Baron International Growth Fund (BINIX)

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

Institutional Performance

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

International equities appreciated in the first quarter as markets responded to declining sovereign interest rates, largely driven, in our view, by aggressive ECB monetary policy. To us, the key event of the first quarter was the detail of the ECB's easing campaign, which clearly "beat" market expectations. Economic momentum worldwide continued to diverge, with relative strength in much of the developed world, led by a recovering Europe, and ongoing signs of deterioration across the developing world, notably in China and Brazil.

Across the globe, high quality growth stocks, our principal investment focus, lagged their lower quality, more capital intensive and cyclical peers. We also attribute this largely to aggressive ECB easing, as the attendant decline in cost of capital worldwide drove a mean-reverting relief rally for such equities. In contrast, the companies in which we seek to invest tend to be steady, value-creating entities driven by organically high return on capital, and are thereby much less sensitive to changes in the cost of or access to capital.

During the quarter, oil prices, currencies, bond yields, and equities remained volatile, we suspect driven by uncertainty over key macroeconomic variables and the divergence in monetary policy expectations. Uncertainty over the timing of anticipated Fed rate hikes, as well as the likelihood of Greece remaining in the EU, has also elevated market volatility. For international equities overall, we view the strength of the U.S. dollar, exacerbated by ECB policy, as a key risk factor, particularly for countries most exposed to declining commodity prices and/or dollar denominated liabilities. For the most part, we have refrained from investing in companies and markets directly exposed.

We suspect interest rates are likely to remain quite low for a sustained period as any material increase is likely to stress the system and derail economic momentum. We view the current financial and investment environment as a conundrum that we might describe as the "Truman Show" market. Here, global monetary authorities present a constructed reality, where developed world interest rates, the key variable upon which all other market instruments must be evaluated on a relative basis, are manipulated rather than set by market forces. While we continue to discover attractive investments, they are marginally more difficult to find. For these reasons, our cash position is moderately above desired levels and we have become a bit more conservative with regard to liquidity and balance sheet quality.

Although the current investment environment appears complex, our discipline seeks to identify attractive investment opportunities in all environments, often precisely due to the rapid evolution of change across our universe. We believe such change-driven opportunity is emerging now in a variety of countries and industries, and remain confident that our discipline will continue to identify the source of tomorrow’s significant value creation. We note Europe, Japan, China, India and Indonesia as particularly fertile ground for such long-term opportunity given significant reforms already underway.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 3/31/2015)
  • Shares of Japan-based online consumables distributor MonotaRO Co., Ltd. rose in Q1 on strong quarterly growth in user activity and order size. Management has proven it can transact at high returns on capital. We think it will grow market share in the maintenance, repair and operations segment by offering a wide array of products at low cost. Given its success in Japan, we think MonotaRO can successfully compete in Korea and grow profits by consolidating royalty income generated by key shareholder WW Grainger's online initiatives.

  • Shares of Domino’s Pizza Enterprises Ltd. rose in Q1 on reports of strong Q4 earnings. The company is the largest master franchiser of the Domino’s Pizza brand, operating in its home market of Australia/New Zealand, certain European countries, and Japan. It grew same store sales by 11% in Australia/New Zealand, which is considered a saturated market. Its European operation has successfully undergone a turnaround and is showing solid progress. Its newest market, Japan, has been showing strong operational potential.

  • Shares of FANUC Corp. rose in Q1, as a result of strong financial results. Activist investor Dan Loeb (Third Point Capital) recently initiated a position in FANUC, which also contributed to stock price appreciation. As the world’s leading manufacturer of factory automation equipment and robots, the company is a beneficiary of the secular growth in industrial automation. We retain conviction due to the company’s dominant market position and ability to generate high returns on capital.

Detractors (for quarter ended 3/31/2015)
  • GAEC Educação S.A is a for-profit education company in Brazil. GAEC has been a beneficiary of FIES, the government’s student financing program. Due to Brazil’s fiscal problems, the government changed the rules for FIES, and the entire education sector plummeted. GAEC also made two acquisitions prior to the announcement, which heightened concerns that it would be unable to extract synergies given the change in FIES rules. We reduced our position.

