Review and Outlook

as of 12/31/19

Markets concluded an outstanding year on a high note, with the Russell 2000 Growth Index gaining 11.39% in the fourth quarter. Performance was buoyed by increased clarity regarding domestic monetary policy, a Phase 1 trade deal between the U.S. and China, and a roadmap for Brexit stemming from the U.K. election. These were a subset of the key debates that had flummoxed prognosticators for much of the year. It took just one trading day in 2020 for a new geopolitical variable to present itself in the form of rising tensions between the U.S. and Iran. We are confident that many new and unforeseen macroeconomic and geopolitical uncertainties will arise before this year is out. We are equally confident that pundits will try, and fail, to consistently forecast the timing, magnitude, resolution, and ultimate impact on stock process.

Baron Discovery Fund increased in the quarter. Investments in Health Care, Information Technology (IT), and Industrials contributed the most. Real Estate and Financials holdings were modest detractors. Health Care had a strong quarter as investor fears about Medicare for All subsided and Congress unexpectedly passed legislation eliminating certain health care-related taxes. The sector included all three top contributors: Progyny, Inc., Esperion Therapeutics, Inc., and Sientra, Inc. With 19 of 22 holdings advancing, IT also had a good quarter. Performance was led by Ichor Holdings, Ltd., a supplier to semiconductor equipment manufacturers. Shares of Ichor increased as investors regained confidence that the semiconductor down-cycle is nearing its end and after the company guided to a significant acceleration into the next quarter. Wholesale landscape supplier SiteOne Landscape Supply, Inc. led appreciation within Industrials after share rose on a strong sales and earnings report that included a positive outlook for ongoing initiatives to improve productivity and margins. SiteOne also noted a strong pipeline of acquisition targets, including several potential larger deals. Real Estate detracted somewhat on share price declines in two out of three holdings. Financials also pulled back slightly on modest share price drops in the portfolio’s two investments within the sector.

After a volatile 2019, we expect more of the same in 2020. However, we have a portfolio that by our reckoning is more solid than ever before. While macro factors remain impossible to predict (including trade deals, the results of the 2020 elections, interest rate parity among world economies, and the continued strength of the U.S. economy), we focus more on the micro-economic level, and particularly on the ability of our businesses to grow revenues (and ultimately cash flow). By our standards, we see a lot to like in 2020. A major positive is that due to a number of capital raises in 2019, we believe most of our earlier stage companies are now funded through or close to positive free cash flow breakeven. There were also a number of other secondary offerings during the year. While these offerings hurt last year’s performance, they should benefit 2020 results and beyond in a significant way.

Top Contributors/Detractors to Performance

as of 12/31/19

Contributors

  • Shares of Progyny, Inc., a leading benefits management company specializing in fertility and family benefits solutions in the U.S., more than doubled after the company's November IPO. We are bullish on the growth prospects for this already profitable young company which offers better coverage and benefit design options than traditional insurance carriers. We believe growth will be supported by increasing infertility trends, an underpenetrated market, demonstrably better in-network outcomes, and the current war for talent which drives the need for attractive employee benefits.
  • Esperion Therapeutics, Inc. is a lipid management pharmaceutical developing bempedoic acid for the treatment of high cholesterol. The stock rose on news of Novartis' $9.7 billion acquisition of The Medicines Company that helped validate the cardiometabolic space as ripe for investment. We expect continued strong performance as Esperion launches its drug commercially in 2020 and progresses toward a large clinical trial aimed at demonstrating the medication's efficacy in reducing morbidity/mortality.
  • Shares of Sientra, Inc., an aesthetics medical device company, appreciated on an earnings report that beat Street expectations, an announcement to acquire a manufacturing plant in its supply chain, and plans for meaningful cost savings over the next two years. We continue to believe that the company is substantially undervalued and look forward to accelerating growth in 2020.

Detractors

  • TherapeuticsMD, Inc. is a developer of hormone-based drugs for women's health, with three FDA-approved drugs in limited launch. Shares declined in the quarter as the company raised $65 million in a secondary offering. With this event behind it, we believe TherapeuticsMD is poised for hyper-growth in 2020. 
  • ForeScout Technologies, Inc. discovers devices agent-free in real time as they connect to a network and continuously monitors and assesses their security posture. Its solution supports heterogeneous campus and cloud infrastructures and provides security customers with visibility to 30% more devices on the network after installation. Shares fell after the company missed guidance due to the failure to close some large contracts. We retain conviction as overall penetration is low relative to the market opportunity and technology is best in class. 

Quarterly Attribution Analysis (Institutional Shares)

as of 12/31/19

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 12/31/19

Baron Discovery Fund (Institutional Shares) increased 10.16% in the fourth quarter, yet trailed the Russell 2000 Growth Index by 123 basis points due to cash exposure in a rising market and, to a lesser extent, stock selection.

