Review and Outlook

as of 03/31/24

The Review and Outlook for period ending March 31, 2024, is not yet available.

Top Contributors/Detractors to Performance

as of 03/31/24

Contributors

  • Shares of Vertiv Holdings Co, a manufacturer of critical infrastructure equipment for data centers, rose during the quarter due to improved focus on operational execution, strong revenue growth prospects, and robust opportunities for margin expansion. We expect Vertiv to benefit from the rising demand for data center capacity, with approximately 70% of its revenue coming from the data center end-market. As one of the leading providers of precision cooling for data centers, Vertiv also stands to benefit from the increasing adoption of generative AI (GenAI), as GenAI-related servers have higher energy density, which will necessitate more complicated cooling solutions. We trimmed the position into strength, but we remain shareholders, as we think Vertiv's leading market position in data center thermal and power management will lead to strong growth in the future.
  • Specialty insurer Kinsale Capital Group, Inc. contributed on financial results that exceeded Street forecasts. After a slowdown in the prior quarter, gross written premiums grew 34% and EPS grew 49% with a record-high underwriting margin. Market conditions remain favorable with rising premium rates and more business shifting from the standard market to the excess and surplus lines market where Kinsale operates. In addition, insurance stocks broadly rebounded from last quarter’s pullback as interest rates stabilized. We continue to own the stock because we believe Kinsale is well managed and has a long runway for growth in an attractive segment of the insurance market.
  • Installed Building Products, Inc. is a leading distributor and installer of insulation and complementary building products for residential and commercial end markets in the U.S. Shares rose on improving industry conditions, particularly in the new single-family residential construction market, which drives approximately 60% of the company’s revenue. Installed Building Products’ excellent execution across various strategic initiatives continues to generate growth from other construction end markets, including multifamily construction, light and heavy commercial construction, and remodeling. We believe the company also stands to benefit from pricing and profitability improvements and attractive tuck-in acquisition opportunities.

Detractors

  • Shares of IT services provider Endava plc fell after management cut guidance for the fiscal year ending June 30, 2024. Growth has slowed over the last year as business customers pulled back on discretionary IT spending due to macroeconomic uncertainty. Last fall, management was seeing early signs of a recovery, but new projects have been taking longer to materialize as customers delay spending decisions. Higher expenses due to increased staffing to meet anticipated demand weighed on margins as well. Management acknowledged that it misread the market and is taking steps to right-size the cost structure to improve margins. We remain invested because we expect these near-term headwinds to abate over time, leading to better growth as clients embrace digital transformation.
  • Shares of Neogen Corp., a leading provider of food and animal safety products, detracted from performance. While end-market challenges appear to be bottoming, this improvement is happening at a slower pace than the company had forecast, which caused it to lower fiscal year 2024 guidance. While there will likely be some near-term volatility as a result of macroeconomic conditions and the integration with 3M's Food Safety business, we believe Neogen is a good company with solid industry tailwinds and is poised for success once the merger integration process is completed.
  • Shares of Fox Factory Holding Corp., a leading provider of suspension systems and engineered products for the mountain bike, power sport, and off-road truck categories, declined during the quarter following an earnings update that indicated uncertain volumes in its bike and aftermarket truck segments. The company's challenges are mostly attributable to temporary issues such as vehicle production delays associated with the 2023 United Auto Workers strike (now resolved). We believe Fox Factory is protecting its brand positioning and leading innovation within its categories. As near-term demand headwinds dissipate, Fox Factory should return to strong growth rates in the large automotive aftermarket.

Quarterly Attribution Analysis (Institutional Shares)

as of 03/31/24

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 03/31/24

Baron Small Cap Fund (Institutional Shares) increased 11.81% in the first quarter, outperforming the Russell 2000 Growth Index by 423 basis points due to favorable stock selection.

