Review and Outlook

as of 12/31/23

The fourth quarter contributed to a strong bounce-back year in 2023. The Russell 1000 Growth Index gained 14.16% during the quarter and 42.68% during the year, recapturing all its losses from the prior year. Brushing aside ongoing macro concerns, including the Federal Reserve’s continuation of its historical tightening cycle, the recession debate, geopolitical uncertainties, and poor investor sentiment following a tough 2022, the index climbed steadily through the first half of the year. After a third-quarter dip driven largely by investor concerns that rates were going to stay “higher for longer,” lower inflation data and the shifting focus to rate cuts prompted a bull run in the last two months of 2023.

Baron Fifth Avenue Growth Fund increased in the fourth quarter. Holdings within Information Technology (IT), Consumer Discretionary, and Financials contributed the most to performance. Investments within the Industrials sector detracted. IT had a strong quarter, with gains in all portfolio positions, led by top contributor Shopify Inc. and second largest contributor ServiceNow, Inc. Increases within Consumer Discretionary were led by third largest contributor Amazon.com, Inc. Positive returns within Financials were led by mobile payment provider Block, Inc. Shares rebounded from the prior quarter’s decline after the company reported healthy 21% gross profit growth and profitability that beat Street estimates. Declines within the Industrials sector were driven by second largest detractor GM Cruise Holdings LLC.

One of the biggest surprises of 2023 was the highly anticipated recession in the U.S. that has not materialized. While some were in the camp of hard landing and others were in the camp of soft landing, not many were in the camp of no landing…could that remain the case in 2024? When will the Fed start cutting rates? How aggressive will it be? What are the implications of the upcoming elections (the S&P 500 has not declined in an election year since 1940)?

Although we have a view on many of these questions we do not have the answers. The range of outcomes continues to be extremely wide, creating a challenging environment for investors. But since we are not macro investors, we stick to focusing on well-managed, high-quality businesses with durable competitive advantages for the long term. We continue to speak with company management teams as often as we can, test our investment theses, look for disconfirming evidence, and measure how well our businesses are performing fundamentally.

It is our belief that investing in great businesses at attractive valuations will enable us to earn excess risk-adjusted returns for our shareholders over the long term. We are optimistic about the prospects of the companies in which we are invested and continue to search for new ideas and investment opportunities.

Top Contributors/Detractors to Performance

as of 12/31/23

Contributors

  • Shopify Inc. is a cloud-based software provider for multi-channel commerce. Shares rose on strong financial results, with growth in gross merchandise value of 22% year-on-year, revenue growth of 25%, and non-GAAP operating margins surpassing 15% (up 1,900 bps year-on-year). The company also hosted a well-attended investor day in which it shared a variety of data points showcasing growing success in new segments in which it historically has been less well known, such as enterprise, B2B, and offline commerce. Shopify has added more merchants to the platform in the last year than in the prior two combined, while the expansion of existing cohorts of merchants remains ahead of the market. Lastly, the company provided data on the rapid adoption of new offerings, with its emerging products category growing at a 71% CAGR since 2019. We remain shareholders due to Shopify’s strong competitive positioning, innovative culture, and long runway for growth, as it still holds less than a 2% share of the global commerce market.
  • ServiceNow, Inc. offers cloud-based solutions that improve workflow efficiency through automation and digitalization. Stock appreciation was supported by strong quarterly results despite macro complexities, growing investor expectations that ServiceNow would benefit from the integration of generative AI (GenAI) technology into its products, and a favorable appreciation of software stocks in general. In the third quarter, the company beat analyst expectations across all key metrics. Management noted that key drivers included strong traction with government buyers, improving momentum with new customers, and budget consolidation into platforms like ServiceNow. In addition, the company launched its GenAI-supported product line, ProPlus, at the end of the quarter and has already signed on multiple customers with hundreds more in the pipeline. The new product line should generate material efficiencies for customers, which could translate into a substantial part of ServiceNow's business over time.
  • Amazon.com, Inc. is the world’s largest retailer and cloud services provider. Shares of Amazon were up in the quarter. Reported results were better than consensus, with a significant beat in North American operating profit. We believe the AWS cloud division has many years ahead of growth, with recent customer optimizations attenuating. We also believe Amazon is well positioned in the short to medium term to meaningfully improve core North American retail profitability to above pre-pandemic levels, benefiting from its new regionalized fulfillment network and its growing margin-accretive advertising business. Longer term, Amazon has substantially more room to grow in e-commerce, where it has less than 15% penetration of the total addressable market. Amazon also remains the clear leader in the vast and growing cloud infrastructure market, with large opportunities in application software, including enabling generative AI workloads.

