Review and Outlook

as of 12/31/23

Following a three-month downturn, the markets went on a bull run in the last two months of the year. Improving inflation data coupled with dovish comments from the Federal Reserve spurred an “everything rally.” In a significant shift from its earlier stance, the Fed suggested it was planning three interest rates cuts over 2024. The end of “higher for longer” rate fears especially boosted growth and small-cap stocks, as the market views these categories as beneficiaries of lower rates. Despite low unemployment and robust consumer spending – typically viewed as inflation drivers -- inflation continued to trend lower, with the annual inflation rate dropping to 3.4% in December. Investor fears of a recession were replaced by optimism that the Fed had successfully orchestrated a “soft landing,” generating further cause for cheer on top of the prospect that the Fed would soon start cutting interest rates.

Baron Partners Fund increased in the quarter. Holdings in Industrials, Information Technology (IT), and Real Estate contributed the most to performance. Top contributor Space Exploration Technologies Corp. drove positive performance within Industrials, while third largest contributor Gartner, Inc. led appreciation within IT. Real estate gains were led by CoStar Group, Inc. after shares of this marketing and data analytics provider to the real estate industry rose on multiple expansion. Despite challenging commercial real estate headlines, we believe trends in the company’s core subscription offerings remain strong, and we are increasingly encouraged by growing traction in CoStar’s nascent residential offering, which is making remarkable progress. Communication Services detracted from performance, with second largest detractor X Holding Corp. leading declines within the sector.

Looking ahead, we are encouraged by recent signs of recovery in the markets and the U.S. economy. However, as long-term investors who have lived through numerous market cycles, 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 attractive valuations should result in strong returns over time.

Top Contributors/Detractors to Performance

as of 12/31/23

Contributors

  • Space Exploration Technologies Corp. (SpaceX), a high-profile private company founded by Elon Musk designs, manufactures, and launches rockets, and satellites. Shares contributed to performance in the wake of another record-breaking year. The company closed 2023 with a record 96 Falcon rocket launches, nearly twice a week on average, substantially more than the 61 launches in 2022 and surpassing all its private and government program peers. Starlink, SpaceX's satellite constellation, also achieved remarkable milestones, including operating over 5,500 satellites, the majority of active satellites in space, and now providing connectivity services to 2.3 million active customers, more than doubling its customer base during the year. Starship, SpaceX's groundbreaking new rocket, successfully performed its second test flight this quarter. Over time, SpaceX expects Starship to both reduce costs and expand SpaceX's operational capabilities, including supporting SpaceX's long-term goal to enable human beings to inhabit Mars. We value SpaceX using a proprietary valuation model and recent financing transactions, which trended positively even through a more complex funding environment.
  • Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. contributed to performance during the quarter. While foot traffic to veterinary clinics in the U.S. remained subdued, IDEXX’s excellent execution has enabled the company to continue to deliver robust financial results. We believe IDEXX’s competitive trends are outstanding, and we expect new proprietary innovations and field sales force expansion to be meaningful contributors to growth in 2024. We see increasing evidence that long-term secular trends around pet ownership and pet care spending have been structurally accelerated, which should help support IDEXX’s long-term growth rate.
  • Shares of Gartner, Inc., a provider of syndicated research, soared after reporting excellent quarterly earnings results. Gartner’s core subscription research businesses continued to compound at attractive rates, and growth is poised to accelerate over the next several quarters. We believe Gartner will emerge as a critical decision support resource for every company evaluating the opportunities and risks of AI for its business. We expect this development to provide a tailwind to Gartner’s volume growth and pricing realization over time. Gartner’s sustained revenue growth and focus on cost control should drive continued margin expansion and enhanced free cash flow generation. The company’s balance sheet is in excellent shape and can support aggressive repurchases and bolt-on acquisitions, in our view.

Detractors

  • Tesla, Inc. designs, manufactures, and sells electric vehicles, related software and components, and solar and energy storage products. The stock detracted as the core automotive segment remained under pressure due to a complex macroeconomic environment, higher interest rates, factory shutdowns, and Tesla’s price reductions throughout the year, presenting pressure on the near-term growth and margin profile. Nonetheless, Tesla continued to generate sufficient gross profit to support a robust product development plan that can propel the automotive segment higher over time. Tesla also started to deliver its highly anticipated Cybertruck, its first pickup truck with tremendous amount of consumer interest and a slew of new technologies within the car and its manufacturing lines. The refreshed Model 3 also seems to be generating strong demand while improving unit-level economics. Lastly, while early, investors now expect Tesla to benefit from its investment in AI through development of autonomous driving technology Dojo (an AI training compute), autobidder (an automated energy trading platform), and humanoid (a human-like robot).
  • With a vision to become the virtual "town square" and "everything app," X (formerly Twitter) embarked on a transformative journey. Elon Musk led the acquisition of Twitter in October 2022 through X Holding Corp. Post-acquisition, the company experienced a material reduction in revenue and reduced advertising spend by several of its largest customers. On the plus side, the company witnessed improvements in user engagement while rapid product innovation should allow it to grow and diversify its revenues over time. X also announced a technical partnership and equity ownership in Elon Musk's generative AI startup, X.AI. Taking into account significant changes in the business and macroeconomics since the acquisition as well as the first post-acquisition equity transaction, an internal equity grant to employees, we marked down the stock price to ensure it accurately reflected the current state of the business and aligned with our proprietary valuation model. We continue to believe in the importance and unique value X can offer to the ecosystem and closely follow product innovation and its potential implications.
  • Shares of specialty insurer Arch Capital Group Ltd. gave up some gains in the fourth quarter after solid performance for most of the year. We believe the share price weakness was primarily due to a sector rotation away from defensive stocks to more speculative stocks following a decline in interest rates. Company fundamentals remained strong, with net premiums written growing 23%, operating ROE expanding to 25%, and book value per share rising 30% in the third quarter. Management expects favorable market conditions will persist. We continue to own the stock due to Arch’s experienced management team and our expectation of solid growth in earnings and book value.

