Review and Outlook

as of 12/31/20

2020 will undoubtedly go down in history for many things. We think one of them will certainly be the compressed and violent market cycles. Stocks continued the prior year’s rally uninterrupted until the peak on February 12, suffered an unprecedented decline over the next five weeks until the trough on March 23, and then staged an equally unprecedented recovery over the next nine months through the end of the year.

Amazingly, and despite everything that happened, 2020 turned out to be year in which it was hard to lose money as long as one had the courage to remain invested through the downturn. Most equity indices were up double digits. Growth companies continued to be in favor, driven by lower interest rates and in many cases rapidly improving business fundamentals. COVID-19 proved to be a strong accelerant for companies that enable modernization and digital transformation, many of which we are invested in.

Against this backdrop, Baron Fifth Avenue Growth Fund increased in the fourth quarter to end the full year up more than 50%. The Information Technology (IT), Communication Services, and Health Care sectors contributed the most in the quarter. Holdings within Real Estate and Financials detracted. With six of the top ten contributors within the sector, including top contributor Twilio Inc. and second largest contributor CrowdStrike, Inc., IT had a strong quarter. Communication Services advanced on gains in all holdings within the sector, led by Google parent Alphabet Inc. Intuitive Surgical, Inc., which manufactures the da Vinci robotic surgical system, and Illumina, Inc., a leader in veterinary diagnostics, drove gains within the Health Care sector. Real Estate lost some ground on weak performance of data center REIT Equinix, Inc. Third largest detractor S&P Global Inc. drove declines within Financials.

Every day we live and invest in an uncertain world. Well-known conditions and widely anticipated events, such as Federal Reserve rate changes, ongoing trade disputes, government shutdowns, the unpredictable behavior of politicians the world over, and even, as we have seen, global pandemics, are shrugged off by the financial markets one day and seem to drive them up or down the next. We often find it difficult to know why market participants do what they do over the short term. The constant challenges we face are real and serious, with clearly uncertain outcomes. History would suggest that most will prove passing or manageable. The business of capital allocation (or investing) is the business of taking risk, managing the uncertainty, and taking advantage of the long-term opportunities that those risks and uncertainties create. We are confident that our process is the right one, and we believe that it will enable us to make good investment decisions over time.

Top Contributors/Detractors to Performance

as of 12/31/20

Contributors

  • Twilio Inc. is a leading Communications-Platform-as-a-Service (CPaaS) company offering a set of application programming interfaces that help developers embed communications into their software through its cloud platform. Shares were up as Twilio continued showing broad strength due to accelerated digitization trends as a result of COVID-19, driving 50%-plus revenue growth. We believe the accelerating pace of digitization is driving businesses to increasingly embed communications into their software, creating a potential multi-billion-dollar market opportunity for Twilio.
  • Shares of MercadoLibre, Inc., the largest digital marketplace in Latin America, appreciated during the quarter. The company showed accelerating gross merchandise value in its third quarter results despite the reopening of physical retail over the summer, indicating stickiness among recently acquired users and market share growth in some of its largest markets, particularly Brazil. We remain shareholders as we believe the company is a long-term winner in both ecommerce and payments across a region that remains in the early stage of digitization.
  • CrowdStrike, Inc. is a cloud-native cybersecurity vendor. Shares increased on a quarterly report that beat market expectations, driven by growth generated by share taking from legacy vendors, improving cross-sell of newer modules, and international expansion. News of a massive cyberattack on federal agencies and other targets also boosted shares as investors expect spend on cybersecurity to accelerate in the short/mid-term. Longer-term, we believe CrowdStrike remains well positioned with its cloud-first, AI/ML product approach, growing customer base, and improving data insights. 

Detractors

  • Alibaba Group Holding Limited is the largest retailer and e-commerce company in China. Alibaba operates shopping platforms Taobao and Tmall and owns 33% of Ant Group, which operates Alipay, China's largest third-party online payment provider. Shares were down on the news that Chinese regulators had launched an investigation into Alibaba for suspected monopolistic behavior. We continue to believe Alibaba's core business remains highly profitable, complemented by rapid growth in the cloud business and inflection in the Cainiao logistics and New Retail segments.
  • Splunk, Inc. leverages its scalable data analytics solutions to allow customers to more efficiently manage operations across a broad array of use cases including IT operation and cybersecurity. The stock fell after Splunk reported a meaningful deceleration in contract activity within its large customer segment. Management withdrew its long-term targets as it evaluates the implications of these recent changes. We maintain conviction as we expect cloud and new pricing to support growth, although it may take longer to achieve in the pandemic-impacted spending environment.
  • S&P Global Inc. provides credit ratings, indices, data, and analytics to the financial and commodities markets. The company reported strong financial results due to continued growth in debt issuance. The stock declined on investor expectations that issuance will moderate next year due to tough comparisons. The company’s announced acquisition of IHS Markit received a mixed reaction, perhaps due to the size and complexity of the combined company. We continue to own the stock as we see a long runway for growth and significant competitive advantages for the company.

