Baron Discovery Fund (BDFFX)

Portfolio Management

RandolphGwirtzman
Randolph Gwirtzman

Fund Manager since 2013

View All Commentary by Randolph LairdBieger
Laird Bieger

Fund Manager since 2013

View All Commentary by Laird

Fund Description

Baron Discovery Fund invests primarily in small growth companies.
 

Fund Resources

Latest Fact Sheets

Standard Fact Sheet

2Q16 Quarterly Letter

Portfolio Commentary

Retail Performance

Review and Outlook (for quarter ended 6/30/2016)

We were pleased with the increase in our performance this quarter. Of course this is only a short sliver of time, and we strive to earn our returns over the long term in the context of a multi-year investment horizon. In our opinion, it is only through a strategic longer-term view that we can have the key variant opinions that give us a potential investment edge.

Health Care, Industrials, and Consumer Discretionary were the top contributing sectors. Consumer Staples detracted. Health Care performance was led by the health care services, health care technology, and health care equipment sub-industries. The sector included top contributor, Press Ganey Holdings, Inc. Top five contributor ExamWorks Group, Inc. was another notable performer. Industrials benefited from positive performance of the Fund’s aerospace & defense investments, including The KEYW Holding Corporation and Mercury Systems, Inc., two of the top three contributors in the period. Investments in the restaurants and casino & gaming sub-industries boosted results of the Consumer Discretionary sector, including fast food restaurant chain Wingstop, Inc., a top five contributor to performance. Consumer Staples was the only sector to detract in the quarter, due to the weak performance of the third biggest detractor Barfresh Food Group, Inc.

Any number of factors can affect shorter-term performance, including style (growth, value, momentum), industry type (defensive, cyclical, etc.), market capitalization size, technical factors and even reflexivity (where a feedback loop is effectively created that creates virtuous or destructive cycles that perpetuate themselves). Of course, macroeconomic shocks, like the recent Brexit vote, can also cause massive market dislocations. The relative weighting of any of these given factors and/or exogenous shocks or stimulants versus our portfolio can vary radically in a short period of time. We are not market timers because we do not believe that we can accurately predict and modify the portfolio to respond constantly to the vagaries of such changes in these multiple variables. Most of the time, the overall market in the short term is affected by the story of the day. But often times, that story turns out to be not very meaningful on an ex-post basis (remember Y2K?). Generally it is uncertainty, rather than an actual known bad event, that causes the biggest market dislocations. Uncertainty dramatically affects the style factor of the day, and can cause wide variations in actual versus expected performance given a set of fundamentals for a particular company or portfolio.

We are excited about the prospects of the companies in which we invest. Our perspective is that the innovation being driven by these companies will lead to strong revenue and cash flow growth for years into the future. We believe our investors will be rewarded as these plans are realized. While we cannot guarantee results, we strive to earn compounded annual returns of at least 15% by targeting companies that can grow cash flows at these rates with a high probability of conviction. This has been particularly difficult in the current markets. However, we continue to believe this is possible.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 6/30/2016)
  • Shares of Press Ganey Holdings, Inc. rose in Q2 on strong revenue growth and margin expansion. Press Ganey provides patient experience and employee engagement measurement, analytics, and strategic advisory solutions for health care organizations. Growth of more than 13% in the core patient experience business was propelled by share gains and adoption of electronic surveys. We believe core growth will potentially be supplemented by new solutions such as Transparency, PROMs, and quality measures, as well as acquisitions.

  • Mercury Systems, Inc. provides complex electronic subsystems to major defense contractors. In March, Mercury made a significant acquisition of a defense unit from Microsemi Corp. This unit added “embedded protection” capabilities that are similar to military cybersecurity, and solid state storage capabilities for its systems (versus hard disk drives). The market rewarded Mercury for this highly strategic, accretive acquisition.

  • The KEYW Holding Corporation is a government services company that specializes in cybersecurity and intelligence gathering applications. Shares increased sharply as new management executed against its strategy of completing the divestiture of its commercial software business and significantly increased its backlog of government services business. These tactics have started to unlock what we have always believed to be the hidden value in the company.

Detractors (for quarter ended 6/30/2016)
  • MACOM Technology Solutions Holdings, Inc. designs and manufactures high-end analog semiconductors. We see major growth opportunities in optical networking, cellular base station towers, industrial technology, and radar programs. Shares declined in Q2 due to concerns around growth in Chinese telecom markets. We believe these concerns are unfounded, and that the company will continue to grow organically via all of its strategic initiatives.

  • Pacira Pharmaceuticals, Inc., a pharmaceutical that makes pain control drug EXPAREL, had a watershed event in mid-December 2015 when it won a favorable settlement of a marketing dispute with the FDA. Pacira received broad, definitive labeling for many major surgical uses. Shares peaked earlier in 2016, but have since dropped due to broader concerns in the pharma sector as well as growth guidance biased toward the second half of 2016. We believe Pacira has the potential for 25-35% top line growth for years to come.

  • Shares of Barfresh Food Group, Inc., which develops and markets single-serve, ready-to-blend smoothie packs to restaurants, declined during Q2, as investors expect the company will need to raise capital to fund the infrastructure needed for future volume growth. Though the ramp in shipments has been slower than investors may have forecasted, we believe Barfresh’s product offers a compelling solution to restaurants looking to offer highly profitable smoothies and blended beverages without complexity or significant investment in equipment.

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

The Quarterly Attribution Analysis for period ending June 30, 2016 is not yet available

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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 judgement at the time of publication. Our views are not intended as recommendations or investment advise to any person and are subject to chage 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 Fund are subject to risk.

Source: FactSet PA.