Review and Outlook

as of 12/31/20

In the fourth quarter of 2020, equity markets marched higher, continuing their rally of the prior two quarters. Markets looked past an alarming spike in the number of COVID-19 cases and instead focused on positive news around vaccines, the U.S. election results, and continued monetary and renewed fiscal stimulus. While growth equities underperformed value stocks, growth was still ahead by a wide margin for the year.

Baron Partners Fund increased in the fourth quarter. Consumer Discretionary, Financials, and Communication Services contributed the most. No sector detracted. All six holdings within Consumer Discretionary increased by more than 30% in the quarter, led by top contributor Tesla, Inc., which surged nearly 65%. The other five holdings within the sector, including Airbnb, Inc., which went public in December, benefited from the rotation into hard-hit travel and leisure stocks after the mid-November news that three companies had developed effective vaccines against COVID-19. Financials holdings did well in the quarter, led by The Charles Schwab Corp. Shares of this brokerage firm advanced on a market rotation into the sector as well as positive investor sentiment around Schwab's acquisition of TD Ameritrade and its ability to maintain a mid-single-digit organic growth rate even during the pandemic. Third largest contributor Zillow Group, Inc. drove positive performance within Communication Services.

We believe that while certain segments of the market will likely take longer to recover, in many cases, that likelihood is already baked into lower valuations for those companies. At the same time, we think other companies and segments of the market will continue to benefit from the acceleration in digitization and other secular trends as a result of the pandemic’s impact on the way we work, learn, socialize, and entertain ourselves.

We look at 2020 as a testament to our active, long-term approach to investing. Considering the unprecedented and unexpected effects of the pandemic on the economy and our lives, the fact that the markets have recovered all of their losses and then some since the start of the year is an outstanding outcome. The patient investor has been rewarded for staying calm during the storm.

Top Contributors/Detractors to Performance

as of 12/31/20

Contributors

  • Tesla, Inc. designs, manufactures, and sells fully electric vehicles, solar products, and energy storage solutions. The stock increased on strong financial results, including profitability that exceeded market forecasts and strong growth across different geographies and vehicle programs. Newly released full self-driving functionality could also lead to improving unit economics and growth opportunities, in our view. Lastly, Tesla joined the S&P 500 Index, a meaningful milestone that expands the potential shareholder base. 
  • Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. contributed to performance in the quarter. Veterinary visits continued to recover from lows in the early months of the pandemic, with practice visits growing at double-digit rates through October. IDEXX’s competitive trends are outstanding, and we expect new proprietary innovations and field sales force expansion to be meaningful contributors to growth. Margins are moving significantly higher, and we believe margins can exceed 30% over time.
  • Zillow Group, Inc. operates leading U.S. real estate sites, a mortgage marketplace, and the Zillow Offers home-buying business. Shares were up on strong results driven by record top-of-funnel metrics, inflection in mortgages revenue, and excellent profitability in the core business. In our view, Zillow is well-positioned to penetrate the large online real estate advertising opportunity with substantial upside from Offers, leads for Premier Agents, and Zillow Home Loans.

Detractors

  • Shares of GoodRX Holdings, Inc., which operates the nation's largest online platform providing users free access to drug pricing information and pharmacy discounts, gave back some of its heady post-IPO run on Amazon's announcement that it has entered the online pharmacy space. Although Amazon is a formidable rival, we believe its success is not assured as its participation is limited to the low-penetration mail order segment of the market while GoodRX has the advantages of the leading brand, best pricing, telehealth tie-in, and nascent opportunities in drug manufacturer referrals.
  • Shares of American Well Corporation, one of the U.S.’s largest telehealth companies for health systems, health plans, employers, and doctors, gave back some post-September IPO gains after reporting third quarter results that beat consensus but included some pull forward from the fourth quarter as well as the benefit of some nonrecurring service revenues. Full year 2020 guidance beat Street estimates but implied top line and margin deceleration, which we believe could end up being conservative, given the lack of assumed increase in pandemic-driven volumes despite the current spike.
  • Shares of FactSet Research Systems, Inc., a leading provider of investment management tools, detracted from performance. The company reported in-line, resilient FQ1 '21 earnings, but after a strong run during the early stages of the pandemic, the stock lagged during the quarter. We retain conviction in FactSet due to the large addressable market, consistent execution on both new product development and financial results, and robust free cash flow generation.

Quarterly Attribution Analysis (Institutional Shares)

as of 12/31/20

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 12/31/20

Baron Partners Fund (Institutional Shares) was up 42.87% in the fourth quarter, meaningfully outperforming the Russell Midcap Growth Index by 23.85% due to favorable stock selection. Leverage in a market rally and overexposure to the strong performing beta and residual volatility factors also added value.

