Review and Outlook
The fourth quarter of 2014 featured broad swings in stock prices and currencies, with global equities ending the quarter modestly higher. The period also marked a return to a macro-driven market environment, dominated by key variables, including monetary policy expectations, the U.S. dollar, and the price of oil.
While the approximately 1.1% increase in Baron Global Advantage Fund in the fourth quarter appears to be somewhat muted, 14 of the Fund’s investments were up more than 10%, while nine were down more than 10%. The Fund was unusually active this quarter, adding five new names and eliminating two. Three of the top six quarterly contributors, SunEdison, Inc., Dominion Midstream Partners LP, and Shell Midstream Partners LP, were purchased during the quarter, while the largest, Alibaba Group Holding Ltd., was added in late September.
The Information Technology (IT), Health Care, and Financials sectors contributed the most in the quarter. Energy and Consumer Discretionary detracted. While IT had a somewhat mixed quarter, performance was lifted by the Fund’s semiconductor equipment holdings, including SunEdison, one of the world’s largest developers of solar energy projects. Health Care benefited from a strong performance by Illumina, Inc., the leader in next-generation DNA sequencing instruments. A double digit increase in the stock price of India-based bank ICICI Bank Limited boosted the Financials sector. Although Energy included two of the top three performers in the quarter, this was outweighed by the weak performance overall of Energy stocks, which were driven down by plummeting oil prices. Consumer Discretionary fell on the weak performance of education services holding TAL Education Group, as well as stock drops among a number of the Fund’s Internet retail investments.
While we expect the markets to remain volatile, we remain positive on the overall environment. Over the last 50 years, despite the doubling of the population, average global income per capita has tripled, life expectancy has risen by a third, and child mortality is down 70%. Literacy rates are up meaningfully, and average IQs are considerably higher even after adjusting for inflation and better nutrition. People are healthier, smarter, and more prosperous than they have ever been. All predictions of doom have repeatedly proved wrong. Despite disasters and reverses, quality of life and material wealth and prosperity have continued to increase everywhere in the world, and we think that’s unlikely to change. Our goal remains to maximize long-term returns without taking significant risks of permanent loss of capital. Our focus continues to be on identifying and investing in what we believe are unique companies with sustainable competitive advantages that have the ability to reinvest capital at high rates of return.
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.
The Baron Global Advantage Fund (Retail Shares) increased 1.07% in the fourth quarter, yet slightly trailed the MSCI ACWI Growth Index by 69 basis points. During the quarter, stock selection added value, but this positive effect was more than offset by the effect of its relative sector and country weights.
For the quarter, outperformance of the Fund’s investments within emerging markets added the most value, led by those in Indonesia, China, and Brazil. This positive effect was more than offset by the underperformance of the Fund’s developed markets investments, the largest of which were in the U.S., and its meaningfully larger exposure to emerging market equities, which lagged their developed market counterparts.
On a sector basis, the Fund’s investments within the Financials, Energy, and Utilities sectors were the primary contributors to relative results. Strength in Financials was attributable to the outperformance of ICICI Bank Limited, an Indian bank with major assets in retail banking, asset management, and insurance; and Brookfield Asset Management, Inc., a Canadian diversified asset manager with investments in real estate property, power, and infrastructure assets. ICICI’s shares outperformed due to solid earnings growth and a broad re-rating of the Indian banking sector, and shares of Brookfield performed well as business conditions remained strong. Within Energy, significant gains from two IPOs during the quarter, Shell Midstream Partners, L.P. and Dominion Midstream Partners, L.P., added the most value and outweighed the negative effect the Fund’s larger exposure to this lagging sector had on relative results. Within Utilities, the outperformance of the Fund’s only holding in the sector, TerraForm Power, Inc., aided relative results. Shares of solar power generator TerraForm rose after its parent company SunEdison announced the transformational acquisition of First Wind Holdings, Inc. TerraForm also raised its expected dividend-per-share growth rate to 24% through 2019.