Quarterly Attribution Analysis (Institutional Shares)

as of 12/31/23

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 12/31/23

Baron Partners Fund (Institutional Shares) rebounded 8.39% in the fourth quarter, yet failed to keep pace with the Russell Midcap Growth Index as disappointing stock selection overshadowed positive impacts from style biases, leverage, and active sector weights.

The Fund uses leverage to enhance returns, although this does increase the volatility of returns. As of December 31, 2023, the Fund had 114.1% of its net assets invested in securities, and the use of leverage in a rising market added 220-plus basis points of relative gains.

Apart from leverage, other positive highlights came from stock selection in Industrials and Health Care, where private rocket and spacecraft manufacturer Space Exploration Technologies Corp. (SpaceX) and veterinary diagnostics leader IDEXX Laboratories, Inc. led the way. SpaceX shares contributed to performance in the wake of another record-breaking year. The company closed 2023 with a record 96 Falcon rocket launches, nearly twice a week on average, substantially more than the 61 launches in 2022 and surpassing all its private and government program peers. Starlink, SpaceX's satellite constellation, also achieved remarkable milestones, including operating over 5,500 satellites, the majority of active satellites in space, and now providing connectivity services to 2.3 million active customers, more than doubling its customer base during the year. Starship, SpaceX's groundbreaking new rocket, successfully performed its second test flight this quarter. Over time, SpaceX expects Starship to both reduce costs and expand the company's operational capabilities, including supporting SpaceX's long-term goal to enable human beings to inhabit Mars. We value SpaceX using a proprietary valuation model and recent financing transactions, which trended positively even through a more complex funding environment.

IDEXX was able to overcome subdued foot traffic to veterinary clinics in the U.S. through excellent execution, which enabled the company to continue delivering robust financial results. Traffic to clinics now appears to be rebounding, and we expect this to lead to accelerated revenue growth. We believe IDEXX’s competitive trends are outstanding, and we expect new proprietary innovations to contribute to growth in 2024 and beyond. We see increasing evidence that long-term secular trends around pet ownership and pet care spending have been structurally accelerated, which should help support IDEXX’s long-term growth rate.

These gains were undone by adverse stock selection in Consumer Discretionary, Financials, and Communication Services, where declines from a handful of holdings proved costly. The Fund’s Consumer Discretionary holdings detracted nearly 800 basis points from relative performance, with electric vehicle manufacturer Tesla, Inc. accounting for most of the losses in the sector. Tesla’s shares fell slightly as the core automotive segment remained under pressure due to a complex macroeconomic environment, higher interest rates, factory shutdowns, and Tesla’s price reductions throughout the year, presenting pressure on the near-term growth and margin profile. Nevertheless, Tesla continued to generate sufficient gross profit to support a robust product development plan that can propel the automotive segment higher over time. Tesla also started to deliver its highly anticipated Cybertruck, its first pickup truck with a tremendous amount of consumer interest and a slew of new technologies within the car and its manufacturing lines. The refreshed Model 3 also seems to be generating strong demand while improving unit-level economics. Lastly, while early, investors now expect Tesla to benefit from its investment in artificial intelligence (AI) through development of autonomous driving technology Dojo (an AI training compute), autobidder (an automated energy trading platform), and humanoid (a human-like robot). Global ski resort company Vail Resorts, Inc. also underperformed on concerns that limited snowfall would impact its results for the ski season, but we are optimistic that strong sales of season ski passes will offset this effect. The company's higher-end customer base should also provide some resiliency in earnings and cash flow.

Specialty insurer Arch Capital Group Ltd. accounted for most of the relative losses in Financials as the company gave back a portion of its strong performance from earlier in the year. We believe the share price weakness was largely due to a market rotation away from defensive securities to more speculative stocks following a decline in interest rates. Company fundamentals remained strong, with net premiums written growing 23%, operating ROE expanding to 25%, and book value per share rising 30% in the third quarter. Management expects favorable market conditions will persist. We continue to own the stock due to Arch’s experienced management team and our expectation of solid growth in earnings and book value.