Detractors

  • Argenx SE is a biotechnology company focused on autoimmune disorders. Shares fell in the quarter on the back of failed clinical trials in immune thrombocytopenic purpura and pemphigus vulgaris that called into question the applicability of the FcRn treatment landscape. While the exact nature of these data sets is nuanced and not entirely thesis-breaking, in our view, there are now real questions for the FcRn space that have not existed in the narrative for years. On the positive side, the strong launch of Vyvgart, with early sales tripling consensus expectations and global approvals coming earlier than guided, should continue to grow revenue and justifies a defensible valuation based on cash flow analysis. We expect 2024 to be another year of solid performance, with many catalysts including readouts in myositis, Sjogren's syndrome, multifocal motor neuropathy, and argenx's subcutaneous formulation launch.
  • GM Cruise Holdings LLC offers autonomous driving software and a fleet of vehicles aimed at reducing costs and improving the safety of transporting people and goods. We marked down the stock after the company lost its autonomous operating license in California. Despite achieving significant milestones over the past year, including completing millions of fully autonomous miles with passengers in various states and cities, an October incident involving a pedestrian in San Francisco prompted the California DMV to rescind the company's license. The regulator cited concerns about incomplete incident information disclosure. Consequently, this triggered a near-complete cessation of operations and key management changes at Cruise, as General Motors, the majority shareholder, charts a new course for the organization and its capital needs. While we strongly believe the life-saving technology achieved through the autonomous revolution holds immense value for both investors and society at large, the path to recovery for Cruise remains uncertain at this juncture, which is reflected in our valuation framework.
  • The Trade Desk is the leading internet advertising demand-side platform, enabling agencies to efficiently purchase digital advertising across desktop, mobile, and online video channels. Shares were down due to a rare miss on quarterly results. Still, we believe the company is well positioned for 2024 and beyond, with strong tailwinds in Connected TV, a secular growth category capturing spend at an increasing pace from linear TV, retail media, platform upgrade adoption, audio, and more. Longer term, we remain positive on the company given its technology, scale, and estimated 10% share in the $100 billion programmatic advertising market, a small and growing subset of the $700 billion global advertising market.

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 Fifth Avenue Growth Fund (Institutional Shares) increased 17.61% in the fourth quarter, outperforming the Russell 1000 Growth Index by 345 basis points due to stock selection and tailwinds from style biases, notably overexposure to the top performing Beta and Residual Volatility factors.

Favorable stock selection in Information Technology (IT) and Financials was responsible for most of the outperformance in the period. Strength in IT was partly due to significant gains from the Fund’s software holdings, which were up more than 30% as a group. CrowdStrike Holdings, Inc., ServiceNow, Inc., Snowflake Inc., Cloudflare, Inc., and Datadog, Inc. led the way in the group after reporting strong quarterly results. Cloud-based commerce platform Shopify Inc. and outsourced software development provider Endava plc were other key drivers of performance in the sector. Shopify was the largest contributor after the company’s excellent financial results featured gross merchandise value growth of 22% year-on-year, revenue growth of 25%, and non-GAAP operating margins in excess of 15% (and up 1,900 bps year-on-year). The company also hosted a well-attended investor day in which management shared a variety of data points showcasing the company's growing success in new segments, such as enterprise, business-to-business, and offline commerce. 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.

Performance in Financials was bolstered by meaningful gains from payment platforms Block, Inc. and Adyen N.V., with both companies reversing last quarter’s losses. Block’s shares rose sharply after 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. Adyen’s shares rebounded from last quarter’s steep drop after the company reported faster revenue growth and provided long-term guidance that was better than expected. Third-quarter revenue growth accelerated to 27% on a constant currency basis from 19% in the first half of the year, alleviating concerns about competition and pricing pressure. Long-term revenue growth guidance was revised to a lower but more realistic target between the low-twenties to high-twenties percent, which is still much faster than the broader payments industry. Additionally, management indicated that the pace of hiring has slowed, which should drive faster margin expansion.

