Review and Outlook

as of 12/31/23

Following a downdraft from the end of July through October, the markets went on a bull run in the last two months of 2023. 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 3.1% in November. 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. The FactSet Global FinTech Index returned 15.54% in the quarter.

Baron FinTech Fund increased in the fourth quarter. Financials, Information Technology (IT), and Consumer Discretionary holdings contributed the most. No sector detracted. Gains within Financials were led by third largest contributor S&P Global, Inc. Block, Inc. was another noteworthy performer within the sector. Shares of this mobile payment company rebounded after reporting healthy gross profit growth and profitability that beat Street estimates. We retain conviction due to Block’s long runway for growth, durable moat, and unique corporate culture. IT had a strong quarter, with top contributor Fair Isaac Corporation and second largest contributor Intuit Inc. within the sector. MercadoLibre, Inc. drove positive returns within Consumer Discretionary. Shares of Latin America's leading e-commerce company increased on quarterly results that beat Street expectations across the board. The company is generating above-market growth in gross merchandise value across its major markets and increasingly outperforming peers, particularly in Brazil.

While we are certainly aware of the macroeconomic environment, we do not invest based on predictions of GDP growth, inflation, interest rates, or foreign currencies. We take an agnostic approach to short-term market and economic forecasts because nobody really knows. We do know economies tend to grow and equity markets tend to appreciate over time. We also know fintech includes a plethora of companies with long runways for growth and durable competitive advantages that we expect will outperform the broader equity market over the long run.

We have curated a diversified portfolio of fintech businesses to reduce exposure to any single economic outcome. The portfolio is balanced across seven themes, each of which is influenced by idiosyncratic factors. We include a mix of Leaders and Challengers, with the relative mix driven by top-down risk considerations and bottom-up opportunities. We believe fintech remains in the early innings of growth, as incumbent financial institutions still have a long digitization journey ahead and younger consumers continue favoring digital solutions.

Top Contributors/Detractors to Performance

as of 12/31/23

Contributors

  • Shares of Fair Isaac Corporation (FICO), a data and analytics company focused on predicting consumer behavior, contributed to performance. The company reported good earnings results and gave preliminary guidance that looks quite conservative, especially since pricing initiatives in the Scores business remain on track. CEO Will Lansing expressed confidence that the business can perform relatively well across different economic backdrops and expressed optimism about the momentum in the software business. We retain conviction, as we believe FICO will be a steady earnings compounder, which should drive solid returns for the stock over a multi-year period.
  • Intuit Inc. is the leading provider of accounting software for small businesses and tax preparation software for individuals and tax professionals. Shares increased after the company reported quarterly financial results that exceeded Street expectations, with 15% revenue growth and 49% EPS growth. Intuit is benefiting from the sale of higher-value services and is well positioned to capitalize on increasing adoption of artificial intelligence given its vast data sets. The company recently launched Intuit Assist, a generative AI-powered digital assistant that improves productivity and unlocks valuable insights for customers. We continue to own the stock due to Intuit’s strong competitive position and numerous growth opportunities.
  • Shares of rating agency and data provider S&P Global Inc. increased due to higher debt issuance amid more favorable market conditions. Billed issuance rose 47% in October and 26% in November against subdued levels last year, with issuance likely boosted by the decline in yields and tightening of corporate bond spreads. Strong equity market performance in the fourth quarter benefited asset-based fees. In addition, the company reported strong quarterly financial results with double-digit growth in revenue and earnings and raised full-year earnings guidance. We continue to own the stock due to the company's long runway for growth and significant competitive advantages.

