Baron Real Estate Fund (BREFX)

Portfolio Management

JeffreyKolitch
Jeffrey Kolitch

Fund Manager since 2009

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Fund Description

Baron Real Estate Fund invests in securities of real estate and real estate related companies of all sizes.

  

Fund Resources

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Jeff Kolitch on his approach to investing in real estate.

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BREFX Performance as Yields Rose and Fell

Performance Attribution

Portfolio Commentary

Retail Performance

Review and Outlook (for quarter ended 6/30/2015)

Baron Real Estate Fund declined in the second quarter, although it outperformed its benchmark, the MSCI USA IMI Extended Real Estate Index.

The growing likelihood that the U.S. Federal Reserve will increase interest rates in the second half of 2015 had a negative impact on real estate in the quarter, particularly because high-dividend yielding stocks like REITs usually become less attractive to investors when treasury yields climb.

We are aware of the impact that an increase in interest rates could have on some categories of real estate. However, we believe that the Fund, with its broader and more comprehensive investment approach than the typical REIT-dominated fund, could potentially generate solid results should interest rates increase in the next few years.

In addition to interest rates, other contributors to positive equity market performance in the last five years – namely, favorable valuations and the undervalued U.S. dollar – are now somewhat less compelling. Consequently, the outsized equity returns of the last five years are unlikely to be repeated. Nevertheless, we continue to believe that the prospects for the equity market and the Fund are attractive.

In our opinion, economic conditions are generally solid, and currently offer a rare and welcome combination of low interest rates, low inflation, cheap oil prices, solid job growth, and increased household formation.

Stocks, while generally not cheap, remain attractive versus bonds (especially factoring in longer-term inflation expectations of at least 2.0%).

Also, the backdrop for commercial and residential real estate remains appealing. Demand, in most cases, is outstripping new construction activity. Strong balance sheets, low interest rates, and wide access to cheap capital afford many companies the opportunity to develop and acquire real estate, thus propelling growth.

It appears that, at long last, the pieces are falling in place for a normalized and growing housing market. Employment and household formation have improved. Credit conditions are easing, and mortgage rates remain near historical lows. In numerous markets, renting is more expensive than owning a home, thus fueling the preference to purchase. There are signs that the millennial generation (approximately 75 million people ages 18-34) is beginning to move out of their parents’ home. New home sales are increasing and construction levels remain below historical norms, creating a favorable ratio between demand and supply.

We remain optimistic. We are hopeful that the Fund’s investments will continue to report solid business results, favorable business outlooks, and perhaps additional initiatives to increase shareholder value such as strategic acquisitions or corporate reorganizations.

We are pleased with the Fund’s holdings. We believe we have assembled a group of quality companies that are reasonably priced with good growth prospects, led by great management teams.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 6/30/2015)
  • Builders FirstSource, Inc. is a leading distributor of building products, mostly catering to the new residential construction industry in the U.S. Shares rose sharply on the announcement of a merger with a competitor, ProBuild. Management expects the merger to increase the company’s cash flow by five-fold and be highly accretive to earnings. We remain excited about the combined company’s prospects, as residential construction levels are still depressed relative to demographic needs, and the company is gaining market share.

  • Equinix, Inc. provides global data center and interconnection services. Despite currency headwinds, Equinix beat Q1 expectations and raised annual guidance as a result of increased data center demand, Internet traffic growth, and a stabilizing pricing environment. Equinix converted to a REIT in January. Lastly, Equinix announced its intention to acquire Telecity, a European-based competitor, in a move that will allow Equinix to establish its leading position in Europe. This busy quarter for Equinix sent the stock higher.

  • CaesarStone Sdot-Yam Ltd. saw its stock price rise during Q2. CaesarStone is a leading global manufacturer of quartz surfaces for kitchens and bathrooms. Strong performance was driven by an earnings beat for Q1 and management’s rosy outlook, as earnings growth has continued to accelerate from successful new product launches and quartz-gained market share vs. other countertop materials, such as granite and marble.

Detractors (for quarter ended 6/30/2015)
  • Despite an earnings beat and news of a 4.7% position filed by an activist shareholder, shares of senior housing provider Brookdale Senior Living, Inc. fell over concerns regarding the integration with Emeritus and business fundamentals. Investors appear to be waiting to see if management will pursue actions to unlock shareholder value, such as a real estate spin-off or the sale of the company. Absent such an event, we still believe Brookdale will benefit from positive demographics, deeper penetration and a favorable supply-demand balance.

  • Shares of MGM Resorts International, a global owner and operator of casinos, decreased in Q2 on concerns surrounding the continued slowdown in Macau and the potential effect on the opening of MGM’s new casino there next year. News of Kirk Kerkorian’s death also hurt the stock as his will provides for the sale of his 16% position in the stock. We believe the current stock price does not accurately reflect improving Las Vegas Strip trends as well as MGM’s pipeline of new casinos in Massachusetts, Maryland, and Macau.

  • Shares of real estate company Forest City Enterprises, Inc. fell due to uncertainty around potential impacts to the business from rising interest rates. The company, which operates the Barclays Center arena in Brooklyn, plans to convert to a real estate investment trust next year. We remain excited about our investment in Forest City, as the company continues to take steps to simplify its portfolio and improve its balance sheet.

Quarterly Attribution Analysis (for quarter ended 6/30/2015)

The Quarterly Attribution Analysis for period ending June 30, 2015 is not yet available

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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.