Review and Outlook

as of 12/31/20

In the fourth quarter of 2020, equity markets marched higher, continuing their rally of the prior two quarters. Markets looked past an alarming spike in the number of COVID-19 cases and instead focused on positive news around vaccines, the U.S. election results, and continued monetary and renewed fiscal stimulus. Small stocks rallied in the quarter, and while growth equities underperformed value stocks, growth was still ahead by a wide margin for the year.

Baron Discovery Fund increased in the fourth quarter. Health Care, Industrials, and Information Technology (IT) investments contributed the most. No sector detracted. Performance within Health Care was led by top contributor Pacific Bioscience of California, Inc., whose share price surged by nearly 162%, and second largest contributor CareDx, Inc., with another impressive share price gain of more than 91%. With double- or triple-digit increases across all 12 of the portfolio's Industrials holdings, this sector had a strong quarter as well. Advances were led by third largest contributor TPI Composites, Inc. IT gained ground on overall strong performance in the portfolio's holdings within the sector, led by Allegro Microsystems, Inc. and PAR Technology Corporation. Shares of Allegro, a fabless designer and manufacturer of sensor integrated circuits (ICs) and application-specific analog power ICs for automotive and industrial markets, rose after its IPO in the quarter, driven by investor expectations of improved near-term earnings due to a recovery in automotive end markets that beat market forecasts. Shares of PAR Technology, a leading provider of software, systems, and service solutions to the restaurant industry, rose during the quarter as pandemic-driven restaurant investment in technology built business momentum. An equity raise also signaled that an acquisition might be close.

While markets have moved substantially in the past three quarters, we have consistently risk-managed the portfolio as part of our process to ensure that we are matching our enthusiasm about the business prospects of our holdings with their valuations. To the extent we sell or trim positions, we believe we still have terrific new ideas flowing into the portfolio. With the massive amount of capital markets activity we are seeing (including IPOs, secondary offerings, and SPAC mergers) we believe we have some exciting new opportunities on tap for 2021.

Top Contributors/Detractors to Performance

as of 12/31/20

Contributors

  • Pacific Biosciences of California, Inc. (PacBio) provides long-read DNA sequencing systems to help scientists conduct genetic analysis. Shares performed well for the quarter. We believe there is increasing excitement about the potential for its platform as it lowers sequencing costs and seeks to move beyond its current commercial niche. Recently appointed CEO Christian Henry previously served as CFO and Chief Commercial Officer at Illumina, Inc., and we think he is well-qualified to commercially execute on PacBio’s differentiated long-read platform.  
  • CareDx, Inc. is the market leader in transplant diagnostics, with a presence in nearly all U.S. and EU centers. Shares were up sharply in the fourth quarter as the company continued to successfully execute on its growth strategy. CareDX reported roughly $128 million in kidney testing revenue in 2020, up about 72% year-over-year. Despite this impressive growth rate, we estimate CareDX is only mid-teens penetrated into the $2 billion kidney opportunity and has additional testing opportunities worth over $5 billion in incremental total addressable market.
  • Shares of TPI Composites, Inc., the only global independent wind turbine blade manufacturer, rose during the quarter. Global stimulus and an upcoming regime change in the U.S. have revived optimism for the renewable energy industry. The company also reported strong quarterly earnings and hinted that it plans to boost its long-term targets based on the more favorable industry outlook. On top of the strength in the wind industry, we believe the company will continue building out its transportation business for additional upside.

Detractors

  • Shares of Vital Farms, Inc., a producer of pasture-raised butter and eggs, fell during the quarter after reaching post-IPO highs in the prior quarter. While financial results beat consensus, investors shifted near-term focus to more immediate potential beneficiaries of the COVID-19 vaccine. Longer term, we expect Vital Farms to gain from increased consumer focus on better-for-you and better-for-the-environment products and to grow its platform through category expansion and distribution gains in natural and traditional grocery stores.
  • Esperion Therapeutics, Inc. is a biotechnology company commercializing a novel cholesterol-lowering therapeutic. Shares detracted due to a tepid set of early launch sales metrics. While this is somewhat explainable due to the nature of launching a primary care drug during a pandemic, the market has adopted a wait-and-see mindset, making it impossible to gauge the success of the drug launch until 2021/2022 in a more normalized environment. For these reasons, we maintain conviction in Esperion.  
  • Emergent BioSolutions Inc. is a pharmaceutical company that provides vaccines and post-exposure treatments for extreme pathogens. In the third quarter, Emergent was awarded contracts from four drug companies (J&J, Novavax, Vaxart, and AstraZeneca) and the U.S. government to help develop and provide volume production of COVID-19 vaccines.  News in the fourth quarter that the FDA approved two rival vaccines pressured shares. We still believe Emergent’s partners are on track for FDA approvals and the company will benefit for years from COVID-19 and other development programs.

