Baron Growth Fund (BGRIX)

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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Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 12/31/2015)

U.S. stock markets continued to exhibit volatility during the three months ended December 31, 2015, as investors reacted to events overseas and at home. After a significant decline in the third quarter, the fourth quarter began with a strong rally in U.S. equities. Markets were boosted by soft economic data suggesting the Federal Reserve would continue to delay a rate hike. Talk of additional stimulus from the European Central Bank and a rate cut by China augmented the global trend of easy monetary policy. An easing of concerns around the negative impact of a slowdown in China and a modest recovery in oil prices also helped drive gains.

As the quarter progressed, signs of an improving U.S. economy and a seemingly more stable global economy inspired the Fed to signal it would start a rate increase cycle. In December, the Fed raised interest rates modestly for the first time since 2006. After an initial rally, the markets sold off some fourth quarter gains over concerns about the implications of Fed tightening in the face of questions around employment trends, commodity prices, overseas growth, and corporate earnings.

Baron Growth Fund increased in the quarter. Information Technology (IT), Utilities and Industrials were the top contributing sectors. Consumer Discretionary, Health Care, and Consumer Staples detracted. IT contributed on stock price increases in 10 of 12 holdings, led by the third largest contributor to performance, CoStar Group, Inc.  Utilities gained on a share price increase in ITC Holdings Corp., the Fund’s sole sector holding and the second largest contributor to performance. Industrials benefited from the strong performance of quartz countertop manufacturer CaesarStone Sdot-Yam Ltd. The Consumer Discretionary sector had a mixed quarter, although detractors outweighed contributors. The sector included both the top contributor, Vail Resorts, Inc., and the two biggest detractors, Under Armour, Inc. and Dick’s Sporting Goods, Inc. Weakness in the Health Care sector was due primarily to the poor performance of Community Health Systems, Inc., the third biggest detractor in the quarter. Consumer Staples holdings had a mixed quarter. Healthy foods distributor United Natural Foods, Inc. was the largest sector detractor and fourth largest detractor overall, after its stock price fell as a result of weak financial results.

A significant percentage of the market weakness was attributable to Energy and companies that service the energy industry as a result of the decline in oil prices. We think the constrained economic environment caused by low oil prices will eventually be offset by faster growth in the rest of the economy, as assets previously allocated by consumers and businesses to energy-related costs are redeployed.

Investing for growth is investing in the future, and when the future seems especially uncertain, investors tend to exit growth stocks. This behavior has contributed to the recent contraction in many growth stocks, despite the strong fundamentals and continued growth of these companies. Furthermore, the economy is in good shape and has been getting stronger. We believe this creates investment opportunities for growth investors like us.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 12/31/2015)
  • Shares of Vail Resorts, Inc., an operator of ski resorts across the U.S. and Australia, increased in Q4 as the company generated strong results from its first season at Perisher in Australia, as well as robust pass sales for the current ski season in the U.S. In addition, snow storms across Tahoe, Colorado, and Utah resulted in positive sentiment on the stock. The company continued to generate significant cash flow, and it has started to use it to repurchase stock.

  • ITC Holdings Corp. is the nation’s largest independent transmission company. ITC’s shares rose in Q4 in response to a company announcement that it is reviewing strategic alternatives to maximize value for shareholders, including a potential sale of the company. We believe ITC will be sold at a premium to the current share price. We think ITC’s stable regulatory structure, ability to earn returns on equity at the mid-to-high teens level, and above-average growth rate will appeal to buyers.

  • Shares of CoStar Group, Inc., a real estate information and marketing services company, contributed to Q4 performance. The company’s financial results beat Street expectations, particularly on margin expansion. Bookings growth was strong, with net annualized subscription bookings more than doubling versus the prior year. We believe CoStar is poised to generate accelerating organic revenue growth and significant margin expansion as it leverages the multifamily marketing investments made over the last 18 months.

Detractors (for quarter ended 12/31/2015)
  • Shares of athletic apparel company Under Armour, Inc. fell in Q4. While the company reported another strong quarter of top line sales growth, some macro headwinds, investments, higher costs, and a product mix shift led to a temporary slowdown in income growth. Additionally, unseasonably warm weather during the important holiday season raised concerns around softer sales and discounting.

  • Shares of sporting goods retailer Dick’s Sporting Goods, Inc. fell in Q4 on reports of a weak Q3 and lowered guidance for the key holiday season. While we feel that demand is strong, consumers seek deals and discounts and are migrating incremental purchases to e-commerce where Dick’s locations and merchandise are not as competitively advantaged. Adding to these pressures has been unseasonably warm weather, resulting in excess inventory.

  • Shares of hospital operator Community Health Systems, Inc. fell in Q4 on an earnings miss driven by lower volumes and deteriorating payor mix. Concerns that the Affordable Care Act tailwind is largely over and leveraged companies will be hurt by rising interest rates also brought out sellers. We think the spinoff of Quorum Health will create value, HMA synergies will exceed initial guidance, record numbers of recruited doctors will boost admissions, more states will expand Medicaid, and deleveraging will strengthen the balance sheet.

Quarterly Attribution Analysis (for quarter ended 12/31/2015)

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.

