Baron Asset Fund (BARIX)

Portfolio Management

AndrewPeck
Andrew Peck

Fund Manager since 2003

View All Commentary by Andrew

Fund Description

Baron Asset Fund invests primarily in mid-sized growth companies.

    

Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 3/31/2016)

Market indexes experienced substantial volatility in the first quarter, dropping approximately 10% through mid-February and then rebounding. The Russell Midcap Growth Index ended the quarter modestly higher. The market downdraft was driven by several factors, including data points signaling a slowdown in the Chinese economy, the continued drop in energy prices, widespread dislocation in the credit markets, and general fears of global political instability. Later in the quarter, oil prices rebounded, credit spreads narrowed, positive data points emerged concerning U.S. employment and housing trends, and the equity markets recovered.

Against this backdrop, investors sought a “flight to safety” early in the quarter. Companies that suffered included those with outsized exposure to China, exposure to commodity end-markets, reliance on credit markets for access to capital, or leverage on their balance sheet. Defensive areas generally did best, and Utilities was the best-performing sector in the Index. Many higher growth stocks fared poorly in this environment, and “value” indexes generally outpaced “growth” indexes – this was most pronounced in the mid-cap space, where the Russell Midcap Value Index outperformed the Russell Midcap Growth Index by 334 basis points.

Industrials and Health Care were the top sector contributors to performance of Baron Asset Fund. The Information Technology (IT) and Financials sectors were the top detractors. Performance of the Industrials sector was led by Fastenal Company, the third largest contributor to performance. Although Health Care investments had a mixed quarter, contributors outweighed detractors. The sector included the top two contributors, IDEXX Laboratories, Inc. and West Pharmaceutical Services, Inc., respectively. Other notable contributors included Henry Schein, Inc. and Cooper Companies, Inc. Shares of Henry Schein, a distributor of dental, medical and animal health products, rose on business strength and earnings outperformance. Shares of soft contact lens manufacturer Cooper rose after a reported beat and raise in its fiscal Q2, including strong ex-U.S. sales driven by its silicon hydrogel portfolio. Top detractor LinkedIn Corp. was the main driver of weak performance of the IT sector. Guidewire Software, Inc. also weighed on performance. Shares of this property and casualty insurance software vendor fell as high-growth, high-multiple technology stocks sold off. The third largest detractor in the quarter, The Charles Schwab Corp., led the decline of the Financials sector.

Despite the ongoing volatility, we continue to believe high-quality, mid-sized growth stocks represent an attractive long-term investment opportunity. The U.S. economy is among the world’s healthiest, and its equity market multiples are within the range of their long-term averages. Employment and housing trends continue to improve, and energy prices – even after their two month jump - remain meaningfully below recent levels. We think our portfolio of what we believe are well-managed, competitively advantaged, fast growing companies will perform well in this environment, although we cannot guarantee that it will.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 3/31/2016)
  • Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. contributed to Q1 performance. The stock rallied on strong financial results. Competitively, we believe that trends are strong and improving, highlighted by instrument placement growth of almost 50%, domestic lab growth more than twice that of its main competitor, rising field sales productivity, and a rebound in rapid assays. We think IDEXX’s direct go-to-market model coupled with meaningful R&D-driven product enhancements will drive organic revenue and earnings growth over time.

  • West Pharmaceutical Services, Inc. contributed to performance in Q1. West manufactures components and systems for the packaging and delivery of injectable drugs. West reported strong financial results and provided solid earnings guidance for 2016. We retain conviction in the stock because we believe the company’s earnings has potential to more than double over the next five years, driven by sales of higher margin packaging components and proprietary product sales.

  • Shares of Fastenal Co., a leading distributor of industrial supplies, rose during Q1 after reporting improving sales trends to start the year. We view the sequential strengthening of sales as evidence of abating energy and F/X headwinds as well as share gains in manufacturing and construction end markets. Based on several growth initiatives, including Vending and On-Site programs, we believe Fastenal is poised to deliver outstanding customer service to its key accounts and generate accelerating earnings growth over the next two years.

Detractors (for quarter ended 3/31/2016)
  • LinkedIn Corp. is the world’s largest online professional network. It has three business segments: Hiring Solutions, Marketing Solutions, and Premium Subscriptions, each serving different customers. Despite strong 4Q15 results, shares were down in Q1 due to a weak 2016 outlook. After several quarters of inconsistent results, we believe management is finding it increasingly difficult to manage the complexity of three businesses. We exited the position.

