Review and Outlook

as of 03/31/23

U.S. equities posted gains to start the year, but the path higher remained turbulent as investors grappled with tightening financial conditions and concerns of a recession. Stocks rose in January as moderating inflation and weakening economic indicators raised investor hopes that the current cycle of interest rate hikes might be ending. The rally was supported by easing supply chain constraints, falling energy prices, and the reopening of the Chinese economy from pandemic lockdowns. The rebound stalled in February as resilient economic data and persistently high inflation left investors concerned that the Federal Reserve would keep rates higher for longer. The sudden failures of Silicon Valley Bank and Signature Bank exacerbated the market sell-off in early March, but federal regulators quickly intervened to prevent contagion from spreading throughout the banking sector. The episode ignited a market rebound in late March given investor expectations that the banking turmoil would cause the Fed to potentially pivot on rate hikes and resume its balance sheet expansion.

Baron FinTech Fund increased in the quarter. Investments within the Financials, Information Technology (IT), and Consumer Discretionary sectors contributed the most. No sector detracted. Second largest contributor MSCI Inc. led advances within the Financials sector. Tradeweb Markets, Inc. was another noteworthy contributor after shares of this operator of electronic marketplaces for trading bonds, derivatives, and other financial instruments rose on robust trading activity and market share gains. Top contributor MercadoLibre, Inc. drove appreciation within Consumer Discretionary. Guidewire Software, Inc. led gains within IT. Shares of this P&C insurance software vendor contributed on more consistent recurring revenue growth and durable gross margin expansion after the company crossed the midpoint of its cloud transition.

While we are certainly aware of the macroeconomic environment, we don’t 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 sustainable 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 the 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 03/31/23

Contributors

  • MercadoLibre, Inc., the dominant e-commerce platform in Latin America, contributed in the first quarter. The company reported a significant fourth quarter earnings beat, driven by strong performance on essentially all key drivers of operating margins across both the commerce and fintech segments. On its earnings call, the company suggested these drivers will continue to generate sequential margin expansion in the coming quarters and years, and we believe retrenchment by some top e-commerce competitors could lead to a possible acceleration of MercadoLibre's market share growth, especially in Brazil. We remain shareholders.
  • Shares of MSCI Inc., a leading provider of investment decision support tools, contributed to performance. The company reported resilient Q4 2022 earnings results and gave a cautiously optimistic outlook for 2023. MSCI also benefited from improved performance in the global equity markets in the quarter, which most directly impacts MSCI's asset-based fee revenue. We retain long-term conviction, as MSCI owns strong, "all weather" franchises and remains well positioned to benefit from numerous secular tailwinds in the investment community.
  • Intuit Inc. is the leading provider of accounting software for small businesses and tax preparation software for individuals and tax professionals. Shares contributed after the company reported quarterly results that exceeded Street expectations with 14% revenue growth and 42% EPS growth. Management expressed confidence in their outlook and reaffirmed full-year financial guidance, which came as a relief to investors who feared a macro-driven guidance cut. We continue to own the stock due to Intuit’s strong competitive position and numerous growth opportunities.

Detractors

  • Shares of online brokerage firm The Charles Schwab Corp. declined during the quarter following the bankruptcy of Silicon Valley Bank (SVB) and the resulting weakness in financials generally and particularly in regional banks. Despite running a much different business than SVB, Schwab is facing deposit pressure through cash sorting in the wake of the collapse. As investors continue to move uninvested cash balances into higher-yielding money market funds, with the assets remaining at Schwab, the company must raise high-cost external funding in the short term. Although this is pressuring earnings estimates and contributing to near-term weakness in shares, we retain long-term conviction given accelerating net inflows year-to-date, with Schwab gathering over $75 billion in new assets in just the first two months of 2023. We are encouraged by the firm’s exceptional client loyalty levels, robust organic growth, and industry-leading operating expense per client assets. Schwab is well positioned to retain clients and increase long-term earnings growth, in our view.
  • Endava plc provides outsourced software development for business customers. Shares fell after the company reduced financial guidance to reflect slower bookings as macroeconomic uncertainty weighed on client decision-making in December. Nevertheless, the company reported solid quarterly results, with 30% revenue growth and 26% EPS growth. Management noted that bookings have improved in the first couple of months of 2023, and they expect annualized revenue growth to quickly return to greater than 20%. We remain investors because we believe Endava will continue gaining share in a large global market for IT services.
  • LPL Financial Holdings Inc. is the largest independent broker-dealer in the U.S. Following a strong run in 2022, the stock detracted in the quarter. The weakness was largely driven by the stress to the banking system resulting from the bankruptcy of Silicon Valley Bank, which caused investors to sour on financial stocks in general due to fears of contagion. We believe LPL is not exposed to the vast majority of issues facing banks. LPL is not a bank, has different regulators, and has a relatively small balance sheet. Over 95% of client cash is covered by FDIC insurance, and the limited securities LPL holds are U.S. Treasury bills with almost no interest rate or credit risk. The banking crisis has caused investors to take a more dovish view on the path of interest rates, which is a headwind to LPL's earnings as the economics on a large portion of client cash is tied to floating rates. However, we believe the company has a strong long-term earnings profile even in a lower interest rate environment, and stock weakness is being influenced by the short-term narrative. We retain long-term conviction.