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as of 03/31/20
U.S. equity markets suffered their worst quarter since the 2008 financial crisis, abruptly ending the longest bull market in U.S. history. U.S. equities achieved new all-time highs in mid-February before falling sharply as the spread of the COVID-19 virus worsened outside of China, raising concerns about global health risks and impacts on global supply chains and economies. The situation was made worse by an escalating oil price war between Russia and Saudi Arabia, which sent oil prices tumbling more than 20% in early March. Despite the Federal Reserve’s drastic actions and Washington’s massive stimulus plan to counter the coronavirus-induced economic slowdown, stock prices remained under pressure as the number of reported cases continued to rise globally. Small-cap stocks, which investors view as more vulnerable to economic disruption and less liquid, were particularly hard hit.
Against this backdrop, Baron Discovery Fund declined in the quarter. No sector contributed. Health Care, Information Technology (IT), and Consumer Discretionary investments detracted the most. Top detractor Sientra, Inc. led declines within Health Care. Despite some gains within IT, detractors outweighed contributors, led by third largest detractor PAR Technology Corporation. The portfolio’s Consumer Discretionary investments experienced steep losses as many retail, restaurant, and casino locations were shuttered as a result of COVID-19. The sector included second largest detractor Floor & Décor Holdings, Inc.
As long-term investors, our investment horizon goes beyond the impact of COVID-19. We believe we will get through this pandemic -- it is just a question of timing. Knowing this allows us to capitalize on the benefits of contractionary periods. Most importantly, we will be able to buy high- quality, fast growing businesses at valuations you will not see at other points in the business cycle. In addition, as weaker companies tend to go bankrupt during contractions, survivors are left in better competitive positions, allowing for faster growth and higher profit margins post-contraction. Businesses also become more efficient in challenging economic times, making targeted cost cuts that typically do not need to be layered back on during the recovery. Finally, we expect valuations to increase when investors have more visibility into the coming recovery.
We fully expect our small, fast growing businesses to weather the current economic environment and emerge in a stronger competitive position on the other side. We also believe that the current uncertainty and dislocation will create opportunities to purchase additional fast-growing businesses at reasonable valuations. Economic recoveries have typically been good environments to be invested in fast growing small companies and we would expect the next recovery to be no different.
as of 03/31/20
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 Discovery Fund (Institutional Shares) fell 19.95% in the first quarter, yet outperformed the Russell 2000 Growth Index by 581 basis points due to stock selection and, to a lesser extent, relative sector weights and modest cash exposure in a down market. Style biases also added value, driven by underexposure to the poor performing earnings yield and leverage factors.
Investments in Industrials, Real Estate, Information Technology (IT), and Financials and lower or lack of exposure to the lagging Consumer Discretionary, Materials, and Energy sectors added the most value. Stock selection in Industrials contributed nearly 300 basis points to relative performance, driven by defense company Mercury Systems, Inc. and hydraulic and electronic control solutions manufacturer Helios Technologies, Inc. Mercury’s stock price rose in the quarter because the company is considered a necessary enterprise, allowing it to operate without interruption during the COVID-19 crisis. Helios’ shares benefited from a backlog of orders entering the year, which provided stability in a shifting environment. Performance in the sector was also bolstered by wood-alternative decking and railing manufacturer Trex Company, Inc., wholesale landscape supplies distributor SiteOne Landscape Supply, Inc., and composite wind blade manufacturer TPI Composites, Inc. Strength in Real Estate came from temperature-controlled warehouse operator Americold Realty Trust and industrial real estate firm Rexford Industrial Realty, Inc., whose shares outperformed as investors appreciated the stability of their business models amid an uncertain macroeconomic environment. Within IT, outperformance of Qualys, Inc., RIB Software SE, and other software holdings and higher exposure to this better performing industry added the most value. Shares of cloud-based security solutions provider Qualys outperformed because security spending is expected to less impacted by any potential changes in overall IT spending. Shares of construction modeling software company RIB were up sharply for the period held after the company received an acquisition offer from Schneider Electric. The Fund’s largest position in Financials, specialty insurer Kinsale Capital Group, Inc., performed well after being less impacted by COVID-19 and slower economic growth than many other businesses.
Health Care and Communication Services investments and lack of exposure to the defensive Utilities sector detracted the most from relative results. Weakness in Health Care was driven by aesthetics medical device company Sientra, Inc., whose shares fell sharply on fears about lower sales due to COVID-19. Lower exposure to outperforming biotechnology stocks also weighed on performance in the sector. The primary sources of underperformance in Communication Services were tracking stock Liberty Media Corp. – Liberty Formula One Group and U.K.-based special interest publisher Future plc.
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.