Review and Outlook
The year 2015 was characterized by steadily increasing volatility, although this volatility is not reflected in the final 2015 results for the averages and indexes. The Dow Jones Industrial Average traveled over 31 thousand points during the year only to close essentially flat. The broader based S&P 500 and Russell 1000 Growth indexes had many violent daily swings, especially in the latter part of the year, but with little to show for it in the end. The glaring disparity in stock price performance between the leaders and the laggards was even more profound than in years past, and we participated meaningfully on both sides.
For the year ended December 31, 2015, Amazon, Alphabet (formerly Google), Facebook, Starbucks, Equinix, Ctrip, and Regeneron Pharmaceuticals all appreciated over 30% and were among Baron Fifth Avenue Growth Fund's largest winners. Visa, MasterCard, Red Hat, Priceline, Verisk Analytics, Costco, and Charles Schwab all posted double digit percentage gains and contributed nicely to the Fund’s overall performance.
On the other side, FireEye, Alibaba, Tallgrass Energy, Twitter, Wynn Resorts, and Vmware were all down over 20%, and, combined with other double-digit laggards Monsanto, ASML Holdings, Fastenal, and Brookfield Infrastructure Partners, damaged our returns. And then there was SunEdison and its related yieldco TerraForm Global, where in our opinion, management’s awful decision making, combined with our inability to recognize it and move quickly, inflicted a 4.3% loss on the Fund’s overall results.
Every year we make some good decisions and some bad ones. Though we manage a high conviction portfolio, it is rare for a single decision or one investment to have a profound impact on the portfolio’s overall performance over a 12-month period. This year we had two. Our decision to make Amazon the largest investment in the Fund after it declined 22% in the prior year paid massive dividends after the stock rose 118% in 2015. The costly mistake of getting involved in SunEdison and its yieldco proved to be the difference between a respectable year and a very good one.
We live and invest in a world full of uncertainty. China, oil, potential for rising interest rates, and terrorism are all serious challenges with clearly uncertain outcomes. 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.
Our goal remains to maximize long-term returns without taking significant risks of permanent loss of capital. We will continue to focus on identifying and 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.
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 increased 9.42% in the fourth quarter and outperformed the Russell 1000 Growth Index by 210 basis points due to stock selection.
Outperformance of the Fund’s Consumer Discretionary, Health Care, and Energy investments and its lower exposure to the lagging Industrials sector contributed the most to relative results. Strength in Consumer Discretionary was largely due to the outperformance of Internet retailers Amazon.com, Inc. and Ctrip.com International Ltd. and the Fund’s meaningfully larger exposure to this sub-industry, which rose 22.2% in the index. Amazon was the largest contributor to absolute performance for the third consecutive quarter, while shares of Chinese online travel agency Ctrip rose after the company consolidated its leadership position with its recent acquisition of a stake in number two player Qunar. The Fund’s investment in Naspers Limited, a South Africa-based holding company that includes positions in global Internet companies and a South African pay television operation and print media business, also added value in the sector. Naspers shares outperformed after its largest holding, Tencent Holdings Ltd., reported strong Q3 results. Within Health Care, outperformance of biotechnology holdings Alexion Pharmaceuticals, Inc. and Regeneron Pharmaceuticals, Inc. contributed the most to relative results. Alexion, which develops therapeutics for patients with severe and ultra-rare disorders, continued to execute in the quarter with another strong earnings report, FDA approval of its drug Kanuma, and an R&D investor day where it presented data from a drug in development that supported the drug's ability to act as a replacement for a missing enzyme in children with a rare, life-threatening genetic mutation. Shares of Regeneron, a biopharmaceutical company with three marketed products, including EYLEA for eye diseases, rose after EYLEA’s sales exceeded Street expectations and the company raised guidance. Favorable stock selection in Energy owing to the outperformance of Shell Midstream Partners, L.P. was somewhat offset by larger exposure to this poor performing sector, which fell 17.2% in the index. Shares of Shell Midstream, a master limited partnership (MLP) formed by Royal Dutch Shell, rebounded sharply as it recovered from the selling pressure on the broad MLP market in the third quarter.
The Fund’s Information Technology (IT) holdings detracted the most from relative performance. Weakness in IT was mostly attributable to the underperformance of FireEye, Inc., VMWare, Inc. and SunEdison, Inc., the three largest detractors on an absolute basis. Twitter, Inc., an online social networking and micro-blogging service, and Mobileye N.V., a developer of vision-based advanced driver assistance systems, also hurt relative performance in the sector. Slower user growth weighed on shares of Twitter, while shares of Mobileye came under pressure after short sellers made what we believe are false allegations and contended its high valuation is unsustainable. These negative effects were somewhat offset by the larger exposure to the outperforming Internet software & services sub-industry and lower exposure to Apple, Inc., which declined 4.2% in the quarter.
Yearly Attribution Analysis
Baron Fifth Avenue Growth Fund gained 6.61% for the year and outperformed the Russell 1000 Growth Index by 94 basis points, mainly due to stock selection.
Investments within the Consumer Discretionary, Industrials, Financials, and Health Care sectors added value. Consumer Discretionary holdings contributed 651 basis points to relative results mostly due to the outperformance of Amazon.com, Inc., the largest contributor on an absolute basis, after shares more than doubled. Starbucks Corp., the leading specialty coffee company, and Ctrip.com International Ltd., the leading online travel agency in China, also aided relative sector performance. Shares of Starbucks increased more than 48% on the strength of robust sales and earnings growth. Global same-store sales growth at company-owned cafes accelerated, driven by growth in emerging markets, as well as key merchandising and marketing initiatives. Within Industrials, lower exposure to this lagging sector and outperformance of Verisk Analytics, Inc., a leading provider of data and analytics to insurance, financial services, and energy markets, lifted relative results. Verisk reported outstanding financial results during the year. It also announced its intent to divest its health care analytics business, which has proven to have less consistent growth and lower margins than the broader business. Strength in Financials was mainly due to outperformance of Equinix, Inc., which was reassigned from IT to Financials by GICS after the company’s completed its REIT conversion, and The Charles Schwab Corp., an investment brokerage firm. Equinix’s shares rose after it reduced its cost of capital and bid for a large European competitor and a smaller Japanese one, while shares of Schwab performed well despite market volatility and low interest rates. Within Health Care, outperformance of biotechnology holding Regeneron Pharmaceuticals, Inc. contributed the most to relative results.
Underperformance of Information Technology (IT) and Utilities holdings and meaningfully lower exposure to the top performing Consumer Staples sector detracted the most from relative performance. Within IT, underperformance of SunEdison, Inc. and systems software investments FireEye, Inc. and VMware, Inc. weighed on relative results. Underperformance of Internet software & services investments, led by Alibaba Group Holding Ltd. and Twitter, Inc., also hurt relative results, but this negative effect was partly offset by larger exposure to this strong performing sub-industry. Shares of Alibaba, the largest e-commerce company in China, declined after a faster-than-expected transition to mobile by its customers left it playing catch-up. Weakness in Utilities was largely attributable to the underperformance of SunEdison's subsidiary TerraForm Global, Inc., a dividend growth-oriented renewable energy company (a yieldco) focused on emerging markets. TerraForm Global’s shares fell sharply after an increase in the cost of capital for yieldcos caused concerns regarding its ability to grow. In addition, corporate governance concerns arose when parent company SunEdison changed the management and board of TerraForm Global to better align the companies.
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