Baron Partners Fund (BPTIX)

Portfolio Management

RonBaron
Ron Baron

Fund Manager since 1992

View All Commentary by Ron

Fund Description

Baron Partners Fund invests in all-cap companies with significant growth opportunities.

   

   

Portfolio Commentary

Institutional Performance

Review and Outlook (for quarter ended 9/30/2016)

After the initial shock of the Brexit vote in late June, the U.S. stock markets settled down in the third quarter, experiencing significantly less volatility than in the first half of 2016. Stable economic data, monetary policy rates that remained relatively unchanged, and the lack of a major disruptive event allayed investor concerns and drove a broad-based rebound during the three-month period ending September 30, 2016.

Investor appetite for risk increased, and stocks (particularly small-cap stocks) rose more or less steadily throughout the quarter. Lower quality stocks outperformed their higher quality counterparts. After mostly underperforming in the first half of the year, risk-on categories such as biotechnology and semiconductors outperformed. On the other hand, defensive sectors retreated after strong performance in the first half of 2016.

Baron Partners Fund increased in the quarter. Holdings in Financials, Consumer Discretionary, and Health Care were the top contributors. Financials advanced primarily on the strength of contributor The Charles Schwab Corp. Arch Capital Group Ltd. also added to sector performance. The share price of this specialty insurance and reinsurance company performed well during Q3 on solid quarterly results, with profitable underwriting, modest catastrophe losses, and favorable reserve development. Although the Consumer Discretionary sector had a somewhat mixed quarter, contributors outweighed detractors. Positive performance was led by third largest contributor Vail Resorts, Inc. Health Care advanced primarily on the strength of top contributor IDEXX Laboratories, Inc.

Information Technology investments detracted. Zillow Group, Inc. and Gartner, Inc., respectively the third and fourth largest detractors from Fund performance, led the decline in the sector. Shares of Gartner, a provider of syndicated IT research, relinquished some gains due to tougher comparisons and slightly more challenging macro conditions. We believe Gartner’s key metrics are solid and that, over time, the company will generate accelerating top-line growth, significant growth in earnings and free cash flow, and persistent return of capital.

The U.S. economy showed signs of acceleration in the third quarter. Historically, the U.S. stock market has been closely aligned with GDP. In 1960, GDP was $520 billion and the Dow Jones Industrial Average was 600. In 2007, GDP was $14 trillion and the Dow was 14,000. In 2015, GDP was $17.9 trillion and the Dow was 17,000. We think the U.S. economy and the stock market are closely intertwined. Over the past half century or so, our economy and stock market have grown at a compound annual rate between 6-7% in nominal terms. Factoring in annual dividends of about 2-3%, stock prices have approximately doubled every 10 years during the same period. We think our nation’s economy and stock markets will continue to achieve similarly strong results over the long term.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 9/30/2016)
  • Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. increased in Q3. The stock continued to rally on strong financial results and multiple expansion. Competitive trends are strong and improving, highlighted by instrument revenue growth, domestic lab growth, rising sales productivity, and stability in rapid assays. We believe that IDEXX’s direct go-to-market model coupled with research and development-driven product enhancements will put steady upward pressure on organic revenue and earnings growth over time.

  • Shares of brokerage business The Charles Schwab Corp. appreciated in Q3 on continued strong asset growth. The business continued to shift to fee-based advice from trading activity, a move that we believe creates more stability and the potential for increased profitability. Speculation of an interest rate hike by the U.S. Federal Reserve also helped boost the stock price as a rate increase would likely improve earnings for the company.

  • Shares of ski resort company Vail Resorts, Inc. increased in Q3 on news that the company had entered into an agreement to acquire Whistler Blackcomb in Canada. Vail owns some of the best ski resorts across North America, including Vail, Beaver Creek, Park City, and now Whistler. The deal gives the company even greater scale, which we think it will be able to leverage in its bid to continue to grow its season pass sales.

Detractors (for quarter ended 9/30/2016)
  • Shares of health care data and analytics vendor Inovalon Holdings, Inc. fell in Q3 on weak financial results and reduced guidance through year-end. Management attributed the revenue shortfall to price reductions in its retrospective risk adjustment business, and the margin shortfall to investments aimed at long-term growth. We think the recent poor performance is temporary. Inovalon has high quality products that generate solid ROI for its customers, and we think it is well-positioned to capitalize on the need for robust data and analytics in health care.

  • Shares of electric vehicle company Tesla Motors, Inc. fell during Q3 as the market continued to evaluate the potential merger with SolarCity. An investigation into a fatal accident involving Tesla’s autopilot and the possibility of an additional equity round by year end also pressured the stock. We feel good about the brand Tesla has built and its ability to bring substantial innovation to its products. Tesla has received over 370,000 Model 3 reservations, representing close to $18 billion in backlog and the largest product launch in history.

  • Zillow Group, Inc. is the leading online real estate company in the U.S. Shares fell in Q3 as investors paused prior to a new product roll out. While investors appear cautious about the near-term impact of this roll out, we expect that after a short transition period, the program will have a positive impact on revenue growth. Zillow continues to invest in its brand as the leader in an $8 billion real estate advertising market.  We believe that, as the leader of a highly fragmented market, Zillow remains well positioned to grow its share going forward.

Quarterly Attribution Analysis (for quarter ended 9/30/2016)

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 Partners Fund increased 3.72% in the third quarter, yet trailed the Russell Midcap Growth Index by 87 basis points due to stock selection.

The Fund may use leverage and is especially likely to do so when we believe prospects for businesses are favorable and stock prices of those businesses do not reflect those prospects. As of September 30, 2016, Baron Partners Fund had 136.3% of its net assets invested in securities, and this use of leverage in an up market contributed 170 basis points to relative performance.

Aside from leverage, Financials investments and lack of exposure to the underperforming Consumer Staples sector, which fell 4.6% in the index, contributed the most to relative results. Within Financials, significantly larger exposure to this strong performing sector and outperformance of The Charles Schwab Corp. and Arch Capital Group Ltd. added value. Schwab was the second largest contributor on an absolute basis, while Arch’s shares performed well after reporting solid quarterly results, driven by profitable underwriting, modest catastrophe losses, and favorable reserve development.

Underperformance of investments in Information Technology (IT) and Industrials weighed the most on relative results. IT investments detracted 329 basis points from relative performance after falling 3.2%, with the Fund’s two largest holdings in the sector, Zillow Group, Inc. and CoStar Group, Inc., driving the decline. Zillow was the third largest detractor from absolute results, while shares of CoStar, a real estate information and marketing services company, fell slightly on modest multiple compression after outperforming in Q2. Another detractor from relative performance was syndicated IT research provider Gartner, Inc., whose shares declined due to tougher comparisons and slightly more challenging macro conditions. Weakness in Industrials was mainly due to the underperformance of Fastenal Co., a leading distributor of industrial supplies, and Verisk Analytics, Inc., which provides information about risk to companies in the insurance, financial services, and energy industries. Both of these stocks underperformed after reporting disappointing financial results.

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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.