Review and Outlook
After reaching new highs in early September, most market indexes contracted somewhat sharply during the last two weeks of the quarter. The reasons for the sell-off remain unclear. The Federal Reserve issued a mid-September statement that was more dovish than many expected and reiterated that it will not raise interest rates for some time. Consumer confidence reached a seven-year high in August, leading economic indicators remain healthy, and lower oil prices bode well for the U.S. consumer. Within equities, larger-capitalization indexes continued to perform better than mid-capitalization indexes, which, in turn, surpassed smaller-capitalization indexes. Within the Russell Midcap Growth Index, stocks in the largest market cap quartile outperformed stocks in the smallest market cap quartile by approximately 400 basis points.
The Information Technology (IT) sector was among the best-performing for the Fund during this quarter. Too much pessimism had taken hold, and valuations across the Fund’s IT holdings rebounded. Fleetcor Technologies, Inc., which provides payment processing services and fuel cards to gas station owners and business fleets, rose after announcing a large, accretive acquisition. Guidewire Software, Inc., a software as a service (SaaS) company focused on the insurance space, also rose as M&A activity highlighted some attractive valuations within the sector. A few travel-related holdings in the Consumer Discretionary sector also had positive moves. Vail Resorts, Inc. acquired Park City, the Utah ski resort, paving the way for Vail to integrate Park City into its existing resort network profitably. Choice Hotels International, Inc. continued to experience a rebound in its mid-priced hotel business. Falling commodity prices led to weakness across the Fund’s Energy holdings, with driller Helmerich & Payne, Inc., distributor MRC Global, Inc. (an Industrials company that services the Energy industry), and E&P firm Concho Resources, Inc. all declining. The Fund established a position in West Pharmaceutical Services, Inc., a leading manufacturer of components and systems for the packaging and delivery of injectable drugs.
Despite the recent market volatility, we continue to believe that mid-sized growth stocks represent an attractive investment opportunity. The U.S. economy is among the world’s healthiest, its equity market multiples remain in-line with their long-term historic averages, and interest rates continue to remain low by historic standards. We believe that our portfolio of well-managed, competitively advantaged, fast growing companies will perform well in this environment.
Top Contributors/Detractors to Performance
Quarterly Attribution Analysis
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.
The Baron Asset Fund (Institutional Shares) declined 1.40% in the third quarter and modestly underperformed the Russell Midcap Growth Index by 67 basis points, mainly due to stock selection.
Outperformance of the Fund’s investments within Information Technology (IT) and Consumer Discretionary, and its larger exposure to the defensive Telecommunication Services sector, which was the best performing sector in the index, contributed the most to relative results. Strength in the IT sector was mostly attributable to the outperformance of FleetCor Technologies, Inc., which provides payment processing services to vehicle fleets around the world, and Gartner, Inc., the leading independent provider of research and analysis on the IT industry. Shares of FleetCor rose on news of the company’s acquisition of competitor Comdata, Inc. We believe the acquisition provides FleetCor with greater scale in the domestic fuel card market, gives it an entry into the attractive virtual card business, and will be accretive to next year’s earnings. The company also reported solid Q2 results and raised full-year guidance. Shares of Gartner increased on better-than-expected financial results and continued share repurchases. The Fund’s larger exposure to application software stocks, which rose 4.1% as a group within the index, also aided relative performance in the IT sector. Within Consumer Discretionary, the outperformance of Mobileye N.V. and Vail Resorts, Inc., which were the Fund’s two largest contributors on an absolute basis, added the most value.
The Fund’s investments within the Industrials and Health Care sectors were the largest detractors from relative performance. As a group, the Fund’s Industrials holdings fell 6.7% and trailed their counterparts in the index by 381 basis points. Colfax Corp. was the Fund’s largest detractor from absolute and relative performance during the quarter. The Fund’s two trading company & distributor holdings, MRC Global, Inc., the largest North American distributor of pipes, valves and fittings to the energy industry, and Fastenal Co., a leading distributor of industrial supplies, also underperformed. MRC’s shares struggled due to the company’s cyclical and currently underperforming end market, while shares of Fastenal fell due to depressed gross margins from higher sales to larger accounts and a shift in sales to lower margin products. Within Health Care, underperformance of the Fund’s two largest holdings in the sector, IDEXX Laboratories, Inc. and Illumina, Inc., and its lack of exposure to outperforming biotechnology and pharmaceuticals stocks, detracted the most from relative results. IDEXX and Illumina were also two of the Fund’s largest detractors from absolute performance.
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