Review and Outlook

as of 06/30/20

The market backdrop during the period was unprecedented. The stock market rally was fueled, first and foremost, by an accommodative – to put it mildly – Federal Reserve. On top of that, investors focused on stepped-up reopening efforts, positive economic momentum off the depths reached in March, COVID-19 treatment and vaccine optimism, and corporate commentary highlighting sequential improvements in consumer demand and business trends.

Baron Opportunity Fund increased in the quarter. All sectors contributed, led by Information Technology (IT), Consumer Discretionary, and Communication Services. IT's exceptionally strong performance included four stocks that more than doubled in the quarter and 23 others that increased by double digits. Third largest contributor Microsoft Corporation led appreciation within the sector. Gains within Consumer Discretionary were led by top contributor Tesla, Inc., whose shares more than doubled in the quarter, and second largest contributor Amazon.com, Inc. ZoomInfo Technologies Inc., which operates a cloud-based B2B intelligence platform, led performance within Communication Services after its successful IPO in early June.

Even with the market’s stunning recovery, there is still a great deal of uncertainty about the COVID-19 pandemic, the next stage of the U.S. and global economic recovery, the 2020 election, relations with China, what the Fed and/or Congress will do next, and the market’s future direction. However, we don’t have to answer the unanswerable. As we have always done, we continue to focus our research, analysis, and investment decisions on identifying the powerful, durable secular growth trends that will drive economic growth going forward, regardless of short-term economic cycles or stock market gyrations, and the companies that are leading or riding those trends and possess sustainable competitive advantages, profitable business models, and long-term oriented managers.

We are convinced that our investments and themes, many of which thrived and proved vital during this period, will be even stronger in the post-COVID-19 world. A major disruptive trend underlying many of our secular themes and investments is known by the phrase “digital transformation”: the process of using digital technologies to create new or modify existing products and services to deliver better customer, user, and employee experiences to meet evolving business and market needs. Digital transformation captures changes in commerce/retail, cloud computing, cybersecurity, big data and artificial intelligence, mobile, digital media and advertising, electronic payments, and other digital trends. It is even impacting health care and real estate businesses. In our view, consumer and business responses to the crisis have only accelerated these changes.

Top Contributors/Detractors to Performance

as of 06/30/20

Contributors

  • Tesla, Inc. designs, manufactures and sells electric vehicles, solar products and energy storage solutions. Despite significant operational COVID-19-related disruptions, the stock rose on strong Q1 delivery numbers, unit economics of mature and new vehicle programs that beat Street estimates, and significant growth in production from its new factory in Shanghai. With reduced business model risks, the stock is benefiting from Tesla's investments in growth as evidenced by its opportunities around Model Y and CyberTruck and its localization of manufacturing in China and Europe. 
  • Amazon.com, Inc. is the world’s largest retailer and cloud services provider. Shares rose on strong first quarter results as Amazon benefited from investments in logistics and distribution to meet increased COVID-19-related demand. While e-commerce penetration is rising rapidly and Amazon continues to grow its addressable market by entering new verticals, we believe the more material driver of growth is Amazon Web Services (AWS). AWS is the leader in the vast and growing cloud infrastructure market, and we expect this business to compete in application software as well.
  • Microsoft Corporation is a software mega cap that has successfully pivoted from the client-server and PC era to today’s world of digital transformation and cloud. Microsoft is a cloud leader through its Azure, Office 365, Dynamics 365, and Teams offerings, among others. Shares increased as Microsoft’s transition to cloud-based subscriptions has made its business more durable in downturns, with 90% of its commercial revenue base paid on an annuity basis. Microsoft also stands to benefit from the acceleration of digital transformation trends driven by the pandemic.

Detractors

  • Applied Therapeutics, Inc. is a biotechnology company developing a class of drugs called aldose reductase inhibitors for the treatment of an orphan disorder called Galactosemia. Shares fell during the period held in the quarter given a debate on the clinical meaningfulness of Phase 2 test results reported in April. We retain conviction based on the unmet need in the disease and the potential expansion opportunity for the drug into rare neuropathies and diabetes complications.
  • Defense company Kratos Defense & Security Solutions, Inc. detracted from performance during the period held due to market volatility as we built our position in late June. We believe revenue will grow substantially as Kratos pioneers low cost, force multiplying, autonomous jet drones that could replace a significant number of manned missions. Kratos is growing rapidly in additional markets like small jet engines, space, secure communications, hypersonics, and missile defense. We believe these technologies should drive Kratos’ revenue growth in any government defense budget environment.

Quarterly Attribution Analysis (Institutional Shares)

as of 06/30/20

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 06/30/20

Baron Opportunity Fund (Institutional Shares) rallied 39.78% in the second quarter and significantly outperformed the Russell 3000 Growth Index by almost 12% due to stock selection and, to a lesser extent, relative sector/sub-industry weights and an assortment of style biases.

Investments in Information Technology (IT), Consumer Discretionary, Health Care, and Communication Services and lack of exposure to the lagging Consumer Staples sector contributed the most to relative results. Stock selection in IT accounted for approximately a third of the Fund’s outperformance in the period, led by triple-digit gains from web development services provider Wix.com Ltd., cloud-based monitoring and analytics platform Datadog, Inc., Communications-Platform-as-a-Service company Twilio Inc., and internet advertising demand-side platform The Trade Desk. These businesses accelerated due to increasing digitization trends as a result of COVID-19. Higher exposure to strong performing internet services & infrastructure and application software stocks, which were up 40% or more in the index, also added value. Strength in Consumer Discretionary was driven by electric vehicle manufacturer Tesla, Inc. and online used car retailer Vroom, Inc., whose share prices more than doubled in the period. Tesla was the top contributor on an absolute basis after the company’s quarterly delivery numbers and unit economics of mature and new vehicle programs surpassed Street expectations. Investors were also impressed by the significant growth in production from Tesla’s new factory in Shanghai. Vroom’s shares were up sharply following the company’s well-received IPO in early June. Higher exposure to strong performing internet & direct marketing retail stocks through positions in Amazon.com, Inc., Alibaba Group Holding Limited, Trainline Plc, and MercadoLibre, Inc. also added value. Within Health Care, lack of exposure to underperforming pharmaceutical stocks and sharp gains from biotechnology company argenx SE and chemical simulation software leader Schrodinger, Inc. lifted relative results. Argenx’s shares rose sharply following the company’s successful Phase 3 trial in Myasthenia Gravis, where the data quality all but ensures regulatory approval and commercial launch over the next 12 months. Schrodinger’s stock price continued to advance as investors increasingly recognized it as a unique and competitively advantaged business. Communication Services holdings outperformed after appreciating 44% as a group, with marketing solutions provider ZoomInfo Technologies Inc. and social network Snap Inc. leading the way. ZoomInfo’s stock price was up sharply following the company’s successful IPO in early June, while Snap’s shares increased after daily active users and revenue topped Street estimates despite a challenging advertising market environment.

Cash exposure in a sharp up market detracted the most from relative performance.

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.