Review and Outlook
Baron Fifth Avenue Growth Fund was flat in the second quarter of 2016, compared to gains of 0.6% for the Russell 1000 Growth Index and 2.5% for the S&P 500 Index.
Small caps outperformed large caps and value significantly outperformed growth, an unfavorable backdrop for the kinds of companies we own in the Fund. Though most of our core holdings performed well over the last three months, relative performance was uninspiring due to lower exposure to Consumer Staples and Energy, two of the better performing GICS sectors in the S&P 500 Index during the quarter and year-to-date. While our stock picking was fine overall, stock selection in Health Care, and especially biotechnology and life sciences tools and services, detracted and was largely to blame for the portfolio’s lack of total positive returns during the quarter.
The Consumer Discretionary, Financials, and Materials sectors contributed the most to performance in the quarter. The Information Technology (IT), Health Care, and Consumer Staples sectors detracted. A double-digit gain in the stock price of Amazon.com, Inc., the Fund’s top contributor, drove contribution of the Consumer Discretionary sector. Financials benefited from the strong performance of Equinix, Inc., the second largest contributor in the quarter. A gain in the stock price of the Fund’s sole Materials holding, Monsanto Co., lifted that sector’s performance. Shares of this agriculture biotechnology company rose after German agricultural giant Bayer AG made an unsolicited takeover bid of $62 billion. With declines in 12 of 14 holdings, including the top and third biggest detractors, the IT sector had a challenging quarter. Illumina, Inc., the Fund’s second largest detractor, led the overall weak performance of the Health Care sector. Consumer Staples lost ground due to a decline in the stock price of membership-based warehouse club company Costco Wholesale Corp., the Fund's only holding in the sector.
Our goal is to maximize long-term returns without taking significant risks of permanent loss of capital. We continue to focus on identifying and investing in unique companies with sustainable competitive advantages and the ability to redeploy capital at high rates of return. We are optimistic about the long-term prospects of the companies we are invested in and continue to search for new ideas and investment opportunities.
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.
Baron Fifth Avenue Growth Fund finished roughly unchanged in the second quarter and trailed the Russell 1000 Growth Index by 50 basis points. During the quarter, stock selection added value, but was overshadowed by the negative effect of the Fund’s relative sector weights.
Outperformance of Consumer Discretionary and Materials investments and larger exposure to the strong performing Financials sector contributed the most to relative performance. Strength in Consumer Discretionary was mainly due to the outperformance of the Fund’s largest holding, Amazon.com, Inc., and Naspers Limited, a South Africa-based Internet and media platform operator. Amazon was the largest contributor on an absolute basis while Naspers shares rose due to its large ownership position in Tencent Holdings Limited, whose share price increased sharply in the quarter. Within Materials, outperformance of the Fund’s only holding in the sector, Monsanto Co., added value. Shares of Monsanto, which produces agricultural products for farmers that include genetically modified seeds and crop protection chemicals, rose sharply after Bayer AG made a $62 billion bid for the company.
Underperformance of the Fund’s Health Care holdings, its lower exposure to the outperforming Consumer Staples sector, and its significantly larger exposure to lagging Internet software & services stocks within the Information Technology (IT) sector detracted the most from relative results. Weakness in Health Care was partly attributable to the underperformance of Illumina, Inc., the second largest detractor from absolute results, and Allergan plc, the manufacturer of wrinkle reducer Botox. Allergan’s shares fell after the U.S. Treasury disallowed the Pfizer-Allergan inversion. The company responded with a strong message for growth and a planned $10 billion share buyback, which helped stabilize shares off their lows. Biotechnology holdings also underperformed after falling 10.1% as a group, with Alexion Pharmaceuticals, Inc. driving the decline. Aside from being hurt by the sell-off in high-multiple biotechnology stocks, shares of Alexion, which serves the orphan disease markets, declined due to slowing Soliris (lead product) growth and a light launch for new drug Kanuma. We retain conviction. Recent test results from the closest potential Soliris competitor pointed to its use only as a backup rather than an alternative to Soliris, and we expect four to five years of potentially monopolistic sales for the drug.
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