Baron Growth Fund rose 1.40% in the fourth quarter, yet underperformed the Russell 2000 Growth Index by 292 basis points due to a combination of relative sector weights and stock selection.

The Fund’s Utilities, Telecommunication Services, and Industrials investments and its lack of exposure to the lagging Energy sector, which fell 13.8% in the index due to the continued decline in oil prices, contributed the most to relative results. Strength in Utilities was due to the outperformance of the Fund’s only holding in the sector, ITC Holdings Corp., the second largest contributor on an absolute basis. The Fund’s only holding in the Telecommunication Services sector, Iridium Communications Inc., contributed to relative results. Shares of this global satellite communications company Iridium increased on strong reported results, supported by a robust machine-to-machine market and strong margins due to lower warranty-related expenses. Within Industrials, outperformance of CaesarStone Sdot-Yam Ltd. and the Fund’s slightly lower exposure to this poor performing sector added the most value. Shares of quartz countertop manufacturer CaesarStone Sdot-Yam Ltd. rose more than 42%, recapturing some of the ground it lost in the third quarter after reporting weak Q2 financial results.

The Fund’s Health Care, Consumer Discretionary, and Consumer Staples investments were the primary detractors from relative performance. Within Health Care, the Fund’s significantly lower exposure to outperforming biotechnology and pharmaceutical stocks, which rose 9.5% and 22.3%, respectively, within the index, detracted 118 basis points from relative results. The Fund’s investment in Community Health Systems, Inc., the third largest detractor on an absolute basis, also hurt relative results. Within Consumer Discretionary, underperformance of Under Armour, Inc. and Dick's Sporting Goods, Inc., the two largest detractors on an absolute basis, weighed the most on relative results. Underperformance of hotels, resorts & cruise lines holding Marriott Vacations Worldwide Corp. and the Fund’s larger exposure to this lagging sub-industry, which declined 9.0% in the index, also hampered relative results. Shares of Marriott, a seller and marketer of timeshare resorts, decreased after timeshare sales to its Latin American customers dipped due to the stronger dollar. Weakness in Consumer Staples was mostly attributable to the underperformance of United Natural Foods, Inc., the leading natural foods distributor in the U.S. United Natural’s share price declined after reporting disappointing results. Healthy brands have rapidly gained shelf space at retailers not traditionally served by the company, such as traditional grocery, drug, and convenience stores. We believe United Natural and its customers have been temporarily pressured, as a result.

Yearly Attribution Analysis (for year ended 12/31/2015)

Baron Growth Fund declined 4.06% for the year and trailed the Russell 2000 Growth Index by 268 basis points, primarily due to stock selection.

Outperformance of Consumer Discretionary and Information Technology (IT) investments, lower exposure to the lagging Materials and Energy sectors, and larger exposure to the better performing Financials and Utilities sectors contributed to relative results. Within Consumer Discretionary, outperformance of leisure facilities holding Vail Resorts, Inc. added the most value. Vail was the largest contributor on an absolute basis. Investments in Under Armour, Inc. and Bright Horizons Family Solutions, Inc. also aided relative performance. Athletic apparel company Under Armour reported strong financial results throughout 2015 due to continued revenue growth and impressive cost management, while Bright Horizons was the third largest contributor to absolute performance. Strength in IT was partly attributable to outperformance of almost all of the Fund’s application software holdings, led by FactSet Research Systems, Inc. and SS&C Technologies, Inc., and larger exposure to this sub-industry, which gained 16.8% in the index. FactSet shares rose on financial results that demonstrated accelerating market share gains, while shares of SS&C were bolstered by the acquisition of Advent Software, Inc. Outperformance of CoStar Group, Inc. and larger exposure to the better performing IT consulting & other services sub-industry through Gartner, Inc. and Booz Allen Hamilton Holding Corp. also contributed to relative results. Shares of CoStar, a real estate information and marketing services company, increased on robust financial results and synergies from the acquisitions of Apartments.com and ApartmentFinder.

Health Care, Industrials, and Consumer Staples investments were the largest detractors from relative performance. Within Health Care, lower exposure to outperforming biotechnology stocks detracted 127 basis points. Underperformance of Community Health Systems, Inc. and Inovalon Holdings, Inc. and lower exposure to strong performing health care equipment and pharmaceuticals stocks also weighed on relative results. Community Health was the largest detractor from absolute performance, while shares of health care data and analytics company Inovalon were negatively impacted by M&A in the managed care space, which raised concerns around the risk of customer consolidation. Weakness in Industrials was mainly due to the underperformance of Genesee & Wyoming, Inc., the third largest detractor on an absolute basis, and Colfax Corp., an industrial machinery company focused on infrastructure. Colfax’s shares fell sharply due to exposure to negative macroeconomic factors including energy-oriented capital expenditures, foreign exchange headwinds, and slowing international and emerging markets. Other sector detractors were generator manufacturer Generac Holdings, Inc. and quartz countertop manufacturer CaesarStone Sdot-Yam Ltd. Consumer Staples holdings fell 16.4%, trailing their index counterparts, with United Natural Foods, Inc. leading the decline. United Natural was the second largest detractor from absolute performance.

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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.