Review and Outlook

as of 06/30/19

U.S. equity indexes added to their first quarter gains, ending the first half of 2019 at or near all-time highs. As was the case last quarter, the market was periodically unnerved by the prospect of additional tariffs on Chinese and Mexican imports. However, eventual signs of easing trade tensions, coupled with indications that the Federal Reserve was becoming more dovish, helped lead the market higher. Larger capitalization stocks and mid-caps, in particular, were among the best performers. Growth-oriented stocks also continued to outperform their value-oriented peers.

Baron Discovery Fund increased in the quarter. Investments in Industrials, Financials, and Information Technology (IT) contributed the most. Health Care and Consumer Staples holdings detracted. Industrials performance was led by SiteOne Landscape Supply, Inc., a wholesale landscape supplier, and Kornit Digital Ltd., a supplier of digital printing solutions to the textile industry. The sole holding in Financials, Kinsale Capital Group, Inc., drove performance of that sector. Kinsale was the second largest contributor in the quarter. The IT consulting & other services sub-industry led performance of the IT sector. The sub-industry included top contributor Endava plc. Health Care had a challenging quarter overall due to investor concerns over sector-specific political rhetoric as we approach the 2020 Presidential election. The sector included TherapeuticsMD, Inc. and Sientra, Inc., respectively the top and third largest detractors. A decline in the share price of beverage company Limoneira Company weighed on the Consumer Staples category.  

We believe that valuations for our current investments leave room for significant upside over the medium and long term (which we define as a three-to-five year period). We continue to look for our targeted returns on each of our investments on an individual basis. Our energy has not waned a bit, and we continue to analyze, visit and question management teams for each of our portfolio companies as well as for many other companies that could become investments for the Fund.

Top Contributors/Detractors to Performance

as of 06/30/19

Contributors

  • Shares of Endava plc, a provider of outsourced software development to business customers, appreciated after reporting excellent quarterly results and raising full-year guidance.  In March, revenue grew 25% and EPS grew 46% due to strong client demand and significant margin expansion. The share price also likely benefited from a secondary offering that increased liquidity, removed an overhang from pre-IPO shareholders, and increased awareness to new investors. We believe Endava will continue gaining share in a large global market for IT services.
  • Kinsale Capital Group, Inc. is a specialty insurance company. Shares contributed to performance after Kinsale reported excellent first quarter results that exceeded Street expectations. Premium growth accelerated to 33% due to share gains, higher pricing, and favorable market conditions as large competitors retrenched. Underwriting margins were especially strong due to favorable reserve development and price increases exceeding loss trends. We continue to own the stock, as we believe Kinsale has a long runway for growth in an attractive segment of the P&C insurance market.
  • Silk Road Medical, Inc. contributed to performance during the period held in the quarter. Silk Road is a newly public company offering a novel approach to the treatment of carotid artery disease. Shares appreciated because of the potential for this approach to become the standard of care. We think the company has a long runway for growth, as clinical data has shown that its treatment offers the advantages of a minimally invasive solution with lower stroke risk than existing alternatives.

Detractors

  • Shares of specialty pharmaceutical company TherapeuticsMD, Inc. detracted from performance due to political scrutiny of pharmaceutical industry pricing and revenue guidance that fell short of Street expectations. Since TherapeuticsMD’s drugs are relatively low priced, we do not see pricing as a regulatory issue. Further, the variance in revenue guidance was due to legacy products having no value in our model. As payers finalize reimbursement of the company’s three FDA-approved drugs in the second half of 2019 and early 2020, we expect revenues and margins to accelerate dramatically.
  • Shares of medical device company Sientra, Inc. detracted from performance. Slight delays in the company’s ramping of its third-party breast implant facility and industry concerns over textured implant safety weighed on the stock. Sientra’s textured implants have far fewer negative incidences per implant versus competitors, and there was no bad news in the wake of an FDA industry oversight meeting. The company raised $115 million in an equity offering in the quarter, and we believe shares will rebound as Sientra ramps production of implants in the second half of 2019.

Quarterly Attribution Analysis (Institutional Shares)

as of 06/30/19

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 06/30/19

Baron Discovery Fund appreciated 1.08% in the second quarter, yet trailed the Russell 2000 Growth Index by 167 basis points largely due to stock selection.

Investments in Financials, Communication Services, and Real Estate contributed the most to relative results. Within Financials, outperformance of the Fund’s only holding in the sector, specialty insurer Kinsale Capital Group, Inc., added value. Kinsale was the second largest contributor to absolute performance after reporting another strong quarter. Kinsale’s technology advantage and a dislocation in the Excess & Surplus lines market contributed to the company’s peer-leading top-line growth. Strength in Communication Services came from GCI Liberty, Inc., a holding company with a significant stake in Charter Communications, Inc. GCI’s stock price was up in response to solid quarterly results from Charter Communications. Stock selection in Real Estate contributed approximately 40 basis points to relative results, driven by REITs Rexford Industrial Realty, Inc. and Americold Realty Trust. Shares of industrial real estate firm Rexford rose as the company continued to execute on its differentiated business strategy. Private market values for Rexford’s real estate assets continued to rise as well, leading to multiple expansion. Shares of temperature-controlled warehouse operator Americold were up after management’s positive outlook caused investors to overlook a first quarter earnings miss.

Underperformance of investments in Health Care and Information Technology (IT) detracted the most from relative results. Stock selection in Health Care was the main cause of underperformance in the quarter, driven by share price declines from TherapeuticsMD, Inc., Sientra, Inc., Intersect ENT, Inc., and Myriad Genetics, Inc. TherapeuticsMD and Sientra were among the three largest detractors from absolute performance, while shares of Intersect, a medical technology company dedicated to advancing the treatment of ear, nose and throat conditions, fell after the company’s SINUVA product launch demonstrated less momentum than investors expected. The stock was also pressured by the announcement of a CEO transition. Shares of molecular diagnostic company Myriad Genetics declined on concerns over whether private payers will cover the company’s GeneSight test for anti-depressive drugs. Weakness in IT was driven by education technology company 2U, Inc. The company was the second largest detractor from absolute performance after reporting disappointing guidance for the second quarter and fiscal year 2019. Other sources of underperformance in IT were systems software companies Blue Prism Group plc and ForeScout Technologies, Inc.

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.