Baron Opportunity Fund (BIOIX)
Fund Manager since 2006View All Commentary by Michael
Portfolio CommentaryInstitutional Performance
Review and Outlook (for quarter ended 3/31/2013)
The stock market opened the year with a strong first quarter. The market cheered the New Year’s Eve compromise averting the fiscal cliff, and the rally continued, spurred on by the Fed’s easy money policy, a gradually improving U.S. economy, better-than-feared fourth quarter earnings, and strong money flows into U.S. equity markets.
Many of the Fund’s investments performed well during the quarter. Top contributors included e-commerce leaders HomeAway, Inc. and Shutterfly, Inc., and the world’s leading real estate services firm, CBRE Group. Information Technology (IT) holdings were also top performers, particularly Guidewire Software, Inc., Gartner, Inc., ANSYS, Inc., CoStar Group, Inc., and Acxiom Corp.
Even so, the Fund’s significant weighting to IT and Telecommunication Services negatively impacted performance. First quarter IT spending was weak, impacted by the annual re-setting of IT budgets and global macro-economic concerns. A number of well-known tech companies reported or pre-announced poor results to start the year. While this has had a short term negative impact on performance of the Fund, we are not making any major changes to the portfolio. Our experience tells us that technology spending can be lumpy, particularly in the first quarter of the year, after the year-end budget flush and as budget priorities for the current year are being set. We remain confident that the technology themes in which we are investing are intact, that these themes will drive outsized growth, and that our portfolio companies are not only benefiting from these growth themes, but are taking market share within them. Consequently, we have taken advantage of the broad weakness in IT stocks to selectively add to certain positions in the portfolio.
Amounting to just under 9% of the portfolio, the Fund’s Health Care stocks declined about 2.5% in aggregate due to stock price declines for Edwards Lifesciences Corp., Intuitive Surgical, Inc., Illumina, Inc., and Masimo Corp. While we decided to exit our Intuitive Surgical position, neither the short-term price movements in any of these stocks, nor anything we learned during the quarter altered our opinion that minimally-invasive surgical procedures and better diagnostics (including DNA-based testing) will continue to be meaningful secular growth drivers in the Health Care space. In fact, Illumina recently reported a strong first quarter, driven by adoption of its DNA sequencing technology and its dominant competitive position in the market.
We invest in higher growth, often innovative businesses that are benefiting from powerful secular growth themes. Our portfolio holdings are growing their top lines at about twice the rate as the companies that make up our benchmark. Our investments also tend to have higher free cash flow margins and thus faster free cash flow growth. We sometimes pay higher multiples for these faster-growing businesses, and we accept slightly more volatility, but we believe over time our strategy will yield higher risk-adjusted returns for our investors.
While we strive to outperform in every period, we acknowledge periods of underperformance are unavoidable. We attempt to use those periods to improve the portfolio by taking advantage of compelling opportunities when they present themselves. We believe the best approach to long-term investing is to pursue a consistent and proven strategy. We remain focused on identifying businesses with powerful secular growth drivers, predictable and/or recurring revenue streams, sustainable competitive advantages, strong balance sheets, positive operating cash flows, and products and services that we expect to remain in high demand and critical to customers.
Top Contributors/Detractors to Performance
Contributors (for quarter ended 3/31/2013)
Detractors (for quarter ended 3/31/2013)
Quarterly Attribution Analysis (for quarter ended 3/31/2013)
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 Opportunity Fund (Institutional Shares) gained 8.94% in the first quarter, yet underperformed the Russell Midcap Growth Index by 257 basis points. During the quarter, the Fund’s unfavorable stock selection and, to a lesser extent, relative sector weights detracted from relative performance.
The Fund’s investments in the Financials and Consumer Discretionary sectors were the primary contributors to relative performance for the quarter. Favorable stock selection within the Financials sector was mostly attributable to outperformance of the Fund’s two holdings in the sector, CBRE Group, Inc. and Artisan Partners Asset Management, Inc. Shares of CBRE Group, a leading commercial real estate services company, outperformed in the quarter due to strong year-end operating results, an optimistic outlook from management, and its favorable valuation. Shares of Artisan Partners, an investment management firm with over $75 billion in assets under management, rose sharply following its IPO late in the quarter. Strength in the Consumer Discretionary sector was mainly attributable to outperformance of two of the Fund's Internet retail investments, HomeAway, Inc. and Shutterfly, Inc. Shares of both HomeAway and Shutterfly rose more than 45% in the quarter after reporting better than expected quarterly results.
The Fund’s holdings within the Information Technology (IT), Health Care, and Consumer Staples sectors were the largest detractors from relative performance. Within IT, a combination of unfavorable stock selection and the Fund’s meaningfully larger exposure to the underperforming sector, hampered relative results. Weakness in the sector was largely attributable to underperformance of the Fund’s investments in the Internet software and services and system software sub-industries. The largest detractors from relative performance were Internet software and services holdings Liquidity Services, Inc. and Rackspace Hosting, Inc. Shares of both companies declined after reporting weaker than expected earnings results due to greater levels of investment in their respective businesses. As a result, the Fund exited its position in both companies. Another detractor in IT was RealPage, Inc., an application software company which markets a comprehensive suite of property management software and analytical tools for the rental housing industry. The company’s shares declined in the quarter as financial results and 2013 guidance fell short of expectations.
Within Health Care, underperformance of the Fund’s three investments in the health care equipment sub-industry, Masimo Corp., Intuitive Surgical Inc., and Edwards Lifesciences Corp., and the Fund’s larger exposure to this lagging segment were the primary drivers of underperformance. Masimo, a medical diagnostics company, was the largest detractor from relative results in the sector. While Masimo reported respectable quarterly results, investors were disappointed in sales of its new Rainbow monitoring products, sending the company’s shares lower. Another detractor in the sector was Illumina, Inc., a leading provider of genetic analysis tools, including DNA sequencing instruments and consumables. Shares of Illumina declined after Roche’s CEO said the companies could not reach an agreement on price and Roche was abandoning its efforts to acquire Illumina. Our investment thesis has not been contingent upon Illumina being acquired. Within Consumer Staples, underperformance of the Fund’s only holding in the sector, Whole Foods Market, Inc., and the Fund’s lower exposure to the outperforming sector, hurt relative results. Whole Foods, which operates the largest chain of natural food supermarkets in the country, was a new addition to the Fund during the quarter.Invest In Baron Funds Today
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