Quarterly Attribution Analysis (Institutional Shares)

as of 12/31/20

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 12/31/20

Baron Fifth Avenue Growth Fund (Institutional Shares) appreciated 8.15% in the fourth quarter, yet underperformed the Russell 1000 Growth Index by 324 basis points due to negative impacts from stock selection and cash exposure in a market rally.

Outperformance of Information Technology (IT) investments and lack of exposure to the lagging Consumer Staples sector added the most value. Strength in IT came from the Fund’s software holdings, which were up more than 23% as a group, led by Twilio Inc., CrowdStrike, Inc., and RingCentral, Inc. Cloud communications platforms Twilio and RingCentral continued to exhibit broad strength due to accelerated digitization trends as a result of COVID-19. Cybersecurity vendor CrowdStrike was the third largest contributor after the company’s quarterly results beat market expectations, driven by growth generated by share taking from legacy vendors, improving cross-sell of newer modules, and international expansion. News of a massive cyberattack on federal agencies and other targets also boosted shares as investors expect spend on cybersecurity to accelerate in the short/mid-term. Performance in the sector was also bolstered by semiconductor production equipment manufacturer ASML Holding N.V., whose shares appreciated on renewed market confidence that the semiconductor cycle has turned positive, driven by tighter supply and a robust demand environment.

Aside from cash, investments in Consumer Discretionary, Health Care, and Financials detracted the most from relative results. Adverse stock selection in Consumer Discretionary was largely due to the underperformance of Alibaba Group Holding Limited, the largest retailer and e-commerce company in China. Alibaba was the top detractor on news that Chinese regulators are investigating the company for suspected monopolistic behavior. Within Health Care, underperformance of life sciences software solutions provider Veeva Systems Inc. and global biotechnology company Vertex Pharmaceuticals Incorporated weighed the most on relative results. Veeva’s shares declined after management offered a cautious outlook for 2021 with a potential reduction in sales representatives, suggesting headwinds to its commercial business. Vertex’s share price was hurt by the negative initial readout of a pipeline asset targeting alpha one antitrypsin disease, an inherited disorder that increases the chance of lung and liver disease. Weakness in Financials was driven by S&P Global Inc., a provider of credit ratings, indices, data, and analytics to the financial and commodities markets. S&P Global was the third largest detractor due to investor expectations that debt issuance will moderate next year because of tough comparisons.  Additionally, the company’s announced acquisition of IHS Markit received a mixed reaction, perhaps due to the size and complexity of the combined company.

as of 12/31/20

Yearly Attribution Analysis (for year ended 12/31/2020)

Baron Fifth Avenue Growth Fund (Institutional Shares) was up 50.81% for the year, significantly outperforming the Russell 1000 Growth Index by more than 12% primarily due to favorable stock selection. Relative sector weights and an assortment of style biases also contributed to relative results.

Outperformance of investments in IT, Health Care, Consumer Discretionary, and Real Estate and lack of exposure to the lagging Industrials and Consumer Staples sectors added the most value. Stock selection in IT accounted for over half of the Fund’s outperformance in the period, driven by triple-digit gains from web development services provider Wix.com Ltd. and software companies Twilio Inc., CrowdStrike, Inc., Datadog, Inc., and RingCentral, Inc. These businesses accelerated mostly due to increasing digitization trends as a result of COVID-19. Digital payment platform Adyen N.V. also saw its shares nearly triple in the period after reporting accelerating growth in payment volumes and revenue as well as significant investments in headcount and marketing to sustain its high growth rate. Adyen has been less impacted by pandemic-related store closures and a slowdown in consumer spending than other payment companies. Strength in Health Care, owing largely to the outperformance of life sciences software solutions provider Veeva Systems Inc., was somewhat offset by higher exposure to this lagging sector. Veeva was the third largest contributor as the company continued to present strong growth in new and existing products while maintaining high levels of profitability. COVID-19 has been less impactful on the companies in Veeva's life sciences customer base than in other verticals. Within Consumer Discretionary, higher exposure to Amazon.com, Inc. added the most value after the company’s shares increased more than 75% in the period. Amazon’s shares outperformed the broader market as the company benefited from recent investments in logistics and distribution to meet sustained COVID-related demand. Performance in the sector was also lifted by Latin American digital marketplace MercadoLibre, Inc., whose shares almost tripled as the COVID-19 pandemic accelerated the shift from brick and mortar consumption to e-commerce and from traditional forms of payments to digital. This was evident in the resilient volumes MercadoLibre experienced in both gross merchandise value and payments across different verticals and geographies. Within Real Estate, gains from data center REIT Equinix, Inc. were partly offset by higher exposure to this underperforming sector. Equinix’s stock price benefited from robust quarterly bookings, accelerating cloud adoption trends, and continued execution on strategic M&A transactions to enhance its moat.

Cash exposure in a sharp up market and higher exposure to the poor performing Financials sector through sizeable positions in S&P Global Inc. and CME Group, Inc. weighed the most on relative results.

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.