Baron Fifth Avenue Growth Fund: Latest Insights and Commentary

U.S large-cap growth equities were once again the place to be in the second quarter. The main theory behind 2023’s impressive bounce back, with the Russell 1000 Growth Index gaining 42.7%, was the Federal Reserve’s gearing up for significant interest rate cuts with the consensus pricing in seven cuts in 2024, which would ostensibly support the economy and be bullish for growth stocks. How many observers would have expected the index to appreciate an additional 20.7% with zero rate cuts in the first half of 2024? We think there are two main reasons for markets decoupling from rates and continuing to power higher: 1) the economy is proving to be surprisingly resilient even at much higher rates, and 2) generative AI (GenAI).

The decline in inflation to normalized levels persisted, with June’s 3.0% CPI reading the lowest since May 2020. While the economy has slowed, real GDP growth was 1.4% in the first quarter and the early reading for the second quarter is for stronger growth. Unemployment remained low at roughly 4%, and a “soft landing” now seems the most likely outcome. The current dot plot and consensus expectation is for three rate cuts starting in September.

U.S large cap stocks continued to outperform most other asset classes, driven largely by the Magnificent 7. These seven mega-cap stocks accounted for 99.8% of the index’s return in the second quarter and now represent more than 50% of the index following the annual Russell reconstitution. While NVIDIA may be the poster child for GenAI, all of the Magnificent 7 names stand to be leading beneficiaries of advances in GenAI.

Against this backdrop, Baron Fifth Avenue Growth Fund increased in the quarter. Holdings within Information Technology (IT), Consumer Discretionary, and Communication Services contributed the most. IT had a strong quarter, led by NVIDIA Corporation and CrowdStrike Holdings, Inc., respectively the top and second largest contributor to performance. Gains within Consumer Discretionary were led by third largest contributor Amazon.com, Inc. Communication Services benefited from appreciation in the portfolio’s three sector holdings, led by The Trade Desk, the leading online advertising demand-side platform. With declines in all three holdings within the sector, Financials detracted from performance.

We are optimistic about the long-term prospects of the companies in which we are invested and continue to search for new ideas and investment opportunities while remaining patient and investing only when we believe target companies are trading at attractive prices relative to their intrinsic values.

CONTRIBUTORS

• NVIDIA Corporation sells semiconductors, systems, and software for accelerated computing, gaming, and GenAI. NVIDIA’s stock rose on continued strong demand for its GPUs at the epicenter of the generative AI revolution. NVIDIA continued to report unprecedented rapid growth at scale, with quarterly revenues of $26 billion growing 262% year-over-year, datacenter segment revenues of $22.6 billion up 427% year-on-year, and operating margins of 69.3%. NVIDIA’s growth is even more impressive as it is nearing a new product cycle with the Blackwell chip going into production in Q3 and speaks to the urgency of demand for GPUs as customers are not willing to wait for the next generation architecture despite its improved performance-to-cost ratio. Management has commented as well that Blackwell would be supply constrained well into 2025. While the stock's strong performance has pulled forward some of the longer-term upside (which we manage through position sizing), it is still early in the accelerated computing platform shift and the adoption of GenAI across industries.
• CrowdStrike Holdings, Inc. is a cloud-architected SaaS cybersecurity vendor offering endpoint security, threat intelligence, and cyberattack response services. Despite one of the worst quarters for software stocks since the start of the pandemic, CrowdStrike contributed on better execution than its peers in the broader security space. With accelerating share gains in its core endpoint detection and response market, emerging products including Cloud, Identity, and SIEM reaching material scale, and newer products in Data Protection and AI ramping quickly, net new annual reoccurring revenue and total revenue look to sustain 28% to 30% growth the next two years at massive scale. We continue to believe this is a must-own large-cap name.
• Amazon.com, Inc. is the world’s largest retailer and cloud services provider. Shares of Amazon were up in the quarter on reported results that were better than expected, particularly with another large beat in overall operating profit. We believe Amazon is well positioned in the short to medium term to meaningfully improve core North American retail profitability to above pre-pandemic levels, benefiting from its new regionalized fulfillment network and its fast-growing, margin-accretive advertising business. We also believe Amazon's cloud division is re-accelerating from a period of customer cloud optimization. Longer term, Amazon has substantially more room to grow in e-commerce, where it has less than 15% penetration in its total addressable market. Amazon also remains the clear leader in the vast and growing cloud infrastructure market, with large opportunities in application software, including enabling generative AI workloads.

 

DETRACTORS

• Shopify Inc. is a cloud-based software provider for multi-channel commerce. Shares declined after the company announced it is entering an investment cycle. While the investment comes after over a year of consistent margin expansion, it left short-term-focused investors disappointed. We believe this is the right course of action for several reasons. First, the company expects solid returns on the increased marketing spend with 18-month payback periods. Second, the investment should help solidify Shopify's competitive position and drive market share gains. Finally, the increased spend should contribute to the chances for success in newer areas of opportunity with large addressable markets, including offline commerce, international, and enterprise. Shopify's strong financial results are an early indication of success, with gross merchandise value up 130%, 38%, and 32% year-on-year in B2B, EMEA, and offline respectively. We like Shopify’s strong competitive position, innovative culture, and long runway for growth, as it still holds less than a 2% share of the global commerce market.
• Snowflake Inc. is a leading cloud data platform that is predominantly used for data analytics. The stock declined as investors evaluated the impact of a recently announced CEO transition, a cybersecurity incident, and rapidly changing competitive dynamics. With generative AI capturing a larger portion of the public discourse, Snowflake's position in the future data stack is under scrutiny by both investors and customers. We believe Sridhar Ramaswamy, the newly appointed CEO, can help the business more efficiently transition toward an AI-first world. While Databricks and other key competitors are presenting strong results, we believe Snowflake’s brand, existing customer base, and accelerating product innovation could allow it to continue to capture share in a relatively large and strategic market. Management continues to describe strong demand trends for its core data analytics, which is also demonstrated by the relatively healthy expansion rates among existing customers while new go-to-market initiatives can help grow the customer base further.
• Cloudflare, Inc. provides content delivery network services, cloud cybersecurity, denial-of-service mitigation, Domain Name Service, and ICANN-accredited domain registration services. Shares fell on remarks from the CEO about sequentially worse macro conditions, citing the negative impact of geopolitical uncertainties on customer buying behavior. On the positive side, the company posted slightly better quarterly revenue with evidence that the changes to the go-to-market strategy were resonating with strong growth across large customer cohorts, double-digit improvement in sales productivity, and new pipeline attainment ahead of plan. Cloudflare reiterated revenue guidance for the year on resilience in cybersecurity spend. While we fine-tuned our model on the back of the company's increased macro headwind commentary, pushing out revenue reacceleration estimates from Q2 2024 to Q1 2025, this is still ahead of guidance. We retain conviction in the long-term thesis: a strong founder-led business with a unique global network and significant pricing advantages powering a disruptive multi-product growth story with improving margins.