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 9/30/2016)

After the initial shock of the Brexit vote in late June, the U.S. stock markets settled down in the third quarter, experiencing significantly less volatility than in the first half of 2016. Stable economic data, monetary policy rates that remained relatively unchanged, and the lack of a major disruptive event allayed investor concerns and drove a broad-based rebound during the three-month period ended September 30, 2016.

Lower quality stocks outperformed their higher quality counterparts during the quarter. Investor appetite for risk increased, and, after mostly underperforming in the first half of the year, risk-on categories such as biotechnology and semiconductors outperformed. On the other hand, defensive sectors retreated after strong performance in the first half of 2016.

Baron Asset Fund gained in the quarter. Investments in Health Care, Financials, and Industrials were the top contributors during the three-month period. Health Care included the top two contributors to Fund performance: IDEXX Laboratories, Inc. and Illumina, Inc. Rising equity markets and increased speculation that the Federal Reserve would raise interest rates provided a tailwind for most of the Fund’s Financials sector investments. These included brokerage firm The Charles Schwab Corp., which was the third largest contributor. Insurer Arch Capital Group Ltd. also performed well during Q3 on solid quarterly results, with profitable underwriting, modest catastrophe losses, and favorable reserve development. The market also reacted favorably to Arch’s agreement to acquire mortgage insurance company United Guaranty from AIG. Industrials advanced on the strength of share price gains in eight of nine Fund holdings in the sector. Contribution within the sector was led by Westinghouse Air Brake Technologies Corp., which provides technology-based components to the rail industry, and IDEX Corp., which supplies highly engineered industrial and technology solutions across an array of end markets.

Information Technology (IT) was the only sector with negative performance, with detractors slightly outweighing contributors. IT research firm Gartner, Inc. and Guidewire Software, Inc., which sells various solutions to the global insurance industry, both gave up ground on earnings reports that Wall Street perceived to be disappointing. The share price of Verisign, Inc., which operates internet domain name registries, fell on fears of adverse regulatory changes.

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. 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 have improved throughout 2016, and energy prices remain meaningfully below recent levels. We think 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 9/30/2016)
  • Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. increased in Q3. The stock continued to rally on strong financial results and multiple expansion. Competitive trends are strong and improving, highlighted by instrument revenue growth, domestic lab growth, rising sales productivity, and stability in rapid assays. We believe that IDEXX’s direct go-to-market model coupled with research and development-driven product enhancements will put steady upward pressure on organic revenue and earnings growth over time.

  • Shares of Illumina, Inc., the leading provider of DNA sequencing technology to academic and commercial laboratories, contributed to performance in Q3. The company reported financial results that beat Street expectations and reiterated guidance for the year. 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 brokerage business The Charles Schwab Corp. appreciated in Q3 on continued strong asset growth. The business continued to shift to fee-based advice from trading activity, a move that we believe creates more stability and the potential for increased profitability. Speculation of an interest rate hike by the U.S. Federal Reserve also helped boost the stock price as a rate increase would likely improve earnings for the company.

Detractors (for quarter ended 9/30/2016)
  • Shares of Gartner, Inc., a provider of syndicated IT research, relinquished some gains due to tougher comparisons and slightly more challenging macro conditions. We believe Gartner’s key metrics are solid. The company has significant financial flexibility, and we think it will aggressively deploy capital for repurchases or mergers and acquisitions. Over time, in our view, Gartner will generate accelerating top line growth, significant growth in earnings and free cash flow, and persistent return of capital.

  • Tractor Supply Co. is a leading farm and feed retail chain in the U.S. Shares declined during Q3 after the company reported weak results due to depressed farm incomes from unusually low crop prices and exposure to deflated energy-related markets. Although we reduced our position, we believe these factors are largely transitory. We think Tractor Supply offers the potential for better-than-market earnings growth based on its growing private label assortment and increasing mix of consumable goods.

  • Shares of internet infrastructure services provider Verisign, Inc., fell in Q3 due to concerns that it would face difficulties extending its .com contract with the National Telecommunications and Information Administration (NTIA) as the result of a letter from Senator Ted Cruz to the agency. We think the letter is tangential to the senator’s main concern – the perceived risk of the NTIA relinquishing its oversight of the domain name registration process – and expect Verisign will extend its .com contract at pricing similar to current terms.

Quarterly Attribution Analysis (for quarter ended 9/30/2016)

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 5.15% in the third quarter and outperformed the Russell Midcap Growth Index by 56 basis points due to relative sector weights.

Consumer Discretionary, Financials, and Real Estate investments, lack of exposure to the lagging Consumer Staples sector, and larger exposure to outperforming life sciences tools & services stocks within Health Care contributed the most to relative results. Within Consumer Discretionary, lack of exposure to poor performing general merchandise store stocks and outperformance of Vail Resorts, Inc. and The Priceline Group, Inc. added the most value. Shares of ski resort operator Vail increased on news that the company had entered into an agreement to acquire Whistler Blackcomb, while shares of leading online travel agency Priceline rose on the strength of solid Q2 results and a robust outlook for Q3. Within Financials, outperformance of The Charles Schwab Corp., the third largest contributor on an absolute basis, and Arch Capital Group Ltd., a specialty insurance and reinsurance company, contributed to relative results. Arch’s shares performed well after reporting solid quarterly results, with profitable underwriting, modest catastrophe losses, and favorable reserve development. The market also reacted favorably to Arch’s agreement to acquire mortgage insurance company United Guaranty from AIG. Larger exposure to this outperforming sector, which rose 7.6% in the index, also aided relative results. Strength in Real Estate was mostly attributable to the outperformance of commercial real estate services company CBRE Group, Inc., whose stock price appreciated after reporting impressive Q2 financial results.

Underperformance of investments in Information Technology (IT) detracted the most from relative performance. Weakness in the sector was partly due to the underperformance of Gartner, Inc., the largest detractor from absolute results, and internet software & services and application software holdings, led by Verisign, Inc. and Guidewire Software, Inc., respectively. Shares of internet infrastructure services provider Verisign declined on concerns that the company would face difficulties extending its .com contract with the National Telecommunications and Information Administration. Shares of P&C insurance software vendor Guidewire fell after earnings guidance was slightly below Street expectations due to an accounting-related deferral that we expect will reverse next year. Lack of exposure to semiconductor stocks, which rose nearly 30% as a group within the index, also hurt relative performance.

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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.