Review and Outlook

as of 09/30/22

Although the U.S. equity market stabilized somewhat in the three-month period, 2022 continued to prove to be a challenging year. Sticky inflation data, the expectation of more rate hikes, slowing growth, and the potential for a recession weighed heavily on investor sentiment, and the September quarter ended close to 2022 lows.

U.S. economic signals were mixed. Despite two consecutive quarters of negative GDP growth and near-record lows in consumer confidence, the labor market continued to show unusual strength, and household and company balance sheets overall remained healthy. Inflation stayed stubbornly high, driven by a spike in energy costs, lingering global supply-chain issues, pent-up demand as economies re-opened, and payroll and wage increases as businesses rushed to staff up to meet demand. That said, the Fed’s tighter monetary policy appears to be slowly cooling down some parts of the economy – in particular, the housing market. A concern now is that the Fed will overcorrect and spark a recession. We are starting to see some businesses taking steps in preparation for tougher times ahead, reducing budgets for non-essential functions, shelving technology upgrades, and making other cutbacks.

Baron Partners Fund increased in the quarter. Consumer Discretionary, Financials, and Industrials holdings contributed the most to performance. Health Care and Real Estate investments detracted. Top contributor Tesla, Inc. led positive returns within Consumer Discretionary. Hyatt Hotels Corp. was another notable contributor within the sector after shares of this global hotelier increased on strong revenue-per-available-room results as business travel continued to recover from pandemic lows. Gains within Financials were led by third largest contributor The Charles Schwab Corp. Second largest contributor CoStar Group, Inc. drove appreciation within the Industrials sector. Health Care lost some ground, led by second largest detractor Figs Inc. Declines within the Real Estate sector were the result of a decline in the share price of Douglas Emmett, Inc., an office REIT with properties in Los Angeles and Hawaii.

As long-term investors who have lived through multiple bear markets, downturns, and even recessions, we have learned not to try to predict the unpredictable. Instead, we focus on identifying and researching well-managed unique businesses with durable competitive advantages and compelling growth prospects and investing in them at attractive prices. We think the combination of unchanged long-term growth outlooks and more compelling valuations should result in attractive returns over time.

Top Contributors/Detractors to Performance

as of 09/30/22

Contributors

  • Tesla, Inc. manufactures electric vehicles (EVs), related software offerings, solar and energy storage products, and battery cells. Shares rose on increased production volumes from Tesla's global factories, new full self-driving functionality, manufacturing techniques that improve quality and reduce costs, and industry-leading margins despite complex COVID-related shutdowns. A new federal tax incentive program should also provide material benefits for Tesla's differentiation, margins, and demand. We remain investors in this uniquely innovative company leading the EV revolution.
  • Shares of real estate data and marketing platform CoStar Group, Inc. contributed to performance on strong financial results and its addition to the S&P 500 Index. We believe the company is well positioned to benefit from the continuing migration of real estate market spend to online channels. CoStar is investing aggressively to build out its residential marketing platform, which will launch later in 2022 and offers significant upside potential, in our view. CoStar has over $4.7 billion of cash on its balance sheet, which we expect it to begin to deploy for opportunistic M&A.
  • Shares of The Charles Schwab Corp., an online brokerage firm, rose in the quarter, buoyed by investor expectations that rising interest rates will lead to increased profits on the company’s more than $600 billion in interest-earning assets. We are also encouraged by Schwab's organic growth. Despite turbulent markets, the company attracted over $400 billion of net new client assets over the past 12 months. We also believe Schwab’s operating expense per client assets should drop to record low levels once equity markets improve.

Detractors

  • Space Exploration Technologies Corp. (SpaceX) is a high-profile private company founded by Elon Musk that designs, manufactures, and launches rockets, satellites, and spacecrafts. Its ultimate goal is to make humanity multi-planetary. Products include reusable orbital launch offering and a broadband service leveraging its satellite constellation, Starlink. We value SpaceX using prices of recent financing transactions and a proprietary valuation model.
  • Figs Inc. is the largest direct-to-consumer platform in health care apparel. While the company reported quarterly results that beat consensus and reaffirmed its outlook for the rest of the year, shares fell due to market-related weakness in late September. Despite macroeconomic uncertainty, we believe Figs will be more resilient than other apparel categories as its products are largely non-discretionary and replenishment-driven. We also believe Figs can continue to expand its customer base due to its superior product offering.
  • Shares of P&C insurance software vendor Guidewire Software, Inc. detracted from performance due to broader multiple compression in high-growth stocks. We remain shareholders. Guidewire has crossed the midpoint of its cloud transition, which should correspond with improving financial results. Guidewire has tripled its potential market through new products and cloud delivery. Over time, we think Guidewire will be the key software vendor for the global P&C insurance industry, with 30% to 50% of its $15 billion to $30 billion total addressable market and margins above 40%. 

Quarterly Attribution Analysis (Institutional Shares)

as of 09/30/22

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 09/30/22

Baron Partners Fund (Institutional Shares) appreciated 10.00% in the third quarter, meaningfully outperforming the Russell Midcap Growth Index by 10.65% due to stock selection and tailwinds from style biases, notably overexposure to the strong performing Beta factor and underexposure to the poor performing Leverage and Earnings Yield factors.

The Fund uses leverage to enhance returns, although this does increase the volatility of returns. As of September 30, 2022, the Fund had 114.9% of its net assets invested in securities, and the use of leverage in a roughly unchanged market did not materially impact relative performance.

Investments in Consumer Discretionary, Financials, and Communication Services along with significantly lower exposure to the lagging Health Care sector added the most value. Favorable stock selection in Consumer Discretionary accounted for about 85% of the outperformance in the period, with most of the strength coming from electric vehicle manufacturer Tesla, Inc. Tesla was the largest contributor due to increased production volumes from the company’s global factories, new full self-driving functionality, manufacturing techniques that improve quality and reduce costs, and industry-leading margins despite complex COVID-related shutdowns. Global hotelier Hyatt Hotels Corp. also performed well in the sector due to strong revenue-per-available-room results as business travel continued to recover from pandemic lows. While leisure rates dropped a little in the seasonally slower back-to-school period, this decline was expected and was more than offset by increases in business transient and group bookings. Aside from stock selection, the Fund’s meaningfully higher exposure to this better performing sector contributed another 70 basis points to relative performance. Performance in Financials was bolstered by online brokerage firm The Charles Schwab Corp. and investment management tools provider FactSet Research Systems, Inc. Schwab’s shares were buoyed by investor expectations that rising interest rates will lead to increased profits on the company’s more than $600 billion in interest-earning assets. We are also encouraged by Schwab's organic growth. Despite turbulent markets, the company attracted over $400 billion of net new client assets over the past 12 months. Similarly, FactSet continued to perform quite well in the quarter, with the company’s earnings demonstrating strong revenue growth. Stock-specific strength in Communication Services came from satellite communications company Iridium Communications Inc., whose shares appreciated 18% as expectations for smartphone compatibility increased after the company announced a related development agreement and other market participants revealed similar capabilities. Additionally, the company reported record quarterly results, featuring accelerating revenue growth and strong profitability.

Underexposure to the top performing Information Technology and Energy sectors were the only material detractors 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.