Outperformance of Information Technology (IT) and Communication Services investments and minimal exposure to the defensive Utilities and Consumer Staples sectors contributed the most to relative results. Stock selection in IT added nearly 240 basis points to relative performance, driven by identity and access management solutions provider Ping Identity Corporation and semiconductor capital equipment firm Ichor Holdings, Ltd. Ping’s shares were up sharply after reporting a strong first quarter as a public company, exceeding Street expectations in all key metrics. Ichor’s stock price rose after the company guided to a significant acceleration into next quarter and investors regained confidence that the semiconductor downcycle is nearing its end. Several other IT holdings also performed well, such as professional services and enterprise intelligence software provider PAR Technology Corporation, outsourced software development company Endava plc, and intelligent business payments platform Bill.com Holdings, Inc. Strength in Communication Services came from U.K.-based special interest publisher Future plc, whose shares were lifted by a positive earnings update and the announced acquisition of TI Media.

Apart from cash, investments in Health Care, Real Estate, Industrials, and Financials detracted the most from relative performance. The Fund’s Health Care investments were up sharply in the period, yet failed to keep pace with their counterparts in the index due to a difficult quarter for women's health company TherapeuticsMD, Inc. TherapeuticsMD was the top detractor from absolute performance after the company raised $65 million in a secondary offering. Genetic testing labs operator Myriad Genetics, Inc. and blood products company Cerus Corporation also weighed on performance in the sector. Weakness in Real Estate came from Americold Realty Trust, Alexander & Baldwin, Inc., and Rexford Industrial Realty, Inc., which underperformed alongside other REITs as investors rotated into higher growth stocks in a risk-on market environment. Negative stock selection in Industrials and Financials came from aerospace and defense company Mercury Systems, Inc. and specialty insurer Kinsale Capital Group, Inc., respectively. Mercury’s shares pulled back after the company’s valuation became a bit extended following a significant run-up in the prior quarter. Kinsale’s shares fell slightly after the company reported disappointing third quarter financial results. Reserve development was less favorable than expected, which combined with broader industry concerns about rising loss cost inflation led investors to take profits after a strong run.

as of 12/31/19

Yearly Attribution Analysis (for year ended 12/31/2019)

Baron Discovery Fund (Institutional Shares) appreciated 26.85% for the year, yet underperformed the Russell 2000 Growth Index by 163 basis points as the positive effect of relative sector weights was overshadowed by cash exposure in a sharp up market. The Fund’s higher than usual cash position was due to inflows during the year.

Investments in Information Technology (IT), Communication Services, and Financials added the most value. Stock selection in IT contributed over 350 basis points to relative performance, driven by the Fund’s application software holdings, which were up nearly 50%. The Trade Desk and RIB Software SE were among the best performing companies in the sub-industry after reporting robust financial results. Strength in the sector also came from outsourced software development company Endava plc, semiconductor capital equipment firm Ichor Holdings, Ltd., and identity and access management solutions provider Ping Identity Corporation. Aside from stock selection, higher exposure to semiconductor equipment and application software stocks, which were up sharply in the index, added value. Within Communication Services, outperformance of holding company GCI Liberty, Inc. and U.K.-based special interest publisher Future plc bolstered relative results. GCI’s stock price was up in response to solid quarterly results from Charter Communications, which accounts for approximately 70% of GCI’s gross asset value. GCI was sold due to market cap considerations, and we re-allocated proceeds into new smaller market cap investment ideas. Future’s shares were up on strong e-commerce performance driven by Amazon Prime Day, increased investor awareness in the U.S., foreign exchange tailwinds, and an accretive acquisition. Positive stock selection in Financials came from specialty insurer Kinsale Capital Group, Inc. Kinsale reported outstanding financial results in the first half of the year as conditions in the Excess & Surplus lines market improved following retrenchment from several large competitors.

Aside from cash, Health Care investments detracted approximately 730 basis points from relative results. Weakness in the sector was driven by radiation therapy systems developer ViewRay Incorporated and women's health company TherapeuticsMD, Inc. ViewRay’s stock price fell after management lowered full-year guidance by five units, causing a $30 million shortfall. These unit sales were delayed, not lost, but it still hurt from a financial perspective. TherapeuticsMD’s shares were pressured early in the year by political scrutiny of pharmaceutical industry pricing and disappointing revenue guidance. Genetic testing labs operator Myriad Genetics, Inc., excimer laser systems developer Ra Medical Systems, Inc., medical aesthetics company Sientra, Inc., and medical technology company Intersect ENT, Inc. also hampered performance in the sector.

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.