Partially offsetting the above was disappointing stock selection in Health Care, Consumer Discretionary, Communication Services, and Industrials. Biotechnology company argenx SE accounted for most of the losses in Health Care after the company’s shares were pressured by failed clinical trials in immune thrombocytopenic purpura and pemphigus vulgaris that called into question the total applicability of the FcRn treatment landscape. Though we believe these developments are not entirely thesis breaking, there are now questions surrounding the FcRn space moving forward that had not factored into the narrative for years. On the positive side, the strong launch of Vyvgart, with early sales tripling consensus expectations and global approvals coming earlier than guided, should continue to grow revenue and justifies a defensible valuation based on cash flow analysis. We retain conviction as we expect 2024 to have many catalysts including the company’s subcutaneous formulation launch along with readouts in myositis, Sjogren's, and multifocal motor neuropathy. Cloud-based life sciences software solutions provider Veeva Systems Inc. and robotic surgery system pioneer Intuitive Surgical, Inc. also weighed on performance in the sector.

Electric vehicle manufacturers Rivian Automotive, Inc. and Tesla, Inc. were mostly responsible for the relative shortfall in the Consumer Discretionary sector due to company-specific issues. Despite substantial improvements in production and delivery volumes along with improved unit economics, Rivian’s shares declined in the period as the operation is still subscale, with elevated cash outflows. Additionally, while Rivian's current manufacturing facility in Normal, Illinois, is scaling production, the company is poised to construct another multi-billion-dollar facility in Georgia in the near future, implying large funding needs to support its early stage of operations. Lastly, despite recently announcing a trial with AT&T to deploy Rivian vehicles in its fleet, Amazon's purchasing of Rivian's electric vans has been slower than initially scheduled. We recognize Rivian's potential to become an important player in the electric vehicle sector but appreciate the tremendous challenges ahead. Tesla’s stock detracted as the core automotive segment remained under pressure due to a complex macroeconomic environment, higher interest rates, factory shutdowns, and Tesla’s price reductions throughout the year, presenting pressure on the near-term growth and margin profile. Nonetheless, Tesla continued to generate sufficient gross profit to support a robust product development plan that can propel the automotive segment higher over time. Tesla also started to deliver its highly anticipated Cybertruck, its first pickup truck with a tremendous amount of consumer interest and a slew of new technologies within the car and its manufacturing lines. The refreshed Model 3 also seems to be generating strong demand while improving unit-level economics. Lastly, while early, investors now expect Tesla to benefit from its investment in artificial intelligence (AI) through development of autonomous driving technology Dojo (an AI training compute), autobidder (an automated energy trading platform), and humanoid (a human-like robot).

Adverse stock selection in Communication Services and Industrials was mostly due to declines from internet advertising demand-side platform The Trade Desk and autonomous vehicle company GM Cruise Holdings LLC, respectively. Trade Desk’s shares were down due to a rare miss on quarterly results. Nevertheless, we believe the company is well positioned for 2024 and beyond, with strong tailwinds in Connected TV, a secular growth category capturing spend at an increasing pace from linear TV, retail media, platform upgrade adoption, audio, and more. Longer term, we remain positive on the company given its technology, scale, and estimated 10% share in the $100 billion programmatic advertising market, a small and growing subset of the $700 billion global advertising market. Cruise was a top detractor after the company lost its autonomous operating license in California. Despite achieving significant milestones over the past year, including completing millions of fully autonomous miles with passengers in various states and cities, an October incident involving a pedestrian in San Francisco prompted the California DMV to rescind the company's license. The regulator cited concerns about incomplete incident information disclosure. Consequently, this triggered a near-complete cessation of operations and key management changes at Cruise, as General Motors, the majority shareholder, charts a new course for the organization and its capital needs. While we strongly believe the life-saving technology achieved through the autonomous revolution holds immense value for both investors and society at large, the path to recovery for Cruise remains uncertain at this juncture, which is reflected in our valuation framework.

as of 12/31/23

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

Baron Fifth Avenue Growth Fund (Institutional Shares) posted a massive gain of 57.58% for the year, meaningfully outperforming the Russell 1000 Growth Index by 14.90% due to stock selection and, to a lesser extent, active sector weights. Style biases also played a role in the Fund’s outperformance during the period, with the principal drivers being overexposure to the strong performing Beta, Residual Volatility, and Growth factors.

