Dear Baron Asset Fund Shareholder:
Performance
The second quarter was very challenging for U.S. equity markets. Investors remained focused primarily on the Federal Reserve’s likely need to continue raising interest rates to contain rising inflation.
Pessimistic sentiment was further exacerbated by geopolitical tensions, rising commodity prices, the negative impact on corporate earnings from a strengthening U.S. dollar, and the potential effects of COVID-related lockdowns in China on global supply chains. Lackluster financial results from several technology bellwethers, including Amazon (AMZN), Netflix (NFLX), and Microsoft (MSFT), also contributed to the market downdraft.
The best performing sectors included traditionally defensive areas. Consumer Staples, Utilities, and Health Care benefited from investors’ flight to safety during the quarter. The Energy sector also continued its meaningful outperformance, as oil prices topped $120 a barrel in early June. In contrast, the growth-oriented Consumer Discretionary, Information Technology (IT), and Communication Services sectors were each down more than 20%, as investors continued to sell longer duration growth stocks with elevated near-term valuations.
For the second consecutive quarter, growth meaningfully underperformed value as the higher interest rate environment disproportionately impacted growth stocks. Against this difficult backdrop for the type of growth stocks we favor, Baron Asset Fund (the “Fund”) fell 21.09% (Institutional Shares) in the quarter, performing roughly in line with the Russell Midcap Growth Index.
Table I – Performance† Annualized for periods ended June 30, 2022
Baron Asset Fund |
Baron Asset Fund Institutional Shares1,2,[3] |
Russell Midcap Growth Index1 |
S&P 500 Index1 |
|
Three Months5 |
(21.15)% |
(21.09)% |
(21.07)% |
(16.10)% |
Six Months5 |
(32.63)% |
(32.55)% |
(31.00)% |
(19.96)% |
One Year |
(29.43)% |
(29.25)% |
(29.57)% |
(10.62)% |
Three Years |
2.04% |
2.31% |
4.25% |
10.60% |
Five Years |
8.35% |
8.63% |
8.88% |
11.31% |
Ten Years |
11.86% |
12.16% |
11.50% |
12.96% |
Fifteen Years |
7.76% |
8.01% |
8.21% |
8.54% |
Since Inception (June 12, 1987) |
10.97% |
11.08% |
9.75%4 |
9.85% |
Performance listed in the above table is net of annual operating expenses. Annual expense ratio for the Retail Shares and Institutional Shares as of September 30, 2021 was 1.29% and 1.03%, respectively. The performance data quoted represents past performance. Past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate; an investor’s shares, when redeemed, may be worth more or less than their original cost. The Fund’s transfer agency expenses may be reduced by expense offsets from an unaffiliated transfer agent, without which performance would have been lower. Current performance may be lower or higher than the performance data quoted. For performance information current to the most recent month end, visit www.BaronFunds.com or call 1-800-99BARON. †The Fund’s 3-year historical performance was impacted by gains from IPOs and there is no guarantee that these results can be repeated or that the Fund’s level of participation in IPOs will be the same in the future.
|
Favorable stock selection in IT, Industrials, and Real Estate together with higher exposure to the better performing Financials sector and lower exposure to the lagging Consumer Discretionary sector added the most value. Within IT, lack of exposure to poor performing systems software stocks and outperformance of syndicated research provider Gartner, Inc. (IT) added the most value. Gartner’s shares outperformed amid macroeconomic uncertainty as its business conditions remained strong, with its core research business compounding at a double-digit rate.
Strength in Industrials was broad-based, led by private rocket and spacecraft manufacturer Space Exploration Technologies Corp., whose shares were revalued higher using prices of recent transactions and Baron’s proprietary valuation model. Real estate data and marketing platform CoStar Group, Inc. (CSGP), diversified technology company Roper Technologies Inc. (ROP), applied solutions provider IDEX Corporation (IEX), and pest control leader Rollins, Inc. (ROL) also outperformed after reporting strong financial results.
REITs SBA Communications Corp. (SBAC) and Equinix, Inc. (EQIX) bolstered performance in Real Estate, as investors rewarded their underlying secular growth drivers in an uncertain macroeconomic environment.
These positive impacts were mostly offset by adverse stock selection in the Health Care and Communication Services sectors. Weakness in Health Care was largely due to the underperformance of veterinary diagnostics company IDEXX Laboratories, Inc. and DNA sequencing market leader Illumina, Inc. (ILMN) IDEXX was the largest detractor as multiple compression was particularly acute for companies that benefited disproportionately from the pandemic, given challenging growth comparisons in 2022.
