Review and Outlook

as of 03/31/20

We consider the COVID-19 pandemic and resulting economic and market fallout to be an exogenous black swan event. The speed of the market correction, job loss, and advent of a recession has been unprecedented. We expect business results of most companies to be challenged this and next quarter, and, perhaps, the balance of this year.

As we believe this black swan event necessitated a departure from our typical lower turnover approach, we took an active and opportunistic approach in managing Baron Real Estate Fund in the quarter.

Our first step was to exit or reduce travel-related holdings – hotel, gaming, cruise line, and timeshare companies -- early in the quarter at favorable prices. We also trimmed housing-related securities, given the likely severe impact of the shutdown of much of the global economy. At times, we held a cash position of 15% to 19%. We felt this was appropriate, in large part, due to the precarious near-term market outlook given the extreme uncertainty regarding the pandemic.

Our second step was to re-invest the cash we raised with a two-pronged approach. We upgraded the quality of our holdings with purchases of  “best-in-class” companies that prior to the market correction had been too expensive, in our view. Examples include housing-related stocks such as Home Depot, Inc., The Sherwin-Williams Company, D.R. Horton, Inc., and Lennar Corporation; commercial real estate services companies such as CBRE Group, Inc.; real estate operating companies such as Brookfield Asset Management, Inc.; and REITs such as Prologis, Inc. and American Tower Corporation. We also bought cyclical stocks that had declined sharply in the downturn. When economic activity resumes, we anticipate that the shares of many beaten down cyclical companies, such as travel-related and housing-related companies, may lead the market higher, possibly rebounding as much as 100% in a relatively short period. Examples include Hilton Worldwide Holdings, Inc., Wynn Resorts Ltd., MGM Resorts International, Penn National Gaming Inc., and Marriott Vacations Worldwide Corp.

For a number of reasons – some signs that the virus will soon be brought under control, unprecedented and massive monetary and fiscal stimulus, inexpensive valuations, an expected rebound in most segments of commercial and residential real estate, and historically low interest and inflation rates – we are optimistic that the economic effects of the pandemic will be largely mitigated in time. We also believe that, partly as a result of our aggressive first quarter action steps, we have positioned the Fund for strong returns in the next few years.

Top Contributors/Detractors to Performance

as of 03/31/20

Contributors

  • GDS Holdings Limited is a leading Chinese data center operator within Tier 1 cities. Shares increased on robust quarterly results and full-year outlook, accelerating bookings growth, continued strong cloud growth from its core customers, and several M&A opportunities to augment growth. 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.
  • Wynn Resorts Ltd., an owner and operator of casinos in Las Vegas, Macau, and Boston, contributed to performance as we sold some stock prior to the steep price decline, then bought shares after it had declined sharply, making its valuation attractive. Assuming declines in casino revenue and earnings resulting from the COVID-19 outbreak, and the expected slow recovery for the company’s operations, the stock was previously not attributing any value to its U.S. assets. Although the balance sheet leverage will increase, we believe Wynn has enough liquidity to survive. 
  • Americold Realty Trust contributed to performance during the first quarter. Americold is a REIT that owns and operates temperature-controlled warehouses, primarily in the U.S. Shares outperformed as investors expect the company’s business model to better withstand COVID-19 market disruptions. We believe Americold may see near-term financial performance that beats analyst forecasts as consumers stockpile food during shelter-in-place mandates.

Detractors

  • Shares of CBRE Group, Inc. detracted in the first quarter. CBRE is the largest global provider of commercial real estate services, including leasing, capital markets, and property outsourcing solutions. Despite strong fourth quarter financial results and full-year guidance that beat market forecasts, the stock declined over concerns of a broad slowdown in the business due to the COVID-19 pandemic. 
  • Brookfield Asset Management, Inc., a leading global alternative asset manager with over $540 billion in assets under management, detracted from performance during the first quarter. Shares declined due to COVID-19 market disruptions and weakness in the credit markets as the company relies on debt financing for both its businesses and acquisitions. We retain conviction in Brookfield due to its diversified asset base, sustainable cash flows, strong asset management platform, conservative financing, and ability to deploy capital globally.
  • Lowe's Companies, Inc., the second largest home improvement retailer in the U.S., detracted in the quarter on weak fourth quarter financial results and full-year financial guidance, both of which missed Street expectations. Further weighing on performance were concerns of a business slowdown due to the COVID-19 pandemic. We retain conviction as we believe management will be successful in its multi-year turnaround efforts at Lowe's.

Quarterly Attribution Analysis (Institutional Shares)

as of 03/31/20

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 03/31/20

Baron Real Estate Fund (Institutional Shares) fell 19.86% in the first quarter, yet meaningfully outperformed the MSCI USA IMI Extended Real Estate Index by 893 basis points due to a combination of several well-timed sales prior to the market downturn, elevated cash exposure, and the redeployment of cash into certain securities at attractive prices. Stock selection also contributed to the Fund’s outperformance in the quarter.

Investments in REITs and data centers and lower exposure to hotels & leisure companies, which were hit hardest by the COVID-19 pandemic, added the most value. Strength in REITs came from data center operators Equinix, Inc. and Digital Realty Trust, Inc., as well as temperature-controlled warehouse owner Americold Realty Trust, life sciences landlord and developer Alexandria Real Estate Equities, Inc., and industrial real estate firm Rexford Industrial Realty, Inc. These companies outperformed because investors appreciated the stability of their business models amid an uncertain macroeconomic environment. Performance in the data centers category was bolstered by GDS Holdings Limited of China and NEXTDC Limited of Australia. GDS was the top contributor on an absolute basis due to strong cloud growth in China, while NEXTDC’s shares benefited from 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.

Investments in casinos & gaming operators and homebuilders & land developers, lack of exposure to strong performing tower operators & wireless telecommunication services companies, and higher exposure to lagging real estate service companies weighed the most on relative results. Within casinos & gaming, higher exposure to this underperforming category through positions in Penn National Gaming, Inc., MGM Resorts International, Boyd Gaming Corporation, Wynn Resorts Ltd., and Red Rock Resorts, Inc. hurt relative results. These and other casino & gaming operators were negatively impacted by business closures related to COVID-19. Within homebuilders & land developers, higher exposure to this lagging category and underperformance of installation contractor Installed Building Products, Inc. (IBP) hurt relative results. IBP’s shares fell sharply after investors became concerned that the COVID-19 pandemic would slow the pace of U.S. housing construction activity in 2020.

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.