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. Real estate-related companies and REITs posted positive results in the fourth quarter, although REITs ended in the red for the full year.

Against this backdrop, Baron Real Estate Fund advanced in the quarter. Holdings in the casinos & gaming operators, hotels & leisure, and real estate service companies categories contributed the most. Casinos & gaming operators and hotels & leisure companies benefited from the rotation into hard-hit travel-related stocks after the mid-November news of the development of effective COVID-19 vaccines. Casinos & gaming operators included top contributor Wynn Resorts Ltd. and second largest contributor Red Rocks Resorts, Inc. Timeshare company Marriott Vacations Worldwide Corp. led gains within hotels & leisure. Commercial real estate services provider Jones Lang LaSalle Incorporated led advances within real estate services companies. Homebuilders & land developers detracted on mixed results as the share price of some holdings within the category corrected on investor concerns that homeownership was becoming less affordable. Tower operators & wireless telecommunication services was a modest detractor in the quarter as well.

We are currently prioritizing three investment themes for 2021: 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; and 3) hospitality and travel-related companies – a.k.a. “epicenter" companies.

The news of multiple vaccines in November suggests an end to the pandemic is on the horizon. For the real estate market in particular, historically low interest rates should also help boost growth. 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 as a result of the pandemic. 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 12/31/20

Contributors

  • Shares of Wynn Resorts Ltd., an operator of casinos in Las Vegas, Boston, and Macau, increased in the quarter as the company began to generate positive cash flow at its properties in Macau and Las Vegas. While Wynn continued to burn cash due to debt taken on in the depths of the pandemic, it has reduced its cash burn rate. We believe Wynn's finances will improve in 2021 as visitation and spend levels return to pre-pandemic levels given its high-quality portfolio of properties.
  • Opendoor Technologies Inc. operates a digital platform where buyers can tour homes, make offers, and get financing, while sellers can receive next-day cash offers with flexible close dates. Shares were up in the quarter on continued reacceleration in residential real estate activity. In our view, Opendoor is the iBuying industry leader disrupting an enormous and highly inefficient industry, with 2019 revenue of $4.7 billion representing less than 0.5% share of a $1.3 trillion addressable market and strong unit economics driving expectations of EBITDA breakeven by 2023.
  • Shares of Red Rock Resorts, Inc., a casino company with assets in the Las Vegas Locals market, increased in the quarter on strong earnings driven by improved margins. The company used its improved cash flow to pay down debt on its balance sheet, and it now has less debt than before the onset of the pandemic. We think Red Rock will continue to use excess cash flow to reduce debt, bringing it down to its targeted leverage of under four times by the end of 2022. The sale of excess owned land, which should begin in the second half of 2021, should also help reduce debt levels.

Detractors

  • Lennar Corporation, a leading U.S. homebuilder, detracted during the fourth quarter. The stock fell during the quarter following strong performance in the first nine months of the year on investor concerns that homeownership was becoming less affordable and homebuilders will face difficult comps in 2021. We retain conviction because Lennar is a best-in-class homebuilder, and we believe the prospects for U.S. housing remain bright. 
  • D.R. Horton, Inc. is the nation's largest homebuilder. After strong performance in the first nine months of the year, the share price corrected on investor concerns that homeownership was becoming less affordable and that homebuilders will face difficult comps in 2021. We retain conviction because we believe D.R. Horton is a best-in-class homebuilder and the prospects for U.S. housing remain bright. 
  • After strong performance earlier in the year, Equinix, Inc. was a detractor during the quarter due to market rotation into “laggards” and a slight backup in interest rates that impacted companies with elevated valuations. 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, its unique position as one of the only operators that can offer a global platform, and continued execution on strategic M&A transactions to enhance its moat.

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 Real Estate Fund (Institutional Shares) gained 16.79% in the fourth quarter and outperformed the MSCI USA IMI Extended Real Estate Index by 644 basis points due to differences in real estate category exposures.

