Review and Outlook

as of 03/31/23

U.S. stocks rose sharply to start the year on market optimism that moderating inflation data and weakening economic indicators would convince the Federal Reserve to stop raising rates and perhaps allow it to orchestrate a soft landing. But lagging inflation data proved stubborn, rates and fed funds futures rose, and the market retreated in February. In early March, unease in the banking system set off by the sudden failures of Silicon Valley Bank and Signature Bank amplified market and economic risks. As a result, the Fed raised rates by just 25 basis points, U.S. Treasury yields collapsed, the yield curve inverted further, and stocks sold off. Federal regulators quickly intervened to backstop bank depositors and to prevent contagion into the rest of the banking sector. The market ended the quarter on a rebound, with mega-cap technology stocks leading the rally.

Against this backdrop, Baron Fifth Avenue Growth Fund increased in the quarter. Investments within Information Technology (IT), Consumer Discretionary, and Communication Services contributed the most. No sector detracted. Top contributor NVIDIA Corporation led gains within IT. Appreciation within Consumer Discretionary was led by third largest contributor Amazon.com, Inc. Electric vehicle manufacturer Tesla, Inc. was another noteworthy contributor after shares surged on investor expectations that the company will continue to grow and maintain industry-leading margins despite a potential recession, COVID-related concerns, competition in China, and a price reduction. Second largest contributor Meta Platforms, Inc. led positive performance within Communication Services.

While near-term uncertainty remains high, we maintain conviction regarding the long-term prospects of our companies. We have no insight, or even a view, on whether the economy is headed for a recession, or a prediction on how the market, or the portfolio, will perform in the second quarter or for the rest of 2023. Our pattern recognition continues to suggest, however, that this period of time will prove to be a good entry point for investors in the not-too-distant future. We continue to search for new ideas opportunities while remaining patient and investing only when we believe target companies are trading at attractive prices relative to their intrinsic values.

Top Contributors/Detractors to Performance

as of 03/31/23

Contributors

  • NVIDIA Corporation is a fabless semiconductor mega cap company and global leader in gaming cards and accelerated computing hardware and software. Despite subdued demand for gaming cards due to an ongoing PC slowdown and inventory correction, shares of NVIDIA rose nearly 90% during the first quarter as a result of material developments in generative AI as evidenced by the release of ChatGPT and GPT-4. These technologies hold the promise of enabling significant productivity gains across domains from content creation, coding, and even biologic discovery. During its annual GTC conference in March, NVIDIA announced new products that expand its addressable market such as the L4 chip, which opens the opportunity for video processing, representing 80% of internet traffic. We continue to believe NVIDIA’s end-to-end AI platform and leading market share in gaming, data centers, and autonomous machines, along with the size of these markets, will enable the company to benefit from durable growth for years to come.
  • Shares of Meta Platforms, Inc., the world’s largest social network, were up this quarter due to decisive cost discipline actions, improving adoption of new advertising products, the company's work in generative AI, and the broader technology rally. Meta is the mega-cap technology company most focused on profitability through cost cutting, including layoffs of more than 20% of its staff and reductions in its data center and office footprint. On the top line, engagement remains healthy, and newer advertising formats (like Instagram Reels) are reportedly picking up steam. Longer term, we believe Meta will utilize its leadership in mobile advertising, massive user base, innovative culture, and technological scale to perform, with further monetization opportunities ahead.
  • Amazon.com, Inc. is the world’s largest retailer and cloud services provider. Shares were up in the quarter, driven by positive commentary and actions around cost discipline as well as the broader technology rally. We believe that Amazon is well positioned in the short-to-medium-term to meaningfully improve core North American retail profitability to pre-pandemic levels. Longer term, Amazon has substantially more room to grow in eCommerce, where it has less than 15% penetration in its 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 AI workloads.

Detractors

  • ZoomInfo Technologies Inc. provides go-to-market business intelligence software. Shares detracted from performance after the company shared a weaker topline outlook driven by continued macro uncertainty. We have spoken with company management and conducted additional research to validate our longer-term thesis and believe relevant macroeconomic conditions are showing signs of improvement. We continue to believe ZoomInfo has the opportunity to become a much larger company over time as it grows into its $70 billion-plus total addressable market with the potential to expand into marketing and talent acquisition software and other adjacencies.
  • GitLab Inc. provides the only DevOps platform that addresses all stages of the software application lifecycle. Despite reporting decent results with revenue growth of 58% and operating losses that were less than Street forecasts, the company issued below-consensus 2023 revenue growth guidance. Technology industry layoffs and tighter IT/ developer budgets resulted in lower net revenue retention rates in GitLab's Premium Tier, as some existing customers cut back on paid licenses to account for reduced hiring, while others anticipate a lower rate of developer headcount growth in 2023. Management is assuming the trend will continue through the remainder of 2023. We see upside to the guidance as 1) customers continued to upgrade to GitLab's higher-priced Ultimate Tier to add security and compliance features; 2) new customer sign-up growth remained healthy; and 3) GitLab is implementing a 25% to 50% price increase on its Premium Tier that should drive growth toward the end of 2023 and into 2024. The price increases will also help GitLab achieve profitability sooner than it initially projected.
  • 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.

