Baron International Growth Fund (BIGFX)

Portfolio Management

MichaelKass
Michael Kass

Fund Manager since 2008

View All Commentary by Michael

Fund Description

Baron International Growth Fund invests primarily in non-U.S. growth companies.

   

   

Portfolio Commentary

Retail Performance

Review and Outlook (for quarter ended 9/30/2014)

The third quarter of 2014 witnessed a reversal of second quarter trends:  equities retraced a large portion of previous gains, broader Europe and other key economies shifted into a slowdown, political reform momentum slipped, while, on the bright side, the geopolitical environment largely stabilized. On the liquidity front the status quo prevailed; the U.S. Federal Reserve inched closer to the final tranche of scheduled QE, while the ECB and Bank of Tokyo continue to condition market participants for an escalation – perhaps as an offset to the wind-down in the U.S. In our second quarter letter we questioned whether the complacency grounded in record low sovereign bond yields was fundamentally based, and whether prevailing low measures of volatility were sustainable given what appeared to be rising levels of risk-taking and leverage in many markets. We are, therefore, not surprised by the recent turn of events and rise in market volatility to more normalized levels, and further suspect such conditions are likely to continue. Increasing volatility is consistent with a maturing bull market in equities.

We often suggest that our intermediate and long-term enthusiasm for particular international markets is rooted in the potential for, and progress in executing, market-friendly and productivity-enhancing reforms. Over the past year we have suggested that reform momentum across multiple countries was a key catalyst for the improving performance in such equities. Of course, markets are forward looking, so the recent pause in momentum has likewise driven a mean-reverting pullback. Unwelcome developments during the third quarter include intermittent resistance to Prime Minister Abe’s “Third Arrow” reforms in Japan, and ongoing discourse and uncertainty regarding fiscal and monetary flexibility in Europe, given the conflicting positions of Germany and the peripheral countries. Key emerging markets, including China, Brazil, Indonesia, and India, also hit roadblocks in the quarter. To a large degree, we consider such developments as a part of the “two steps forward, one step back” progression, and we remain optimistic particularly regarding the long-term potential of the companies in which we are invested.

In the short term, we observe several divergences suggesting to us that we have likely entered a period of higher volatility, and that the recent correction in international and emerging market equities may have further to go. Key divergences we are monitoring include generally rising credit spreads over sovereign yields, the recent weakness in commodity prices relative to equities, and the strength in sovereign bonds relative to equities. All suggest to us a potential change in liquidity and risk conditions in such markets. On the plus side, we continue to observe solid capital flows into the principal international fixed income markets, and we will carefully follow future developments here.

Most importantly, we remain of the view that that the ongoing shift in opportunity, resources and capital towards those companies most capable of driving sorely needed economic efficiency and productivity is not only a long-term phenomenon, but also a primary driver of value creation. We believe this trend underlies the Fund’s solid performance to date, as we invest nearly exclusively in what we believe to be value creating entrepreneurs, running attractive businesses grounded in intellectual capital and competitive advantage.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 9/30/2014)
  • Mobileye N.V. is a software and systems design leader for camera-based advanced driver assistance systems (ADAS). The share price increased after we participated in Mobileye's IPO in the quarter. We believe the company has the potential to become a multi-decade leader in the race to autonomous driving, a trend that we believe will improve transportation safety and efficiencies.

  • Mellanox Technologies Ltd. supplies semiconductor-based systems for computing, storage and communications applications that connect servers to servers and servers to storage. Mellanox's stock rose on reports of better Q2 results and Q3 guidance, as the latest generation of Intel chips spurred customer demand for high performance interconnect systems. We believe we are still in the early innings of the Mellanox growth story.

  • French firm Ingenico SA manufactures point-of-sale (POS) payment terminals and provides secure electronic payment services. The stock rose in Q3 as revenue growth and margin expansion beat expectations. POS terminal sales are growing rapidly due to (i) a merchant refresh cycle in the U.S. driven by the adoption of a more secure payment technology called EMV; (ii) rapid growth in emerging markets; and (iii) market share gains. In addition, margins have expanded due to strong operational execution and successful integration of recent acquisitions.

