Baron Small Cap Fund (BSFIX)
Fund Manager since 1997View All Commentary by Cliff
Baron Small Cap Fund invests primarily in small growth companies.
Portfolio CommentaryInstitutional Performance
Review and Outlook (for quarter ended 3/31/2013)
The market was strong in the first quarter, as investors returned to equities. Despite all the worries about global macro issues such as European debt, Chinese growth, Middle East tensions, and austerity measures passed to deal with the U.S.’s fiscal cliff, surprisingly, the economy accelerated. Retail sales were firm, auto and industrial production rose, the housing market continued to strengthen, and employment reports beat consensus estimates by wide margins. Corporate earnings, which we contend are most important in determining stock prices, were solid. Corporate executives reported an improved tone to business and more optimism concerning their outlooks for the near future. Stocks rode the optimism to all-time highs. The upswing in stocks is four years old, yet this quarter it felt like a distinct change in attitude to us, with increased money flowing into equities, and the Fund. Still, there were some anomalies, in our view, in that defensive sectors such as Health Care led the rally, energy and commodity prices fell, and bonds weakened. These are all unusual occurrences for a rally based upon a firming economy.
The Fund’s strong returns were broad-based, with about a quarter of the Fund’s positions appreciating 20% or more in the quarter.
Consumer Discretionary stocks, which represented about 23% of the portfolio at quarter end, contributed the most based on fundamental factors. HomeAway, Inc. reported improved organic growth and positive trends with its expanded service offerings. Starz Liberty Capital, Inc., the pay cable service operator, was spun out from Liberty Media and its strategy to focus on developing original programming was well received. Shares of The Madison Square Garden Co. rose with the success of the Knicks, the end of the NHL strike, and strong returns from the capital invested in the Garden.
Other stocks which were strong in the quarter include holdings from the Information Technology sector, such as FleetCor Technologies, Inc., which had terrific earnings and continued to make strategic and accretive acquisitions.
The portfolio had less than 10% of its assets invested in Health Care, the best performing sector in the benchmark. Two of the portfolio’s Health Care investments, Masimo Corp. and IDEXX Laboratories, Inc., declined in the quarter and dampened overall performance of our stocks in this sector.
With the market rally and growth stocks trading at higher multiples, our new purchases focused on special situations and initial public offerings. Our largest purchase was DigitalGlobe, Inc., the operator of a constellation of high resolution satellites. We also bought stakes in IPOs Tesoro Logistics, an MLP, and Artisan Partners, an asset manager.
Subsequent to the end of the quarter, the positive trend in employment reversed. In the last three years, both the economy and stock markets cooled after March. We have been impressed by the economy’s and markets’ resiliency in the face of what should have been significant headwinds. On the other hand, bears think the economy will contract, earnings will disappoint and the market will fall, especially since stocks have been bought with impunity fueled by excessive liquidity provided by central banks. Though stocks have risen, valuations are still reasonable on an absolute basis and stocks are attractive relative to alternatives. If earnings don’t disappoint, it would not surprise us if the rotation back to equities could last longer than many expect.
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 Small Cap Fund (Institutional Shares) gained 12.66% in the first quarter, yet slightly underperformed the Russell 2000 Growth Index by 55 basis points. During the period, stock selection was favorable, yet the Fund’s sector weightings detracted from relative performance.
The Fund's investments within the Consumer Discretionary, Energy, and Information Technology (IT) sectors were the primary contributors to relative performance. Within Consumer Discretionary, more than half of the Fund's investments outperformed, led by HomeAway, Inc., the leading online vacation rentals company, and Starz Liberty Capital, Inc., a premium subscription video programming service. Shares of HomeAway rose 47.7% in the quarter after the company reported better than expected quarterly results and showed acceleration in its revenue-per-listing metric. Shares of Starz increased sharply in the quarter after Liberty Media Corp. spun-off the company in early January. Other contributors in the sector were Krispy Kreme Doughnuts, Inc., which operates as a branded retailer and wholesaler of doughnuts, beverages, and packaged sweets worldwide, and The Madison Square Garden Co., which operates sports teams, venues, and cable networks. Within Energy, the majority of the Fund's investments outperformed, led by Core Laboratories N.V. and Susser Petroleum Partners LP. Favorable stock selection within the IT sector was mainly the result of outperformance of FleetCor Technologies, Inc., a provider of payment processing services to the vehicle fleet industry. Strong organic growth and accretive acquisitions led to better than expected earnings and guidance.
Underperformance of the Fund’s investments within the Industrials and Health Care sectors and the Fund’s larger exposure to Telecommunication Services, one of the worst performing sectors in the benchmark, were the largest detractors from relative performance. Weakness within Industrials was mainly attributable to underperformance of Polypore International, Inc. Polypore’s shares declined after their run up last quarter as a result of lower than expected sales of lithium-ion battery separators. Within Health Care, a combination of unfavorable stock selection and the Fund’s lower exposure to the outperforming sector, and to biotechnology stocks in particular, hurt relative results. The Fund’s largest detractor from relative results in the sector was IDEXX Laboratories, Inc., the leading provider of diagnostics to the veterinary industry. Shares of IDEXX retreated from all-time highs reached late last year as investors analyzed the impact of a change in the company’s relationship with one of its distributors.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 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.