Baron Growth Fund (BGRFX)

Portfolio Management

RonBaron
Ron Baron

Fund Manager since 1994

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Fund Description

Baron Growth Fund invests primarily in small growth companies.

   

  

Fund Resources

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Ron Baron on investing in small companies.

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Attribution Analysis
Attribution as of 9/30/14

Portfolio Commentary

Retail Performance

Review and Outlook (for quarter ended 3/31/2015)

U.S. stock markets experienced significant volatility in the first quarter. Driving the volatility: concerns over interest rates, the strong dollar, declining oil prices, mixed domestic economic data, and corporate earnings disappointments. While gains were moderate overall, small caps did better than large caps. The Russell 2000 Growth Index gained 6.63%, while large cap indexes were flat to slightly up.

After declining more than 40% in the fourth quarter, oil prices dipped another 11%, ending the first quarter at $48 per barrel. The decline in the price of oil since June 2014 has translated to significant savings for the U.S. economy.

On March 18, the Federal Open Market Committee removed forward guidance that they would be “patient” on hiking rates. Analysts are now predicting the first rate hike sometime later this year. Elsewhere, banks moved in the opposite direction. This divergence caused the U.S. dollar to surge.

Domestic economic reports were mixed. The unemployment rate dropped to 5.5%, a post-recession low. GDP growth remained subdued at 2.2% in the fourth quarter. Corporate profits were also mixed. While foreign profits declined 5.3% in 2014, domestic profits rose slightly, reaching a record high in the fourth quarter. This trend favored domestically focused smaller cap companies.

Baron Growth Fund increased in the quarter. Information Technology (IT), Consumer Discretionary, and Financials contributed the most. Energy and Utilities were notable detractors. IT gained on the strong performances of the Fund’s application software holdings, and its sole data processing & outsourced services holding, MAXIMUS, Inc., which was the second largest contributor in the quarter. Investments in hotels, resorts & cruise lines; apparel; casinos & gaming; and specialty stores helped boost Consumer Discretionary performance. The sector included the Fund’s largest and third largest contributors: Under Armour, Inc., and Pinnacle Entertainment, Inc. Financials had a strong quarter, due primarily to gains in gaming REIT Gaming and Leisure Properties, Inc., on its announced bid to buy the real estate assets of Pinnacle Entertainment Inc.; and index provider MSCI Inc., whose stock reached a record high. Energy lost ground due to sinking oil prices. Utilities detracted due to a stock drop in ITC Holdings Corp., which fell on sector weakness as investors exited utilities and other yield-oriented investments.

We think the trend in the past two quarters favoring small cap companies will continue, in part due to the persistence of low oil prices and a strong dollar. We believe conditions will also favor our style of fundamental investing, as well as companies in sectors and sub-industries such as airlines, cruise lines, automotive companies, hotels & resorts, and health care.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 3/31/2015)
  • Shares of athletic apparel company Under Armour, Inc. increased in Q1, on the strength of yet another quarter of record results. Sales grew over 30% and easily surpassed estimates. Its core apparel product continues to sell well, but more importantly, the company appears to be gaining traction in footwear. The business is continuing its momentum and broadening its distribution points. Additionally, Under Armour has expanded its online presence through acquisitions, which we think will augment purchase frequency and price points.

  • Shares of MAXIMUS Inc., a provider of outsourced government health and human services in the U.S., U.K. and Australia, rose in Q1. MAXIMUS was awarded about $1.3 billion in contracts in Q1, including the new U.K. Health Assessment. Signed contracts year to date are already $1.8 billion vs. $2 billion in 2014. Its pipeline, which represents RFPs to be released in the next six months, is $3.6 billion, which we think will support 15% top line growth through 2016. It also announced the accretive acquisition of government tech contractor Acentia.

  • Shares of regional gaming company Pinnacle Entertainment, Inc. increased sharply in Q1 on strong industry fundamentals and improved spending at its properties, leading to higher revenue and margins across its portfolio. An offer by Gaming and Leisure Properties Inc. to purchase Pinnacle’s real estate assets also boosted shares. We believe the deal will eventually go through, albeit at a higher price than the current offer.

