Baron International Growth Fund: Latest Insights and Commentary

CONTRIBUTORS

• Semiconductor giant Taiwan Semiconductor Manufacturing Company Limited (TSMC) contributed in the second quarter due to expectations for a continued strong cyclical recovery in semiconductors and significant incremental demand for AI chips. We retain conviction that TSMC’s technological leadership, pricing power, and exposure to secular growth markets, including high-performance computing, automotive, 5G, and IoT, will allow the company to sustain strong double-digit earnings growth over the next several years.
• HD Korea Shipbuilding & Offshore Engineering Co., Ltd. is the holding company of Hyundai Heavy, the largest global shipbuilder based on orderbook size and the global leader in high-end vessels including liquified natural gas (LNG)-powered ships. Shares contributed on strong quarterly results at subsidiary Hyundai Samho, which delivered better-than-expected margins on higher pricing. In addition, year-to-date newbuild ship order demand and pricing for the group was better than expected. We retain conviction. Korean shipbuilders have an oligopoly in LNG carrier shipbuilding, LNG dual-fueled container ships, and tankers. The tightening regulation on carbon emission, which will be fully adopted by the International Maritime Organization (IMO) by 2030, should drive higher demand for LNG dual-fueled ships as well as carbon-free ammonia-fueled ships. We expect a structural shortage of compliant ships to emerge as the IMO deadline nears, which should benefit Korea Shipbuilding given its leading position.
• Shares of Trent Limited contributed to performance during the quarter. Trent is a leading retailer in India that sells private label apparel direct-to-consumer through its proprietary retail network. Shares were up this quarter on better-than-expected quarterly sales performance as well as continued footprint expansion of its Zudio value fashion franchise. We remain investors, as we believe the company will generate over 25% revenue growth in the near-to-medium term, driven by same-store-sales growth and outlet expansion. In addition, we believe operating leverage and a growing franchisee mix will lead to better profitability and return on capital, driving more than 30% EBITDA CAGR over the next three to five years.

DETRACTORS

• Shares of Stevanato Group S.p.A detracted from performance. Stevanato sells packaging for injectable drugs. During the pandemic, the significant demand created by COVID vaccines resulted in a global shortage of vials. As a result, lead times were elongated, and customers stocked injectable drug packaging above normal inventory levels. As the supply chain situation normalized and demand for COVID vaccines declined, customers have been working through this excess inventory, leading to lower near-term vial sales and underutilized vial manufacturing capacity. We still think this is an attractive industry long term and remain investors.
• Eurofins Scientific SE is a global leader in bioanalytical testing in the food, environment, pharmaceutical, and clinical sectors. Shares fell after a short report from Muddy Waters Research alleged the CEO had a conflict of interest regarding real estate leasing as well as poor accounting standards. We think the allegations echo a short report from 2019 and believe any impact on fundamentals is not significant. Eurofins is still a market leader in higher-growth areas of testing, unlike its peers which operate in more commoditized inspection and certification.
• Semiconductor production equipment manufacturer Tokyo Electron Limited detracted in the second quarter, driven by investor concerns about a slower-than-expected near-term revenue growth recovery. We remain optimistic about Tokyo Electron's long-term prospects. We expect semiconductor production equipment spend will grow robustly for years to come, as chipmakers expand capacity to meet rising demand, with AI as a key long-term catalyst. We believe the company will remain a critical enabler of major chipmakers’ technological advancements.

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.

Baron International Growth Fund (the Fund) was up 1.25% (Institutional Shares) in the second quarter, modestly outperforming the MSCI ACWI ex USA Index (the Index) by 29 basis points. The Fund managed to separate itself from the Index because of solid stock selection, which helped overcome style-related headwinds from overexposure to the weak performing Beta factor along with underexposure to the better performing Dividend Yield, Book-to-Price, and Earnings Yield factors.

On a country level, stock selection in emerging markets (EM) contributed nearly 150 basis points of relative gains, driven by strong performance from the Fund’s investments in India, Korea, and Poland. Higher exposure to EM also proved beneficial, as strength in Taiwan, India, and China helped EM equities meaningfully outperform their developed market counterparts following a couple quarters of relative weakness. Largely offsetting the above was disappointing stock selection in developed markets, where the Fund’s European investments were a material drag on performance for a fourth consecutive quarter. Weakness in Europe was mostly attributable to poor performance in the U.K., Italy, the Netherlands, France, and Denmark.

From a sector or theme perspective, stock selection was modestly positive overall thanks to solid performance from the Fund’s digitization and EM consumer holdings in the Industrials, Consumer Discretionary, Communication Services, and Real Estate sectors. Strength in Industrials was driven by an assortment of holdings in the sustainability/ESG (HD Korea Shipbuilding & Offshore Engineering Co., Ltd. and HD Hyundai Heavy Industries Co., Ltd.), digitization (InPost S.A. and Full Truck Alliance Co. Ltd.), Japan staffing (Recruit Holdings Co., Ltd.), fintech disruption (Experian plc), and EM consumer (InterGlobe Aviation Limited) themes. Indian retailer Trent Limited (EM consumer) and Korean e-commerce leader Coupang, Inc. (digitization) were responsible for most of the relative gains in Consumer Discretionary, while Indian telecommunications company Bharti Airtel Limited (digitization) led the way in Communication Services. Performance in Real Estate was bolstered by Indian real estate developer Godrej Properties Limited, which is part of the Fund’s EM consumer theme.

Somewhat offsetting the above was adverse stock selection in Health Care, Materials, and Financials, attributable to declines from several holdings in the biotechnology/diagnostics, sustainability/ESG, best-in-class/high-quality growth, and fintech disruption themes. Biotechnology/diagnostics holdings Stevanato Group S.p.A (Italy), Eurofins Scientific SE (France), and Genmab A/S (Denmark) were generally responsible for the relative shortfall in Health Care after their share prices fell double digits in the period. Weakness in Materials came from British industrial gases and engineering company Linde plc (best-in-class/high-quality growth) and sustainability/ESG leaders AMG Critical Materials N.V. (Netherlands) and Suzano S.A. (Brazil). Poor stock selection in Financials was driven by sharp declines from Brazilian investment management company XP Inc. (fintech disruption) and financial instruments exchange operator Japan Exchange Group, Inc. (best-in-class/high-quality growth). Stock selection in Information Technology (IT) was another drag on performance, but this negative effect was mostly offset by the Fund’s higher exposure to this better performing sector. Performance in IT was hindered by declines from China value-added holdings Tokyo Electron Limited and Kingdee International Software Group Company Limited.