management believes these headwinds are temporary and expects growth to accelerate next year. We continue to own the stock because we expect earnings growth to quickly return to a mid-teens rate.

Quarterly Attribution Analysis (Institutional Shares)

as of 12/31/20

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 12/31/20

Baron Durable Advantage Fund (Institutional Shares) appreciated 7.62% in the fourth quarter, yet trailed the S&P 500 Index by 453 basis points due to stock selection and, to a lesser extent, cash exposure in a market rally.

Outperformance of Consumer Staples and Industrials investments and lack of exposure to the lagging Consumer Discretionary and Utilities sectors added the most value. Strength in Consumer Staples came from alcoholic beverages producer Constellation Brands, Inc. and prestige beauty products manufacturer The Estee Lauder Companies Inc. Favorable stock selection in Industrials, related to the outperformance of aerospace and industrial company HEICO Corporation, was mostly offset by lower exposure to this better performing sector. HEICO’s shares increased on market optimism around several vaccines for COVID-19 that could eventually allow a return to normal travel levels, which, in turn, would benefit the company's commercial aerospace business.

Aside from cash, investments in Financials, Health Care, Information Technology (IT), and Communication Services and lack exposure to the Energy sector, which was up sharply alongside the price of oil, weighed the most on relative results. Stock specific weakness in Financials, coming from credit rating agencies S&P Global Inc. and Moody's Corporation, was somewhat offset by higher exposure to this strong performing sector. Despite reporting solid financial results, these companies were hurt by investor expectations that debt issuance will moderate next year due to tough comparisons. Within Health Care, underperformance of pharmaceutical company AstraZeneca PLC and greater exposure to this lagging sector hampered relative results. AstraZeneca was the second largest detractor given a setback in the company’s vaccine timeline. Science and technology innovator Danaher Corporation and life sciences tools provider Thermo Fisher Scientific Inc. also failed to keep pace with the broader market after meaningfully outperforming in the early stages of the COVID-19 pandemic. Weakness in IT was mainly due to the underperformance of Fidelity National Information Services, Inc., which provides software to financial institutions and enables merchants to accept electronic payments. Fidelity National was the third largest detractor due to pandemic-related revenue headwinds as declines in travel and spending activity led to lower transaction volumes. Management believes these headwinds are temporary and expects growth to accelerate next year. Performance in the sector was also hindered by computer software company Adobe Inc. and global payment networks Mastercard Incorporated and Visa, Inc. Within Communication Services, underperformance of social network Facebook, Inc. and cable operator Charter Communications, Inc. detracted the most from relative results. These companies underperformed as investors rotated into stocks that were considered to be COVID-19 recovery beneficiaries during the quarter.

as of 12/31/20

Yearly Attribution Analysis (for year ended 12/31/2020)

Baron Durable Advantage Fund (Institutional Shares) was up 20.32% for the year, outperforming the S&P 500 Index by 192 basis points due to favorable stock selection and tailwinds from style biases.

Outperformance of investments in Financials, Health Care, Industrials, and Real Estate and lack of exposure to the declining Energy sector contributed the most to relative results. Financials holdings outperformed after appreciating more than 25% as a group, with investment decision support tools provider MSCI, Inc. leading the way. MSCI’s stock price increased in response to solid earnings throughout the year despite the challenging COVID-19 backdrop as management was able to effectively manage costs. MSCI's asset-based fee revenue also positively contributed during the back half of the year due to strong market conditions and inflows. Strength in the sector also came from credit rating agencies S&P Global Inc. and Moody's Corporation, whose shares outperformed as falling interest rates and stimulus measures from the Federal Reserve drove strong corporate bond issuance. Non-financial investment grade issuance hit a record by a wide margin after more than doubling in the period, and high yield issuance was also meaningfully higher. Favorable stock selection in Health Care was driven by science and technology innovator Danaher Corporation and life sciences tools supplier Thermo Fisher Scientific Inc. These companies reported strong financial results throughout the year, driven in part by tailwinds from COVID-19-related products and services. Weighting instruments manufacturer Mettler-Toledo International, Inc. also performed well due to the company's solid execution in the face of challenging end market conditions. Mettler was able to grow revenue and earnings at rates that exceeded investor expectations. Performance in the Industrials and Real Estate sectors was bolstered by critical information provider IHS Markit Ltd. and data center REIT Equinix, Inc., respectively. IHS’s shares increased as news of effective COVID-19 vaccines drove greater optimism for improvement in the company’s end markets. The stock also benefited from the early December announcement that S&P Global plans to acquire IHS. Equinix’s share price benefited from robust quarterly bookings, accelerating cloud adoption trends, and continued execution on strategic M&A transactions to enhance its moat.

Cash exposure in an up market, investments in IT, and minimal exposure to the outperforming Consumer Discretionary sector detracted the most from relative results. Weakness in IT was partly due to the underperformance of payment processing software and services provider Fidelity National Information Services, Inc. Minimal exposure to Apple, Inc., the largest position in the index whose shares were up 82.3% in the period, also weighed on relative results.

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.