The Fund uses leverage to enhance returns, although this does increase the volatility of the returns. As of December 31, 2020, the Fund had 105.3% of its net assets invested in securities, and the use of leverage in an up market contributed approximately 320 basis points to relative performance.

Aside from leverage, outperformance of investments in Consumer Discretionary and Financials, lack of exposure to the lagging Consumer Staples sector, and minimal exposure to poor performing biotechnology stocks within Health Care added the most value. Stock selection in Consumer Discretionary accounted for the entirety of the Fund’s outperformance in the period, driven by a 64.5% gain from electric vehicle manufacturer Tesla, Inc. The company was the largest contributor due to strong operating results, the release of full self-driving functionality, and inclusion in the S&P 500 Index, a meaningful milestone that expands the potential shareholder base. Leisure and hotel/timeshare operators Hyatt Hotels Corp., Vail Resorts, Inc., and Marriott Vacations Worldwide Corp. also performed well given expectations that travel will increase as several newly developed COVID-19 vaccines work to help bring an end to the pandemic. Positive stock selection in Consumer Discretionary was somewhat offset by the Fund’s meaningfully higher exposure to this underperforming sector. Strength in Financials came from brokerage firm The Charles Schwab Corp., whose recent acquisition of TD Ameritrade is proceeding as planned. The combined company should result in improved services as it cross-sells products to clients of Schwab and TD Ameritrade as well as expense synergies that should lower the cost of operation per custodial asset to industry-leading levels. Finally, Schwab has maintained an impressive mid-single-digit organic growth rate.

Lower exposure to strong performing software, semiconductor, and semiconductor equipment stocks within Information Technology and adverse stock selection in Industrials detracted the most from relative performance. Weakness in Industrials was largely due to the underperformance of CoStar Group, Inc., a real estate information and marketing services company. CoStar’s shares failed to keep pace with the broader market after meaningfully outperforming in the early stages of the COVID-19 pandemic. CoStar has experienced accelerated demand for its digital marketplace businesses as traditionally offline activities are increasingly shifting online. This trend is being partially offset by slower trends in its CRE data licensing businesses.

as of 12/31/20

Yearly Attribution Analysis (for year ended 12/31/2020)

Baron Partners Fund (Institutional Shares) surged 149.18% for the year, significantly outperforming the Russell Midcap Growth Index by 113.59% due to outstanding stock selection. Leverage in a sharp up market and an assortment of style biases were also tailwinds to relative performance in the period.

Apart from leverage, outperformance of investments in Consumer Discretionary, Industrials, Communication Services, and Health Care and lack of exposure to the lagging Energy, Consumer Staples, Materials, and Utilities sectors added the most value. Within Consumer Discretionary, a massive gain from electric vehicle manufacturer Tesla, Inc. was the primary driver of outperformance in the period. Tesla was the top contributor after exceeding key growth and profitability expectations in a difficult environment. Favorable stock selection in Industrials, coming from real estate information and marketing services company CoStar Group, Inc., was partially offset by the Fund’s higher exposure to this underperforming sector. CoStar’s shares outperformed as net new sales re-accelerated more quickly than investor forecasts due to heightened demand for the company’s digital marketplace businesses. The company has over $3.6 billion cash on its balance sheet, which we expect it will use for TAM-expanding acquisitions, particularly in the residential market. Within Communication Services, outperformance of real estate and rental marketplace Zillow Group, Inc. and higher exposure to this top performing sector added value. Zillow was the second largest contributor due to strong quarterly results and a favorable newly public comp for the Offers business. Strength in Health Care was related to the outperformance of IDEXX Laboratories, Inc., a leading provider of diagnostics to the veterinary industry. IDEXX was the third largest contributor as veterinary visits continued to recover from lows in the early months of the pandemic, with practice visits growing at double-digit rates through October.

Financials and Information Technology (IT) investments weighed the most on relative results. Within Financials, underperformance of insurer Arch Capital Group Ltd. and significantly higher exposure to this lagging sector hampered relative results. Arch was the top detractor due to economic-related headwinds in the mortgage business. Within IT, meaningfully lower exposure to software stocks, which were up more than 70% in the index, detracted approximately 555 basis points from relative performance. Weakness in the sector was also due to the underperformance of syndicated research provider Gartner, Inc. and P&C insurance software vendor Guidewire Software, Inc. Gartner’s destination events business has been disproportionately impacted by COVID-19, while Guidewire’s transition to the cloud has caused short-term financial headwinds and slowed the cadence of new license sales.

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.