Review and Outlook

as of 03/31/24

The bull market that started at the end of October of 2023 kept running throughout the first quarter of 2024. Even the renewed threat of "higher for longer" interest rates did not put a check on equity performance. Investors entered the new year optimistic that a soft landing was in store for the economy, in which a recession would be avoided, inflation would continue to dissipate, and the Fed would start cutting interest rates in March. The economy has not only avoided recession but has been stronger than market forecasts. Meanwhile, inflation has again turned sticky, and Fed rate cuts have been delayed to at least June. The FactSet Global FinTech Index advanced 3.60%.

Against this backdrop, Baron FinTech Fund increased. Holdings within Financials, Industrials, and Real Estate contributed, while investments within Information Technology (IT) and Consumer Discretionary detracted. Financials had a strong quarter, with advances in 24 out of 27 holdings, including the top three contributors to performance. Credit bureau company TransUnion led gains within Industrials. Real Estate advanced on share price gains in CoStar Group, Inc., a provider of marketing and analytics to the real estate industry. Top detractor Endava plc led declines within IT. Consumer Discretionary detracted on a modest pullback in shares of MercadoLibro, Inc., the largest e-commerce company in Latin America and the portfolio’s only holding within the sector.

While we are certainly aware of the macroeconomic environment, we do not invest based on predictions of GDP growth, inflation, interest rates, or foreign currencies. We take an agnostic approach to short-term market and economic forecasts because nobody really knows. We do know economies tend to grow and equity markets tend to appreciate over time. We also know fintech includes a plethora of companies with long runways for growth and durable competitive advantages that we expect will outperform the broader equity market over the long run.

We have curated a diversified portfolio of fintech businesses to reduce exposure to any single economic outcome. The portfolio is balanced across seven themes, each of which is influenced by idiosyncratic factors. We include a mix of Leaders and Challengers, with the relative mix driven by top-down risk considerations and bottom-up opportunities. We believe fintech remains in the early innings of growth, as incumbent financial institutions still have a long digitization journey ahead and younger consumers continue favoring digital solutions.

Top Contributors/Detractors to Performance

as of 03/31/24

Contributors

  • Shares of insurance holding company The Progressive Corporation contributed in the quarter. Progressive reported strong results that suggested its current policy rates can support improved revenue and profits. The company spent most of 2023 pulling back on growth while it applied for, and received, rate increases from state insurance regulators. Having achieved adequate rates in most states entering 2024, management plans to increase ad spend to drive greater leads and policy growth. The prospects of strong earnings as a result of the rate increases and the company's growth initiatives led to shares performing well in the quarter.
  • Nu Holdings Ltd. is a digital bank with operations in Brazil, Mexico, and Colombia. Shares appreciated during the quarter, as the company reported strong balance sheet growth and continued improvement in profitability. Initiatives to deploy new products and accelerate growth in new geographies are yielding strong results, leading to enhanced earnings expectations. Nu also benefited from news that its shares had become eligible for inclusion in the MSCI Brazil index, which drove technical flows into the name. We remain investors. Nu is disrupting the financial services industry in Latin America via its digital distribution and intense focus on user experience, which has allowed it to reach over 90 million registered users (almost half of the Brazilian adult population) in less than 10 years with little marketing investment. We believe its superior product offering will allow it to take share from incumbents in this massive market.
  • Shares of leading private equity firm Apollo Global Management, Inc. contributed in the quarter following a positive earnings update in which management expressed optimism regarding opportunities for 2024 and beyond. We remain investors. Apollo continued to raise significant capital through both its captive insurer, Athene, and third-party capital, supporting strong earnings growth expectations. Apollo is also scaling its origination capabilities, which should facilitate the deployment of large amounts of capital and earn compelling returns for LPs. Finally, it kept 2024 guidance as is despite widespread expectations of lower interest rates, which should lead to positive earnings revisions down the road.

Detractors

  • Shares of IT services provider Endava plc fell after management cut guidance for the fiscal year ending June 30, 2024. Growth has slowed over the last year as business customers pulled back on discretionary IT spending due to macroeconomic uncertainty. Last fall, management was seeing early signs of a recovery, but new projects have been taking longer to materialize as customers delay spending decisions. Higher expenses due to increased staffing to meet anticipated demand weighed on margins as well. Management acknowledged that it misread the market and is taking steps to right-size the cost structure to improve margins. We remain invested because we expect these near-term headwinds to abate over time, leading to better growth as clients embrace digital transformation.
  • Shares of Intapp, Inc., a provider of cloud-based software for the legal, accounting, private capital, and investment banking sectors, detracted during the quarter. Intapp reported a solid fourth quarter with 23% revenue growth and 7% operating margins — both above consensus estimates — and management raised its full-year guidance for revenue, operating margins, and earnings per share. However, shares sold off during the quarter due to investor concerns about near-term budgetary headwinds in the investment banking customer segment. In addition, one of Intapp’s pre-IPO investors exited most of its position in early March. We view both issues as short term and purchased more shares on weakness. We are optimistic about Intapp's long-term prospects as it continues to win share in financial services markets, expand its wallet share across large clients, and improve its free cash flow margins.

Quarterly Attribution Analysis (Institutional Shares)

as of 03/31/24

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.

as of 03/31/24

Baron FinTech Fund (Institutional Shares) gained 6.33% in the first quarter, outperforming the more comparable FactSet Global FinTech Index (the Benchmark) by 273 basis points. However, the Fund didn’t fare as well against the broader market principally due to adverse stock selection in the Information Technology (IT) sector, where several of the Fund’s holdings were down in the period. Disappointing stock selection in IT was exacerbated by the Fund’s lack of exposure to NVIDIA Corporation, whose shares continued their strong run during the quarter.