Detractors (for quarter ended 3/31/2015)
  • Shares of hardwood flooring retailer Lumber Liquidators Holdings, Inc. fell sharply during Q1 after a 60 Minutes segment aired allegations that one of its products is not compliant with California regulations due to overly high levels of formaldehyde. The company steadfastly rejects the claims. We have spoken with management and believe they have implemented significant quality control checks within the supply chain. That said, we believe the company is likely to face elevated legal expenses in the short term as well as possible lost sales.

  • AO World plc is the leading online seller of major domestic appliances in the U.K., with a 12% market share. AO’s optimization of proprietary software and logistics and focus on customer service sets it apart from competitors. Shares in Q1 were pressured by a slower growth forecast, down from a spike in sales in the wake of AO’s IPO last May. The company has said that it expects growth to reaccelerate in the second half of 2015, driven by improving sales in the U.K. and a continued ramp up in Germany.

  • The stock of ITC Holdings Corp., the nation’s largest independent transmission company, fell in Q1. An expected increase in interest rates contributed to overall sector weakness as investors exited utilities and other yield-oriented investments. The primary drivers for transmission investment – reliability and connection of new generation (including renewables)  – remain intact, and we believe ITC has robust prospects for growth and will execute on its growth strategy and concurrent five-year capital plan.

Quarterly Attribution Analysis (for quarter ended 3/31/2015)

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 Growth Fund (Retail Shares) increased 4.68% in the first quarter, yet trailed the Russell 2000 Growth Index by 195 basis points. During the quarter, the Fund’s relative sector weights and, to a lesser extent, stock selection detracted from relative performance.

Outperformance of the Fund’s investments within Information Technology (IT) and Financials and its lower exposure to the underperforming Materials sector contributed the most to relative results. Strength in IT was partly attributable to the outperformance of MAXIMUS, Inc. and the Fund’s Internet software & services holdings, led by Benefitfocus, Inc. MAXIMUS was the Fund’s second largest contributor on an absolute basis, while shares of Benefitfocus increased double-digits due to robust financial results, a strong 2015 outlook, and a strategic investment from Mercer, which acquired a 10% stake in the company. Application software companies Advent Software, Inc. and FactSet Research Systems Inc., which both provide services to the global investment community, also aided relative performance. Shares of Advent rose sharply after SS&C Technologies announced its intent to acquire the company in an all cash offer, while FactSet’s shares increased in response to accelerated organic revenue growth, enhanced seat count additions, and meaningful earnings growth. Within Financials, outperformance of MSCI, Inc. and Gaming and Leisure Properties, Inc. added the most value, but this positive effect was somewhat offset by the Fund’s larger exposure to this lagging sector. Shares of index and analytics vendor MSCI rose after investors were encouraged by the possibility that the company may divest some of its underperforming businesses, while shares of Gaming and Leisure Properties (a REIT) increased on speculation that it would buy the real estate assets of Pinnacle Entertainment.

The Fund’s investments within the Health Care, Energy, and Utilities sectors were the largest detractors from relative performance. Within Health Care, the Fund’s meaningfully lower exposure to biotechnology and pharmaceutical stocks, which rose 16.0% and 14.9%, respectively, within the index, and underperformance of Community Health Systems, Inc. detracted the most from relative results. Community Health’s shares retreated in the quarter after investors took a more cautious stance pending the outcome of the Supreme Court’s King vs. Burwell decision, which will determine the legality of federal exchange subsidies under the Affordable Care Act. Weakness in Energy was largely attributable to the underperformance of the Fund’s largest holding in the sector, Targa Resources Corp., the General Partner of a growth oriented MLP. Targa Resources’ acquisition of Atlas Pipeline in the first quarter, while helping to grow and diversify Targa’s onshore U.S. presence, increased Targa’s sensitivity to commodity prices, and caused the stock to drop. Underperformance of the Fund’s only holding in Utilities, ITC Holdings Corp., was partly offset by its larger exposure to this sector, which rose more than 20% in the index. ITC was the Fund’s third largest detractor on an absolute basis.

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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 advise to any person and are subject to chage 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 PA2.0 Performance Analytics Software.