Review and Outlook

as of 12/31/20

U.S. equity markets continued their rally in the fourth quarter. Positive news on COVID-19 vaccines excited investors about the prospects of a return to normalcy. The markets viewed the election results favorably, with the expectation of a more stable governing environment that would also likely provide additional fiscal support to businesses and individuals. Corporate profits remained strong, especially for businesses benefiting from digital conversion, and optimism returned for the prospects of companies that had struggled during the pandemic. Interest rates stayed low, and the Federal Reserve appeared committed to additional accommodation if needed. In mid-November, after the vaccine news came out, there was a change in leadership from strong performing growth and momentum stocks to lagging value and cyclical stocks. Though we are heavily invested in many stocks that fit the former bill, the portfolio still had a strong quarter on an absolute basis.

Baron Small Cap Fund increased in the quarter. Holdings within Information Technology (IT), Industrials, and Consumer Discretionary contributed the most. Top contributor The Trade Desk and second largest contributor Gartner, Inc. led gains within IT. Positive sector performance was broad-based, with double-digit increases in 13 out of 16 investments. Third largest contributor SiteOne Landscape Supply, Inc. topped results within Industrials. Consumer Discretionary also had a solid quarter, with double-digit gains in 10 out of 13 holdings. Real Estate was the only sector to detract. Weak performance within the sector was driven by top detractor SBA Communications Corp.

The market has continued the momentum of the fourth quarter into the first weeks of 2021. We think companies benefiting from the pandemic-driven acceleration of digital trends should continue to see strong growth as these trends play out. We also think business for other companies should bounce back vibrantly post-pandemic driven by pent-up demand. We expect the new administration and Congress to be fine for businesses and the market. While tax rates will probably increase, we will also likely see additional fiscal support, which will add to growth.

Relatively high valuations are the primary concern for us right now. While we think valuations are probably appropriate given the rosy prospects of our investments and historically low interest rates, they are expanded. If stocks trade down because multiples contract, we revert to the teachings of Dick Gilder, who would say “growth cures all,” which means if the companies perform and grow to be much bigger, their stocks won’t seem overvalued for long. This is one of the great advantages of being a long-term, research-driven, investor. We don’t have to time it right, we just have to get it right, which we have more times than not over the life of the strategy.

Top Contributors/Detractors to Performance

as of 12/31/20

Contributors

  • The Trade Desk is the leading online advertising demand-side platform, enabling agencies to efficiently purchase digital advertising across PC, mobile, and online video channels. Shares were up on robust growth in the Connected TV business, which continues to benefit from a shift of advertising dollars away from linear TV and user-generated content. We maintain conviction given the company's technology, scale, and estimated 10% share in the $33 billion programmatic advertising market, a small and growing subset of the $725 billion annual global advertising spend.
  • Shares of Gartner, Inc., a provider of syndicated research, increased after reporting financial results that beat analyst expectations. The company’s research business continued to generate growth, albeit at a slower rate than before the pandemic. We expect growth to re-accelerate as conditions stabilize, leading to meaningful margin expansion and enhanced free cash flow generation. While Gartner’s destination events business has been disrupted by the pandemic, the company has pivoted to virtual events, which may offer enhanced economics over the long term. 
  • SiteOne Landscape Supply, Inc. is the largest distributor of wholesale supplies to the landscape trade in the U.S. The company distributes a wide range of irrigation, fertilizer, and landscape accessories to contractors who design, construct, and maintain residential and commercial outdoor spaces. During the quarter, shares rose given the favorable outlook for the residential landscaping industry and the resumption of the company’s M&A program, which investors estimate will add 7%-13% to sales growth per year. Management also cited a strong pipeline of targets for M&A activity.

Detractors

  • 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.
  • Shares of DraftKings, Inc., an online sports betting and i-gaming platform, fell on profit taking after a strong run since its April IPO. Investor concerns over how quickly states would legalize sports betting and i-gaming, in addition to increased competition that could force DraftKings to increase marketing spend and push out its profit timeline, also weighed on the stock. We maintain conviction as DraftKings continues to generate a strong return on its marketing spend and is seeing better retention rates as a result. It has no debt and over $2 billion of cash. 
  • DexCom, Inc. sells a continuous glucose monitoring device for people with diabetes. The stock fell due to concerns about competition from Abbott Laboratories, which received regulatory approval to market its third generation Libre device in Europe. We continue to have conviction in DexCom based on the company's large addressable under-penetrated market and new product pipeline.