Underperformance of the Fund’s investments within the Consumer Discretionary and Information Technology (IT) sectors and its meaningfully larger exposure to underperforming Telecommunication Services stocks detracted the most from relative results. Weakness in Consumer Discretionary was mainly due to the underperformance of TAL Education Group, a leading K-12 tutoring service in China. The Fund reduced its position in TAL following a CFO transition and after share price gains in the third quarter. Through its investments in Amazon.com, Inc., AO World plc, The Priceline Group, Inc., and MakeMyTrip Ltd., the Fund has significant exposure to Internet retailers, and its larger exposure to these lagging stocks hurt relative performance. Within IT, the Fund’s lack of exposure to Apple, Inc., a meaningful position in the index that rose 10.0%, and the underperformance of Internet software & services holdings Xoom Corporation, Google, Inc., and Just Dial Ltd. weighed the most on relative results. Xoom was one of the Fund’s largest detractors from absolute performance, while shares of Google declined due to weaker-than-anticipated quarterly results as the company accelerated hiring.
Yearly Attribution Analysis
The Baron Global Advantage Fund (Retail Shares) gained 5.11% for the year and performed in line with the MSCI ACWI Growth Index. During the year, the Fund’s favorable stock selection was mostly offset by the negative effect of its relative sector and country weights.
The main drivers of relative performance on a country basis in the fourth quarter were the same for 2014 as a whole.
On a sector basis, the Fund’s investments within the Energy, Financials, and Telecommunication Services sectors were the largest contributors to relative results. Within Energy, significant outperformance of the Fund’s MLPs, led by Tallgrass Energy Partners, LP and Shell Midstream Partners, L.P., and its larger exposure to MLPs, which held up well in a difficult period for energy stocks, added the most value. Shares of Tallgrass, a midstream energy MLP formed in 2013, were up almost 80%, driven by management’s strong execution and the acquisition of Rockies Express Pipeline, LLC. Shares of Shell, a midstream energy MLP spun off by Royal Dutch Shell late in the year, rose sharply post-IPO as investors sought energy companies with stable cash flows and visible growth. The Fund’s Financials holdings increased 20.1% as a group during the year, with ICICI Bank Limited, Brookfield Asset Management, Inc., and Cetip SA - Mercados Organizados outperforming within the sector. Shares of ICICI appreciated through most of the year, and shares of Brookfield Asset Management, Inc., a global alternative asset manager, rose in 2014, driven by strong business conditions in most of its segments. Shares of Cetip, which operates the largest fixed income exchange in Brazil, benefited from solid quarterly earnings results as the company experienced strong growth across many of its products. Strength in Telecommunication Services was due to the outperformance of Indonesian tower operators Tower Bersama Infrastructure Tbk PT and Sarana Menara Nusantara Tbk PT. Tower Bersama was one of the Fund’s largest contributors to absolute performance, and Sarana Menara’s shares rose as the company executed on its new tower build strategy.
The Fund’s investments within the Information Technology (IT) sector were the largest detractors from relative results. Weakness in the sector was primarily due to the underperformance of Acxiom Corp., the Fund’s largest detractor on an absolute basis, and underperformance of its Internet software & services investments, which fell 3.7% as a group. Among the largest detractors from relative performance in Internet software & services were SINA Corp., the Fund’s second largest detractor from absolute performance, Xoom Corporation, an online consumer-to-consumer international money transfer company, and Yandex N.V., the leading search engine in Russia. All three of the holdings were sold by year end. Xoom made management changes, and competitive pressures and poor execution during the World Cup led to slower growth. Shares of Yandex fell sharply, driven by depreciation of the Russian Ruble and a challenging macroeconomic environment. The Fund exited its position in Apple, Inc. in mid-March, so the lack of exposure over the remainder of the year, over which time the stock performed well, also hurt relative performance.
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