Review and Outlook
Baron Fifth Avenue Growth Fund was hit hard during the January sell-off and did not come back as much when the market rallied. There were three principal culprits: reversion to mean, the re-rating of the biotech sector, and past investment mistakes. After outsized gains in 2015, Amazon, Inc., Red Hat, Inc., The Charles Schwab Corp., and Mobileye N.V. all posted double digit declines in the first quarter, while their fundamentals remained unchanged in our view. The presidential election cycle, the made-for-TV drama starring Valeant Pharmaceuticals (which we never owned), and the Treasury’s determination to stop inversions caused a widespread multiple contraction in the pharma/biotechnology space. LinkedIn Corp. gave quarterly guidance that made people question the size of its addressable market, while Twitter, Inc.’s guidance seemed to confirm investors’ fears about its market. And then of course, there was TerraForm Global, Inc., where we have clearly suffered some permanent loss of capital.
According to the MSCI GICS industry classification, just over 40% of the Fund’s assets were invested in the Information Technology (IT) sector during the first quarter. We think it is important to understand the rationale and what is really behind this number. Alphabet Inc. (formerly Google, Inc.), Facebook, Inc., Alibaba Group Holding Limited, Twitter, and LinkedIn represented more than half of these IT investments. None of these companies sell software, servers, routers, or semiconductor chips, and hence, their business fundamentals do not correlate with corporate IT refresh cycles or government budget flushes and IT infrastructure upgrades. Instead, they are part of the digital revolution that is slowly but surely sweeping across the world. The rest of the portfolio's IT investments are Visa, Inc. and MasterCard, Inc., which we think of as digital railroad companies, and Apple, Inc., which looks to us like a classic Consumer Discretionary company.
What we used to describe as volatile market conditions is starting to feel like the norm. The S&P 500 Index fell more than 10% last August and again early this year, only to regain most of its value in a matter of weeks. Interest rates, corporate earnings, China’s economy, energy prices, terrorism, politics and elections, Britain leaving the E.U., and inflation are just a few of the many issues contributing to heightened anxieties. Even the most experienced investors find this kind of volatility unsettling.
Yet, we have always lived and invested in a world full of uncertainty. The business of capital allocation (or investing) is the business of taking risk, managing the uncertainty, and taking advantage of the long-term opportunities that those risks and uncertainties create. We are confident that our process is the right one and that it will enable us to make good investment decisions over time. Our goal remains to maximize long-term returns without taking significant risks of permanent loss of capital through investing in what we believe are unique companies with sustainable competitive advantages that have the ability to compound capital at high rates of return for extended periods of time.
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Quarterly Attribution Analysis
The Quarterly Attribution Analysis for period ending March 31, 2016 is not yet available
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