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 6/30/2016)

During the quarter ended June 30, 2016, equity markets increased before falling suddenly on June 24, when British voters unexpectedly voted in favor of leaving the European Union, the so-called Brexit. After digesting the likely implications of Brexit, U.S. investors appeared to change their view, and the markets rose sharply during the last few days of June and through early July.

Baron Asset Fund increased in the quarter. The top sector contributors to performance were Health Care, Information Technology (IT), and Financials. Industrials and Consumer Discretionary detracted. While results were mixed, contributors among Health Care holdings outweighed detractors. The sector benefited in particular from the strong performance of top contributor IDEXX Laboratories, Inc. Positive performance of the IT sector was largely driven by Gartner, Inc. and Zillow Group, Inc., the second and third largest contributors to performance respectively. A strong showing by property and casualty insurance software vendor Guidewire Software, Inc.  also helped boost performance. Contribution of the Financials sector was led by specialized REIT Equinix, Inc. Weakness in the Industrials sector was driven primarily by holdings in the construction machinery & heavy trucks and trading companies & distributors sub-industries, including top five detractor Westinghouse Air Brake Technologies Corp., which manufactures safety equipment for the rail industry. Consumer Discretionary detracted primarily due to the weak performance of investments in the hotels, resorts & cruise lines and specialty stores sub-industries.

Despite the near-term uncertainty created by various global events, most notably Brexit, we continue to believe that high-quality, mid-sized growth stocks represent an attractive long-term investment opportunity. During the past 30 years, mid-cap growth stocks, as a category, have outperformed small-cap and large-cap growth stocks. We believe that this trend will continue.

The U.S. economy continues to rank among the world’s healthiest, and its equity market multiples are within the range of their long-term averages. Although interest rates declined again during the quarter, perhaps the most prevalent concern among equity investors is uncertainty about what will happen to stocks when interest rates finally begin to increase. We believe that equity markets often perform well during a rising rate environment. Separately, employment and housing trends continue to improve, and energy prices still remain meaningfully below recent levels. We think that our portfolio of what we believe are well-managed, competitively advantaged, fast growing companies will continue to perform well in this environment, although we cannot guarantee that they will.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 6/30/2016)
  • Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. rallied in Q2 on strong financial results and multiple expansion. Competitive trends are strong and improving, highlighted by instrument placement growth of almost 25%, domestic lab growth more than twice that of its main competitor, rising sales productivity, and stability in rapid assays. We think that IDEXX’s direct go-to-market model coupled with meaningful R&D-driven product enhancements will boost revenue and earnings growth over time.

  • Shares of Gartner, Inc., a provider of syndicated IT research, increased in Q2 on strong financial results. We believe that key forward-looking metrics continue to look strong. Contract value growth and productivity trends are approaching levels sufficient to drive margin expansion, retention rates are at all-time highs, and the company has significant financial flexibility. We believe that Gartner will generate accelerating top line growth, significant growth in earnings and free cash flow and persistent return of capital.

  • Zillow Group, Inc. is the leading real estate website in the U.S. In addition to information on rentals and homes for sale, the company owns the Zillow Mortgage Marketplace and Street Easy, New York City’s leading real estate site. Zillow continues to invest in its brand as the leader in an $8 billion real estate advertising market. Shares were up in Q2, based on improving fundamentals and the favorable settlement of a lawsuit with Move, Inc. We think Zillow is well positioned to grow its share of the real estate advertising market.

Detractors (for quarter ended 6/30/2016)
  • Shares of DNA sequencing company Illumina, Inc. fell in Q2 on first quarter revenue that missed Street expectations and a lowered forecast for 2016 due to weak first quarter sales of its HiSeq instrument line and a lower forecast for Europe. Management believes the issues are short-term, fixable, and unrelated to fundamental market demand. 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., a brokerage business, fell due to the steep market decline and volatility in the wake of “Brexit.” Investors appeared concerned that higher volatility would cut into trading revenue, lower market values would pressure asset-based revenue generation, and 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.

  • Shares of financial technology vendor SS&C Technologies Holdings, Inc. detracted from second quarter performance. We attribute the decline to concerns that lackluster hedge fund performance will impact SS&C’s growth. We believe a low single digit percentage of the company’s revenue is directly correlated to equity markets, far less than investors feared. We believe the company will continue to generate attractive revenue growth through market share gains, cross-sales of its expanded services portfolio into the Advent installed base, new product introductions, and share gains in the admin market.

Quarterly Attribution Analysis (for quarter ended 6/30/2016)

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 increased 2.79% in the second quarter and outperformed the Russell Midcap Growth Index by 123 basis points. Relative sector weights and, to a lesser extent, stock selection contributed to relative performance.

Consumer Discretionary and Information Technology (IT) investments and larger exposure to the strong performing Health Care sector contributed the most to relative results. Within Consumer Discretionary, lower exposure to lagging apparel retail and apparel accessories & luxury goods sub-industries and outperformance of ski resort operator Vail Resorts, Inc. added the most value. Vail’s stock price rose on reports of a strong 2015/2016 ski season, with increased visitation and spend across its resorts. Management also indicated that 2016/2017 season pass sales were off to a robust start as units were up 29% over last year. Strength in IT was partly due to the outperformance of Gartner, Inc. and Zillow Group, Inc., which were the second and third largest contributors on an absolute basis. Investments in application software, led by Guidewire Software, Inc. and Mobileye N.V., also aided relative performance. Shares of property and casualty insurance software vendor Guidewire increased on reports of near-perfect retention rates, a growing installed base, and accelerating adoption. Guidewire is early in its core system replacement cycle, and is expanding its addressable market through persistent innovation. Mobileye recouped losses suffered in the first quarter after management allayed investor concerns regarding competitive threats by announcing two autonomous program wins. The Fund’s investment in real estate information and marketing services company CoStar Group, Inc. also lifted relative performance after the company reported outstanding financial results.

Lack of exposure to the outperforming Consumer Staples sector and underperformance of Industrials investments detracted the most from relative performance. The Fund’s Industrials holdings trailed their counterparts in the index after falling 2.8%, with Westinghouse Air Brake Technologies Corporation, Roper Technologies, Inc., and Fastenal Co. driving the decline. Shares of Westinghouse, the market leader in transportation products that improve railroad safety and productivity, declined due to uncertainty around global freight volumes, continued volatility in commodities and the potential impact of “Brexit” on foreign operations. Shares of Roper, which manufactures industrials controls, fluid handling, and analytical instrumentation products, fell after a short report expressed concerns about second half growth and the company’s acquisition-driven growth strategy. The concerns were fairly general in nature and not necessarily specific to Roper in our view. Roper’s strategy has consistently generated value over time, and we believe it has the potential to outperform as it completes additional deals.

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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.