Favorable stock selection in Information Technology (IT) coupled with higher exposure to this top performing sector accounted for about 60% of the outperformance in the period. A portion of the stock-specific gains came from fabless semiconductor company NVIDIA Corporation and cloud-based commerce platform Shopify Inc., whose share prices were up triple digits in the period. NVIDIA had a banner 2023, with the company’s stock rising nearly 240% as a result of the unprecedented demand acceleration for generative artificial intelligence (AI). The company is seeing the fruits of its nearly 20-year investment in AI and accelerated computing with data center revenues growing five-fold from $3 billion in 2019 to $15 billion in 2022 and expected to triple to $45 billion in 2023. This extraordinary growth in revenues drove an even faster growth in earnings-per-share, resulting in multiple contraction despite the rapid rise in shares. Shopify’s shares more than doubled as 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.

Other material contributors in IT were CrowdStrike Holdings, Inc., ServiceNow, Inc., and a few other software holdings, which together were up more than 70%. Shares of cybersecurity vendor CrowdStrike were lifted by a series of strong quarterly results. The company continued to report elongated deal cycles as more businesses look to consolidate vendors, noting that its win rates remained strong across legacy and next-gen vendors. We believe CrowdStrike is innovating at a rapid pace, enabling customers to easily expand and consolidate spend from other point solution providers onto the CrowdStrike platform. The company's ability to upsell and cross-sell new products is a key driver of long-term revenue growth and margin expansion as CrowdStrike’s renewal business, which has lower sales commission percentages, grows each year. In our view, CrowdStrike is on track to becoming one of the preeminent cloud security platforms. ServiceNow offers cloud-based solutions that improve workflow efficiency through automation and digitalization. The company’s shares rebounded on improved execution following a difficult 2022. ServiceNow experienced a noticeable deceleration in purchasing activity of its solutions in mid-2022 as a result of macroeconomic uncertainty. Combined with currency volatility, this soft demand resulted in a reduction of ServiceNow's mid-term financial targets. Throughout 2023, the company consistently improved its execution against these challenges, revitalizing investor confidence in the strategic value of ServiceNow for enterprises and interest in a unique software company that presents strong growth and high levels of profitability at scale. In addition, management described strong demand and large growth opportunities for its generative AI-supported product line, ProPlus, which the company released at the end of September and which can offer substantial revenue opportunities among a diverse set of use cases and customers.

Additional tailwinds to performance came from solid stock selection in Consumer Discretionary and Communication Services together with negligible exposure to the lagging Consumer Staples, Industrials, and Energy sectors. Strength in Consumer Discretionary was partly due to sharp gains from e-commerce platforms MercadoLibre, Inc. and Amazon.com, Inc. Shares of MercadoLibre, the dominant e-commerce platform across Latin America, contributed 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. We believe these encouraging developments will drive continued margin expansion and earnings growth as e-commerce in the region matures over the next five or more years. Amazon was a top contributor after benefiting from a material improvement in overall operating profit and a better backdrop for technology stocks throughout much of the year. Electric vehicle (EV) manufacturer Tesla, Inc. also performed well in the sector, bouncing back from a difficult in 2022. Throughout 2023, Tesla experienced a degradation in margins as it reduced prices, but, while margins declined, they remained healthy, allowed robust investments in growth, and significantly outperformed the negative EV margins of the vast majority of its competitors. 2023 also represented a record year for the Energy division's revenues and margins. Tesla continued to demonstrate its innovation engine, including launching its highly anticipated Cybertruck, initiating the production of its Dojo compute, releasing important updates to its Autopilot solution, and expanding its battery activities.

These gains were somewhat offset by weakness in Financials and Health Care, where a combination of stock selection and active weights hampered performance. All of the Fund’s Financials holdings underperformed in the period, with the largest detractor being Adyen N.V., a provider of technology that enables merchants to accept electronic payments. Adyen’s shares collapsed after the company reported disappointing financial results for the first half of 2023. While payment volume growth of 23% was solid, it had slowed significantly from 41% in the prior period, which management attributed to greater competition and pricing pressure in North America. We remain shareholders. Weakness in Health Care was broad based, led by poor performance from DNA sequencing provider Illumina, Inc., whose stock was pressured by weak financial results, management turnover, and uncertainty about the outcome of the acquisition of Grail, which regulators have challenged on antitrust grounds. Toward the end of the year, management committed to divesting the Grail business in 2024. We continue to believe Illumina has a dominant position in an attractive and growing end market and has a long runway for growth.

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.