Review and Outlook

as of 12/31/18

U.S. equity indexes declined meaningfully during the quarter, with broad-based weakness across nearly all sectors. Growth and value indexes both fell, but the decline in growth stocks was more pronounced.  Reasons for the sell-off included concerns over the looming trade war between the United States and China, indications that the Federal Reserve might increase interest rates several times during 2019, and some signs that global growth, particularly in China, might be slowing.

Baron Asset Fund declined in the fourth quarter. No sector contributed during an exceptionally challenging three months. Among sub-industries, only insurance brokers contributed, buoyed by the positive performance of Willis Towers Watson, the second largest contributor in the quarter. Information Technology (IT), Health Care, and Industrials investments detracted the most. Within IT, application software led the decline, including  Guidewire Software, Inc., a systems software provider to the P&C insurance industry, and ANSYS, Inc., a market leader in simulation-driven product development. The sector also included second largest detractor Gartner, Inc. Declines in Health Care were led by health care equipment, including top detractor IDEXX Laboratories, Inc., and life sciences tools & services holdings. Industrials investments fell on overall weakness as concerns about slowing growth in China pressured the sector.

Despite the stock market’s poor performance during the past quarter, we remain optimistic about the prospects for U.S. equities. We are also encouraged by the market’s upward direction during the early part of January 2019. We believe that the economy remains generally robust and that the outlook for continued strength in earnings among the companies in our portfolio remains solid. The U.S. unemployment rate remains near an historic low, and most leading economic indicators remain positive. Although we are not expert in gauging the future direction of interest rates (and we believe that few such “experts” exist), we are encouraged that the Wall Street consensus has evolved to expect more modest increases by the Federal Reserve going forward.

We believe that our portfolio of well-managed, competitively advantaged, fast growing companies will continue to perform well, although we cannot guarantee that they will. We continue to believe that high-quality, mid-sized growth stocks represent a compelling long-term investment opportunity.

Top Contributors/Detractors to Performance

as of 12/31/18

Contributors

  • MarketAxess Holdings Inc. operates the leading electronic platform for trading corporate and sovereign bonds. The stock performed well after the company reported good third quarter results with daily trading volume up 11% while total market volume fell 7%. The company benefited further from elevated market volatility in the fourth quarter with daily trading volume up 26% while total market volume fell 2%. We continue to own the stock because we expect MarketAxess will be the prime beneficiary of the secular shift to electronic trading in the corporate bond market.
  • Shares of Willis Towers Watson Public Limited Company, a leading insurance broker and HR consultant, contributed to performance in Q4. The company’s stock had become attractively valued, in our view, heading into the quarter, and the company reported strong third quarter earnings in early November, enabling it to hold up relatively well in a volatile market. We retain conviction as we believe Willis Towers Watson can drive sustained double-digit adjusted EPS growth and generate meaningful free cash flow.
  • Shares of SBA Communications Corp. rose in the quarter as all domestic carriers continued high network activity levels on SBA towers. SBA is a significant owner of wireless transmission towers in the U.S. and Central and South America. We continue to believe that U.S. and Latin American wireless carriers will need to place more equipment on SBA’s towers in order to densify 4G networks, and that 5G will present an exciting and virtually undiscounted opportunity for SBA and its share price.

Detractors

  • Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. detracted from performance. While Q3 financial results were strong, unfavorable weather in Europe and depressed global milk prices slightly reduced overall growth. We retain conviction. In the core companion animal business, competitive trends are outstanding, highlighted by instrument installed base growth of 20%, domestic lab growth more than twice that of its main competitor, and improving sales productivity. New proprietary innovations and a sales force expansion should also contribute to growth, in our view.
  • Shares of Gartner, Inc., a provider of syndicated research, detracted from performance as technology stocks broadly sold off. The integration of CEB is proceeding well, and the company increased its investment to pursue this large opportunity. We expect this acquisition to drive faster revenue growth over the medium term. We also believe that key forward looking metrics in Gartner’s traditional IT research business are solid. We observe signs of traction in the acquired CEB business with good uptake of seat-based model sales, particularly to new customers.
  • Shares of Vail Resorts, Inc., the largest operator of ski resorts in the world, decreased in the quarter as the company sold slightly fewer season pass sales for the 2018/19 ski season than investors expected. While disappointing, Vail locked up almost half its lift ticket revenue before the season even started, which helps make earnings more predictable and less susceptible to weather conditions. We believe the company is still able to grow earnings at a double-digit rate and is generating strong cash flow that it is using for dividend increases and accretive acquisitions.

