Review and Outlook

as of 09/30/22

Although the U.S. equity market stabilized somewhat in the three-month period, 2022 continued to prove to be a challenging year. Sticky inflation data, the expectation of more rate hikes, slowing growth, and the potential for a recession weighed heavily on investor sentiment, and the September quarter ended close to 2022 lows.

U.S. economic signals were mixed. Despite two consecutive quarters of negative GDP growth and near-record lows in consumer confidence, the labor market continued to show unusual strength, and household and company balance sheets overall remained healthy. Inflation stayed stubbornly high, driven by a spike in energy costs, lingering global supply-chain issues, pent-up demand as economies re-opened, and payroll and wage increases as businesses rushed to staff up to meet demand. That said, the Fed’s tighter monetary policy appears to be slowly cooling down some parts of the economy – in particular, the housing market. A concern now is that the Fed will overcorrect and spark a recession. We are starting to see some businesses taking steps in preparation for tougher times ahead, reducing budgets for non-essential functions, shelving technology upgrades, and making other cutbacks.

Baron Focused Growth Fund increased in the quarter. Consumer Discretionary, Communication Services, and Financials investments contributed to performance. Health Care, Information Technology (IT), and Industrials holdings detracted the most. Top contributor Tesla, Inc. led positive returns within Consumer Discretionary. Hyatt Hotels Corp. was another notable contributor within the sector after shares of this global hotelier increased on strong revenue-per-available-room results as business travel continued to recover from pandemic lows. Third largest contributor Iridium Communications Inc. drove gains within Communication Services. Financials benefited from share price increases in financial information and analytics provider FactSet Research Systems, Inc. and investment decision support tools provider MSCI, Inc. Both holdings within Health Care declined, including second largest detractor Figs Inc. Third largest detractor Guidewire Software, Inc. led weakness within IT. Top detractor Space Exploration Technologies Corp. drove declines within the Industrials sector.

As long-term investors who have lived through multiple bear markets, downturns, and even recessions, 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 more compelling valuations should result in attractive returns over time.

Top Contributors/Detractors to Performance

as of 09/30/22

Contributors

  • Tesla, Inc. manufactures electric vehicles (EVs), related software offerings, solar and energy storage products, and battery cells. Shares rose on increased production volumes from Tesla's global factories, new full self-driving functionality, manufacturing techniques that improve quality and reduce costs, and industry-leading margins despite complex COVID-related shutdowns. A new federal tax incentive program should also provide material benefits for Tesla's differentiation, margins, and demand. We remain investors in this uniquely innovative company leading the EV revolution.
  • Shares of real estate data and marketing platform CoStar Group, Inc. contributed to performance on strong financial results and its addition to the S&P 500 Index. We believe the company is well positioned to benefit from the continuing migration of real estate market spend to online channels. CoStar is investing aggressively to build out its residential marketing platform, which will launch later in 2022 and offers significant upside potential, in our view. CoStar has over $4.7 billion of cash on its balance sheet, which we expect it to begin to deploy for opportunistic M&A.
  • Shares of Iridium Communications Inc., a leading satellite-based mobile voice and data communications services vendor, rose on increased expectations for smartphone compatibility after it announced a related development agreement and other market participants announced similar capabilities. In addition, Iridium reported record quarterly results showing an acceleration of revenue growth with strong profitability. Lastly, growth initiatives continue to mature including Aireon, an award from the Space Development Agency, and increasing speeds for its Certus offering.

Detractors

  • Space Exploration Technologies Corp. (SpaceX) is a high-profile private company founded by Elon Musk that designs, manufactures, and launches rockets, satellites, and spacecrafts. Its ultimate goal is to make humanity multi-planetary. Products include reusable orbital launch offering and a broadband service leveraging its satellite constellation, Starlink. We value SpaceX using prices of recent financing transactions and a proprietary valuation model.
  • Figs Inc. is the largest direct-to-consumer platform in health care apparel. While the company reported quarterly results that beat consensus and reaffirmed its outlook for the rest of the year, shares fell due to market-related weakness in late September. Despite macroeconomic uncertainty, we believe Figs will be more resilient than other apparel categories as its products are largely non-discretionary and replenishment-driven. We also believe Figs can continue to expand its customer base due to its superior product offering.
  • Shares of P&C insurance software vendor Guidewire Software, Inc. detracted from performance due to broader multiple compression in high-growth stocks. We remain shareholders. Guidewire has crossed the midpoint of its cloud transition, which should correspond with improving financial results. Guidewire has tripled its potential market through new products and cloud delivery. Over time, we think Guidewire will be the key software vendor for the global P&C insurance industry, with 30% to 50% of its $15 billion to $30 billion total addressable market and margins above 40%. 

Quarterly Attribution Analysis (Institutional Shares)

as of 09/30/22

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 09/30/22

Baron Focused Growth Fund (Institutional Shares) was up 2.18% in the third quarter, outperforming the Russell 2500 Growth Index by 230 basis points due to stock selection and, to a lesser extent, cash exposure in a difficult market environment.

Aside from cash, investments in Consumer Discretionary, Communication Services, and Financials together with limited exposure to the lagging Materials and Real Estate sectors added the most value. Favorable stock selection in Consumer Discretionary was responsible for the bulk of the outperformance in the period, with most of the strength coming from electric vehicle manufacturer Tesla, Inc. Tesla was the top contributor due to increased production volumes from the company’s global factories, new full self-driving functionality, manufacturing techniques that improve quality and reduce costs, and industry-leading margins despite complex COVID-related shutdowns. Global hotelier Hyatt Hotels Corp. also performed well in the sector due to strong revenue-per-available-room results as business travel continued to recover from pandemic lows. While leisure rates dropped a little in the seasonally slower back-to-school period, this decline was expected and was more than offset by increases in business transient and group bookings. Positive stock selection in Communication Services, related to the outperformance of satellite communications company Iridium Communications Inc., was somewhat offset by the Fund’s higher exposure to this poor performing sector. Iridium was the third largest contributor as expectations for smartphone compatibility increased after the company announced a related development agreement and other market participants revealed similar capabilities. Additionally, the company reported record quarterly results, featuring accelerating revenue growth and strong profitability. Performance in Financials was bolstered by financial data providers FactSet Research Systems, Inc. and MSCI, Inc. FactSet continued to fare quite well in the quarter, with the company’s earnings demonstrating strong revenue growth. Similarly, MSCI’s earnings impressed and the underlying business continued to perform well despite broad market weakness, which has hurt the company's asset-based fee revenue.

Investments in Health Care and Industrials detracted the most from relative performance. Within Health Care, lower exposure to strong performing biotechnology stocks coupled with the underperformance of direct-to-consumer health care apparel platform Figs Inc. weighed heavily on performance. Figs was the second largest detractor despite reporting solid quarterly results and reaffirming full-year guidance as the company’s shares participated in the broad market sell-off in late September. Weakness in Industrials came from private rocket and spacecraft manufacturer Space Exploration Technologies Corp., whose shares are valued using prices of recent transactions and a proprietary valuation model.

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.