Quarterly Attribution Analysis (Institutional Shares)

as of 03/31/23

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 03/31/23

Baron Fifth Avenue Growth Fund (Institutional Shares) was up 19.67% in the first quarter, outperforming the Russell 1000 Growth Index by 530 basis points due to stock selection and, to a lesser extent, differences in sector weights. Style biases also aided performance, driven by the Fund’s overexposure to the strong performing Beta, Growth, and Residual Volatility factors along with underexposure to the weak performing Dividend Yield and Earnings Yield factors.

Favorable stock selection in Consumer Discretionary, Communication Services, and Health Care accounted for about three-quarters of the outperformance in the period. Strength in Consumer Discretionary came from Latin American e-commerce company MercadoLibre, Inc. and electric vehicle manufacturer Tesla, Inc. MercadoLibre was a material contributor after reporting impressive quarterly results, driven by strong performance on essentially all key drivers of operating margins across both the commerce and fintech segments. Management 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. Tesla’s shares rebounded after management said it expects to build 1.8 million vehicles in 2023, up 31% from 2022, while maintaining industry-leading margins despite a potential recession, concerns about competition in China, and recent price reductions. In addition, investor confidence in Elon Musk’s commitment to Tesla increased over the past few months, while a broader management presentation during the company’s analyst day provided additional visibility into the depth and quality of talent leading Tesla. Lack of exposure to Home Depot, Inc. and other poor performing home improvement retailers coupled with the outperformance of retailer and cloud services leader Amazon.com, Inc. also added value. Amazon’s shares rose in response to positive commentary and actions around cost discipline.

Performance in Communication Services was bolstered by social network Meta Platforms, Inc. and demand-side advertising platform The Trade Desk. Meta was the second largest contributor due to decisive cost discipline actions, improving adoption of new advertising products, the company's work in generative AI, and the broader technology rally. Trade Desk’s financial results demonstrated that the company continues to outperform the broader digital advertising industry, with revenue guidance coming ahead of expectations for the March quarter. In addition, the company continues to gain share even amid the uncertain macroeconomic environment. Positive stock selection in Health Care, owing to double-digit gains from DNA sequencing leader Illumina, Inc. and life sciences software provider Veeva Systems Inc., was partly offset by higher exposure to this lagging sector. Illumina benefited from activist investor Carl Icahn’s involvement in the stock. Icahn nominated three directors to the Illumina board and criticized the current management team’s decisions with respect to Grail, an acquisition with an early cancer detection test called Galleri. Icahn urged Illumina to sell the Grail business to eliminate the near-term earnings dilution and allow investors to participate in the core Illumina business. In early April, the FTC ordered the divestment of Grail. We continue to have a positive view of Illumina’s business and are evaluating Icahn’s proposals and management’s responses. Veeva reported solid quarterly results with top and bottom-line beats, and management provided above-consensus guidance for fiscal year 2024 excluding termination for convenience rights (TFC) impacts. Aside from stock selection, the Fund benefited from its limited aggregate exposure to Consumer Staples, Industrials, Energy, Real Estate, and Materials, all of which failed to keep pace with the broader market during the quarter.

Adverse stock selection in Information Technology offset a portion of the above-mentioned gains, as outsourced software development providers Endava plc and EPAM Systems, Inc. weighed heavily on performance in the sector. Endava’s shares declined 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 also 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%. Similarly, EPAM’s stock fell after the company provided 2023 financial guidance that was below Street expectations. After growing revenue by 28% and EPS by 20% in 2022, management expects slower growth this year due to near-term client caution around IT spending in an uncertain macroeconomic environment. However, management anticipates only a temporary slowdown as visibility on new projects supports accelerating revenue growth back to 20% by early 2024. Software holdings Datadog, Inc., GitLab Inc., and Snowflake Inc. also hampered performance, but these negative impacts were somewhat offset by the Fund’s higher exposure to this strong performing industry.

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.