Review and Outlook

as of 03/31/20

As the manager of a health care fund, we are in the unusual position of investing in the industry most directly involved in developing solutions to the COVID-19 pandemic. There is no question that the pandemic is a life-altering event. At the same time, we believe there is reason to be optimistic. The scientific community and leading health care companies are racing to launch diagnostics, discover novel therapeutics, and develop vaccines. While no one can predict when the pandemic will subside or end, we believe that compared with other historical pandemics, this one has the benefit of an interconnected global scientific community all focused on “cracking the case” with modern technology. Both the genetic code and the shape and characteristics of the SARS-CoV-2 virus’ key lifecycle proteins have been described and shared since the virus emerged in China late last year. We believe there will ultimately be positive news, it’s just a question of when.

Against this backdrop, Baron Health Care Fund declined in the quarter. Holdings within the health care technology sub-industry contributed positively to performance. Investments within the health care equipment, managed health care, and life sciences tools & services sub-industries detracted the most. All three health care technology holdings added to performance, led by top contributor Schrodinger, Inc. Teleflex Incorporated and Silk Road Medical, Inc. led declines within health care equipment. Teleflex was the third largest detractor while Silk Road, which offers a new treatment for carotid artery disease, was hurt by the deferral of elective hospital procedures. Losses within managed health care were led by top detractor UnitedHealth Group Inc. Contract research organization Iqvia Holdings, Inc. led declines within life sciences tools & services along with other CROs on concerns of clinical trial disruptions.

We think one of the long-term impacts of the pandemic will be a greater appreciation for science and increased investment in life sciences research, pandemic preparedness, and health care infrastructure. Political attacks on the biopharmaceutical industry will likely diminish as the industry emerges with vaccines. Drug pricing reform is likely off the table for now as well. Regulation of telemedicine has been loosened and the FDA has been quick in granting emergency use authorizations related to the pandemic. We also believe there will be greater investment in life sciences research and health care infrastructure. Finally, with no major presidential candidate advocating Medicare for All, the risk of a transformational change that would threaten the long-term viability of profit-making health care companies is significantly lower. We are more convinced than ever that health care will be an attractive place to invest over the long term.

While near-term earnings will no doubt be hurt by the COVID-19 pandemic, we are optimistic about the long-term growth prospects for our holdings.  For that reason, we remain focused on our core strategy.  We believe the companies in which the Fund invests are unique, competitively advantaged, well-managed growth companies.

Top Contributors/Detractors to Performance

as of 03/31/20

Contributors

  • Schrodinger, Inc. was a successful IPO in the quarter whose stock increased on investor interest in a diversified way to invest in the biotechnology space. Schrodinger has a recurring software revenue business married to its drug development efforts and benefits from the widely held belief that it is bringing next generation computers into the biotechnology space. 
  • Acceleron Pharma Inc. is a biopharmaceutical company developing drugs that regulate the transforming growth factor beta superfamily of proteins, which play fundamental roles in the growth and repair of cells and tissues. Shares appreciated sharply on positive reports for Acceleron’s pulmonary arterial hypertension treatment Sotatercept across all studied markers. This represents Acceleron’s second potential commercial drug and a new clinical vertical. 
  • Vertex Pharmaceuticals Incorporated, the leader in cystic fibrosis treatment, contributed to performance in the quarter given a flight to quality. Vertex has a strong balance sheet, is in the middle of a fast cash flow growth cycle, and has lifesaving drugs, making it a critical need for patients despite COVID-19 disruptions. 

Detractors

  • Shares of UnitedHealth Group Incorporated, the U.S.'s leading provider of health care services and insurance, fell in the first quarter as investors feared the COVID-19 pandemic would increase medical costs and a potential recession could reduce the rolls of insured. However, in our view, physician capitation, delayed elective procedures, and other care deferrals will be a cushion to COVID-19 claims and post-crisis job losses should reverse given the previous robust economy. We retain long-term conviction in this market-leading company.
  • HCA Healthcare, Inc. is a large provider of health care services, with 185 hospitals and about 1,800 sites of care, including surgery centers, freestanding ERs, urgent care centers, and physician clinics. It operates in 42 primarily urban markets largely in the Southeast and Southwest. Shares of HCA declined along with other providers on concerns that the COVID-19 outbreak represents a perfect storm of elevated expenses, lower payer mix, and cancellation/deferral of elective procedures with higher pay margins. We retain conviction as we believe HCA is well positioned for the long term. 
  • Teleflex Incorporated detracted from performance in the quarter. Teleflex is a medical device company that sells primarily single-use products used by hospitals and health care providers for common diagnostic and therapeutic procedures in critical care and surgical applications. The stock declined as hospitals delayed medical procedures to make room for patients with COVID-19. While elective procedure delays will likely have a negative short-term impact on sales, we continue to have conviction in the company’s long-term growth outlook.

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 Health Care Fund (Institutional Shares) fell 9.37% in the first quarter, yet outperformed the Russell 3000 Health Care Index by 351 basis points due to favorable stock selection and, to a lesser extent, cash exposure in a difficult market environment.

Aside from cash, investments in health care technology, biotechnology, and health care equipment contributed the most to relative performance. Positive stock selection in health care technology accounted for more than half of the Fund’s outperformance in the period, driven by Schrodinger, Inc.’s tremendous gain following the company’s IPO in early February. The company, which develops state-of-the-art chemical simulation software for use in pharmaceutical, biotechnology, and materials research, was the top contributor to absolute performance in the period. Strength in biotechnology was due to share price gains from Acceleron Pharma Inc., Vertex Pharmaceuticals Incorporated, Zai Lab Limited, and Alector, Inc. Acceleron and Vertex were among the largest contributors on an absolute basis, while Zai Lab’s shares benefited from the commercial launch of ovarian cancer treatment Zejula in China and increased investor awareness about the future potential of the Chinese biotechnology market. Alector develops novel therapeutics for the treatment of neurodegeneration and other brain disorders. The company’s shares rose sharply after Biogen’s successful re-filing of its Alzheimer's drug, Aducanumab, signaled potential leniency by the FDA towards approving drugs to treat these devastating disorders. Within health care equipment, outperformance of diabetes management platforms DexCom, Inc. and Insulet Corp. added the most value. DexCom’s stock appreciated after reporting significantly higher sales and profits in the fourth quarter of 2019, driven by strong demand for the company's G6 device. Although we think DexCom's growth may be moderately impacted in the near term by the COVID-19 pandemic, we continue to believe the company has a long runway for growth. Insulet’s shares outperformed after the company’s quarterly financial results surpassed Street expectations, fueled by: the launch of the OmniPOD DASH system; the accompanying move to pharmacy benefit managers; international momentum; and technology adoption trends broadly in diabetes. Masimo Corporation also performed well in the sub-industry due to increased demand for its patient monitoring technologies because of the pandemic.

Underperformance of managed health care holdings and meaningfully lower exposure to outperforming pharmaceutical stocks detracted the most from relative results. Weakness in managed health care was driven by Health Savings Account administrator HealthEquity, Inc., whose custodial revenue was negatively impacted by the precipitous decline in interest rates during the quarter.

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.