Investments in Industrials and Financials were responsible for most of the relative gains in the period. Positive stock selection in Industrials added over 350 basis points to relative performance, with the primary driver being Vertiv Holdings Co, a manufacturer of critical infrastructure equipment for data centers. Vertiv’s shares rose more than 70% during the quarter due to improved focus on operational execution, strong revenue growth prospects, and robust opportunities for margin expansion. We expect Vertiv to benefit from the rising demand for data center capacity, with approximately 70% of its revenue coming from the data center end-market. As one of the leading providers of precision cooling for data centers, Vertiv also stands to benefit from the increasing adoption of generative AI (GenAI), as GenAI-related servers have higher energy density, which will necessitate more complicated cooling solutions. Sizeable gains from engineered aerospace components supplier TransDigm Group, Inc., gas and liquid handling storage technology leader Chart Industries, Inc., and composite decking manufacturer Trex Company, Inc. also aided performance. Strength in Financials came from specialty insurer Kinsale Capital Group, Inc., whose shares were bolstered by a combination of strong financial results and the general outperformance of insurance stocks in a stabilizing interest rate environment. We believe Kinsale is well managed and has a long runway for growth in an attractive segment of the insurance market.

Health Care was another driver of outperformance thanks to lower exposure to this lagging sector coupled with solid performance from global contract research organization ICON Plc, whose shares rose on upbeat commentary from management in light of improving industry conditions and accelerating trends. The company noted an encouraging uptick in request for proposal (RFP) opportunities, with pharmaceutical RFPs up mid-teens and business technology RFPs up mid-single digits, driven by improving funding trends and sentiment. Additionally, ICON expects to repay $100 million of debt, aiming to complete refinancing by mid-year to achieve roughly $200 million in interest savings. The company continues to prioritize M&A activity and recently authorized a $500 million repurchase for opportunistic use. Lastly, management has indicated a transition to more functional service provision work, which should have a gradual and manageable impact on margins, with gross margins likely to stay flat at around 30% this year.

Stock selection in Consumer Discretionary added another 80-plus basis points of relative gains, driven by strong performance from Installed Building Products, Inc. (IBP), a leading distributor and installer of insulation and complementary building products for residential and commercial end markets in the U.S. IBP’s shares were lifted by improving industry conditions, particularly in the new single-family residential construction market, which drives approximately 60% of the company’s revenue. IBP’s excellent execution across various strategic initiatives continues to generate growth from other construction end markets, including multifamily construction, light and heavy commercial construction, and remodeling. We believe the company also stands to benefit from pricing and profitability improvements and attractive tuck-in acquisition opportunities. Double-digit gains from casino operator Red Rock Resorts, Inc., specialty flooring retailer Floor & Decor Holdings, Inc., corporate daycare provider Bright Horizons Family Solutions, Inc., and online sportsbook DraftKings, Inc. also bolstered performance in the sector.

Partially offsetting the above was disappointing stock selection in Information Technology (IT), where outsourced software development provider Endava plc and cloud-based professional services software company Intapp, Inc. were responsible for a portion of the underperformance. Endava’s shares collapsed after management cut guidance for the fiscal year ending June 30, 2024. Growth has slowed over the last year as business customers pulled back on discretionary IT spending due to macroeconomic uncertainty. Higher expenses due to increased staffing to meet anticipated demand weighed on margins as well. We remain invested because we expect these near-term headwinds to abate over time, leading to better growth as clients embrace digital transformation. Intapp was a new addition to the Fund during the quarter. Despite reporting solid quarterly financial results, the company’s shares sold off on investor concerns about near-term budgetary headwinds in the investment banking customer segment. In addition, one of Intapp’s pre-IPO investors sold most of their position in early March. We view both issues as short term and purchased additional shares on weakness. We are optimistic about Intapp's long-term prospects as it continues to win share in financial services markets, expand its wallet share across large clients, and improve its free cash flow margins.

Adverse stock selection in IT was exacerbated by the Fund’s lack of exposure to benchmark heavyweights Super Micro Computer, Inc. (Supermicro) and MicroStrategy Incorporated, whose shares increased 255.3% and 169.9%, respectively, in the period. Together, these companies were a 370-plus basis point drag on performance in the sector. As a manufacturer of commodity motherboards for servers, Supermicro has been caught up in the hype surrounding AI, pushing its market cap from nearly $6 billion a year ago to nearly $60 billion as of quarter end. MicroStrategy sells business intelligence software and is the largest public holder of Bitcoin. The company’s software business is not growing, but its shares spiked alongside the price of Bitcoin in recent months. Neither business suits our investment criteria given our view that the core businesses lack sustainable competitive advantages, have low profit margins, are inconsistent generators of cash flows, and are dependent on demand trends that we view as cyclical rather than secular.

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.