Review and Outlook

as of 03/31/20

The first quarter of 2020 was like no other that we or any money manager have ever experienced. After a strong start, with the market at all-time highs, the world fell into the grip of a global health pandemic. The market declined dramatically in response. The S&P 500 Index fell 33.8% from mid-February till late March. Volatility was intense, with the indexes swinging over 3% on 22 of 26 days from late February to the end of March. Smaller capitalized stocks, as measured by the Russell 2000 Growth Index, fell even more.

Economies around the world have shuttered in an effort to control the spread of the disease, resulting in a drastic contraction in economic activity. Unemployment claims have skyrocketed and small business and larger ones that are leveraged or directly impacted are fighting for survival. The severity and duration of the pandemic, the length and depth of the sharply reduced economic activity, and the path and timing of reopening the economy are all unknowns. The Federal Reserve and Congress have unleashed massive monetary and fiscal programs to try to blunt the impacts of the crisis, providing liquidity to markets and the financial system, increasing unemployment benefits, and extending loans and grants to businesses in need.

Against this backdrop, Baron Small Cap Fund declined in the quarter. Real Estate investments contributed to positive performance. Holdings in Consumer Discretionary, Information Technology (IT), and Industrials detracted the most. Americold Realty Trust, which owns temperature-controlled warehouses, led performance in Real Estate amid expectations that it will benefit from consumer stockpiling of food during the pandemic. Consumer Discretionary holdings were hard hit by the economic shutdown resulting from the pandemic. Gartner, Inc. and WEX Inc., respectively the second and third largest detractors, led declines within IT. Top detractor ASGN Inc. led weak performance within Industrials.

As of this writing, we are seeing cautious optimism from early signs that the COVID-19 spread across the U.S. may be slowing and hope that the government's resolve and response to carry its citizens and businesses during the shutdown would succeed. However, we remain concerned that it will not be so easy to quickly re-open the economy, that substantial damage will be done the longer the economy stays shut, and that it is unlikely that the recovery will be robust.

Our optimism and study of the situation causes us to believe that this will pass. We think in time our companies will earn more than we originally expected this year, and their stocks will be higher. We believe small caps are set up to shine when the equity markets recover, as usually is the case. We suspect it will be a tug of war along the way, based on the pace of economic recovery and investor sentiment. At the bottom, bearishness is extreme and anxiety high, which is a good time to buy. We think investors who can stomach the uncertainty and stay invested, as we are in our strong businesses, even if 2020 will be a lost year for some of them, will benefit in the long run.

Top Contributors/Detractors to Performance

as of 03/31/20

Contributors

  • Shares of Teladoc Health Inc., the U.S.'s leading provider of telehealth services, soared during the first quarter due to the COVID-19 outbreak. Telehealth is perfectly suited as an initial patient touchpoint in a time of social distancing and growing concerns of overwhelming the health care system. Call volumes have spiked, reimbursement for telehealth has been widely expanded, and restrictions on MD cross-state licensure have been lifted to expand the pool of available doctors. We believe the crisis has accelerated the adoption and cemented the use of telehealth. 
  • Clarivate Analytics Plc, a provider of IP and scientific information and services, contributed to performance on solid fourth quarter earnings, which provided optimistic views on 2020 performance. We expect the company to be relatively well positioned to manage through a challenging macro backdrop given its high recurring revenue base and bestselling products. We believe that Clarivate will be a steady earnings compounder, which should drive solid returns for the stock over a multi-year period.
  • DexCom, Inc. sells continuous blood glucose monitoring devices for patients with diabetes. The stock rose after the company reported significantly higher sales and profit in the fourth quarter driven by strong demand for the company's G6 device. Although we expect DexCom's growth to experience some disruption from the COVID-19 pandemic, we continue to believe DexCom has a long runway for growth.

Detractors

  • Shares of ASGN Incorporated, the second largest U.S. staffing firm and a leader in the non-commoditized high end of the professional staffing industry, fell sharply in the quarter. We believe this is unwarranted as 20% of revenue comes from the segment that serves the federal government, which is more stable and protected than commercial businesses. We believe its IT focus is less cyclical and some functions can be done remotely. We also think investor concerns around leverage will subside as working capital needs decrease due to the slowdown, which will naturally delever the balance sheet.
  • Shares of Gartner, Inc., a provider of syndicated research, detracted from performance on investor expectations that Gartner’s destination events business, which represents approximately 11% of revenue, will be disproportionately impacted by the COVID-19 pandemic. We believe that this headwind is transitory, and the company’s core research business should remain resilient despite elevated uncertainty.
  • WEX Inc. provides payment services that enable businesses to manage employee spending. Shares declined sharply due to the COVID-19 pandemic’s negative impact in travel spending as well as reduced fleet segment revenue due to low fuel prices. In addition, WEX announced strategically important acquisitions of two related travel payment companies that will likely incur a higher-than-expected cost of debt financing, and will cause WEX’s leverage ratio to spike above 4 times in an environment when investors are wary of highly leveraged companies. 

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.