Review and Outlook

as of 03/31/21

The first quarter of 2021 saw a perceptible shift in market leadership from growth to value. At the same time, the “reopening trade,” or rotation away from the work-from-home stocks, picked up steam. Russell 1000 Growth Index returns were driven by energy, bank stocks, airlines, cruise lines, and hotels – areas we typically do not invest in -- while many of the work-from-home beneficiaries (i.e., companies enabling digital transformation, some of which we have owned for years) sold off. After enjoying a favorable investing environment over the last four years, we think it is fair to point out these headwinds, which, while challenging, were not entirely unexpected. That said, we have no intention of adjusting the portfolio in response. The reasons are rooted in our investment philosophy and process and how we execute it in circumstances like these.

  • We focus on big ideas – companies we believe to be beneficiaries of disruptive change – which are rarely found in the industries benefiting from the reopening. Bricks and mortar retailers, for example, will see more short-term foot traffic but will continue to be structurally disrupted by e-commerce.
  • We are long-term investors with a focus on duration of growth. If our research suggests a company has sustainable competitive advantages that will enable it to compound its intrinsic value over the long term, we will exercise patience, even during periods of underperformance.
  • We believe all investing is value-based – everything else is speculation. We invest only when companies are trading at 20% discounts (or more) to our estimate of intrinsic value. Because we prioritize businesses we believe will compound their intrinsic value over the long term, we are willing to hold them when they are fairly valued, or even modestly overvalued, to allow fundamentals to catch up to the stock price.
  • As long-term investors we do not equate risk to market volatility. We define risk as probability of permanent loss of capital. As a result, we do not attempt to manage market volatility through cash management or sector rotation. There is nothing wrong with either; it is simply not a part of our process or skill set.

While the recent shift in market leadership has been a headwind to the businesses we favor, we are not all that concerned. We think rotations, pullbacks, and corrections are generally necessary and healthy and often create attractive opportunities for long-term investors like us. The more important development, in our view, has been the steady rise in interest rates. Besides offering a bit of an alternative to savers, higher interest rates make fast growing companies more expensive since future earnings must be discounted back at higher rates. Having said that, the Federal Reserve has said that it intends to keep interest rates low until at least 2023. And as the saying goes: “don’t fight the Fed,” especially, as in this case, when the government is helping with fiscal stimulus.

Top Contributors/Detractors to Performance

as of 03/31/21

Contributors

  • Alphabet Inc. is the parent company of Google, the world’s largest search and online advertising company. Shares rose in the quarter on strong fourth quarter results that saw continued recovery in ad spend and accelerated cloud revenue growth. We remain highly convicted in Alphabet's merits as it continues to benefit from growth in mobile and online video advertising, which accrues to its core assets of search, YouTube, and the Google ad network. Alphabet's investments in AI, autonomous driving (Waymo), and life sciences (Verily, Calico) provide additional optionalities for growth.
  • ASML Holding N.V. designs and manufactures semiconductor production equipment, specializing in photolithography, in which light sources are used to photo-reactively create patterns on wafers that ultimately become printed integrated circuits. Shares of ASML appreciated on continued market confidence that the semiconductor cycle has turned positive, driven by tight supply and a robust demand environment. We maintain conviction in ASML as it is the de-facto standard in next generation lithography, which is a required step for semiconductor chip production
  • 10X Genomics, Inc. sells products combining hardware, software, and chemistry to offer life sciences researchers single cell, spatial, and in situ views of biological systems. Shares performed well for the quarter. There continues to be growing excitement about the company’s position on the cutting edge of research, with a strong core competency in single-cell analysis and continued innovation in launching new instruments and product lines. We see a future for applications in clinical diagnostics as well.

Detractors

  • RingCentral, Inc. provides global cloud communications and collaboration solutions across multiple channels (voice, video, and messaging). Despite continued solid execution with revenue acceleration, RingCentral’s stock corrected during the quarter as the market rotated out of fast growing stocks. With its distribution advantage and the pandemic crystalizing the need for a communications platform that is agile, scalable, and global, RingCentral remains early in penetrating its addressable market, which we think should drive sustainable growth for years to come.
  • Splunk, Inc. offers a scalable data analytics solutions to allow customers to more efficiently manage operations across IT, cybersecurity, and other use cases. A meaningful deceleration in contract activity during Splunk's third quarter pressured the share price. Despite improvements in business trends during the fourth quarter, Splunk's on-premises business remains under pressure. Although we expect continued volatility due to an uncertain spending environment, we retain conviction based on Splunk's Cloud offering and new pricing initiatives.
  • Amazon.com, Inc. is the world’s largest retailer and cloud services provider. Shares detracted as part of the broader technology sell off. We believe Amazon will continue to benefit from the rapid rise of e-commerce penetration and expand its addressable market by entering new verticals. We also think the more material driver of growth is Amazon Web Services, which remains a leader in the vast and growing cloud infrastructure market and which we believe will compete in application software in the coming years.

Quarterly Attribution Analysis (Institutional Shares)

as of 03/31/21

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 03/31/21

Baron Fifth Avenue Growth Fund (Institutional Shares) declined 1.57% in the first quarter and underperformed the Russell 1000 Growth Index by 251 basis points due to negative impacts from stock selection and various style biases.

Outperformance of Communication Services and Financials investments and lack of exposure to the lagging Consumer Staples sector added the most value. Strength in Communication Services was driven by social network Facebook, Inc. and online advertising company Alphabet Inc., whose shares were up 7.9% and 17.7%, respectively, in the period. Facebook reported robust quarterly results driven by strong advertising pricing growth and e-commerce-enabled tailwinds from newer shopping and payments products. Alphabet was the top contributor after the company’s quarterly results beat Street expectations due to recovering advertising spend and accelerating cloud revenue growth. Favorable stock selection in Financials came from financial information services provider S&P Global Inc., whose shares were lifted by strong fourth quarter results and 2021 guidance.

Investments in Information Technology (IT), Consumer Discretionary, and Health Care detracted the most from relative performance. Negative stock selection in IT accounted for half of the underperformance in the period, led by share price declines from RingCentral, Inc., CrowdStrike, Inc., Snowflake Inc., ServiceNow, Inc. and several other software companies. These holdings relinquished a portion of last year’s gains as valuations contracted for growth-oriented software stocks during the quarter. Cloud-based data platform Splunk, Inc. also weighed on performance after experiencing a meaningful deceleration in contract activity. Weakness in Consumer Discretionary was largely due to the underperformance of Latin American digital marketplace MercadoLibre, Inc. and Chinese retailer and e-commerce company Alibaba Group Holding Limited. MercadoLibre’s stock price was down despite reporting strong quarterly results as investors rotated out of last year’s COVID-19 lockdown beneficiaries and into stocks perceived to benefit from economic reopening and normalization. Alibaba’s shares continued to be negatively impacted by an ongoing antitrust investigation. Worries about increased competition and a muted margin expansion outlook given greater investment in growth initiatives also weighed on the stock. Health Care holdings trailed their counterparts in the index due to share price declines from robotic surgical system leader Intuitive Surgical, Inc. and global biotechnology company Vertex Pharmaceuticals Incorporated. Intuitive Surgical’s shares were pressured by downbeat commentary on the company’s most recent earnings call during which management outlined a list of headwinds to near-term revenue and earnings growth. We reduced our Vertex position because of concerns about the company’s long-term growth being more dependent upon acquisitions than originally thought.

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.