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 Discovery Fund (Institutional Shares) increased 25.54% in the fourth quarter, yet trailed the Russell 2000 Growth Index by 407 basis points, primarily due to stock selection and cash exposure in a sharp up market. The Fund’s overexposure to size, momentum, and growth were also headwinds to relative performance as these factors were out of favor during the quarter.

Investments in Industrials contributed the most to relative results, driven by sharp gains from wind turbine blade manufacturer TPI Composites, Inc. and solar tracking solutions maker Array Technologies, Inc. TPI was the third largest contributor after the company reported strong quarterly earnings and hinted at plans to boost long-term targets based on a more favorable industry outlook. Array’s shares nearly doubled following the company’s successful IPO in mid-October. The company’s solar trackers allow for more energy generation at moderate incremental cost. We remain excited about the opportunity due to Array's patented technology, its ability to convert and penetrate the international market, and the overall growth of the solar energy industry.

Apart from cash, stock selection was negative across most sectors, led by investments in Consumer Staples, Health Care, Real Estate, Information Technology (IT), and Financials. Weakness in Consumer Staples was largely due to the underperformance of ethical food company Vital Farms, Inc., which specializes in pasture raised eggs and butter. Vital was the top detractor on an absolute basis after reaching post-IPO highs in the prior quarter. While financial results beat consensus, Vital’s shares sold off as investors shifted their near-term focus to more immediate potential beneficiaries of the COVID-19 vaccine. Health Care holdings were up more than 29% as a group, yet failed to keep pace with their counterparts in the index due to share price declines from Silk Road Medical, Inc., Esperion Therapeutics, Inc., Emergent BioSolutions Inc., and Axonics Modulation Technologies, Inc., among others. We maintain conviction in all these names. Performance in Real Estate was hindered by REITs Americold Realty Trust and Rexford Industrial Realty, Inc. as investors rotated away from businesses with defense characteristics into more cyclical companies. Several software companies weighed on performance in the IT sector, led by Ping Identity Corporation, Dynatrace Holdings LLC, and Everbridge, Inc. These companies saw their share prices trail the broader market after meaningfully outperforming in the early stages of the COVID-19 pandemic. Negative stock selection in Financials came from specialty insurer Kinsale Capital Group, Inc., whose shares underperformed following a strong run of performance. Despite reporting strong premium growth of 48% in its latest quarter, Kinsale’s financial results fell short of Street expectations due to unusually high natural catastrophe losses.

as of 12/31/20

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

Baron Discovery Fund (Institutional Shares) rallied 66.13% for the year, significantly outperforming the Russell 2000 Growth Index by 31.50% due to stock selection and an assortment of style biases.

Outperformance of investments in Industrials, IT, Consumer Discretionary, and Financials added the most value. Stock selection in Industrials accounted for a quarter of the outperformance in the period, driven by triple-digit gains from wind turbine blade manufacturer TPI Composites, Inc. and digital printing solutions company Kornit Digital Ltd. TPI’s stock price was up in response to outstanding financial results and renewed optimism for the renewable energy industry brought on by the results of the latest U.S. election. Kornit’s shares benefited from the pandemic-driven digitization of a legacy textile industry. Wholesale landscape supplies distributor SiteOne Landscape Supply, Inc., composite residential decking manufacturer Trex Company, Inc., and environmental solutions company Montrose Environmental Group, Inc. also performed well in the sector. Strength in IT was broad based, led by sharp gains from hospitality solutions provider PAR Technology Corporation and construction modeling software company RIB Software SE. PAR’s stock price rose as the pandemic caused restaurants to increasingly invest in technology, while RIB’s shares outperformed for the period held after the company received an acquisition offer from Schneider Electric. Higher exposure to systems software stocks, which were up nearly 70% in the index, and outperformance of Repay Holdings Corporation, Nova Measuring Instruments Ltd., and Varonis Systems, Inc. also added value. Consumer Discretionary investments outperformed after increasing nearly 79% as a group, with regional casino company Penn National Gaming, Inc., hard-surface flooring retailer Floor & Decor Holdings, Inc., and online gambling platform DraftKings, Inc. leading the way. Penn’s revenues quickly rebounded at its recently opened properties and betting activity was strong following the launch of the Barstool Sportsbook app. Floor & Decor’s financial results and business outlook benefited from accelerating home improvement spending during the summer months, while DraftKings experienced strong traffic and wagering on its site and announced an exclusive collaboration with ESPN. Within Financials, the Fund’s sizeable position in specialty insurer Kinsale Capital Group, Inc. added value. Kinsale was the second largest contributor after reporting strong quarterly financial results, with premium growth in excess of 40% in each of the first three quarters of the year and an improvement in the core underwriting margin. Industry conditions remain favorable and the company is meaningfully raising rates, which we believe should lead to continued strong earnings growth over time.

Cash exposure in a rising market and higher exposure to the lagging Real Estate sector were the only material detractors from relative performance.

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.