Baron Global Advantage Fund (BGAIX)

Portfolio Management

AlexUmansky
Alex Umansky

Fund Manager since 2012

View All Commentary by Alex

Fund Description

Baron Global Advantage Fund invests in growth companies of all sizes anywhere.

  

Portfolio Commentary

Institutional Performance

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

Baron Global Advantage Fund got hit hard during the January sell-off and did not come back as much when the market rallied. We suffered from some profit taking as JUST EAT plc, Amazon.com, Inc., and Worldpay Group plc gave up some of last year’s gains. Our earlier stage, smaller market cap Health Care investments not only went down more during the selloff, but also failed to participate in the ensuing recovery. In many ways, this first quarter of the year was the reversal of the last quarter, with the exception of China, where our investments continued to outperform. We only had three double-digit gainers (Mellanox Technologies Ltd. up 28%, Cetip SA – Mercados Organizados up 18%, and ASML Holdings N.V. up 13%) against 16 double-digit decliners.

What we used to describe as unusually volatile market conditions is starting to feel like the norm. The MSCI All Country World Index fell more than 10% last August and again early this year, only to regain most of its value in a matter of weeks both times. Investors seem to be scared of everything. Fed policy and rising interest rates, corporate earnings, China’s economy, energy prices, terrorism, politics and elections, Britain leaving the EU, and inflation are just a few of the many issues contributing to the heightened anxieties. The stark disparity in short-term price performance between the leaders and the laggards continues to make for a difficult investing environment.

Yet, we have always lived and invested in an uncertain world, and that’s unlikely to change. Economic growth in China has been slowing down for almost a decade and a hard or soft landing or what the government will do with the exchange rate are difficult to predict. Similarly, we think it is hard to know whether oil should be trading at $40/barrel or $60/barrel and where it will be some years from now. What we can do is continue to focus on our process and on the companies in which we invest. Finding and investing in what we believe are competitively advantaged businesses will continue to be our primary goal.

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 also unlikely to change.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 3/31/2016)
  • Mellanox Technologies Ltd. supplies semiconductor-based interconnect solutions and services. Strong Q4 results re-instilled investor confidence in Mellanox’s ability to grow profitably. In addition, the completion of its EZchip acquisition and adjusted guidance laid out a strong financial case for this combination. We view Mellanox’s Ethernet business as a significant open ended opportunity. We expect Mellanox to be a high-end market leader and protect its high margin business model with strong innovation and product leadership.

  • Shares of Facebook, Inc., the world’s largest social network, rose in Q1, driven by improving consumer engagement and monetization. Facebook is the largest beneficiary of the shift in consumer engagement to mobile. Facebook is using its leadership position to provide global advertisers targeted marketing capabilities at scale. Facebook is in the early stages of monetizing online video and Instagram, which are starting to contribute to incremental revenue growth. WhatsApp and Oculus provide additional avenues for growth opportunities.

  • TAL Education Group is a leading Chinese K-12 tutoring company, operating over 300 learning centers in two dozen cities across China. Shares of TAL rose in Q1, driven by growth in student enrollments of more than 50%. We maintain conviction in TAL Education Group as we see its significant opportunity to gain market share in after-school tutoring by expanding existing learning centers, opening new learning centers in existing cities, and expanding into new cities, while generating strong cash flow.

Detractors (for quarter ended 3/31/2016)
  • Shares of JUST EAT plc, the leading online food takeout marketplace in Europe, Latin America, and Canada, were down in Q1 despite reporting second half of 2015 results that beat analyst estimates. Potential entry by Uber into restaurant delivery in the U.K., JUST EAT’s largest market, is driving heightened competitive concerns. We believe JUST EAT competes in a different market segment from Uber and other delivery-oriented companies. We think JUST EAT is the leader in a winner-take-most/all business that will not be meaningfully disrupted by new competitors.

  • Shares of Amazon.com, Inc., the world’s largest retailer, declined in Q1 despite reporting strong revenue growth due to retail margins being lower than anticipated. Amazon has responded by instituting substantial fulfillment and supply chain fee increases for merchants on the platform. We estimate that these fee increases should start to alleviate the recent pressure on retail margins in the upcoming quarters. Amazon’s other major business segment, Amazon Web Services (AWS) continues to gain traction with enterprise customers, and over time, we expect AWS to be the larger contributor to value creation for the company.

  • Shares of TerraForm Global, Inc., an owner of renewable energy power plants in emerging markets, fell during Q1 due to uncertainty related to the implications of a potential bankruptcy of parent company SunEdison. In addition, TerraForm Global was unable to execute on transactions to create its formation portfolio. These factors make the company difficult to value, and the stock sold off as a result. We continue to hold the stock as we believe the company is solvent and has enough liquidity to continue.

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 Global Advantage Fund declined 4.93% in the first quarter and trailed the MSCI ACWI Growth Index by 463 basis points, largely due to stock selection.

On a country basis, stock selection in developed markets detracted the most from relative results, mainly due to underperformance of the Fund’s investments in the U.S. and U.K, although stock selection in Israel was a noteworthy contributor to relative results.

On a sector basis, Financials investments contributed to relative results. Strength in the sector was partly due to the outperformance of Cetip SA - Mercados Organizados, which administers over-the-counter markets in Brazil for trading and registration of fixed income securities, derivatives, and auto liens. Cetip’s shares rose following the announcement of a takeover offer from BM&FBOVESPA at a premium valuation. The company also benefited from appreciation of the Brazilian Real against the U.S. Dollar and strong quarterly financial results. We continue to own the stock because we expect the merger with BM&FBOVESPA has the potential to create significant shareholder value. The Fund’s lower exposure to this lagging sector, which declined 2.2% in the index, also helped relative performance.

Underperformance of Health Care, Utilities, Consumer Discretionary, and Information Technology (IT) investments detracted the most from relative results. All six Health Care investments underperformed, led by Pacira Pharmaceuticals, Inc. Pharmaceutical holdings Allergan plc and Aerie Pharmaceuticals, Inc., were noteworthy detractors after their stock prices fell as a result of the correction in the biotech/pharma space. Shares of DNA sequencing company Illumina, Inc. also weighed on relative sector performance. Despite solid Q4 financial results, Illumina’s shares fell in response to moderated sales forecasts. These negative effects were partly offset by lack of exposure to underperforming biotechnology stocks, which declined 14.8% within the index. Weakness in Utilities was mostly attributable to the underperformance of renewable energy company TerraForm Global, Inc., the third largest detractor on an absolute basis. Within Consumer Discretionary, underperformance of Internet retailer Amazon.com, Inc. and meaningfully larger exposure to this lagging sub-industry, which declined 10.5% in the index, hurt relative performance. Shares of Amazon, the second largest detractor from absolute results, gave back some gains after more than doubling in 2015. Another detractor from relative performance in the sector was Smiles SA, the second largest loyalty program in Brazil. The Fund exited its position. IT holdings trailed their index counterparts after falling 1.2%, with U.K. holdings JUST EAT plc and Worldpay Group plc driving the decline. JUST EAT was the largest detractor from absolute performance, while shares of payment processing company Worldpay declined after earnings results fell short of expectations due to weakness in the U.S. segment. Underperformance of IT investments was somewhat offset by greater exposure to strong performing semiconductor and semiconductor equipment stocks.

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