Illumina’s shares were pressured by concerns over increased competition from new entrants into its market. Performance in Communication Services was hindered by marketing solutions provider ZoomInfo Technologies Inc. (ZI), whose shares fell over concerns about the company’s compliance with changing privacy regulations in its market.
The Fund also suffered a material headwind from its negligible exposure to the Energy, Consumer Staples, and Materials sectors, which were among the best performing areas amid a treacherous market environment. Energy and Materials companies benefited from rising commodity prices. The Fund generally has limited exposure to these areas because we believe it is difficult to identify companies with secular growth characteristics and durable competitive advantages.
The Fund generally has few Consumer Staples holdings because of our preference for generally faster growing businesses in the Consumer Discretionary sector.
Table II – Top contributors to performance for the quarter ended June 30, 2022
Year Acquired |
Percent Impact |
|
Space Exploration Technologies Corp. |
2020 |
0.23% |
argenx SE (ARGX) |
2021 |
0.09 |
Rollins, Inc. |
2016 |
0.02 |
Diversey Holdings, Ltd. (DSEY) |
2021 |
0.01 |
Space Exploration Technologies Corp. (SpaceX) is a high-profile private company founded by Elon Musk that designs, manufactures, and launches rockets, satellites, and spacecrafts. Its long-term goal is to enable human beings to inhabit Mars. We believe SpaceX is creating substantial value through the ongoing expansion of its Starlink service, a broadband offering that connects its proprietary user terminals to its proprietary satellite constellation.
In addition, the company continues to reliably provide reusable launch capabilities, including crewed space flights, and it is advancing the development of its largest rocket, Starship. We value SpaceX using prices of recent financing transactions and a proprietary valuation model.
Argenx SE is a biotechnology company focused on developing treatments for autoimmune disorders. Shares increased given the encouraging launch of Vyvgart, argenx’s treatment for generalized myasthenia gravis, a chronic autoimmune disease that causes muscle weakness. Early sales tripled consensus expectations, and global approvals for the drug are coming in earlier than many investors had expected. Data from Vyvgart’s trial to treat immune thrombocytopenia was positive as well. We expect the company to announce several further positive developments during the next two years.
Rollins, Inc., which provides pest and termite control services for residential and commercial customers, contributed to performance. The company reported solid quarterly earnings and continued its consistent execution despite macroeconomic uncertainties. We believe Rollins has a strong brand and leading market share within in an attractive and defensive end market. The company has historically raised its prices to offset growth in its operating expenses. We expect that Rollins should be able to continue compounding its revenues, earnings, and free cash flow for many years.
Diversey Holdings, Ltd. is global leader in infection prevention, hygiene, and cleaning solutions. Its shares stabilized during the quarter after a first quarter sell-off. The price of raw materials Diversey needs to make its products has risen sharply in the inflationary environment, and the company increased its prices and added energy-related surcharges to mitigate some of these cost pressures.
Table III – Top detractors from performance for the quarter ended June 30, 2022
Year Acquired |
Percent Impact |
|
IDEXX Laboratories, Inc. |
2006 |
–2.34% |
Gartner, Inc. |
2007 |
–1.55 |
Mettler-Toledo International, Inc. (MTD) |
2008 |
–0.93 |
ZoomInfo Technologies Inc. |
2020 |
–0.90 |
ANSYS, Inc. (ANSS) |
2009 |
–0.83 |
Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. fell in the quarter. The broader veterinary industry benefited during the pandemic, as the pet population grew and owners working from home were often more attentive to their pets’ well-being. As the pandemic subsides, IDEXX may be adversely impacted by difficult year-over-year growth comparisons, and the company’s overseas’ earnings will likely suffer from the strengthening U.S. dollar.
Nevertheless, we believe that the pandemic accelerated the long-term secular trends impacting pet ownership and pet care, and we believe that foreign exchange rates will eventually move in the opposite direction. Furthermore, we believe that IDEXX’s competitive position is the strongest that it has ever been. We further expect the company’s proprietary testing innovations and its field sales force expansion to meaningfully contribute to its long-term growth rate and operating leverage.
Shares of Gartner, Inc., which sells syndicated research to corporations largely…
Read More: Baron Asset Fund Q2 2022 Shareholder Letter