Review and Outlook

as of 12/31/23

Following a three-month down turn, the markets went on a bull run in the last two months of the year. Improving inflation data coupled with dovish comments from the Federal Reserve spurred an “everything rally.” In a significant shift from its earlier stance, the Fed suggested it was planning three interest rates cuts over 2024. The end of “higher for longer” rate fears especially boosted growth and small-cap stocks, as the market views these categories as beneficiaries of lower rates. Despite low unemployment and robust consumer spending – typically viewed as inflation drivers -- inflation continued to trend lower, with the annual inflation rate dropping to 3.4% in December. Investor fears of a recession were replaced by optimism that the Fed had successfully orchestrated a “soft landing,” generating further cause for cheer on top of the prospect that the Fed would soon start cutting interest rates.

Baron Focused Growth Fund increased in the quarter. Holdings within Consumer Discretionary, Industrials, and Information Technology (IT) contributed the most to performance. No sector detracted. Consumer Discretionary had a strong quarter, with Hyatt Hotels Corporation and Red Rock Resorts, Inc., respectively, the second and third largest contributor, leading gains within the sector. Top contributor Space Exploration Technologies Corp. drove advances within Industrials. All three IT holdings posted positive returns, led by P&C insurance software vendor Guidewire Software, Inc. After a multi-year transition period, we think the company’s cloud transition is substantially complete and that cloud will be the sole path forward, with revenue benefiting from new customer wins and migrations of the existing customer base to InsuranceSuite Cloud. We believe Guidewire will become the critical software vendor for the global P&C insurance industry, capturing 30% to 50% of its $15 billion to $30 billion total addressable market and generating margins above 40%.

Looking ahead, we are encouraged by recent signs of recovery in the markets and the U.S. economy. However, as long-term investors who have lived through numerous market cycles, we have learned not to try to predict the unpredictable. Instead, we focus on identifying and researching well-managed unique businesses with durable competitive advantages and compelling growth prospects and investing in them at attractive prices. We think the combination of unchanged long-term growth outlooks and attractive valuations should result in strong returns over time.

Top Contributors/Detractors to Performance

as of 12/31/23

Contributors

  • Space Exploration Technologies Corp. (SpaceX), a high-profile private company founded by Elon Musk designs, manufactures, and launches rockets, and satellites. Shares contributed to performance in the wake of another record-breaking year. The company closed 2023 with a record 96 Falcon rocket launches, nearly twice a week on average, substantially more than the 61 launches in 2022 and surpassing all its private and government program peers. Starlink, SpaceX's satellite constellation, also achieved remarkable milestones, including operating over 5,500 satellites, the majority of active satellites in space, and now providing connectivity services to 2.3 million active customers, more than doubling its customer base during the year. Starship, SpaceX's groundbreaking new rocket, successfully performed its second test flight this quarter. Over time, SpaceX expects Starship to both reduce costs and expand SpaceX's operational capabilities, including supporting SpaceX's long-term goal to enable human beings to inhabit Mars. We value SpaceX using a proprietary valuation model and recent financing transactions, which trended positively even through a more complex funding environment.
  • Shares of global hotelier Hyatt Hotels Corporation increased in the quarter. The company reported strong demand across its portfolio, led by robust leisure travel and improvement in its business transient and group business that is now pacing above pre-COVID levels. Room rate increases are generating solid margins and cash flow. In our view, Hyatt's sound, underleveraged balance sheet keeps it well positioned should we enter a possible downturn in 2024. The hotel transaction market is improving, and the company has two properties for sale that should close in early 2024, resulting in an attractive business model in which more than 80% of revenue will be generated from fees with the remainder from owned assets. We also believe the transactions should help boost the stock's multiple over time.
  • Shares of Red Rock Resorts, Inc., a casino operator in the Las Vegas Locals market, increased on the opening of its new Durango casino in early December. The company reported strong initial visitation and spend levels without cannibalization at its other properties. Red Rock expects the casino to generate profits from its first day of operation and projects a 20% return on its $800 million investment by 2026. The company has 300 acres of gaming-entitled land in the Las Vegas Locals market to develop and expects to double its current EBITDA levels by the end of the decade while funding all new developments internally with cash flow. We believe its stock remains attractively valued at current levels.

Detractors

  • Shares of timeshare company Marriott Vacations Worldwide Corporation fell in the quarter, driven by soft sales of timeshare units due to higher interest rates and the slow ramp of a new product offering. A default rate that was higher than the company had anticipated forced it to take a charge to increase its reserves, pressuring earnings and cash flow. We remain investors. The company has a strong balance sheet with a well-covered 3% dividend. It continues to use cash flow to buy back its shares, and management has personally bought stock at much higher levels than current prices.
  • Iridium Communications Inc. is a mobile voice and data communications services vendor offering global coverage via satellite. In 2022, Iridium announced an agreement with Qualcomm to incorporate Iridium's technology into Qualcomm's Snapdragon chip, allowing devices to seamlessly connect to both cellular and satellite networks. In a surprise turn of events, Qualcomm backed out of the partnership in November 2023. The decision shook investors' confidence in Iridium's direct-to-device opportunity. We retain conviction. Iridium remains a unique satellite owner and operator, with L-band spectrum, years of operational experience, relatively new satellite hardware, and hundreds of partners across verticals and geographies. In addition, management announced a commitment of $3 billion in return to shareholders between 2023 and 2030, representing a material portion of the current enterprise value.
  • Shares of specialty insurer Arch Capital Group Ltd. gave up some gains in the fourth quarter after solid performance for most of the year. We believe the share price weakness was primarily due to a sector rotation away from defensive stocks to more speculative stocks following a decline in interest rates. Company fundamentals remained strong, with net premiums written growing 23%, operating ROE expanding to 25%, and book value per share rising 30% in the third quarter. Management expects favorable market conditions will persist. We continue to own the stock due to Arch’s experienced management team and our expectation of solid growth in earnings and book value.

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.