Investments in casinos & gaming operators, hotels & leisure companies, and data centers and higher exposure to the strong performing real estate services, building products/services, and real estate operating categories contributed the most to relative results. Within casinos & gaming, higher exposure to this outperforming category and sharp gains from Wynn Resorts Ltd., Red Rock Resorts, Inc., and Boyd Gaming Corporation added the most value. Wynn and Red Rock were among the top three contributors to absolute performance while Boyd’s shares were driven higher by the company’s sports betting and internet gaming opportunity. Optimism that many states would legalize sports betting and i-gaming over the next year to fill large state budget deficits boosted investor expectations for Boyd's growth potential given its 5% equity stake in FanDuel Sports. Boyd is also seeing strength in its core casino business through improved margins, generating additional cash flow and improving its balance sheet. Most of the Fund’s hotels & leisure holdings rebounded in the period, led by timeshare companies Marriott Vacations Worldwide Corp. and Hilton Grand Vacations Inc., amusement park operators Six Flags Entertainment Corporation and Seaworld Entertainment Inc., and global hotelier Hyatt Hotels Corp. These attractively valued real estate companies meaningfully outperformed after lagging for much of the year due to temporary operational headwinds caused by COVID-19. Higher exposure to the hotels & leisure category, which outpaced the broader market in the period, also added value. Within data centers, outperformance of 21Vianet Group, Inc. and GDS Holdings Limited bolstered relative results. 21Vianet’s shares rose sharply after management’s new three-year growth plan implied a meaningful acceleration in growth and a more than doubling of the business. GDS’s stock price was lifted by robust quarterly results, accelerating bookings growth, strong cloud growth from its core customers, and continued M&A opportunities to augment growth.

Underperformance of REITs, higher exposure to lagging homebuilders & land developers, and lack of exposure to the outperforming senior housing and other health care facilities and infrastructure related categories detracted the most from relative results. Weakness in REITs, owing largely to share price declines from data center company Equinix, Inc. and apartment rental operator Equity Residential, was somewhat offset by the Fund’s significantly lower exposure to this underperforming category. Equinix was the third largest detractor after the company’s shares pulled back following an extended run of strong performance, while Equity Residential’s shares fell after being added to the Fund late in the quarter.

as of 12/31/20

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

Baron Real Estate Fund (Institutional Shares) appreciated 44.28% for the year, significantly outperforming the MSCI USA IMI Extended Real Estate Index by 40.07% due to stock selection. Other tailwinds to relative performance were differences in real estate category weights and the opportune building up of and subsequent redeployment of cash in a volatile market.

Apart from cash, investments in casinos & gaming operators, REITs, data centers, and real estate service companies, higher exposure to strong performing homebuilders & land developers, and lower exposure to declining hotels & leisure companies added the most value. Within casinos & gaming, outperformance of regional casino operator Penn National Gaming, Inc. and higher exposure to this better performing category bolstered relative results. Penn was the top contributor after revenues quickly rebounded at its recently opened properties and betting activity was strong following the launch of the Barstool Sportsbook app. Wynn Resorts Ltd., Red Rock Resorts, Inc., and Boyd Gaming Corporation also added value in the category. Strength in the REITs category came from data center operators Equinix, Inc. and Digital Realty Trust, Inc., whose shares were up double digits when REITs as a group were down in the index. Equinix’s stock price benefited from robust quarterly bookings, accelerating cloud adoption trends, and continued execution on strategic M&A transactions to improve its moat. Digital Realty’s shares increased as the company enhanced its European and global colocation platforms and closed its acquisition of InterXion early in the year. The Fund’s meaningfully lower exposure to lagging REITs also contributed to relative performance in the period. The Fund’s largest positions in the data centers category, GDS Holdings Limited and NEXTDC Limited, added the most value. GDS was the third largest contributor after the company’s shares appreciated more than 80% for the year. NEXTDC’s stock price reacted positively to outstanding first half results and robust large-scale lease signings with the world’s premier cloud companies, which provides multi-year cash flow growth visibility. Favorable stock selection in real estate services was related to the outperformance of real estate and rental marketplace Zillow Group, Inc. and real estate information and marketing services company CoStar Group, Inc.  Zillow was the second largest contributor due to strong quarterly results and a favorable newly public comp for the Offers business. 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. CoStar has over $3.6 billion cash on its balance sheet, which we expect it will use for TAM-expanding acquisitions.

Lower exposure to the strong performing tower operators & wireless telecommunication services and building products/services categories weighed the most on 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.