Review and Outlook

as of 09/30/22

After a brief summer rally, global equities reversed course, and the quarter ended near 2022 lows. In our view, this renewed risk-off behavior was a reaction to the rising likelihood the Federal Reserve will over-tighten and spark a recession. After failing to be data-dependent in the post-COVID recovery period and keeping rates too low for too long, the Fed abruptly hiked rates, focusing squarely on the rear-view mirror as inflation reports are notoriously a lagging indicator. The market’s lack of confidence in the Fed exacerbated the retreat in equities as well as relentless U.S. dollar strength.

Fiscal tightening can take time to impact the real economy; however, it often has a more immediate impact on the financial economy. The spectacular decline of the British pound, stress on British long-duration investment pools, scrutiny around Credit Suisse Group AG, and accelerated U.S. dollar appreciation and real interest rates are signals we have entered a high-risk zone, and without a more flexible Fed, contagion is increasingly likely. In financial markets, bad news can be “good news,” as we believe this high-risk zone can now act as a constraint on the Fed. Thus, just as it appeared that the Fed was locked on course to a policy error, the markets’ discounting of this reality began to trigger financial instability, which suggests we are now likely at or near peak hawkishness. We are watching for a peak in the U.S. dollar, real interest rates, and sovereign bond yields for confirmation.

While the rate-hike cycle by the Fed and other central banks will impede economic growth and curtail corporate earnings overall, this tightening began much earlier in many emerging market jurisdictions while COVID-related stimulus was much more measured. As such, we believe the adjustment to both interest rates and earnings expectations is more advanced for such economies, and the inflation impulse is generally more measured. China, the largest EM economy by a wide margin, has already embarked on an easing campaign. If we are experiencing peak Fed hawkishness, then a coincident peak in the U.S. dollar should trigger improving relative performance of EM equities. We also believe that, after the conclusion of the Party Congress in mid-October, Chinese authorities will likely lay the groundwork for the emergence from “Zero COVID,” which has impaired economic activity while overwhelming China’s easing measures over the past year. As we look to 2023, we believe China stands out as the most likely prospect for earnings stabilization and recovery, which would support EM equities in a period of widespread global earnings weakness.

In the longer term, EM performance is a story of relative earnings growth and valuation, and we believe both are at trough levels given fundamental developments within EM economies and the global capital investment cycle needed to fund the new priorities of global security, de-globalization, and sustainability. In short, we believe now is a time to take a contrarian view of EM equities and consider allocating to this asset class.

Top Contributors/Detractors to Performance

as of 09/30/22

Contributors

  • Bajaj Finance Limited is a leading, data driven, non-bank financial company in India. Shares recouped prior losses driven by improving earnings visibility and growth prospects as Bajaj continued to scale its digital services platform. With its best-in-class management team and conservative risk management frameworks, we believe Bajaj is well positioned to benefit from growing demand for consumer financial services such as mortgages and personal and credit card loans.
  • Coupang, Inc., the largest e-commerce platform in South Korea, contributed after reporting a sizable beat on second quarter earnings and raising annual EBITDA guidance. Upside was concentrated in ecommerce, where Coupang is now driving sequential margin expansion while maintaining a growth rate that is triple that of the industry average, lending credence to the investment case that Coupang will consolidate the fragmented ecommerce industry in Korea across both general merchandise and grocery, with healthy long-term margins to follow.
  • Bharti Airtel Limited contributed during the quarter driven by steady earnings performance and Bharti's completion of 5G spectrum auctions that should lead to additional market share gains. As India's dominant mobile operator, the company is benefiting from ongoing industry consolidation. In particular, Vodafone Idea, a key player and competitor, is on the verge of bankruptcy amid severe pricing pressure and an unsustainable balance sheet. We retain conviction as Bharti transforms into a digital services company and benefits from rising mobile tariffs.

Detractors

  • Alibaba Group Holding Limited is the largest retailer and e-commerce company in China. Alibaba operates shopping platforms Taobao and Tmall and owns 33% of Ant Group, which operates Alipay, China's largest third-party online payment provider. Shares of Alibaba declined this quarter given macro weakness across the company's business units. Longer term, we retain conviction that Alibaba will benefit from an improving macro environment and the ongoing growth in online commerce in China.
  • Tencent Holdings Limited operates the leading social network and messaging platforms (QQ, WeChat), the largest online entertainment and media business, and the largest online gaming business in China. Shares of Tencent were down this quarter given broader macro concerns as well as potential weakness in gaming. Despite the near-term uncertainty, we retain conviction that Tencent can sustain durable growth given its track record of execution, scale, and unique and diversified online assets.

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.