Review and Outlook

as of 03/31/23

Stocks rose sharply to start the year on investor hopes 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 financial 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 the market sold off. Federal regulators quickly intervened to backstop bank depositors and to prevent contagion into the rest of the banking sector, helping the market to end the quarter on a rebound.

Against this backdrop, Baron Opportunity Fund increased in the quarter. Information Technology (IT), Consumer Discretionary, and Communication Services investments contributed the most to performance. Holdings within the Industrials and Health Care sectors detracted materially. With the rebound in mega-cap technology growth stocks, IT had a robust quarter, led by top contributor NVIDIA Corporation and third largest contributor Microsoft Corporation. Positive returns within Consumer Discretionary were led by second largest contributor Tesla, Inc. Amazon.com, Inc. also was a noteworthy contributor within the sector after shares of the world’s largest retailer and cloud services provider rose on positive commentary and actions around cost discipline as well as the broader technology rally. Second largest detractor CoStar Group, Inc. drove declines within Industrials and third largest detractor Arrowhead Pharmaceuticals, Inc. led weakness within Health Care.

As we sit here today, the data and consensus expert opinions suggest that peak rates for U.S. Treasuries (not fed funds, where another 25 basis points increase is widely anticipated) and peak inflation may now be in the rear-view mirror. Looking at the road ahead, consensus expectations are consolidating that a recession is likely, with the banking crisis and tighter credit conditions bolstering this view. The range of projections is too wide to call if it will be short and shallow or long and deep. Bull and bear debates abound regarding market timing (did we bottom in October or are we in a bear market rally?), whether the negative of a weakening economy or the positive of lower rates on valuations influence stocks more, and which sectors or styles will lead the market’s next phase. While we stay informed on these issues, we eschew making portfolio decisions based on market or macro projections and continue to “run our play,” managing a relatively more concentrated portfolio for the long term with an emphasis on the secular trends we have identified.

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.
  • Tesla, Inc. designs, manufactures, and sells electric vehicles, related software and components, and solar and energy storage products. Following a rapid decline at the end of 2022, the stock rebounded in the first quarter of 2023 on investor expectations that Tesla will continue to grow and maintain industry-leading margins despite a potential recession, COVID-related concerns, competition in China, and a price reduction. In addition, after devoting considerable time to reorganizing Twitter post-acquisition, CEO Elon Musk has re-established his commitment to Tesla, while a management presentation during its analyst day provided visibility into the broad quality of talent leading Tesla. We expect Tesla to continue to lead the electrification of the automotive and energy storage markets through its vertical integration, scale, and cost leadership. As long-term shareholders, we have witnessed Tesla increase deliveries from practically zero to over 1.3 million units while proving it can reduce costs and rapidly expand its product line and manufacturing footprint. We expect Tesla's next platform to have a similar impact on company results.
  • Shares of mega cap software company Microsoft Corporation increased after results beat investor expectations. In the Consumer business, Windows revenue was roughly inline, although Surface revenue missed investor expectations due to execution issues around new hardware launches. On the Commercial side, despite some technical snafus with Azure, year-over-year revenue growth came in at more than 38%, or 1% better than guidance after missing by 1% in the prior two quarters. Stepping back from the short-term noise, in the first half of fiscal 2023, more than 70% of revenue was generated by the Commercial business, with 70% of that from Microsoft Cloud, the company's key long-term growth driver. Innovation appears to be getting even stronger, with significant enhancements in areas such as Power Apps, Security, and most recently Azure OpenAI, which the company has said it plans to infuse across the entire portfolio over time. We are confident Microsoft is well positioned to continue taking share through any downturn and come out the other side better positioned than ever.