Weakness in Communication Services was partly due to poor performance from Iridium Communications Inc., a mobile voice and data communications services vendor offering global coverage via satellite. Earlier in the year, Iridium announced a strategic partnership with Qualcomm seeking to integrate Iridium’s satellite communication technology into Qualcomm’s Snapdragon chip series. While this collaboration was projected to yield substantial profits for Iridium over time, Qualcomm unexpectedly backed out of the partnership in November. The decision shook investors' confidence in Iridium's direct-to-device opportunity and generated further competitive uncertainty. We retain conviction. Iridium remains a unique satellite asset and operator, with L-band spectrum, years of operational experience, relatively new satellite hardware, and hundreds of partners across verticals and geographies. In addition, management announced a commitment of $3 billion in return to shareholders between 2023 and 2030, representing a material portion of the current enterprise value.

X Holding Corp. was another reason for the relative shortfall in Communication Services after the company’s shares were revalued sharply lower in the period. Following Elon Musk’s acquisition of X (formerly Twitter) in October 2022, the company experienced a material reduction in revenue and reduced advertising spend by several of its largest customers. On the plus side, the company witnessed improvements in user engagement while rapid product innovation should allow it to grow and diversify its revenues over time. X also announced a technical partnership and equity ownership in Elon Musk's generative AI startup, X.AI. Taking into account significant changes in the business and macroeconomics since the acquisition as well as the first post-acquisition equity transaction, an internal equity grant to employees, we marked down the stock price to ensure it accurately reflected the current state of the business and aligned with our proprietary valuation model. We continue to believe in the importance and unique value X can offer to the ecosystem and closely follow product innovation and its potential implications.

as of 12/31/23

Yearly Attribution Analysis (for year ended 12/31/2023)

Baron Partners Fund (Institutional Shares) rose 43.47% for the year, meaningfully outperforming the Russell Midcap Growth Index by 17.60% due to stock selection, leverage, active sector weights, and tailwinds from an assortment of style biases.

Aside from leverage, which contributed 540-plus basis points of relative gains, the Fund’s performance was bolstered by strong stock selection in Consumer Discretionary and Health Care. Within Consumer Discretionary, electric vehicle (EV) manufacturer Tesla, Inc. was almost entirely responsible for the Fund’s outperformance in the period, contributing nearly 24% of relative gains. Tesla’s shares rebounded after coming under significant pressure towards the end of 2022 due to investor concerns about macroeconomic uncertainty, softer demand, stronger competition, and headwinds to profitability. Throughout 2023, Tesla experienced a degradation in margins as it reduced prices, but, while margins declined, they remained healthy, allowed robust investments in growth, and significantly outperformed the negative EV margins of the vast majority of its competitors. 2023 also represented a record year for the Energy division's revenues and margins. Tesla continued to demonstrate its innovation engine, including launching its highly anticipated Cybertruck, initiating the production of its Dojo compute, releasing important updates to its Autopilot solution, and expanding its battery activities.

Another material contributor was global hotelier Hyatt Hotels Corporation, whose shares increased nearly 45% in the period. The company reported strong demand across its portfolio, led by robust leisure travel and improvement in its business transient and group segment that is now pacing above pre-COVID levels. Room rate increases are generating solid margins and cash flow. Hyatt's sound, underleveraged balance sheet keeps it well positioned should we enter a possible downturn in 2024. The hotel transaction market is improving, and the company has two properties for sale that should close in early 2024, resulting in an attractive business model in which more than 80% of revenue will be generated from fees with the remainder from owned assets. Apart from stock selection, the Fund benefited from its significantly higher exposure to this strong performing sector, which was up over 30% in the index.

A portion of the gains in Health Care came from the Fund’s limited exposure to lagging biotechnology and life sciences tools & services stocks, which were a major drag on performance in the index. Stock selection was also positive in the sector owing to solid performance from IDEXX Laboratories, Inc., a global leader in pet healthcare innovation. IDEXX’s shares contributed to performance for the year, helped by financial results that beat consensus expectations and multiple expansion. We retain conviction given IDEXX’s outstanding competitive trends. We expect new proprietary innovations and field sales force expansion to be meaningful contributors to growth in 2024. We see increasing evidence that secular trends around pet ownership and pet care spending have been structurally accelerated, which should help support IDEXX’s growth rate over the long term.

Somewhat offsetting the above was adverse stock selection in Financials coupled with limited exposure to strong performing software stocks within Information Technology, which together detracted 900-plus basis points from relative performance. Weakness in Financials was driven by a difficult year for online brokerage firm The Charles Schwab Corp., whose shares came under significant pressure following the March bankruptcy of Silicon Valley Bank (SVB). Despite running a much different business than SVB, Schwab faced deposit pressure through cash sorting in the wake of the collapse, resulting in near-term weakness in earnings estimates and the share price. We retain long-term conviction. Schwab continued to gain new assets and expected rate cuts by the Federal Reserve in 2024 should help the company pay off some of its short-term funds, ultimately providing a boost to earnings. Over the long run, we believe Schwab has powerful asset-gathering momentum and scale and a reinvestment tailwind from maturing securities being invested at higher rates. We are encouraged by Schwab’s exceptional client loyalty levels, robust organic growth, and industry-leading operating expense per client assets, and we believe the company is well positioned to retain clients and increase long-term earnings growth.

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.