Review and Outlook
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 Growth Fund increased modestly in the first quarter. Investments in the Consumer Discretionary and Financials sectors contributed to performance. Information Technology (IT) and Industrials were the top sector detractors. Consumer Discretionary had a solid quarter, with the top three contributors all within the sector. Top five contributor Vail Resorts, Inc. also added to sector performance. Shares rose on strong earnings results as good ski conditions drove visitation to, and increased spend at, its resorts. Strong performance of asset manager Cohen & Steers, Inc. and gaming REIT Gaming and Leisure Properties, Inc. boosted performance of the Financials sector. Shares of Cohen & Steers rose as the Fed suggested it would delay planned interest rate hikes, which would likely benefit the company's REIT-heavy portfolio. Shares of Gaming and Leisure Properties rose on increasing expectations that it will close its acquisition of Pinnacle Entertainment’s real estate assets. The second largest detractor, CoStar Group, Inc., led the decline of the IT sector. SS&C Technologies Holdings, Inc. was another notable detractor. Shares of this financial technology vendor fell over concerns that a broader market correction would impact SS&C’s growth. Industrials holdings had a mixed quarter, although losses outweighed gains. Weak performance was led by quartz countertop manufacturer CaesarStone Sdot-Yam Ltd., whose stock price fell as a result of delays in the production ramp at a new manufacturing facility.
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
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 Growth Fund increased 0.31% in the first quarter and significantly outperformed the Russell 2000 Growth Index by 499 basis points. During the quarter, the Fund’s relative sector weights and, to a lesser extent, stock selection contributed to relative performance.
Health Care and Consumer Discretionary investments and larger exposure to the outperforming Financials sector contributed the most to relative results. Within Health Care, meaningfully lower exposure to lagging biotechnology and pharmaceutical stocks, which fell 30.6% and 23.2%, respectively, within the index, contributed 420 basis points to relative results. Strength in the sector was also attributable to the outperformance of IDEXX Laboratories, Inc., Inovalon Holdings, Inc., and life sciences tools & services holdings Mettler-Toledo International, Inc. and Bio-Techne Corporation. Shares of veterinary diagnostics leader IDEXX rallied on strong financial results, while shares of health care data and analytics vendor Inovalon increased as investors purchased shares at a discounted valuation. Within Consumer Discretionary, outperformance of Dick's Sporting Goods, Inc. and Under Armour, Inc., the two largest contributors on an absolute basis, added the most value. Outperformance of hotels, resorts & cruise lines holdings Marriott Vacations Worldwide Corp. and Choice Hotels International, Inc., and leisure facilities investment Vail Resorts, Inc., as well as larger exposure to these outperforming sub-industries also aided relative performance. Marriott was the third largest contributor to absolute results, while shares of ski resort operator Vail outperformed as good ski conditions led to higher visitation. In addition, greater spending from visitors led to higher free cash flow which Vail used to improve its industry-leading balance sheet and increase its dividend.
Industrials and Information Technology (IT) investments and increasing cash exposure as the market rebounded in the latter half of the quarter detracted the most from relative performance. Weakness in Industrials was partly due to the underperformance of CaesarStone Sdot-Yam Ltd. and lower exposure to this outperforming sector, which rose 5.5% in the index. Shares of CaesarStone, a leading global manufacturer of quartz surfaces for kitchens and bathrooms, fell over concerns that a recently constructed manufacturing facility was taking longer than expected to ramp up production. Lack of exposure to transportation-related stocks, which were up double-digits for the quarter, and underperformance of Colfax Corp. and The Middleby Corp. relative to their industrial machinery peers, also hurt relative performance. The Fund exited its position in Colfax Corp. in early January. Within IT, underperformance of CoStar Group, Inc. and lack of exposure to outperforming semiconductor stocks, which rose 1.1% as a group within the index, weighed the most on relative results. Shares of CoStar, a real estate information and marketing services company, sold off alongside other high growth, high multiple technology stocks early in the quarter despite reporting financial results that exceeded Street estimates.
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