Baron Focused Growth Fund (BFGIX)

Portfolio Management

RonBaron
Ron Baron

Fund Manager since 1996

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Fund Description

Baron Focused Growth Fund invests in a focused portfolio of small and mid-size growth companies.

    

  

Fund Resources

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1Q16 Quarterly Letter

Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 3/31/2016)

Last year’s volatility continued into 2016, with the U.S. equity markets plunging dramatically during the first six weeks of 2016 before executing an about-face to recover much of their losses, although small cap stocks fared worse than their larger cap counterparts. Concerns around the implications of a tightening credit market in the face of a possible U.S. recession, signs of slowing global growth, China and the RMB, and continued low oil prices drove the U.S. equity markets into correction territory by early February. During the quarter, oil prices declined at one point to near 15-year lows of $26/barrel, before rebounding to near $40/barrel by quarter end. In addition, slowed global growth and deflationary pressure early in the quarter prompted the central banks in Europe and Japan to ease monetary policy, including several that pushed interest rates into negative territory. As global concerns subsided, oil prices ticked up, and domestic job numbers improved, stock markets rallied strongly. In March, the U.S. Federal Reserve boosted equity markets even further with its suggestion that it would defer interest rate hikes that it earlier had been contemplating for 2016.

Baron Focused Growth Fund declined in the first quarter. Investments in the Consumer Discretionary, Health Care, and Consumer Staples sectors contributed to performance. Information Technology (IT) and Financials were sector detractors. Consumer Discretionary had a solid quarter, with the top three contributors all within the sector. Top five contributor Choice Hotels International, Inc. also added to sector performance. Shares of this hotel franchisor rose as its recurring revenue and earnings from franchise fees attracted investors seeking safe havens in a volatile quarter. Health Care advanced on an increase in the share price of Inovalon Holdings, Inc., the portfolio’s only sector holding. The stock price of this health care data and analytics vendor advanced as investors purchased shares at a discounted valuation. The Fund’s sole Consumer Staples investment, consumer products company Church & Dwight Co., Inc., benefited from an investor shift to this defensive sector in the first half of the quarter. The IT sector experienced losses in all four Fund holdings, as high-growth, high-multiple stocks sold off in the volatile market. FactSet Research Systems, Inc., a leading provider of investment management tools led the retreat in the Financials sector, as investors contemplated headcount reductions in its sell side business.

Overall, we think the U.S. economy is doing well. Wages have increased somewhat. Income growth and low prices at the gas pump are providing consumers with more money for discretionary spending. Until now, much of the savings from low energy prices was being used to pay down debt, as consumers and businesses were not convinced that prices would stay low. With the extended low oil price environment, we believe assets previously allocated to energy costs will soon start to be redeployed to other parts of the economy.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 3/31/2016)
  • Shares of global hotelier Hyatt Hotels Corp. increased in Q1 on revenue per available room (RevPAR) and margins that beat analyst predictions and 2016 RevPAR guidance of 3-5%. The company continues to generate strong free cash flow that it is using to buy back its stock and invest in its hotels. In our opinion, Hyatt still has one of the strongest balance sheets in the industry. We think it will continue to buy strategic assets as they become available. We also think Hyatt is well positioned to weather a downturn should we enter one.

  • Shares of Vail Resorts, Inc., an operator of ski resorts in the US and Australia, increased in Q1 on strong earnings increases. Good ski conditions drove visitation and increased spend at its resorts. This led to improved cash flow, which the company used to improve its industry-leading balance sheet as well as to increase its dividend by 30%. This robust growth led to an increase in season pass sales pricing for next ski season as pricing improved mid-single digits over the prior year.

  • Dick's Sporting Goods, Inc. is the country’s largest sporting goods retailer. After a major competitor revealed it was filing for bankruptcy and closing a third of its stores, shares of Dick’s increased on expectations that the competitor’s exit will result in increased sales at Dick’s. While the space is facing increased competition from e-commerce sellers, we think Dick’s is better positioned among traditional sporting goods retailers as an omni-channel retailer, and is improving the management of its online channel.

Detractors (for quarter ended 3/31/2016)
  • Manchester United plc is an English Premier League professional sports team that generates revenue from broadcasting, sponsorship, and licensing. Shares declined in Q1 over concerns that Manchester United will not qualify for the Champions League next year. We believe the team still has a chance to qualify, and even if it does not, the financial impact will be modest. We expect the company to continue to benefit from future sponsorship deals, the roll-out of new merchandise agreements, and a new digital offering under development.

  • Shares of CoStar Group, Inc., a real estate data and marketing services company, fell in Q1 as high-growth, high-multiple technology stocks sold off. The company reported financial results that were ahead of Street expectations, particularly on margin expansion. Bookings growth was strong. We believe that CoStar has potential to generate accelerating organic revenue growth and significant margin expansion as it leverages the multifamily marketing investments it has made over the last 18 months.

  • The stock price of CaesarStone Sdot-Yam Ltd. detracted from performance during Q1. CaesarStone is a leading global manufacturer of quartz surfaces for kitchens and bathrooms. The stock price fell over concerns that a recently constructed manufacturing facility was taking longer than expected to ramp up production. We remain positive on our investment in CaesarStone, as earnings growth continues to accelerate from successful new product launches and quartz market share gains vs. other countertop materials, such as granite and marble.

Quarterly Attribution Analysis (for quarter ended 3/31/2016)

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 Focused Growth Fund declined 0.83% in the first quarter, yet outperformed the Russell 2500 Growth Index by 183 basis points due to differences in sector weights relative to the index.

The Fund’s Health Care and Utilities investments and its meaningfully larger exposure to the outperforming Consumer Discretionary sector contributed the most to relative results. Within Health Care, the Fund’s lack of exposure to lagging biotechnology and pharmaceutical stocks, which fell 31.2% and 24.4%, respectively, within the index, contributed 284 basis points to relative performance. Outperformance of the Fund’s only Health Care holding, health care data and analytics vendor Inovalon Holdings, Inc., also aided relative performance. Inovalon’s stock price rose in the quarter as investors purchased shares at a discounted valuation. We were encouraged by the +19% organic revenue growth Inovalon generated in its most recent quarter and remain optimistic about the company’s ability to compound revenue at mid-to-high-teens rates and drive sustained margin expansion. Within Utilities, outperformance of, and larger exposure to, ITC Holdings Corp. during the period held added the most value. We exited our position in ITC after Fortis, Inc. announced it would acquire the company.

The Fund’s Industrials and Information Technology (IT) holdings and its lack of exposure to the outperforming Materials sector were the primary detractors from relative performance. Within Industrials, underperformance of quartz countertop manufacturer CaesarStone Sdot-Yam Ltd. and the Fund’s lack of exposure to strong performing industrial machinery and airline stocks detracted the most from relative results. CaesarStone was the third largest detractor from absolute results after the company’s stock price declined more than 20% in the quarter. Within IT, underperformance of Guidewire Software, Inc. and the Fund’s significantly larger exposure to the poor performing Internet software & services sub-industry through its investments in CoStar Group, Inc. and Benefitfocus, Inc. hurt relative results. Despite reporting outstanding financial results, shares of Guidewire, CoStar, and Benfitfocus sold off aggressively alongside other high growth, high multiple technology stocks early in the quarter.

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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 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 Fund are subject to risk.

Source: FactSet PA.