Review and Outlook

as of 03/31/22

After a strong 2021, a convergence of negative factors set the stage for a difficult start to 2022. U.S. stocks closed out the worst three months since the first quarter of 2020 - the “COVID shutdown quarter.” Growth stocks took the biggest hit as investor fears of rising interest rates, inflation, and a slowing economy prompted a steep risk-off rotation. Russia’s invasion of Ukraine added another level of uncertainty. However, we expect the United States to be impacted less than many other economies given its energy independence and lower share of commodity consumption in GDP.

While consumer sentiment worsened in response to higher prices, the U.S. labor market remained healthy. Moreover, U.S. households now have over $2.5 trillion more in savings than before the pandemic, which offers some cushion in the face of rising costs. While the Fed appears committed to monetary tightening, this risk factor for markets is now largely priced in. Overall, we think 2022 still looks to be a year of above-trend growth, as strong household and corporate balance sheets keep the economy on solid ground.

Baron Partners Fund declined in the quarter. No sector contributed. The Information Technology (IT), Communication Services, and Industrials sectors detracted the most. All six IT holdings gave up gains, led by second largest detractor Shopify Inc. Top detractor Spotify Technology SA drove declines within Communication Services and third largest detractor CoStar Group, Inc. drove weak performance within the Industrials sector.

While market volatility can be nerve-wracking, over our 40 years of managing money, we have seen multiple cycles and periods like this. As long-term investors, we are committed and disciplined in our process, strategy, and philosophy. We believe the slow-to-moderate-growth, low-rate market environment since the financial crisis is now transitioning to one that will be marked by higher inflation and interest rates. Stock returns dispersion, a measure of market breadth, is now well above its average since the financial crisis. In this environment, we believe stock selection becomes more important as companies navigate more challenging conditions with differing degrees of success. We believe this strategy is best achieved through a focus on high quality companies – e.g., those with strong free cash flow, healthy balance sheets, and the like – something we have always emphasized at Baron.

Top Contributors/Detractors to Performance

as of 03/31/22

Contributors

  • Tesla, Inc. designs, manufactures, and sells electric vehicles, solar products, energy storage solutions, and batteries. Despite a complex supply-chain environment, shares increased on continued strong growth and record profitability. Robust demand and operational optimization allow the company to offset inflationary pressure, and vertical integration enables flexibility around supply bottlenecks. Moreover, we expect new localized manufacturing capacity to drive additional optimization while software initiatives, including the autonomous driving program, are accelerating.
  • Arch Capital Group Ltd. is a specialty insurance company based in Bermuda. The stock increased after reporting quarterly earnings that exceeded consensus estimates and 11% growth in book value per share. Pricing trends remain favorable in the property & casualty insurance market, and margins for the mortgage insurance business improved substantially from last year’s cyclically depressed levels as delinquencies decline. We continue to own the stock due to Arch’s strong management team and our expectation of solid growth in earnings and book value.

Detractors

  • Spotify Technology S.A. is a leading digital music service available in over 175 international markets, offering on-demand audio streaming through paid premium subscriptions as well as a free ad-supported model. Shares were down given controversy around Joe Rogan, a podcaster exclusive to Spotify's platform, along with broader macro concerns. We view Spotify as a long-term winner in audio streaming with potential to reach more than one billion monthly active users, driven by its scalable core music product and growing library of spoken-word content.
  • Shopify Inc. is a cloud-based software provider offering an operating system for multi-channel commerce. Shopify has been adopted by over two million merchants that processed $175 billion of gross merchandise volume in 2021, making it the second largest e-commerce player in the U.S. The stock corrected due to the normalization in e-commerce from the early stages of the pandemic and the rotation out of fast-growth stocks. We believe Shopify has a long runway for growth as it has less than 1% of global commerce spend.
  • Real estate data and marketing platform CoStar Group, Inc. detracted from results as valuations for high-growth technology stocks compressed. The company is pushing into the residential market, which meaningfully expands its total addressable market. While this initiative requires meaningful short-term investment, it should ultimately yield high returns and enhance the company’s growth and profitability.

Quarterly Attribution Analysis (Institutional Shares)

as of 03/31/22

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 03/31/22

Baron Partners Fund (Institutional Shares) declined 5.84% in the first quarter, yet outperformed the Russell Midcap Growth Index by 674 basis points as favorable stock selection overshadowed adverse impacts from leverage and differences in sector weights.

The Fund uses leverage to enhance returns, although this does increase the volatility of returns. As of March 31, 2022, the Fund had 110.8% of its net assets invested in securities, and the use of leverage in a down market detracted 80-plus basis points from relative performance.

Outperformance of investments in Consumer Discretionary, Financials, and Industrials added the most value. Electric vehicle manufacturer Tesla, Inc. accounted for most of the relative gains in the Consumer Discretionary sector as the company continued to report strong growth and record profitability despite a complex supply-chain environment. Global hotelier Hyatt Hotels Corp. also performed well given the company’s ability to reprice its rooms on a daily basis, which should lead to stronger margins despite a challenging inflationary environment. Favorable stock selection in Consumer Discretionary was somewhat offset by the Fund’s significantly higher exposure to this lagging sector, which was down more than 16% in the index. Strength in Financials was largely due to the outperformance of specialty insurer Arch Capital Group Ltd. and online brokerage firm The Charles Schwab Corp. Arch was the second largest contributor after reporting above-consensus quarterly earnings and 11% growth in book value per share. Pricing trends remain favorable in the property & casualty insurance market, and margins for the mortgage insurance business improved substantially from last year’s cyclically depressed levels as delinquencies decline. Schwab’s shares were lifted by the potential for higher profits from rising interest rates given the company’s nearly $600 million of interest-earning assets. Private rocket and spacecraft manufacturer Space Exploration Technologies Corp. bolstered performance in the Industrials sector after the company’s shares were revalued higher using a proprietary valuation model.

Aside from leverage, underperformance of investments in Information Technology (IT) and lack of exposure to the top performing Energy sector detracted the most from relative results. Weakness in IT was driven by cloud-based commerce platform Shopify Inc. and payment company Adyen N.V., whose shares were hurt by the rotation out of high-multiple growth stocks during the quarter. Shopify’s stock price was also negatively impacted by the normalization in e-commerce from the early stages of the pandemic.

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.