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.
  • CoStar Group, Inc. is the leading provider of information and marketing services to the commercial real estate industry. After two straight quarters of robust performance, shares detracted during the quarter, likely due to profit taking. The company is generating robust financial performance, with net new sales growing 15% in the quarter, and margins expanding by 200 basis points excluding growth investments. We expect the company’s core businesses to continue to benefit from the migration of real estate market spend to online channels. CoStar has begun to invest aggressively in building out its residential marketing platform. We estimate CoStar invested around $230 million in this initiative in 2022, and its initial 2023 guidance implies a total investment approaching $500 million. While this is a significant upfront commitment, we believe the residential market represents a transformative opportunity. The company’s proprietary data, broker-oriented approach, and best-in-class management position it to succeed in this endeavor, in our view.
  • Arrowhead Pharmaceuticals, Inc., a biotech company specializing in RNA interference (RNAi) medications to treat a variety of diseases, detracted from performance this quarter given long gaps in an already incremental positive news flow. The company has lacked major wins in recent years, while also tallying some losses. Management's late-stage drug licensing efforts to bolster balance sheets and ensure a longer cash runway have also pressured shares by creating a challenging short-term narrative. Reinvigorating the company’s strategic story remains a key consideration for Arrowhead going forward. We also believe Arrowhead’s efforts to target RNAi to the lungs will open up a new therapeutic area of exploration. In our view, this initiative will lead to RNAi economies of scale, allow for an explosion of pipeline and collaboration opportunities, and generate a long runway for growth.

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 Opportunity Fund (Institutional Shares) was up 17.96% in the first quarter, outperforming the Russell 3000 Growth Index by 411 basis points due to differences in sector/sub-industry weights and, to a lesser extent, stock selection. Style biases also aided performance, driven by overexposure to the better performing Beta and Growth factors.

The Fund’s Information Technology (IT) and Consumer Discretionary investments were responsible for about 80% of the outperformance in the period. Within IT, higher exposure to semiconductor stocks, which were up more than 45% in the index, along with sharp gains from NVIDIA Corporation and indie Semiconductor, Inc. added the most value. NVIDIA is a fabless semiconductor mega cap company and global leader in gaming cards and accelerated computing hardware and software. The company was the largest overall contributor due to 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. The company also revealed new products that expand its addressable market such as the L4 chip, which opens the opportunity for video processing, representing 80% of internet traffic. Shares of indie, a provider of automotive semiconductors and software solutions, rose sharply after the company announced the acquisition of GEO Semiconductor and met/exceeded revenue and gross margin guidance for a seventh straight quarter since coming public. The Fund’s meaningfully higher exposure to strong performing software stocks served as another material tailwind to performance in the sector. Strength in Consumer Discretionary came from electric vehicle manufacturer Tesla, Inc., whose shares bounced back strongly during the quarter, contributing roughly 140 basis points to relative results. 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 the lagging Consumer Staples and Energy sectors coupled with no exposure to declining managed health care and pharmaceutical stocks within Health Care also bolstered performance.

These favorable impacts were somewhat offset by disappointing stock selection in Communication Services and Industrials. Adverse stock selection in Communication Services, owing largely to share price declines from marketing solutions provider ZoomInfo Technologies Inc. and video game publisher Electronic Arts Inc., was partly offset by higher exposure to this better performing sector. ZoomInfo’s shares declined as the broader software and technology spending environment, to which the company is disproportionately exposed, continued to show weakness. We are closely monitoring customer intent and spending patterns with ZoomInfo during this trickier macroeconomic time. Longer term, we believe that ZoomInfo can become a much larger company as it grows into its ever-expanding $70 billion-plus total addressable market and potentially expands into adjacencies like marketing and talent acquisition software. Electronic Arts stock declined in response to mixed quarterly earnings results where strength in FIFA, Madden, and The Sims video games was offset by weakness in Apex Legends and some smaller new releases. Management also lowered annual guidance for the coming years to account for a tougher macroeconomic backdrop. Despite the potential near-term uncertainty, we retain conviction due to an attractive valuation level, strong set of durable core franchises, and positive commentary from the CEO that the business is gaining momentum. Weakness in Industrials was driven by CoStar Group, Inc., the leading provider of information and marketing services to the commercial real estate industry. CoStar was a top detractor after earnings and guidance fell short of Street expectations due to aggressive investment in the company’s residential real estate segment. We estimate CoStar invested around $230 million to build out its residential marketing platform in 2022, and its initial 2023 guidance implies a total investment approaching $500 million. While this is a significant upfront commitment, we believe the residential market represents a transformative opportunity. The company’s proprietary data, broker-oriented approach, and best-in-class management position it to succeed in this endeavor, in our view.

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.