Review and Outlook

as of 03/31/23

The first quarter saw the market rebound nicely from the drubbing of 2022, while the macro outlook gyrated. The three-month period started on a high note, with solid economic data, a steady decline in inflation, and a prevailing sense among investors that the Federal Reserve was close to ending rate hikes. In February, economic data that came in stronger than anticipated shifted the narrative back to the Fed’s continuation of its tightening program. Then, three regional banks failed, which raised serious issues about the health of the banking sector. Though concerns about the safety of consumer deposits and systemic risk have diminished, it is now assumed that bank lending practices will be more restrictive, which could have a dampening effect on the economy. March data showed softening in employment numbers and continued declines in inflation, resulting in lower interest rates and fear of a potential slowdown in the offing.

Baron Small Cap Growth Fund increased in the quarter. Holdings within Consumer Discretionary, Industrials, and Information Technology (IT) contributed the most to performance. Real Estate investments were a modest detractor. With gains in 10 out of 11 holdings, Consumer Discretionary had a strong quarter. Appreciation within the sector was led by top contributor Floor & Decor Holdings, Inc. and second largest contributor Installed Building Products, Inc. Industrials also did well, with gains in 17 out of 18 investments. Third largest contributor Guidewire Software, Inc. led advances within IT. A share price decline in tower REIT SBA Communications Corp. drove modest weakness within the Real Estate sector.

While we are nearing the end of the Fed’s aggressive tightening cycle, inflation readings and employment levels are still well above target levels. Restrictive monetary policy usually takes about a year to impact the economy, which we are now feeling. We find evidence of lower inflation and slowing growth from both economic reports and our discussions with companies. The severely inverted yield curve is a warning sign that the risk of recession is elevated. Against this complicated backdrop, we believe stocks acted well because they were oversold and cheap, even if the outlook is softer. If rates stabilize and eventually decline and business remains firm for the most part, the environment for equities will be supportive. However, there is much investor consternation as to the degree of the slowdown and the time in which rates need to rise or stay elevated to get inflation to levels the Fed is targeting.

Longer term, we believe strongly that our companies will revert to their historic growth rates and earnings will be considerably higher. Stocks will revert to trading at appropriate multiples, which, for the most part, are higher than present, irrespective of where interest rates settle out. We believe the combination of higher earnings and higher multiples will result in higher stock prices and strong returns for the portfolio.

Top Contributors/Detractors to Performance

as of 03/31/23


  • Floor & Decor Holdings, Inc. is a high-growth, differentiated specialty retailer of hard-surface flooring and accessories in the U.S. Shares rose during the quarter on strong 2023 guidance that beat consensus. Despite a weaker housing market, Floor & Decor expects revenue to grow roughly 10% this year as temporary softness in existing stores is more than offset by new unit openings. The company's direct sourcing model, low-cost leadership, and wide selection should enable it to take share from both big box retailers and independent specialty shops. We believe Floor & Decor will also benefit from lower freight rates as supply chains normalize. We remain positive about the stock’s long-term prospects and potential for double-digit unit growth in the years ahead.
  • Installed Building Products, Inc. is a leading installer of insulation and other building products for the residential and non-residential construction end markets. Shares of the stock increased during the quarter on improving trends in the U.S. housing market, an important end market for the company, and strong business performance. We retain conviction and continue to view the long-term opportunity favorably.
  • Shares of P&C insurance software vendor Guidewire Software, Inc. contributed to performance for the quarter. The company has crossed the midpoint of its cloud transition and is now demonstrating more consistent recurring revenue growth and durable gross margin expansion. We believe Guidewire will be the critical software vendor for the global P&C insurance industry, capturing 30% to 50% of its $15 to $30 billion total addressable market and generating margins above 40%. During the quarter, Guidewire’s largest competitor was acquired by a private equity firm at a meaningful premium to Guidewire’s current valuation. We believe this acquisition will help further enhance Guidewire’s win rates and pricing power while also illustrating the significant multiple expansion opportunity embedded in its current share price.


  • After meaningfully increasing last year, shares of Gartner, Inc., a provider of syndicated research, gave up some gains in the first quarter. Business conditions have softened modestly, as Gartner’s IT vendor customer base is being negatively impacted by layoffs and cost reductions across the sector. Despite this headwind, Gartner is still generating attractive double-digit growth in research contract value. We expect sustained revenue increases and renewed focus on cost control to drive margin expansion and enhanced free cash flow generation over time. The company’s balance sheet is in excellent shape and can support aggressive repurchases and bolt-on acquisitions, in our view.
  • Axonics, Inc. offers a novel implantable sacral neuromodulation device for the treatment of urinary and bowel dysfunction. Through an acquisition, it also offers Bulkamid, a unique injectable product to treat stress urinary incontinence (SUI) in women. Shares declined somewhat during the quarter. There wasn’t any particular negative catalyst. We retain conviction.that Axonics' product is unique. It believes its current market of $650 to $700 million, representing 45,000 implants, is less than 1% penetrated, as the addressable market is close to seven million patients. Axonics thinks the market can double in three to five years. Bulkamid has a market of $125 million, representing 125,000 procedures. With 29 million women affected by SUI, we believe this market represents a significant growth opportunity as well.
  • Endava plc provides outsourced software development for business customers. Shares fell after the company reduced financial guidance to reflect slower bookings as macroeconomic uncertainty weighed on client decision-making in December. Nevertheless, the company reported solid quarterly results, with 30% revenue growth and 26% EPS growth. Management noted that bookings have improved in the first couple of months of 2023, and they expect annualized revenue growth to quickly return to greater than 20%. We remain investors because we believe Endava will continue gaining share in a large global market for IT services.

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 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.