Review and Outlook

as of 06/30/21

The second quarter of 2021 continued the shift in leadership from growth to value stocks within real estate. After a sharp increase in equities that stood to benefit from a post-pandemic environment (the so-called "reopening trade"), returns in the second quarter were tied more closely to company earnings results. REITs benefited broadly from continued investor expectations of economic growth driven by the successful rollout of vaccines, anticipated pent-up demand from consumers and businesses, the expected recovery in employment, and federal stimulus payments.

Baron Real Estate Fund increased in the quarter. Holdings within the REITs, building products & services, and real estate operating companies categories contributed the most. REITs had a strong quarter, with 16 out of 19 holdings increasing, including third largest contributor Equinix, Inc. Top contributor Latham Group, Inc. led performance within building products & services. Real estate operating companies contributed on the strength of the portfolio's sole holding within the category, Brookfield Asset Management, Inc., whose shares increased due to strong growth in fee-related earnings, a robust fundraising environment, prudent deployment of capital, and attractive asset recycling. Categories that detracted included real estate service companies, casinos & gaming operators, and hotels & leisure. Second largest detractor Tripadvisor, Inc. led declines with real estate service companies. Weak performance within casinos & gaming operators was led by Las Vegas Sands Corporation and Penn National Gaming, Inc., respectively the top and third largest detractors in the quarter. Hotels & leisure stocks posted mixed results, with detractors, led by timeshare company Marriott Vacations Worldwide Corporation, modestly outweighing contributors.

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 06/30/21

Contributors

  • Shares of Latham Group Inc., the leading fiberglass pool manufacturer in North America, Australia, and New Zealand, rose after a successful IPO in April. Pool industry fundamentals remain robust, and we expect new construction to be strong in 2021. Additionally, fiberglass pools are taking share in the marketplace driven by Latham’s direct-to-consumer marketing model and dealership conversion efforts. We believe fiberglass pool penetration has a long runway for growth in the U.S., which will drive strong growth for Latham for many years.
  • Red Rock Resorts, Inc., an operator of casinos in the Las Vegas Locals market, contributed on reported EBITDA 20% above pre-pandemic  levels and a complete recovery in revenue. Management has said that it thinks the margin expansion is sustainable given current revenue levels and a reimagined cost structure. Robust free cash flow combined with the $650 million sale of its Palms casino, which is slated to close by the end of 2021, should help significantly improve the balance sheet. 
  • Equinix, Inc. contributed to performance due to first quarter financial results ahead of investor expectations and strong full-year guidance. The decrease in interest rates also benefited REITs broadly and secular growth companies like Equinix disproportionately. Equinix is a global operator of network-dense, carrier-neutral colocation data centers. We retain conviction due to a long demand runway behind cloud adoption and IT outsourcing, Equinix's unique ability to offer a global platform, and continued execution on strategic M&A transactions to enhance its moat.

Detractors

  • Las Vegas Sands Corporation, a global casino company with assets in Macau, Singapore and Las Vegas, detracted in the quarter due to the slowed reopening of Macau in response to the new, more contagious variant of COVID-19. While Macau is taking longer than expected to recover, we think conditions will normalize by 2022, and we view the company's valuation as attractive. Las Vegas Sands should close on the $6.25 billion sale of its Vegas assets by the end of 2021, which should improve the balance sheet and allow it to focus on higher-return growth in Asia.
  • Tripadvisor, Inc. is an online travel company where users can browse reviews and plan trips. Shares fell on concerns that new COVID-19 variants would delay the recovery of the travel industry. In addition, investors appeared concerned that Tripadvisor’s new Tripadvisor Plus subscription offering, which launched in June, would face competitive pressures. We do not believe traditional loyalty programs will be materially competitive with the upfront savings offered by Tripadvisor Plus. We also think Tripadvisor is well positioned to benefit from pent-up consumer demand for travel. 
  • Penn National Gaming, Inc., a regional U.S. casino operator, detracted on news that the company had lost sports betting and i-gaming market share in both Michigan and Pennsylvania. While the lost market share is a disappointment, Penn has been able to maintain a double-digit share with no marketing. We believe the market is attributing little value to Penn's Barstool equity stake as well as its online gaming and sports betting opportunities including its access fees from other operators. We view the valuation as attractive.

Quarterly Attribution Analysis (Institutional Shares)

as of 06/30/21

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 06/30/21

Baron Real Estate Fund (Institutional Shares) was up 4.65% in the second quarter, yet trailed the MSCI USA IMI Extended Real Estate Index by 234 basis points due to differences in real estate category weights.

Investments in building products/services companies, hotels & leisure operators, and real estate operating companies contributed the most to relative performance. Strength in building products/services was mainly due to the outperformance of Latham Group, Inc., the leading fiberglass pool manufacturer in North America, Australia, and New Zealand. Latham was the top contributor following the company’s successful IPO in late April. Significantly lower exposure to Home Depot, Inc., a sizeable position in the index whose shares trailed the broader market in the period, also added value. Within hotels & leisure, lower exposure to this lagging category and outperformance of timeshare company Hilton Grand Vacations, Inc. bolstered relative results. Shares of Hilton Grand Vacations were lifted by rebounding timeshare sales in the company’s larger markets and excitement about the recently announced acquisition of Diamond Resorts. Favorable stock selection in the real estate operating category, related to the outperformance of Brookfield Asset Management Inc., was somewhat offset by higher exposure to this poor performing category. Brookfield’s shares benefited from strong growth in fee-related earnings, a robust fundraising environment, prudent deployment of capital, and attractive asset recycling.

Investments in real estate service companies, casinos & gaming operators, and data center companies and meaningfully lower exposure to strong performing REITs weighed the most on relative results. Weakness in the real estate service category was driven by share price declines from online travel company Tripadvisor, Inc. and digital real estate platforms Opendoor Technologies Inc. and Zillow Group, Inc. Tripadvisor was the second largest detractor after being negatively impacted by news that competitor Expedia will expand its current rewards program to compete more aggressively with the company’s new Tripadvisor Plus subscription offering. Shares of Opendoor and Zillow were hurt by investor concerns about the potential impact of rising interest rates on the housing market. Within casinos & gaming, underperformance of global casino company Las Vegas Sands Corporation and higher exposure to this weak performing category hampered relative results. Las Vegas Sands was the largest detractor as the reopening of the company’s Macau properties was slowed by a new, more contagious variant of COVID-19. The Fund’s unique exposure to the data centers category, where shares of GDS Holdings Limited were down in the period, hampered performance. GDS detracted from performance due to the overall selloff in Chinese technology-related companies given tightening government regulations, market concerns regarding supply/competition, and escalation of geopolitical tensions.

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.