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 Small Cap Fund (Institutional Shares) was up 17.59% in the fourth quarter, yet underperformed the Russell 2000 Growth Index by 12.02%, primarily due to stock selection. Style biases also hampered relative results, driven by the Fund’s overexposure to poor performing size, earnings quality, and growth factors and underexposure to the strong performing residual volatility factor.

Materials investments added the most value, driven by the outperformance of Avient Corporation, a leading provider of specialized and sustainable material solutions. Avient’s shares were up sharply as business conditions continued to improve and synergies from the company’s recent transformative acquisition are tracking ahead of schedule.

Underperformance of investments in Health Care, Consumer Discretionary, Industrials, and Information Technology (IT) detracted the most from relative results. Most of the Fund’s Health Care holdings underperformed in a period when the sector was broadly higher due to sharp gains from biotechnology and pharmaceutical stocks, which the Fund tends to avoid. Weakness in the sector came from glucose monitoring device manufacturer DexCom, Inc. and Contract Research Organization ICON Plc. DexCom was the third largest detractor due to concerns about competition from Abbott Laboratories, which received regulatory approval to market its third generation Libre device in Europe. We continue to have conviction in DexCom based on the company's large addressable under-penetrated market and new product pipeline. ICON’s shares underperformed despite the company’s quarterly results and guidance reflecting a faster than expected recovery from COVID-19-related disruptions. Virtual care provider Teladoc Health, Inc. also weighed on performance before being sold late in the quarter due to market cap and valuation considerations. Negative stock selection in Consumer Discretionary was driven by installation contractor Installed Building Products, Inc., online gambling platform DraftKings, Inc., and discount chain Ollie's Bargain Outlet Holdings, Inc., whose share prices trailed the broader market after meaningfully outperforming in the early stages of the COVID-19 pandemic. Within Industrials, shares of insights and analytics leader Clarivate Plc and data center equipment and services provider Vertiv Holdings, LLC failed to participate in the market rally after significantly outperforming earlier in the year. Performance in IT was hindered by web software firm Wix.com Ltd. and process industries optimization software vendor Aspen Technology, Inc. Wix’s stock price fell slightly during the quarter after doubling in the first nine months of the year as the company benefited from accelerating digitization due to COVID-19. Aspen’s shares underperformed as annual spend growth decelerated modestly in the company’s seasonally slow first fiscal quarter.

as of 12/31/20

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

Baron Small Cap Fund (Institutional Shares) gained 40.68% for the year and outperformed the Russell 2000 Growth Index by 605 basis points due to stock selection and a variety of style biases.

Investments in Industrials, Financials, and IT contributed the most to relative performance. Strength in Industrials was largely due to the outperformance of wholesale landscape supplies distributor SiteOne Landscape Supply, Inc. and insights and analytics leader Clarivate Plc. SiteOne’s shares rose sharply after the company’s financial results and business outlook were much better than feared due to rising consumer interest in outdoor living and strong new residential construction. Clarivate’s stock price was lifted by solid quarterly earnings results and optimistic guidance. The company’s $6.8 billion acquisition of CPA Global, which provides IP management and technology solutions to law firms and corporate customers, was also well received by investors. Higher exposure to this sector, which was up more than 35% in the index, also bolstered relative results. The Fund’s largest positions in Financials, insurance distribution firm BRP Group, Inc. and specialty insurer Kinsale Capital Group, Inc., added the most value. BRP’s stock price nearly doubled in response to solid financial results and a capital raise to execute on a robust M&A pipeline. Kinsale’s shares responded well to strong financial results, with premium growth in excess of 40% in each of the first three quarters of the year and an improvement in the core underwriting margin. Industry conditions remain favorable and the company is meaningfully raising rates, which we believe should lead to continued strong earnings growth over time. Positive stock selection in IT was driven by triple-digit gains from internet advertising demand-side platform The Trade Desk and website design and hosting services provider Wix.com Ltd. These businesses benefited from the accelerating pace of digitization following COVID-19. Payment processors Repay Holdings Corporation, Nuvei Technologies Corp., and Shift4 Payments, Inc. also performed well given accelerating volume trends as payments increasingly go digital as a result of the COVID-19 pandemic. Lastly, higher exposure to strong performing application software stocks aided relative results.

Cash exposure in a sharp up market and minimal exposure to strong performing biotechnology stocks within Health Care 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.