  • Shares of Illumina, Inc. detracted from performance in Q1. Illumina is the leading provider of DNA sequencing technology to academic and commercial laboratories. Although Q4 financial results were solid, management tempered expectations for Q1 HiSeq X and benchtop instrument sales. We continue to believe Illumina has a long runway for growth, driven by increasing adoption of DNA sequencing in clinical markets such as cancer screening, diagnosis, and treatment.

  • Shares of The Charles Schwab Corp., an investment brokerage firm, declined in Q1 due to the extreme downward pressure on the equity markets to start the year as a result of signs of a slowing Chinese economy and falling energy prices. Higher market volatility also led to a decline in trading activity. Finally, shares were pressured by investor concerns that interest rate hikes will be paused (or reversed), causing net interest margins to remain low and money market fee waivers to persist. We believe Schwab will continue to experience growth in accounts as brokers leave traditional wirehouses.

Quarterly Attribution Analysis (for quarter ended 3/31/2016)

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.

Baron Asset Fund fell 1.52% in the first quarter and underperformed the Russell Midcap Growth Index by 210 basis points. During the quarter, stock selection added value, but this positive effect was outweighed by the negative effect of the Fund’s relative sector weights.

Investments in the Health Care sector were meaningful contributors on an aggregate basis to relative results. Sector strength was mostly attributable to the outperformance of IDEXX Laboratories, Inc. and health care supplies holdings West Pharmaceutical Services, Inc. and The Cooper Companies, Inc. IDEXX and West were the two largest contributors on an absolute basis, while shares of soft contact lens manufacturer Cooper rose after a reported beat and raise in its fiscal Q2. Cooper’s vision segment posted healthy organic growth, with strong ex-U.S. sales driven by its silicon hydrogel portfolio. Lack of exposure to lagging biotechnology stocks, which fell 28.4% in the index, and outperformance of Henry Schein, Inc. and Inovalon Holdings, Inc. also added value. Shares of Henry Schein, a distributor of dental, medical, and animal health products, rose on solid earnings results, while shares of health care data and analytics vendor Inovalon increased as investors purchased shares at a discounted valuation. These positive effects were partly offset by meaningfully larger exposure to this underperforming sector, which declined 8.8% in the index.

Investments in the Financials, Consumer Discretionary, and Information Technology (IT) sectors detracted the most from relative performance. Within Financials, underperformance of brokerage firm The Charles Schwab Corp. and commercial real estate services company CBRE Group, Inc. detracted the most from relative results. Schwab was the third largest detractor from absolute performance, while CBRE’s shares fell due to concerns that capital markets activity is slowing and the commercial real estate cycle is nearing its peak. Lower exposure to outperforming Consumer Discretionary stocks, particularly in brick & mortar retailers and apparel, accessories & luxury goods stocks, and underperformance of Norwegian Cruise Line Holdings Ltd. and Ralph Lauren Corp. shares detracted the most in the sector. The possibility of a U.S. recession pressured shares of cruise line company Norwegian, while disappointing results due to a heightened promotional environment and F/X headwinds hurt shares of global lifestyle brand Ralph Lauren. Within IT, underperformance of application software holdings, led by Guidewire Software, Inc. and Mobileye N.V., hampered relative results. Shares of property and casualty insurance software vendor Guidewire fell as high-growth, high-multiple technology stocks sold off. Shares of Mobileye, which makes advanced driver assistance systems software, declined on short seller claims that its high valuation and competitive position are unsustainable. We believe Mobileye has a dominant market position due to its solid technology, and evidenced by its wins with the major car manufacturers. Online professional network operator LinkedIn Corp. and syndicated IT research provider Gartner, Inc. also hurt relative performance. We exited our position in LinkedIn.

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The prospective performance of the companies discussed herein is based on our internal analysis and reflect our opinions only. We cannot promise future returns and our opinions are a reflection of our best judgment at the time of publication. Our views are not intended as recommendations or investment advice to any person and are subject to change at any time based on market and other conditions and Baron has no obligation to update them.  Investing in the stock market is always risky. Current and future portfolio holdings in the Baron Funds are subject to risk.