Baron Small Cap Fund (BSCFX)

Portfolio Management

CliffGreenberg
Cliff Greenberg

Fund Manager since 1997

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Fund Description

Baron Small Cap Fund invests primarily in small growth companies.

    

    

Fund Resources

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Cliff Greenberg seeks long-term growth from small companies.

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Risk Return Profile over the Long-Term

Baron Small Cap Fund Risk Return Profile

Portfolio Commentary

Retail Performance

Review and Outlook (for quarter ended 12/31/2015)

Stocks rebounded in the fourth quarter of 2015 as confidence in the strength of large economies picked up.  Stocks rallied about 9% during October and November as economic reports showed renewed strength, especially jobs growth, and leading indicators in Europe and Asia improved. The small cap market reverted to its form of earlier in the year, as biotech/pharma and high growth tech stocks led the bounce.  The Federal Reserve raised the fed funds rate in mid-December, the first increase since 2006.  The increase was expected and generally applauded by the investment community on the rationale that monetary policy was “normalizing” with the economy in good stead.  The Fed indicated that gradual increases in the fed funds rate were to be expected if economic activity continued to expand and inflation started to perk up. Against this backdrop, we continued to do what we do – try to find special small cap growth companies, the fundamentals of which remain strong in the face of a volatile market.

Baron Small Cap Fund gained in the fourth quarter. Industrials, Information Technology (IT), and Health Care were the top contributing sectors to performance. The Fund’s Industrials holdings had a strong quarter. The sector included the top three contributors to performance, Acuity Brands, Inc.; Waste Connections, Inc.; and On Assignment, Inc. IT’s contribution was driven largely by gains in the application software and IT consulting & other services sub-industries. Health Care’s advance was led by the Fund’s life sciences tools & services investments. Consumer Staples and Consumer Discretionary detracted. A sharp decline in the stock price of top detractor United Natural Foods, Inc. weighed on performance of the Consumer Staples sector. The Fund’s Consumer Discretionary  holdings had a mixed quarter, although detractors outweighed contributors. In particular, the two specialty stores holdings hurt performance, including The Container Store Group, Inc., which was the third biggest detractor from performance in the period.

As the new year starts, fear has gripped the markets and stocks have suffered heavy losses.  The major concerns are declining growth in China and the continued fall in the price of oil, which just broke $30 per barrel.  Both are feared to be harbingers of slower global growth, with the potential contagion effect on our domestic economic climate. However, the U.S. economy is performing well.  Jobs reports continue to be robust.  Softness in the Energy and Industrials sectors is being offset by expansion in the service sectors. Many stocks have sold off to levels where we deem them very attractive. After two years of relative underperformance, small-cap stocks now trade in line with their normal 5% premium to large caps, at 16 times 2016 estimates.

We are aware of the challenges, but we have faith in our process and believe over the long term that it will be rewarded.  We continue to favor companies that we believe are able to continue to grow despite the headwinds.  We think our portfolio of small to mid-sized quality growth companies is well positioned.  A key will be if earnings come in as we expect.

Top Contributors/Detractors to Performance

Contributors (for quarter ended 12/31/2015)
  • Acuity Brands, Inc., the leading U.S. provider of lighting solutions, continues to benefit from secular demand for more energy efficiency and the rapid adoption of LED lighting. Earnings grew in Q4, driven by growth in LEDs, which now represent 50% of sales. Acuity is selling sophisticated lighting solutions, not just luminaires, incorporating controls and sensors for which we believe there is great demand. Add in growth in non-residential construction, market share gains, and accretive acquisitions, and we think earnings will have the potential to grow rapidly.

  • Shares of Waste Connections, Inc., a solid waste company focusing on secondary markets in the U.S., rose on industry leading organic growth of about 5%, with EBITDA margins of 34%. The company expects 7% EBITDA growth for 2016, despite weakness in its oil exploration and production waste business, given favorable pricing and high market share in the West Coast market, where housing markets are improving. The stability of the business, strong free cash flow, and ability to grow via acquisitions keep Waste Connections a core holding.

  • Shares of On Assignment, Inc., a leading provider of IT staffing solutions, rose in Q4 as results got back on track with a Q3 beat and raise. Organic growth accelerated as newer recruiters became increasingly productive and end market demand in all verticals perked up. Management decided to continue to add to headcount, which we think will drive long-term top line growth but will put a damper on what would have been even stronger margin leverage near term.

Detractors (for quarter ended 12/31/2015)
  • Shares of United Natural Foods, Inc., the leading natural foods distributor, fell in Q4 on disappointing results. As healthy brands have rapidly gained shelf space at retailers not traditionally served by the company, such as traditional grocery, drug and convenience stores, we believe United Natural and its customers have been temporarily pressured. We believe current valuations do not reflect United Natural’s ability to win new accounts, make accretive acquisitions, and strengthen its competitive positioning in the health and wellness space.

  • Flotek Industries, Inc. supplies a proprietary product dubbed the “complex nano-fluid (CnF)” to oil & gas companies that helps boost shale well productivity. Shares fell on a short seller’s assertion that Flotek had inflated claims of CnF’s efficacy. However, independent analyses supported our views regarding CnF’s positive impact on well productivity. Slumping oil prices also hurt shares. We expect shares to rebound as we think Flotek can show continued solid demand for and, in time, rising sales of CnF, the key to long-term earnings growth.

  • Shares of The Container Store Group, Inc., the leading specialty retailer of storage and organization products, detracted from Q4 performance after a series of disappointing results and an overly optimistic valuation. To counteract weaker trends, management has unveiled several revenue-driving initiatives, including launch of a loyalty program, professional organizing services, and TCS Custom Closets, the largest merchandising effort in company history.

Quarterly Attribution Analysis (for quarter ended 12/31/2015)

The Quarterly Attribution Analysis for period ending December 31, 2015 is not yet available

Yearly Attribution Analysis (for year ended 12/31/2015)

The Yearly Attribution Analysis for period ending December 31, 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 advise to any person and are subject to chage 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.