Review and Outlook

as of 09/30/21

The fallout from the pandemic continues to be a source of uncertainty for the Real Estate sector, although mass vaccinations and relaxed social distancing restrictions have reduced investor pessimism. The pandemic has had unusually divergent impacts on different categories of real estate, with some, such as industrial real estate, benefiting from tailwinds, and others, such as office real estate, facing tailwinds. The last month of the quarter saw a meaningful increase in volatility as investor prepared for the Federal Reserve to scale back on quantitative easing and eventually increase interest rates from current historically low levels.

Against this backdrop, Baron Real Estate Fund declined in the quarter. Holdings within casinos & gaming operators, real estate service companies, and real estate operating companies were the top contributors. Red Rock Resorts, Inc. and Caesars Entertainment Corporation, respectively, the second and third largest contributors, drove positive performance within casinos & gaming operators. Top contributor Jones Lang LaSalle Incorporated led gains within real estate service companies. Sole category holding Brookfield Asset Management Inc. lifted performance of real estate operating companies. Holdings within building products/services, data centers, and homebuilders & land developers were the top detractors. Top detractor Latham Group, Inc. pressured the building products/services category and third largest detractor GDS Holdings Limited weighed on performance of data centers. With declines in all five investments within the category, homebuilders & land developers had a weak quarter.

We continue to prioritize three investment themes: 1) the ongoing recovery of the U.S. housing market, with an additional post-pandemic boost as people migrate to the suburbs and conduct more activities at home; 2) the intersection of technology and real estate (proptech); and 3) hospitality and travel-related companies – a.k.a. pandemic-related “epicenter" companies.

As the pandemic continues to recede in the U.S., we believe this is an opportune time for active managers in real estate who have the flexibility to shift into growth areas while avoiding others facing a longer and more uncertain recovery. 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 09/30/21

Contributors

  • Jones Lang LaSalle Incorporated is one of the largest global commercial real estate services companies. Strong performance was driven by second quarter financial results that far exceeded investor expectations and a rosy outlook for the remainder of the year. We remain investors. Jones Lang has a leading brand, sophisticated technology, a global platform, a deep bench of talent, and a solid balance sheet. Its scale and platform provide a strong moat.
  • Shares of Red Rock Resorts, Inc., a Las Vegas local casino company, increased in the quarter on an acceleration in earnings growth across its properties with EBITDA significantly above pre-COVID-19 levels. The locals market is benefiting from a new higher-income customer base which is staying longer and spending more. The closure of some non-gaming amenities, a reduction in the work force, and more targeted marketing spend has also helped increase margins and cash flow.
  • Caesars Entertainment Corporation, a casino operator with assets in Las Vegas and regionally across the U.S., contributed to performance as its casinos generated EBITDA above pre-pandemic levels despite the impact of the Delta variant, the loss of stimulus payments, and the reopening of other entertainment activities. The company is using its robust cash flow to delever its balance sheet and invest in digital gaming. We think Caesars will generate strong returns on capital over time.

Detractors

  • Shares of Latham Group Inc., the leading fiberglass pool manufacturer in North America, Australia, and New Zealand, declined during the period held. Given robust pool industry fundamentals, investors were largely expecting Latham to increase its outlook for the current fiscal year. Instead, Latham highlighted several supply chain challenges and raw material inflation that would limit upside into early 2022. We exited the position, as we believe the challenges will be worse than street forecasts, leading to lower growth and a lower valuation.
  • Zillow Group, Inc. operates leading U.S. real estate sites, a mortgage marketplace, and a home-buying business. Shares were down due to concerns around rising interest rates and the potential knock-on effects to the housing market. Our channel checks have indicated that the housing market remains robust. Even if demand were to soften, Zillow’s offering could become even more valuable as it delivers high-quality buyer and seller leads. Longer term, we believe Zillow has an ample runway for growth given its strong management team and large customer base.
  • GDS Holdings Limited is a leading Chinese data center operator within Tier 1 cities. Shares fell in concert with a general sell-off in Chinese technology-related companies in response to tightening regulations and unknown future government actions against businesses that may not be perceived as aligned with the government's goals. We retain conviction in GDS given durable secular tailwinds in cloud adoption (early innings in China), increased visibility of growth, ample capital, and its status as a provider of choice to China’s leading technology companies.

Quarterly Attribution Analysis (Institutional Shares)

as of 09/30/21

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 09/30/21

Baron Real Estate Fund (Institutional Shares) declined 1.66% in the third quarter and trailed the MSCI USA IMI Extended Real Estate Index by 176 basis points primarily due to stock selection.

Investments in casinos & gaming operators, tower operators & wireless telecommunication services companies, and real estate operating companies and higher exposure to strong performing real estate service businesses added the most value. Favorable stock selection in casinos & gaming, owing largely to sharp gains from Red Rock Resorts, Inc. and Caesars Entertainment Corporation, was somewhat offset by the Fund’s higher exposure to this lagging category. Red Rock and Caesars both generated EBITDA above pre-pandemic levels despite the impact of the Delta variant, the loss of stimulus payments, and the reopening of other entertainment activities. Strength in the tower operators & wireless telecommunication services and real estate operating categories was due to the outperformance of Cellnex Telecom S.A. and Brookfield Asset Management Inc., respectively. Shares of European tower company Cellnex outperformed after organic growth accelerated and guidance was raised mainly to reflect the earlier closure of the Polkomtel acquisition. Shares of global alternative asset manager Brookfield were lifted by strong growth in fee earnings, a robust fundraising environment, the prudent deployment of capital, attractive asset recycling, and an improved outlook for real estate.

Investments in building products/services companies, data centers, and homebuilders & land developers weighed the most on relative performance. Weakness in the building products/services category was driven by fiberglass pool manufacturer Latham Group, Inc., whose shares were down nearly 45% for the period held. Latham was the top detractor after the company highlighted several supply chain challenges and raw material inflation that would limit earnings upside into early 2022. We exited the position, as we believe the challenges will be worse than Street forecasts, leading to lower growth and a lower valuation. The Fund’s meaningfully lower exposure to index heavyweight Home Depot, Inc. also hampered performance as the company’s shares outpaced the broader market in the period. The Fund’s unique exposure to data centers hurt performance, with Chinese company GDS Holdings Limited accounting for most of the relative shortfall in the category. GDS was the third largest detractor after the company’s shares declined alongside other Chinese technology-related companies in response to tightening regulations and unknown future government actions against businesses that may not be perceived as aligned with the government's goals. We exited the position to reallocate capital to higher conviction ideas. Within homebuilders & land developers, underperformance of real estate development company The Howard Hughes Corporation and higher exposure to this lagging category detracted the most from 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.