Detractors

  • Shares of specialty insurer Kinsale Capital Group, Inc. gave back some gains from earlier this year after the company reported slower premium growth in the third quarter. Earnings beat Street expectations, with EPS doubling and ROE exceeding 34%. However, investors focused on the slowdown in gross written premiums to 33% growth from 58% growth in the prior quarter, which management attributed to normal seasonality for property insurance. Additionally, we believe some of the share price weakness resulted from a sector rotation away from defensive stocks to more speculative stocks following a decline in interest rates. We continue to own the stock because we believe Kinsale is well managed and has a long runway for growth in an attractive segment of the insurance market.
  • TransUnion is a consumer credit bureau that helps businesses make lending and marketing decisions. Shares fell after the company reported quarterly financial results that were below consensus expectations and reduced full-year guidance. Lending and marketing activity softened during the quarter, particularly among smaller, subprime lenders. Management believes the new financial guidance is highly achievable and is increasingly focused on cost efficiency to improve margins. We continue to own the stock because we expect earnings growth to improve as cyclical headwinds abate and the company integrates recent acquisitions.
  • BILL Holdings, Inc., a leading provider of cloud-based software that simplifies, digitizes, and automates complex back-office financial operations, detracted from performance. The company recently reported solid quarterly earnings reports, but the stock fell due to a forward guidance outlook that missed consensus. Macro-related pressure on small-to-medium sized businesses (SMB) is leading to softer total payment volume per customer. In addition, there is some pressure on the payments take-rate due to select larger suppliers reducing their threshold for accepting virtual cards and the strength of the U.S. dollar leading to its increased use to settle cross-border transactions. Despite the potential near-term headwinds, we retain conviction as the digitization of B2B payments is a powerful secular trend with a long runway for continued growth and BILL remains well positioned to be a winner in the SMB market, in our view.

Quarterly Attribution Analysis (Institutional Shares)

as of 12/31/23

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 12/31/23

Baron FinTech Fund (Institutional Shares) gained 13.85% in the fourth quarter, outperforming the broader market yet trailing the more comparable FactSet Global FinTech Index (the Benchmark).

The relative shortfall versus our principal Benchmark was due to disappointing stock selection in a few thematic buckets, namely Tech-Enabled Financials, Information Services, and Capital Markets, which overshadowed positive impacts from active thematic exposures. A portion of the weakness in Tech-Enabled Financials came from premier independent broker-dealer LPL Financial Holdings Inc. and alternative asset manager and insurance company Apollo Global Management, Inc., whose share prices were negatively impacted by the increased likelihood of interest rate cuts in 2024. When it comes to LPL, the company invests idle client cash in both floating and fixed rate contracts. Rate cuts could reduce LPL's revenue and earnings from its floating rate contracts. The company’s interest rate exposure has also made it a favored stock for short-term traders to gain exposure to higher interest rates. We believe some of the stock weakness was a result of these investors reducing their stake as rates look set to fall. On a long-term basis, LPL's execution continues to be strong as it gains share among advisors and wins large enterprise deals. For Apollo, a significant portion of the company’s fundraising is linked to fixed annuity and fixed indexed annuity flows, and some of its assets are invested in floating rate securities. As a result, Apollo has generally been a beneficiary of higher interest rates, as annuity flows have been strong due to higher available crediting rates, while yields from its asset portfolio have also risen with interest rates. In contrast, many of the company’s peers are more sensitive to private equity activity, which has been more muted as interest rates have risen. Hence, Apollo failed to participate in the recent market rally while many of its peers experienced significant share price appreciation. We remain positive on Apollo because of its dominant position in the private credit space coupled with the opportunity to continue raising significant assets under management from the life insurance market, where it is a market leader. Specialty insurers Arch Capital Group Ltd. and Kinsale Capital Group, Inc. also weighed on performance. We believe a portion of the share price weakness was attributable to a market rotation away from defensive stocks into more speculative securities following a decline in interest rates. Kinsale’s recent earnings report also pressured shares as investors focused on the slowdown in gross written premiums to 33% growth from 58% growth in the prior quarter, which management attributed to normal seasonality for property insurance. We remain optimistic about the prospects for both businesses.