Quarterly Attribution Analysis (Institutional Shares)

as of 12/31/18

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 12/31/18

Baron Asset Fund declined 16.35% in the fourth quarter and performed roughly in line with the Russell Midcap Growth Index.

Outperformance of investments in Financials and Industrials, cash exposure in a down market, and higher exposure to better performing REITs within the Real Estate sector contributed the most to relative results. Stock selection in Financials added 125 basis points to relative results, driven by Willis Towers Watson Public Limited Company and MarketAxess Holdings Inc., the two largest contributors on an absolute basis after their share prices reacted favorably to strong third quarter earnings results. Specialty insurer Arch Capital Group Ltd., investment management tools provider FactSet Research Systems, Inc., and bank and wealth management company First Republic Bank also added value after their stock prices held up relatively well in a volatile market. Strength in Industrials came from the outperformance of data and analytics vendor Verisk Analytics, Inc. and diversified technology company Roper Technologies Inc. Verisk’s shares outperformed after the company reported solid third quarter financial results and hosted an upbeat investor day. Roper’s stock outperformed as the high-quality characteristics of the company’s business were positively regarded by investors in a volatile market. Roper is distinguished by its disciplined capital deployment, strong track record for creating shareholder value, and stable earnings with greater than 50% recurring revenue.

Information Technology (IT) and Consumer Discretionary investments and lack of exposure to the outperforming Consumer Staples sector detracted the most from relative results. Weakness in IT was partly due to the underperformance of Gartner, Inc., the second largest detractor from absolute results, as well as credit card processor Worldpay, Inc. Shares of Worldpay were down after investors reduced their growth expectations for 2019. Lack of exposure to systems software stocks, which were roughly flat in the index, and underperformance of ANSYS, Inc., Guidewire Software, Inc., and other application software stocks also hampered relative results. Within Consumer Discretionary, underperformance of global ski resort operator Vail Resorts, Inc. and venerable jeweler Tiffany & Co. weighed on relative results. Vail was the third largest detractor from absolute performance after the company sold slightly fewer season pass sales for this year’s ski season than investors expected. Tiffany’s shares were down sharply after third quarter sales growth decelerated from levels experienced earlier in 2018. However, we believe Tiffany’s ongoing transformation is a process that should be measured over years, not quarters.

as of 12/31/18

Yearly Attribution Analysis (for year ended 12/31/2018)

Baron Asset Fund was up 0.14% for the year, outperforming the Russell Midcap Growth Index by 489 basis points due to stock selection. Style biases were also a tailwind to relative performance, driven by underexposure to the volatility and earnings yield factors.

Investments in Health Care, Industrials, Financials, and Consumer Discretionary and lack of exposure to the lagging Materials sector added the most value. Health Care holdings outperformed after increasing more than 9% as a group, led by veterinary diagnostics leader IDEXX Laboratories, Inc. and DNA sequencing platform Illumina, Inc. IDEXX and Illumina were the top contributors to absolute results. Additionally, higher exposure to the sector, which was up slightly in the index, and outperformance of health care technology company Veeva Systems Inc. lifted relative results. Veeva’s shares increased sharply after reporting consecutive quarters of strong financial results. Veeva continues to report healthy margins growth driven by sustainable growth in both top and bottom lines. Strength in Industrials was mostly attributable to the outperformance of data and analytics vendor Verisk Analytics, Inc. and pest and termite control services provider Rollins, Inc. Verisk’s shares responded well to solid financial results in both the second and third quarters. The Insurance segment continues to perform well, and we are seeing signs of improvement in both Energy and Financial Services. Rollins’ stock price rose as the company executed in a consistent manner and broader pest control industry trends remained positive. Favorable stock selection in Financials, related to share price gains from FactSet Research Systems, Inc., MarketAxess Holdings Inc., and Willis Towers Watson Public Limited Company, was partially offset by higher exposure to this underperforming sector. FactSet’s stock price was buoyed by a large 15,000 seat deal win with Merrill Lynch Wealth Management. Performance in Consumer Discretionary was bolstered by the Fund’s sizeable position in global ski resort operator Vail Resorts, Inc., whose shares were up slightly for the year. Despite poor snowfall, Vail had a strong ski season last year and successfully increased pass sales by double-digits for the upcoming ski season. The company also utilized its strong balance sheet to acquire four additional resorts across the U.S., which further increased pass sales.

Real Estate investments and lack of exposure to the strong performing Consumer Staples sector weighed the most on relative performance. Within Real Estate, underperformance of data center REIT Equinix, Inc. and higher exposure to this lagging sector hindered relative results. Equinix was the third largest detractor from absolute performance.