Review and Outlook
The generally unimpeded six-year rally in the stock market, most real estate securities, and Baron Real Estate Fund hit a speed bump in the third quarter. Investor concerns included uncertainty over China’s economic growth prospects, the devaluation of the yuan, weak oil and commodity prices, uncertainty over the timing of a Fed rate hike, and stretched valuations for certain segments of the market.
REITs was the only real estate category to contribute. Business conditions were generally strong for our REIT companies, and we think they may continue to benefit from low interest rates, occupancy growth and increased rents at a time of limited new construction activity, improved balance sheets, access to low cost capital, and accretive investment opportunities. We are mindful, however, that many of the Fund's non-REIT companies’ valuations are more compelling. Also, REITs may be more vulnerable to an eventual rise in interest rates than non-REIT real estate stocks.
The categories that detracted the most included hotels & leisure, building products/services, and senior housing operators & health care facilities. Hotel & leisure declined due to concerns over the possibilities of a global economic slowdown, the end of the lodging cycle, increased inventory, and/or pricing pressure from new competitors such as Airbnb, as well as difficult year-over-year growth comparisons and weaker-than-expected financial results and forecasts by several companies. We maintain conviction in our hotel & leisure holdings given solid demand forecasts, generally low supply forecasts, company-specific initiatives that may unlock shareholder value, the growing likelihood of mergers & acquisition activity, and attractive valuations. Weak performance of the building products/services category was primarily driven by a sharp drop in the stock price of top detractor CaesarStone Sdot-Yam Ltd. The senior housing operators & health care facilities sub-category was negatively impacted by the stock price decline of the second biggest detractor, Brookdale Senior Living Inc.
We believe many real estate valuations have become more attractive following the recent decline in the markets. Business conditions for commercial and residential real estate are generally appealing. Demand is outstripping supply, credit has improved, balance sheets are solid, interest rates are low, and valuations are reasonable. We think many categories of real estate are on the cusp of entering the growth phase of the real estate recovery. We are bullish on long-term prospects for housing due to improving household formation and employment, pent-up demand, low inventories, favorable mortgage rates, and reasonable prices. We believe the relative lack of real estate construction activity combined with low interest rates following the 2008-09 credit crisis and economic downturn portend a longer lasting real estate recovery cycle than most prior cycles of five to seven years.
We are hopeful that the Fund's investments will continue to report solid business results, favorable business outlooks, and possible initiatives to increase shareholder value such as strategic acquisitions or corporate reorganizations.
Top Contributors/Detractors to Performance
Quarterly Attribution Analysis
The Quarterly Attribution Analysis for period ending September 30, 2015 is not yet available
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