The outperformance versus the Benchmark was largely due to outstanding stock selection in Tech-Enabled Financials, where insurance holding company The Progressive Corporation, Latin American digital bank Nu Holdings Ltd., and private equity firm Apollo Global Management, Inc. were among the leaders. Progressive reported strong results that suggested its current policy rates can support improved revenue and profits. The company spent most of 2023 pulling back on growth while it applied for, and received, rate increases from state insurance regulators. Having achieved adequate rates in most states entering 2024, management plans to increase ad spend to drive greater leads and policy growth. The prospects of strong earnings as a result of the rate increases and the company's growth initiatives led to shares performing well in the quarter. Similarly, Nu reported strong balance sheet growth and continued improvement in profitability. Initiatives to deploy new products and accelerate growth in new geographies are yielding strong results, leading to enhanced earnings expectations. Nu also benefited from news that its shares had become eligible for inclusion in the MSCI Brazil index, which drove technical flows into the name. Apollo’s stock performed well to begin the year, helped by a positive earnings update in which management expressed optimism regarding opportunities for 2024 and beyond. The company continued to raise significant capital through both its captive insurer, Athene, and from third parties, supporting strong earnings growth expectations. Apollo is also scaling its origination capabilities, which should facilitate the deployment of large amounts of capital and earn compelling returns for LPs.

Additional tailwinds to performance in Tech-Enabled Financials came from insurers Kinsale Capital Group, Inc. and Arch Capital Group Ltd., whose shares were bolstered by a combination of strong financial results and the general outperformance of insurance stocks in a stabilizing interest rate environment. Following a slowdown in the prior quarter, Kinsale’s gross written premiums grew 34% and EPS grew 49% with a record-high underwriting margin. Market conditions remain favorable with rising premium rates and more business shifting from the standard market to the excess and surplus lines market where Kinsale operates. In the most recent reported quarter, Arch’s operating ROE was 24% and book value per share rose 44% as underwriting profitability remained excellent. Pricing trends in the property and casualty insurance market are favorable, and elevated interest rates are driving higher investment income.

Payments was another standout theme thanks to double-digit gains from global payment companies Mastercard Incorporated and Fiserv, Inc. Mastercard’s shares rose after the company reported quarterly financial results that exceeded Street expectations, with 13% revenue growth and 20% EPS growth. Spending volume remains healthy, with strength outside the U.S. and in cross-border transactions. Management also provided encouraging financial guidance for 2024, calling for double-digit revenue growth and margin expansion. Meanwhile, investors largely shrugged off potential risks stemming from Capital One’s announced acquisition of Discover. We continue to believe Mastercard has a long runway for growth and significant competitive advantages. Fiserv’s stock rose in response to robust fourth-quarter earnings, supported by strength in Clover, its point-of-sale system for small businesses. Despite investor concerns about macroeconomic weakness potentially impacting Fiserv’s outlook, the company reaffirmed its earlier guidance for 2024, which largely remained steady. Clover revenue jumped 30% year-over-year, with an uptick in value-added services penetration. We remain optimistic, as Fiserv continues to execute well on its long-term vision, and we believe Clover will play a key role in driving growth for the company in the years ahead.

Somewhat offsetting the above was disappointing performance in Digital IT Services, where shares of outsourced software development provider Endava plc and digitally native technology services company Globant S.A. were down sharply. Endava was the top detractor after management cut guidance for the fiscal year ending June 30, 2024. Growth has slowed over the last year as business customers pulled back on discretionary IT spending due to macroeconomic uncertainty. Last fall, management was seeing early signs of a recovery, but new projects have been taking longer to materialize as customers delay spending decisions. Higher expenses due to increased staffing to meet anticipated demand weighed on margins as well. Management acknowledged that it misread the market and is taking steps to right-size the cost structure to improve margins. We remain invested because we expect these near-term headwinds to abate over time, leading to better growth as clients embrace digital transformation. Globant’s shares fell after the company provided financial guidance that missed Street estimates. While management expects market share gains to continue in 2024, forecasted revenue and EPS growth represented a decline from the prior quarter and missed investor expectations. We remain investors. Despite a broad slowdown in IT spending, the company showed resilient business momentum with 16% EPS growth and 18% revenue growth in the most recent quarter, well above peer levels due to Globant’s diversified customer base, favorable geographic mix, and acquisition strategy. We believe Globant has a long runway for expansion in a very large global market for IT services.

Poor stock selection in Enterprise Software coupled with meaningfully lower exposure to this better performing category were other sources of relative weakness. Cloud-based professional services software company Intapp, Inc. and investment management tools provider FactSet Research Systems Inc. were the largest detractors in the category. Intapp was a new addition to the Fund during the quarter. Despite reporting solid quarterly financial results, the company’s shares sold off on investor concerns about near-term budgetary headwinds in the investment banking customer segment. In addition, one of Intapp’s pre-IPO investors sold most of its position in early March. We view both issues as short term and purchased additional shares on weakness. We are optimistic about Intapp's long-term prospects as it continues to win share in financial services markets, expand its wallet share across large clients, and improve its free cash flow margins. FactSet’s solid quarterly results were overshadowed by a downward revision to fiscal year 2024 growth in annual subscription value given ongoing challenges in the financial services end market. The company has a strong pipeline and is seeing signs of stabilization, but client caution continues to delay purchasing decisions. While there is some near-term uncertainty, we maintain long-term conviction in FactSet due to the company’s large addressable market, consistent execution on both new product development and financial results, and robust free cash flow generation.