Adverse stock selection in Information Services was partly due to disappointing performance from data and analytics vendor Verisk Analytics, Inc. and consumer credit bureau TransUnion. Despite reporting strong quarterly earnings, Verisk’s stock lagged due to investor concerns that revenue growth will normalize in 2024 following outsized growth in 2023. We maintain conviction in the competitive positioning, long-term growth, margin expansion, and capital deployment prospects for the business. TransUnion was the second largest detractor after the company reported quarterly financial results that were below consensus expectations and reduced full-year guidance. Lending and marketing activity softened during the quarter, particularly among smaller, subprime lenders. Management believes the new financial guidance is highly achievable and is increasingly focused on cost efficiency to improve margins. We continue to own the stock because we expect earnings growth to improve as cyclical headwinds abate and the company integrates recent acquisitions. A portion of the relative shortfall also had to do with what we didn’t own in the category, as there were several micro-cap stocks that were up in excess of 65% for the period, such as LendingTree, Inc., NerdWallet, Inc., Forge Global Holdings, Inc., and Opendoor Technologies Inc. We don’t consider these micro-cap companies to be investable.

Weak stock selection in Capital Markets, owing mostly to underperformance from automated global electronic broker Interactive Brokers Group, Inc and derivatives marketplace CME Group, Inc., was somewhat offset by the Fund’s higher exposure to this top performing category. Interactive Brokers was another holding that was impacted by investor belief that there would be additional interest rate cuts in 2024. The company generates a significant amount of its revenue from interest income on idle client brokerage deposits, which it typically invests in short-term U.S. treasury bills. Rate cuts would reduce earnings as these investments would be re-invested at lower spreads. Longer term, the company continues to grow client accounts at more than 20% year-over-year, creating a strong foundation for years of revenue and earnings growth, and underwriting solid returns in the stock even in the event that interest rates decline from current levels. CME’s average daily trading volume rose at a robust 17% pace during the quarter due to elevated volatility across interest rates and commodity prices. However, shares underperformed due to concerns that growth will slow as the Federal Reserve’s rate hike cycle comes to an end and volatility moderates. We continue to own the stock because we believe that CME enjoys significant competitive advantages and should benefit from increasing adoption of exchange-traded derivatives and episodic volatility spikes.

Partially offsetting the above was solid stock selection in Payments coupled with lower to this lagging category. Financial services and digital payments company Block, Inc. led the way in the category after the company’s shares rebounded following poor performance in the prior quarter. The company reported healthy 21% gross profit growth and profitability that beat Street estimates. Management emphasized a greater focus on efficiency and cost discipline, which should drive continued margin expansion. The company provided 2024 financial guidance that exceeded consensus and committed to a “Rule of 40” investment framework in 2026 with at least mid-teens gross profit growth and a mid-20% operating margin. We continue to own the stock due to Block’s long runway for growth, durable competitive advantages, and unique corporate culture.

Digital IT Services, E-Commerce, and Enterprise Software were the other areas worth mentioning, as strong performance from outsourced software development provider Endava plc, Latin American e-commerce company MercadoLibre, Inc., and accounting software vendor Intuit Inc. contributed most of the stock-specific gains in these categories. Endava’s shares followed through on last quarter’s positive momentum after lagging for most of 2022 and the first half of 2023. Macroeconomic uncertainty has weighed on client demand and revenue growth, but management expects a meaningful rebound early in 2024 supported by a growing pipeline of large projects from newer clients. Margins should expand alongside faster revenue growth as the company leverages upfront costs to build capacity in anticipation of an expected recovery. The company has been acquisitive and is benefiting from vendor consolidation. MercadoLibre was a top contributor after reporting third-quarter earnings that beat Street expectations across the board. The company is generating above-market growth in gross merchandise value across its major Latin American markets and is increasingly outperforming its peers in e-commerce, particularly in Brazil. Intuit’s stock also rose in response to quarterly financial results that exceeded Street expectations with 15% revenue growth and 49% EPS growth. The company is benefiting from the sale of higher-value services and is well positioned to capitalize on increasing adoption of artificial intelligence given its vast data sets.

as of 12/31/23

Yearly Attribution Analysis (for year ended 12/31/2023)

Baron FinTech Fund (Institutional Shares) was up 27.31% for the year, outperforming the broader market as well as the more comparable FactSet Global FinTech Index due to strong stock selection.

