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. REITs posted positive results in the fourth quarter, buoyed largely by vaccine-related news, although this sector, which was hard hit in the pandemic, ended in the red for the full year.

Against this backdrop, Baron Real Estate Income Fund advanced in the quarter. Non-REIT real estate companies, other REITs, and hotel REITs categories contributed the most. With gains in 11 out of 12 holdings, non-REIT real estate companies had a strong quarter. Performance within the category was led by Wynn Resorts Ltd. and Red Rock Resorts, Inc., respectively the top and third largest contributor to performance. Second largest contributor Colony Capital, Inc. led advances within the other REITs category. The wireless tower REITs and data center REITs categories detracted. Top detractor American Tower Corporation led weak performance within wireless tower REITs. Second largest detractor Equinix, Inc. drove declines within data center REITs.

We are currently prioritizing three investment themes for 2021: 1) REITs that specialize in providing technology facilities and services (data center, wireless tower, and industrial REITs); 2) “alternative” or niche REITs (single-family rental, manufactured housing, cold storage, life science, and triple net casino gaming REITs); and 3) "epicenter" companies (select office, apartment, hotel, and other REITs that were among the hardest hit in the pandemic and are likely to experience a major post-pandemic rebound, in our opinion).

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 income fund – one that focuses on REITs but includes other types of real estate investments – 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.
  • Colony Capital, Inc. contributed positively to performance during the fourth quarter. Colony Capital is a mixed-use REIT that is transforming itself into a pure play, diversified digital infrastructure REIT. Strong performance was driven by several steps that management undertook as part of its multi-year transformation plan, including monetizing several non-digital legacy portfolios, acquiring several new digital assets, and raising third-party fee-bearing capital.
  • 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

  • American Tower Corp. is a REIT that owns 180,000 cell phone towers, with 40,000 in the U.S. and 140,000 internationally. The stock detracted during the quarter due to continued uncertainty about the timing of churn from the T-Mobile/Sprint merger and the resulting impact on organic growth. Tower stocks also sold off broadly in the quarter due to market rotation to “laggards” and a slight backup in interest rates. We retain conviction based on durable demand drivers in data growth and video and the company’s ability to grow its portfolio and return excess capital to shareholders.
  • 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.
  • After strong performance earlier in the year, SBA Communications Corp. detracted from performance in the fourth quarter as the market rotated into “laggards” and a slight backup in interest rates impacted companies with elevated valuations. SBA is a REIT that owns and operates 30,000 cell phone towers, with 16,000 in the U.S. and 14,000 internationally. We retain conviction in SBA due to durable demand drivers in data growth and video as well as the company’s ability to consistently return capital to shareholders via share buybacks and dividends.

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 Income Fund (Institutional Shares) increased 14.36% in the fourth quarter and outperformed the MSCI US REIT Index by 320 basis points due to a combination of stock selection and differences in REIT category weights.

Investments in non-REIT real estate companies, other REITs, and triple net REITs and lack of or lower exposure to lagging data center, self-storage, industrial, and office REITs added the most value. Unique exposure to non-REIT real estate companies was the primary driver of outperformance in the period, led by sharp gains from casino operators Wynn Resorts Ltd., Red Rock Resorts, Inc., Las Vegas Sands Corporation. Wynn and Red Rock were among the top three contributors to absolute performance while shares of Las Vegas Sands rebounded as earnings improved and its casinos became cash flow positive. Strength in the category also came from Chinese data center operators 21Vianet Group, Inc. and GDS Holdings Limited. 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. Favorable stock selection in the other REITs category was mainly due to the outperformance of Colony Capital, Inc., a mixed-use REIT that is transforming itself into a pure play, diversified digital infrastructure REIT. Colony Capital was the second largest contributor as a result of several steps undertaken by management as part of its multi-year transformation plan, including monetizing several non-digital legacy portfolios, acquiring several new digital assets, and raising third-party fee-bearing capital. Diversified REIT American Assets Trust, Inc. also performed well in the category as rent collections improved during the quarter. Within triple net REITs, outperformance of STORE Capital Corporation, Gaming and Leisure Properties, Inc., and MGM Growth Properties LLC bolstered relative results.

Underperformance of wireless tower REITs and limited exposure to strong performing mall, shopping center, health care, and multi-family REITs weighed the most on relative results. Weakness in the wireless tower REITs category was attributable to share price declines from American Tower Corp., SBA Communications Corp., and Crown Castle International Corp. These companies lost out as investors rotated into COVID-19 recovery beneficiary stocks during the quarter.

as of 12/31/20

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

Baron Real Estate Income Fund (Institutional Shares) was up 22.30% for the year, meaningfully outperforming the MSCI US REIT Index by 31.00% due to differences in REIT category weights and, to a lesser extent, cash exposure in a difficult period for most REIT securities.

Apart from cash, investments in non-REIT real estate companies, other REITs, and wireless tower REITs contributed the most to relative performance. Unique exposure to non-REIT real estate companies accounted for more than half of the Fund’s outperformance in the period, led by impressive gains from regional casino operator Penn National Gaming, Inc. and data center operator GDS Holdings Limited. 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. Penn’s quarterly revenue and earnings results beat investor expectations driven by robust margin growth across all of its casino properties. GDS was the second largest contributor due to robust quarterly results, accelerating bookings growth, improving margins, and the removal of the delisting overhang after the company’s shares began trading in Hong Kong. Red Rock Resorts, Inc., Brookfield Infrastructure Partners L.P., Wynn Resorts Ltd., and 21Vianet Group, Inc. also added value in the category. Favorable stock selection in the other REITs category was driven by mixed-use REIT Colony Capital, Inc., whose shares were up more than 66% for the period held. Temperature-controlled warehouse operator Americold Realty Trust and life sciences landlord and developer Alexandria Real Estate Equities, Inc. also outperformed as investors appreciated the stability of their business models amid an uncertain macroeconomic environment. Strength in the wireless tower REITs category came from American Tower Corp., SBA Communications Corp., and Crown Castle International Corp., whose shares were bolstered by robust quarterly results, closure of the Sprint/T-Mobile deal, and an anticipated bookings acceleration. Limited exposure to lagging hotel, mall, shopping center, and multi-family REITs also added value as these real estate segments continue to face headwinds related to the COVID-19 pandemic.

Lower exposure to strong performing self-storage REITs and underperformance of office REITs detracted the most from relative results. Negative stock selection in office REITs, owing largely to share price declines from Hudson Pacific Properties, Inc. and Kilroy Realty Corporation, was mostly offset by lower exposure to this poor performing category. Hudson Pacific and Kilroy Realty were the two largest detractors after being negatively impacted by an expected slowdown in leasing and new development activity. We exited these positions during the year to reallocate capital to other higher conviction ideas.

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.