Baron Focused Growth Fund

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.

Baron Focused Growth Fund (Institutional Shares) increased 1.68% in the first quarter, yet trailed the Russell 2500 Growth Index by 683 basis points principally due to adverse stock selection. Active sector/security weights and style biases, particularly lower exposure to the top performing Momentum factor, also weighed on performance.

Stock selection in Consumer Discretionary was a nearly 500 basis point drag on performance, accounting for about three-quarters of the underperformance in the period. Double-digit losses from electric vehicle manufacturer Tesla, Inc. and health care apparel company FIGS, Inc. were the principal drivers of relative weakness in the sector. Tesla’s shares fell as the core automotive segment remained under pressure due to a complex macroeconomic environment, factory shutdowns, growing competitive risks in China, and vehicle price reductions throughout 2023. During the first quarter, production was negatively impacted by Red Sea maritime supply chain interferences, sabotage at a Tesla factory power supply in Berlin, and the launch of the refreshed Model 3. We remain shareholders. Tesla has started delivery of its highly anticipated Cybertruck pickup, which features new technologies within the car and its manufacturing lines, and launched version 12 of its Full Self Driving product, which features material improvements and should enhance investor confidence in Tesla's unique software and hardware capabilities. We also expect energy storage sales to continue to grow over the coming years. Shares of FIGS stock was down in the quarter due to disappointing guidance for fiscal year 2024. The company expects revenue to be pressured due to macroeconomic weakness impacting its core customer base as well as industry-specific issues impacting the health care space. We retain our long-term conviction. We believe that FIGS' direct-to-consumer, higher quality, and more innovative product offerings vs. those of competitors provide a durable competitive advantage that will allow it to gain market share. 

Investments in Industrials and Information Technology (IT) also contributed to the relative shortfall in the period. Performance in Industrials was hindered by private rocket and spacecraft manufacturer Space Exploration Technologies Corp. (SpaceX) and data and analytics vendor Verisk Analytics, Inc. Shares of SpaceX underperformed after they remained unchanged in the period. Verisk’s stock price fell slightly in the period, giving back a portion of last year’s relative gains. The company reported solid quarterly earnings, but the stock lagged as part of a broader market rotation away from steady, compounding stocks. We maintain conviction in the competitive positioning, long-term growth, margin expansion, and capital deployment prospects for the business.

Weakness in IT came from physics-based simulation software vendor ANSYS, Inc. and multi-channel commerce software provider Shopify Inc. ANSYS’ shares rose sharply late in 2023 on news that several entities were interested in acquiring the company. In January 2024, Synopsys officially announced its intent to acquire ANSYS in a deal valued at nearly $35 billion, marking one of the largest software acquisitions in history. While the stock price remained above levels seen before the acquisition reports, the official announcement spurred a somewhat unfavorable market reaction given an implied price per share slightly below market expectations, a relatively long period between the announcement and anticipated closing date, heightened risk perception stemming from a substantial portion of the deal's value being proposed to ANSYS shareholders in the form of Synopsys shares, and perceived regulatory hurdles. We remain shareholders given ANSYS’ leading and broad product portfolio, multi-year large contracts, and tight relationships with key customers. Shopify’s stock declined despite reporting strong financial results, with 23% year-over-year growth in gross merchandise value, 24% growth in revenues, and non-GAAP operating margins of 18.5%. The share price weakness was principally driven by investor concerns around the low-teens sequential increase in operating expense guidance, after expenses have been on a downward trend since mid-2023. While this increased investment is penalizing margins in the near term, we believe that reinvesting into the business is the right strategic decision due to Shopify's expanding product capabilities.

Adverse stock selection in IT was exacerbated by the Fund’s lack of exposure to Super Micro Computer, Inc. (Supermicro) and MicroStrategy Incorporated, whose shares increased 255.3% and 169.9%, respectively, in the period. Together, these companies were a 200-plus basis point drag on performance. As a manufacturer of commodity motherboards for servers, Supermicro has been caught up in the hype surrounding AI, pushing its market cap from around $6 billion a year ago to nearly $60 billion as of quarter end. MicroStrategy sells business intelligence software and is the largest public holder of Bitcoin. The company’s software business is not growing, but its shares spiked alongside the price of Bitcoin in recent months. Neither business suits our investment criteria given our view that the core businesses lack sustainable competitive advantages, have low profit margins, are inconsistent generators of cash flows, and are dependent on demand trends that we view as cyclical rather than secular.

Partially offsetting the above was favorable stock selection in Financials and Communication Services. Strength in Financials came from specialty insurer Arch Capital Group Ltd. and global electronic broker Interactive Brokers Group, Inc. Arch’s shares were bolstered by a combination of strong financial results and the general outperformance of insurance stocks in a stabilizing interest rate environment. Interactive Brokers stock rallied on the back of increased earnings estimates by market analysts. The company generates over 50% of its revenue from interest income on idle client brokerage deposits, which it typically invests in interest rate-sensitive short-duration securities and client margin loans. Market expectations of interest rate cuts were lowered during the quarter on signs of continued economic strength despite somewhat elevated inflation, which is a positive for Interactive Broker's interest income and earnings.

Favorable stock selection in Communication Services, driven by strong performance from digital music service platform Spotify Technology S.A., was largely offset by higher exposure to this lagging sector. Spotify’s shares were up on operating margins and subscriber adds that exceeded Street expectations. The company is currently prioritizing profitability, with its largest round of layoffs to date and enhanced attention to operating efficiency. We think gross margins should improve meaningfully, driven by contributions from the artist promotions marketplace, the expanding advertising segment, and the increasing profitability of podcasts. The company remains focused on its product roadmap and user value proposition by, for example, providing U.S. premium subscribers free access to 15 hours of audiobook listening time in a bid to increase its audience. We view Spotify as a long-term winner in music streaming with potential to reach more than one billion monthly active users.