Review and Outlook

as of 06/30/22

The first half of 2022 was challenging to navigate. A more hawkish Federal Reserve, higher interest rates, and the possibility of moderating growth and valuation multiple compression in certain segments all converged to pressure real estate stocks. The Russia/Ukraine war and the spill-over effects of even higher inflation (food, wheat, crude oil, natural gas), further COVID-19-related lockdowns in China and ongoing supply-chain bottlenecks, and multi-decade high inflation - a portion of which may remain elevated for an extended period – added to the uncertainty. These factors led to an unusually difficult investment environment, resulting in simultaneous and sharp declines in stocks, bonds, and most investable assets.

Against this backdrop, Baron Real Estate Fund declined in the quarter. No category contributed. Holdings within the casino & gaming operators, REITs, and hotels & leisure categories detracted the most. Losses within casino & gaming operators were led by third largest detractor MGM Resorts International. Prologis, Inc. led depreciation within REITs. Shares of the largest owner/operator/developer of industrial warehouse real estate fell following Amazon's announcement that it would curtail warehouse leasing and potentially shrink its existing warehouse footprint, triggering concerns that industrial warehouse demand more generally would soon slow. Weakness within hotels & leisure was led by top detractor Six Flags Entertainment Corporation. We exited our investment.

We recognize that in the months ahead there may be ongoing elevated volatility and choppy periods in the market. Economic growth is likely to moderate, and several companies are likely to lower growth forecasts. We are also mindful that lower growth forecasts may not be fully reflected in the valuations of certain real estate companies.

We are incrementally positive, in part because of the sharp correction in share prices. We believe many real estate companies offer highly compelling two-to-three-year return prospects that, in some cases, may include a trifecta of growth, dividends, and an improvement in valuation. Most business fundamentals remain strong and do not portend a recession. Commercial and residential real estate is not overbuilt. Expectations for construction activity are modest. Corporate balance sheets are liquid, with appropriate levels of leverage, fixed rate debt, and staggered debt maturities. Certain segments of real estate can raise prices to provide partial inflation protection. Dividend yields continue to grow and are supported by strong cash flows. While the recent spike in interest rates and widening credit spreads are a headwind, we believe real estate, for the most, is in a “good place” relative to prior economic slowdowns and recessions.

Top Contributors/Detractors to Performance

as of 06/30/22

Contributors

  • Tower REIT American Tower Corp. contributed to performance as a result of deal terms that were better than analyst expectations for its acquisition of edge data center company CoreSite. The stock also benefited from higher investor appreciation for its underlying secular growth in a shaky economic backdrop. American Tower owns and operates 220,000 cell phone towers across the globe. We retain conviction due to durable demand drivers in data growth and video as well as the company’s ability to grow its portfolio and return excess capital to shareholders.
  • Gaming and Leisure Properties, Inc., a gaming REIT that owns the real estate of many casino operators, contributed to performance on the strength of its well-covered dividend yield and prospects for growth even in a recessionary economy. Its tenants remain solvent and flush with cash, which suggests that rent payments should remain steady regardless of the economic environment. A strong balance sheet allows for additional acquisitions, which should be accretive to the dividend and enhance shareholder returns.

Detractors

  • Six Flags Entertainment Corporation was a detractor from performance during the quarter, driven by investor concerns about consumer leisure spend as the company shifts to a premiumization strategy. We exited our position due to our uncertainty regarding management's strategic pivot, given the high inflation backdrop and potentially weakening consumer demand.
  • Brookfield Asset Management, Inc. detracted from performance due to the perception that a more expensive financing environment will impact its ability to realize investment gains and to deploy capital at attractive internal rates of return. Brookfield invests in real estate, infrastructure, renewable power, private equity, and credit assets globally and has over $700 billion AUM and $380 billion of fee-bearing capital. We retain conviction, given the company's diversified asset base, sustainable cash flows, strong asset management platform, and ability to deploy capital globally.
  • Shares of MGM Resorts International, a casino owner/operator in Las Vegas and Macau, fell on investor concerns that a potential recession will result in a slowdown or decline in growth. We retain conviction. The company has seen no material change in current visitation or spend levels and continues to generate strong results. Its successful monetization of its casino real estate, coupled with the sale of its stakes in non-core assets, has resulted in a strong balance sheet with financial flexibility. MGM continues to use its cash to buy back shares.

Quarterly Attribution Analysis (Institutional Shares)

as of 06/30/22

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 06/30/22

Baron Real Estate Fund (Institutional Shares) declined 20.62% in the second quarter, trailing the MSCI USA IMI Extended Real Estate Index by 350 basis points due to differences in real estate category weights and, to a lesser extent, disappointing stock selection.

Cash exposure in a down market, underexposure to the lagging senior housing operators & health care facilities and hotels & leisure categories, and outperformance of real estate services companies added value. Favorable stock selection in real estate services, owing to the outperformance of real estate data and marketing platform CoStar Group, Inc., was mostly offset by the Fund’s higher exposure to this poor performing category. CoStar reported excellent financial results during the period, highlighted by record quarterly company-wide net bookings of $68 million.

Investments in building products/services companies and REITs along with significantly higher exposure to underperforming casinos & gaming operators and real estate operating companies weighed heavily on performance. The Fund’s meaningfully lower exposure to benchmark heavyweight Home Depot, Inc. accounted for much of the relative shortfall in the building products/services category. Home Depot’s shares were only down single digits in the period, detracting 80-plus basis points from relative performance. Weakness in the category also came from The AZEK Company Inc., Floor & Decor Holdings, Inc., SiteOne Landscape Supply, Inc., Vulcan Materials Company, and Fortune Brands Home & Security, Inc., as these companies were hurt by fears about a slowdown in the residential housing market stemming from rising home prices and higher mortgage rates. Within REITs, lower exposure to Crown Castle International Corp., Digital Realty Trust, Inc., and other strong performing specialized REITs was responsible for a portion of the underperformance in the category. Performance was also hindered by Rexford Industrial Realty, Inc., a high-growth industrial warehouse REIT focused exclusively on the Southern California market. Rexford’s shares were penalized by Amazon's announcement that it was curtailing new warehouse construction and even considering subleasing a portion of its existing warehouse footprint, which led to investor concerns that warehouse demand in general would soon slow. We believe these concerns are overstated, especially for Rexford, and that business fundamentals and prospects remain favorable.

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.