Review and Outlook

as of 03/31/24

The bull market that started at the end of October of 2023 kept running throughout the first quarter of 2024. Even the renewed threat of "higher for longer" interest rates did not put a check on equity performance. Investors entered the new year optimistic that a soft landing was in store for the economy, in which a recession would be avoided, inflation would continue to dissipate, and the Fed would start cutting interest rates in March. The economy has not only avoided recession but has been stronger than market forecasts. Meanwhile, inflation has again turned sticky, and Fed rate cuts have been delayed to at least June.

Economic data was slightly mixed during the quarter. Strong growth in the U.S. labor supply, driven by increased labor force participation and a surge in immigration, supported job gains without higher inflation. The U.S. unemployment rate, though still low, rose slightly to 3.8%. The S&P Global US Services PMI, an index of the prevailing direction of economic trends in the U.S. service sector, pulled back modestly. Existing home sales jumped 9.5% in February 2024, the highest percentage increase in a year and above consensus expectations. At a 3.2% annualized rate, U.S. inflation, although it has yet to decline to the Fed’s stated 2% preferred level, is significantly less than the June 2022 peak of more than 9%. Looking ahead, a more normalized supply chain and moderating wage growth bode well for a continued slow decline in inflation.

Baron Focused Growth Fund increased in the quarter. Financials, Communication Services, and Real Estate holdings contributed the most. Investments within Consumer Discretionary, Health Care, and Industrials detracted. Second largest contributor Arch Capital Group Ltd. led gains within Financials. Top contributor Spotify Technology S.A. drove positive performance within Communication Services. Gains within Real Estate were attributable to CoStar Group, Inc. Shares of this provider of marketing and analytics to the real estate industry increased on strong quarterly and year-end results, including 2023 revenue of $2.46 billion, a 13% year-over-year increase, and above-consensus estimates. Top detractor Tesla, Inc. and second largest detractor FIGS, Inc. drove declines within Consumer Discretionary. All three holdings within Health Care declined. A modest decline in the share price of Verisk Analytics Inc. accounted for weakness within Industrials. 

While we are encouraged by recent signs of recovery in the markets and the U.S. economy, 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 03/31/24

Contributors

  • Spotify Technology S.A. is a leading global digital music service, offering on-demand audio streaming through paid premium subscriptions and an ad-supported model. Shares of Spotify were up on operating margins and subscriber adds that exceeded consensus expectations. Spotify is currently prioritizing profitability, with its largest round of layoffs to date and enhanced attention to operating efficiency. We think gross margins should improve meaningfully, driven by contributions from the artist promotions marketplace, the expanding advertising segment, and the increasing profitability of podcasts. The company remains focused on its product roadmap and user value proposition by, for example, providing U.S. premium subscribers free access to 15 hours of audiobook listening time in a bid to increase its audience. We view Spotify as a long-term winner in music streaming with potential to reach more than one billion monthly active users.
  • Specialty insurer Arch Capital Group Ltd. contributed to performance after reporting strong financial results that exceeded Street expectations. In the most recent reported quarter, operating ROE was 24% and book value per share rose 44% as underwriting profitability remained excellent. Pricing trends in the P&C insurance market are favorable, and elevated interest rates are driving higher investment income. Insurance stocks broadly rebounded from weakness in the prior quarter as rates stabilized. We continue to own the stock due to Arch’s strong management team and our expectation of significant growth in earnings and book value.

Detractors

  • Tesla, Inc. designs, manufactures, and sells electric vehicles, related software and components, and solar and energy storage products. Shares fell as the core automotive segment remained under pressure due to a complex macroeconomic environment, factory shutdowns, growing competitive risks in China, and Tesla’s price reductions throughout 2023. During the first quarter of 2024, production was negatively impacted by Red Sea maritime supply chain interferences, sabotage at a Tesla factory power supply in Berlin, and the launch of the refreshed Model 3. We remain shareholders. Tesla has started delivery of its highly anticipated Cybertruck pickup, which features new technologies within the car and its manufacturing lines. Tesla also launched version 12 of its Full Self Driving product, which features material improvements and should enhance investor confidence in Tesla's unique software and hardware capabilities. Lastly, we expect energy storage sales to continue to grow over the coming years.
  • FIGS, Inc. is a direct-to-consumer health care apparel company. Shares detracted during the quarter due to disappointing guidance for 2024. FIGS expects revenue to be pressured due to macroeconomic weakness impacting its core customer base as well as industry-specific issues impacting the health care space. We retain our long-term conviction. We believe that FIGS' direct-to-consumer, higher quality, and more innovative product offerings vs. those of competitors provide a durable competitive advantage that will allow it to gain market share. We also believe that FIGS has a long growth runway internationally and are encouraged by the possibility of brick-and-mortar retail stores to complement its e-commerce business.
  • Iridium Communications Inc. is a mobile voice and data communications services vendor offering global coverage via satellite, Shares fell during the quarter. In November 2023, Qualcomm unexpectedly terminated an agreement with Iridium to enable direct-to-device (D2D) workloads on Iridium's network. The decision shook investors' confidence in Iridium's D2D opportunity. In addition, SpaceX generated limited headwinds to Iridium's maritime segment, enhancing competitive risk. We retain conviction. Iridium remains a unique satellite asset and operator, with L-band spectrum, global coverage, 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 returns to shareholders between 2023 and 2030, representing a material portion of the current enterprise 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.