  • As the largest for-profit education company in Brazil, Kroton Educacional SA has been a beneficiary of FIES, the government’s student financing program. We also think it is an exceptionally well-managed company. However, Brazil’s fiscal problems prompted the government to change the rules on FIES, and the entire education sector plummeted in Q1. In addition, the Brazilian Real and market have both been weak due to the same fiscal issues. We reduced our position.

  • GOL Linhas Aéreas Inteligentes SA is the second largest airline in Brazil. Our investment thesis was based on industry-wide capacity rationalization and operational improvements at GOL. GOL was also a cheaper way to own Smiles SA, a high growth, high return loyalty program, of which GOL is a majority shareholder. Shares fell sharply in Q1, weighed down by the impact of the slowdown in Brazil on travel, and GOL’s ballooning debt service as its debt is denominated in U.S. dollars. We reduced our position.

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 International Growth Fund (Institutional Shares) increased 2.87% in the first quarter, yet trailed the MSCI ACWI ex USA IMI Growth Index by 188 basis points, primarily due to stock selection.

Stock selection in developed markets added value, driven by outperformance of the Fund’s holdings in Japan, Canada, and Australia; but this positive effect was more than offset by underperformance of its emerging markets holdings. The Fund’s investments within emerging markets fell 3.0% and trailed their benchmark counterparts by 712 basis points, led by those in Brazil. The Fund’s larger exposure to Brazilian equities, which fell sharply in the quarter, also hurt relative results.

On a sector basis, the Fund’s investments within Financials and Industrials were the largest contributors to relative results. Within Financials, outperformance of the Fund’s investments in diversified banks, led by Axis Bank Ltd., and its lower exposure to this lagging sub-industry added the most value. PATRIZIA Immobilien AG of Germany and Azimut Holding S.p.A. of Italy also drove outperformance in the sector. PATRIZIA’s outperformance was driven by the company’s move to transform itself from a real estate owner to an asset light property manager, a business model to which investors assign higher multiples. Shares of Azimut, a leading wealth management and asset management firm in Italy, rose more than 20% after being added to the Fund in late January. We believe Azimut stands to benefit from the decline in deposit rates and yields on European fixed income assets. Strength in Industrials was mostly attributable to the outperformance of Japanese investments MonotaRO Co., Ltd. and FANUC Corp., which were also two of the Fund’s largest contributors on an absolute basis. Other contributors to relative performance in the sector were Larsen & Toubro Ltd. of India and Aena SA of Spain. Shares of Larsen & Toubro, which is India’s largest engineering and construction conglomerate, were bolstered by the Indian government’s continued efforts to stimulate infrastructure spending in the country. Aena, a new position in the Fund since early March, is the principal operator of airport terminals in Spain. Shares of Aena rose for the period held, and we believe Aena is well positioned to benefit from improving travel volumes as a result of stronger economic activity and the weaker Euro.

The Fund’s investments within the Consumer Discretionary and Health Care sectors, and its average cash exposure of 5.9% amid favorable market conditions for global equities detracted the most from relative results. Within Consumer Discretionary, the Fund’s larger exposure to underperforming education services stocks and, to a lesser extent stock selection in this sub-industry, detracted 153 basis points from relative results. Brazilian education stocks, including our holdings Brazilian education companies GAEC Educação SA and Kroton Educacional SA, suffered in the quarter after fiscal problems in Brazil caused the government to change the rules for FIES, a student financing program. AO World plc of the U.K. and Luk Fook Holdings (International) Ltd. of Hong Kong also hurt relative performance in the sector. Shares of AO, the leading online seller of major domestic appliances in the U.K., declined due to a lower growth forecast. Weakness in Health Care was mainly due to the Fund’s lack of exposure to pharmaceutical stocks, which rose 11.5% as a group within the index.

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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