Payments accounted for the bulk of relative gains in the period due to a combination of stock selection and lower exposure to this lagging category. Strength came from Network International Holdings Plc, a leading payment processing company operating in the Middle East and Africa, and Fiserv, Inc., a leading global provider of payments and financial services technology solutions. Network’s shares spiked higher in April after the company received two takeover offers from private equity firms. Following a period of due diligence and negotiation, Network’s Board agreed in June to be acquired by Brookfield Asset Management for £4.00 per share, representing a 64% premium to the share price before takeover speculation began. Brookfield plans to combine Network’s operations with another Middle Eastern payment processor, Magnati, that it acquired last year to create a regional powerhouse. We exited our position after the share price rose close to the acquisition price. Fiserv’s stock rose in response to consistently strong financial results as the company handily outperformed other large merchant acquirers during the year. We think the company remains poised to deliver strong earnings growth led by solid execution under CEO Frank Bisignano.

Favorable stock selection in E-Commerce and Capital Markets together with lack of exposure to the underperforming Hardware category were the other drivers of outperformance in the period. Performance in E-Commerce was bolstered by MercadoLibre, Inc., the dominant e-commerce platform across Latin America. The company was a top contributor after reporting a string of healthy across-the-board beats to earnings estimates throughout the year, aided by impressive margin expansion. MercadoLibre is clearly generating above-market growth in gross merchandise value on the largest bases across its major Latin American markets and increasingly widening the gap with peers, particularly in Brazil, where the company has benefited from missteps by major competitors. Product innovation in fintech and solid underwriting in the growing credit business have also been positive surprises over the last several quarters. Cloud-based commerce platform Shopify Inc. also performed exceptionally well in the category after the company sold off the capital-intensive and money losing Shopify Fulfillment Network to Flexport while significantly refocusing the business on its core offerings, accelerating innovation, and increasing profitability. Despite a 23% headcount reduction, revenues accelerated to approximately 25% year-on-year growth, while operating margins are expected to expand by more than 10% year-on-year. The company also continued its horizontal addressable market expansion, significantly improving its enterprise, business-to-business, offline and international offerings while simultaneously strengthening its vertical platform capabilities.

Stock-specific strength in Capital Markets accounted for 270-plus basis points of relative gains, but this positive impact was somewhat offset by the Fund’s higher exposure to this lagging category. Electronic trading marketplace Tradeweb Markets Inc. and global investment bank Houlihan Lokey, Inc. led the way in the group. Tradeweb’s shares rose after the company reported strong growth in trading activity due to elevated volatility and market share gains. Annual trading volume grew 28% with accelerating trends throughout the year providing strong momentum into 2024. Revenue and earnings exceeded Street expectations each quarter and likely grew at double-digit rates for the full year. The company also announced a new market data agreement with London Stock Exchange Group at higher revenues over the coming years. Houlihan Lokey’s stock appreciated due to expectations for M&A activity to improve from cyclically depressed levels. Stabilizing interest rates, firming corporate valuations, and significant dry powder across private equity funds are driving renewed interest in deals after a lengthy pause. Meanwhile, restructuring activity is rising and is expected to remain elevated for several years due to looming debt maturities and higher interest rates. Houlihan Lokey has been expanding its capabilities by hiring experienced bankers and making strategic acquisitions.

Somewhat offsetting the above was significantly lower exposure to Enterprise Software, one of the better performing categories in the index during the year. Adverse stock selection in Tech-Enabled Financials coupled with higher exposure to this lagging category also weighed on performance. Weakness in Tech-Enabled Financials was partly due to a disappointing start to the year for online brokerage firm The Charles Schwab Corp. and independent broker-dealer LPL Financial Holdings Inc., as stress to the banking system resulting from the bankruptcies of Silicon Valley Bank (SVB) and Signature Bank caused investors to sour on financial stocks in general due to fears of contagion. We remain investors. Over the long run, we believe Schwab has powerful asset-gathering momentum and scale and a reinvestment tailwind from maturing securities being invested at higher rates. We have been pleased with LPL's strong execution, which has helped the company to gain share among advisors and win large enterprise deals. Specialty insurer Arch Capital Group Ltd. was another drag on performance after being added to the Fund in late September. Despite recent underperformance, Arch’s 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 believes 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.