Review and Outlook

as of 06/30/20

After falling sharply on COVID-19-related fears during the first quarter, U.S. equity markets staged their largest quarterly gain in more than 20 years. The market rally was likely driven by a confluence of factors, including accommodative Federal Reserve policies, stepped up efforts to reopen the economy, optimism about a COVID-19 treatment, renewed speculation about large government infrastructure stimulus, and various economic data (such as unemployment figures) that were more positive than expected. 

For Baron Real Estate Fund, we are currently prioritizing three investment themes. First is the ongoing recovery in the U.S. housing market, which we believe may be boosted by the pandemic as we anticipate a possible shift in households from urban to suburban centers as COVID-19 outbreaks have largely been centered around major cities and work from home arrangements have become more prevalent. In addition, more time at home may lead to more investment in home improvement and repair.

Second, we are focused on real estate-related companies that embrace and adopt the latest technological advances and innovations. The growth in cloud computing, the internet, mobile data and cellphones, and wireless infrastructure are powerful secular drivers that should continue unabated for years. Key beneficiaries include data center companies, wireless tower companies, industrial REITs, and real estate data analytics companies. If anything, the pandemic will accelerate these trends as more people conduct business, leisure, residential, and commerce activities online.

Third, we believe what we are calling “epicenter” companies are likely to experience a major rebound when a medical breakthrough for COVID-19 emerges and economic activity is restored. “Epicenter” companies include hospitality-related real estate companies such as hotels, casino and gaming companies, timeshare, amusement parks, ski resorts, and cruise lines, which were hard hit by the pandemic as they were forced to shut down operations almost without exception. We exited or reduced many of our positions in these companies early in 2020 at favorable prices. Since then we have been selectively reinvesting at compelling valuations. We believe these businesses are cyclically depressed – not secularly challenged – and are likely to lead the market higher in the post-COVID-19 period. Our holdings have strong balance sheets and ample liquidity to survive without revenue for at least a year, if not two.

We are mindful of the economic and real estate uncertainty generated by the pandemic. While the current increase in the number of COVID-19 cases is concerning, we know more about how the virus spreads and doctors are much better at treating patients than a few months ago, so we do not anticipate a return to a total shutdown. For the real estate market in particular, historically low interest rates should also help boost growth. We believe our philosophy of structuring a more inclusive and unique real estate fund – one that includes REITs but is more expansive, balanced, and diversified than a typical “REIT only” fund – is a compelling long-term strategy.

Top Contributors/Detractors to Performance

as of 06/30/20

Contributors

  • Shares of Penn National Gaming, Inc., a U.S. regional casino company, increased as the company completed an equity and convertible offering deal and increased its liquidity. Penn has seen a quick rebound in revenues at recently opened properties, and its margins are improving as revenue builds while keeping costs low by delaying its ramp of labor and marketing to pre-COVID-19 levels. Penn anticipates it will generate 2020 EBITDA levels at 95% of 2019 revenue. Its online sports betting deal with Barstool should be an additional positive over time.
  • Lennar Corporation contributed positively to performance during the second quarter.  Lennar is a leading U.S. homebuilder. Strong performance was driven by a notable improvement in Lennar's business and, more broadly, in the U.S. new housing industry beginning in mid-April.
  • GDS Holdings Limited was a contributor to performance due to robust Q1 results, strong bookings visibility, continued strong cloud growth from its core customers, and several M&A opportunities to augment growth. GDS is a leading Chinese data center operator within Tier 1 cities. We retain conviction in GDS due to durable secular tailwinds in cloud adoption (early innings in China), increased visibility of growth/funding, and its status as a provider of choice to China’s leading technology companies.

Detractors

  • The Howard Hughes Corporation detracted from performance during the period held. Howard Hughes develops and owns residential and commercial real estate in master planned communities in the U.S. Its business has been negatively impacted by the pandemic as a substantial portion of tenants have opted to defer rental payments and residential sales activity has slowed. In addition, the decline in oil prices may negatively impact its business near Houston, TX. We believe these headwinds are adequately reflected in the company's depressed valuation and retain conviction.
  • Jones Lang LaSalle Incorporated detracted from performance during the second quarter. Jones Lang is a leading global provider of commercial real estate services. Weak performance was driven by concerns that near-term financial performance would be materially negatively impacted by the global slowdown in leasing and transaction activity. We retain conviction in Jones Lang because of its high-quality platform, scale advantages, and strong liquidity position.
  • Armstrong World Industries, Inc. detracted from performance during the quarter. Armstrong is a leading manufacturer of mineral fiber and acoustical ceiling tiles, primarily servicing commercial customers in the U.S. Shares declined over investor concerns around slower commercial construction and renovation activity over the next few years due to the COVID-19 pandemic. We believe these concerns are overblown and Armstrong will continue to grow through share gains and acquisitions.

Quarterly Attribution Analysis (Institutional Shares)

as of 06/30/20

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 06/30/20

Baron Real Estate Fund (Institutional Shares) gained 29.93% in the second quarter and meaningfully outperformed the MSCI USA IMI Extended Real Estate Index by 817 basis points due to a combination of stock selection and differences in real estate category exposures.

Investments in casinos & gaming operators, homebuilders & land developers, data centers, and hotels & leisure companies and lower exposure to underperforming office and residential REITs added the most value. Favorable stock selection in the casinos & gaming category accounted for a third of the Fund’s outperformance in the period, led by sharp gains from Penn National Gaming, Inc. and Boyd Gaming Corporation. These companies benefited from a quick rebound in revenues at recently opened properties as most of their business is local. Higher exposure to the casinos & gaming category, which was up more than 36% in the index, also added value. Within homebuilders & land developers, higher exposure to this top performing category and outperformance of installation contractor Installed Building Products, Inc. (“IBP”) bolstered relative results. IBP’s stock price rose sharply on strong quarterly results and an encouraging business outlook. Homebuilders Lennar Corporation, D.R. Horton, Inc., and Taylor Morrison Home Corporation also performed well in the category after reporting an acceleration in new home orders. Strength in the data centers and hotels & leisure categories was driven by the outperformance of GDS Holdings Limited and Marriott Vacations Worldwide Corp., respectively. Chinese data center operator GDS was the third largest contributor due to robust quarterly results, solid bookings visibility, continued strong cloud growth from its core customers, and several M&A opportunities to augment growth. Shares of timeshare resort company Marriott increased after occupancy levels and sales at recently opened resorts exceeded Street forecasts. The company’s delinquency rates have not increased materially, new construction projects remain on schedule, and management successfully preserved cash by operating at a cash flow neutral level while its resorts and sales centers were closed.

Cash exposure in a rising market, significantly lower exposure to strong performing home improvement retail stocks within the building products/services category, and higher exposure to lagging real estate operating companies hampered relative results.

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.