Detractors (for quarter ended 9/30/2014)
  • Germany-based RIB Software AG is the leading provider of efficiency software for the construction industry, combining the power of 3-D modeling and enterprise resource planning (ERP) business management solutions. RIB’s flagship software is quickly becoming the new standard in construction and its shares have more than tripled since their trough in 2011. We believe the decline in Q3 represents quarterly volatility inherent in businesses that depend on the timing of contract wins, and is not indicative of the vast potential of RIB Software.

  • Shares of plasma products company Grifols SA declined in Q3, after the company reported a weak Q2, including one-time expenses in conjunction with the integration of its recently acquired Novartis diagnostics unit, and incremental price competition in a small commoditized product line. We regard these developments as either one-off or regionally isolated events that do not impact Grifols' competitive advantage derived from its vast plasma collection network, coupled with what we expect to be significant growth of the plasma industry.

  • Shares of Indian cable TV provider DEN Networks Ltd. declined in Q3, as the deadline for pan-India digitization was pushed back by two years. DEN is also experiencing near-term challenges in collecting its fair share of subscription revenue from local cable operators. The company is well positioned to benefit from the ongoing digitization of cable systems as mandated by the Government of India. We retain conviction in DEN due to the expected multifold increase in subscription revenue/earnings post-digitization.

Quarterly Attribution Analysis (for quarter ended 9/30/2014)

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 International Growth Fund (Retail Shares) declined 6.88% in the third quarter and trailed the MSCI ACWI ex USA IMI Growth Index by 180 basis points, primarily due to stock selection.

Positive stock selection effect from developed markets investments, primarily those in Israel, France, and Australia, added the most value. This was more than offset by the underperformance of the Fund’s emerging markets holdings, led by those in India and Brazil.

On a sector basis, the Fund’s investments within the Information Technology (IT) sector and its average cash exposure of 4.2% in a down market were the largest contributors to relative results. Strength in IT was largely attributable to the outperformance of Mellanox Technologies Ltd. and Ingenico SA, which were also two of the Fund’s largest contributors on an absolute basis. Just Eat plc, a leading online restaurant delivery platform based in the U.K., also aided relative performance. The company’s shares rebounded strongly from the previous quarter’s losses on signs that business remained solid and that competitive concerns had been exaggerated.

Underperformance of the Fund’s investments within the Health Care and Consumer Discretionary sectors detracted the most from relative results. Weakness in Health Care was mainly due to the underperformance of Grifols SA, the Fund’s second largest detractor from absolute performance, and Eurofins Scientific SE, a provider of analytical testing services to clients in the food, pharmaceutical, and environmental industries. These two long-held and successful investments pulled back in the quarter after near-term earnings momentum slowed. The Fund’s lack of exposure to pharmaceuticals stocks, which finished up slightly as a group in the index, also hampered relative performance. Within Consumer Discretionary, a combination of stock selection and the Fund’s meaningfully larger exposure to this lagging sector hurt relative results. More than half of the Fund’s investments in the sector underperformed, led by the Fund’s cable & satellite investments, which are based in India. Shares of DEN Networks Ltd. and Hathway Cable & Datacom Ltd. declined after regulators pushed back the deadline for pan-India digitization by two years. Other key detractors in the sector were AO World plc, the leading online seller of major domestic appliances in the U.K., and Steinhoff International Holdings Ltd., a leading furniture retailer based in South Africa. AO World’s shares fell in the quarter due to contractions in valuations for the online sector in the U.K. Steinhoff is planning to dual-list on the Frankfurt Stock Exchange and was required to raise roughly $1.6 billion of equity capital to satisfy all listing procedures. We believe the potential earnings dilution from the equity raise caused the stock to decline.

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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 advice to any person and are subject to change 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 PA