Baron Durable Advantage Fund | Q3 2026

We had an in-line quarter.

Baron Durable Advantage Fund (the Fund) gained 2.2% (Institutional Shares) during the third quarter, compared to the 2.3% gain for the S&P 500 Index (the Index), the Fund’s benchmark.

Year to date, the Fund is up 5.7%, compared to the 12.8% gain for the Index.

At first glance, the Index’s 2.3% gain and the Fund’s 2.2% return look rather uneventful. It was anything but. The Fed raised interest rates for the first time in three years, and the 10-year Treasury yield reached 5.3%, its highest level since 2002. Developments in the Middle East (think oil prices), Russia – Ukraine (think oil prices), trade wars and inflation, AI build out and AI “bubble” debate, and of course the endless stream of X and Truth Social posts – drove considerable amount of activity.

The third quarter opened with a sell-off in AI buildout stocks, triggered by a confluence of rumors, news, and events. The Situational Awareness hedge fund that held large, leveraged bets on semiconductors and AI infrastructure stocks had collapsed. Unconfirmed rumors that Meta was considering renting out some of its AI compute caused the talking heads to speculate that Meta’s internal AI demand had weakened. Data showing that open-source models were gaining token share from the frontier companies’ proprietary LLMs, which was accompanied by token price declines. Widely circulated speculation that Anthropic and OpenAI’s growth was decelerating culminated in a leak that Anthropic had reached $65 billion of annual recurring revenue (ARR) in July⁴, adding “only” $18 billion in two months – roughly a Texas Instruments’ worth of revenues. Obviously disappointing, eye-roll emoji.

By the end of July, semiconductors, which had grown to 16.6% of the Index, fell 8.4%; semiconductor materials & equipment dropped 32.5%, and electronic components declined 27.7%. Some of the biggest darlings of the first six months, such as Micron, Sandisk, Corning, and Lam Research, declined anywhere from the high 20% to mid-40% range. AI-buildout-related Industrials sub-industries also sold off sharply with construction machinery & heavy transportation equipment down 16.5% and heavy electrical equipment 15.7% lower. Despite these declines, the Index ended July down just 0.1% as a result of a 12.6% gain for the Energy sector, a 6.2% rise for Financials, and a 4.9% advance by the Magnificent Seven.

The AI-buildout sell-off abruptly ended in August as strong earnings from hyperscalers, neoclouds, and semiconductor companies did not disappoint. Hyperscalers reported accelerating growth at massive scale with their cloud revenue run-rate rising 50% year-on-year to $420 billion⁵. Neoclouds reported signing deals at rising (rather than declining) prices, with shorter payback periods and higher ROI. CoreWeave (which we do NOT own) secured a contract to rent its six-year-old Ampere GPUs through 2029, while Nebius (which we own in our Global Opportunity Fund®) disclosed price increases for both old and new GPUs as demand continued to strengthen. This momentum continued in September. NVIDIA reported $96 billion in revenue, with growth accelerating to 106% year-on-year, a broader customer base, and growing content per GW. The company also guided to 70% growth for next fiscal year, significantly above expectations noting that supply constraints prevented an even higher outlook! Broadcom likewise reported strong results with 86% year-on-year revenue growth and projected that its AI business would double next fiscal year and then double again the year after! We have not seen this kind of growth… profitable growth… at scale… before. Ever!

The Index’s valuation multiple as measured by P/E⁶ declined from 20.2x to 19.3x during the third quarter, implying that earnings growth accounted for over 100% of its 2.3% return. Year to date, the multiple declined from 22x to 19x, while year-on-year EPS growth accelerated from 13.9% in the fourth quarter of 2025 to 28.9% and 52.2% in the first and second quarters of 2026, respectively.⁷ Earnings exceeded market expectations by 16.4% and 25.8% in those quarters, compared with an average beat of roughly 8% over the past decade. Third quarter EPS growth is expected to reach 29.6% or about 37% assuming an average beat. A beat in the 16% to 25% range, similar to the first half of 2026, would bring those growth rates closer to 2021-2022 levels, when the market benefited from the COVID recovery and massive fiscal stimulus.

AI was the primary driver of earnings growth. NVIDIA, which averaged 7.9% of the Index in the third quarter, grew second-quarter EPS 111.8% year-on-year. Microsoft, at 5.2%, increased EPS 29.9%. Amazon, at 3.8%, grew EPS 242% (its 43% operating-income growth is a better measure because it excludes gains on its investment in Anthropic). Alphabet, at 5.6%, increased EPS 294%, while operating income grew 30%, excluding gains on Anthropic and SpaceX. Broadcom, at 2.7%, grew EPS 96.4%.

There was not much insight to be had from a performance attribution standpoint, which is not surprising in an in-line quarter. Favorable stock selection added 62bps, but was offset by a 70bps drag from sector allocation. We added value in Communication Services (Meta +28.8%), Consumer Discretionary (Amazon +4.5%), Financials (CME Group +19.2%), and Real Estate, while not owning any Utilities, which was the worst sector in the Index, added 32bps. All of that was offset by poor performance of our holdings in Information Technology (IT) (-135bps), while not owning Energy stocks, the best performing sector in the Index (+17.2%), detracted an additional 45bps.

From a stock-specific perspective, the Fund ended the quarter with 13 contributors against 16 detractors. Microsoft, Meta, and NVIDIA contributed over 100bps each to absolute returns. We did not have any large detractors, although Taiwan Semiconductor Manufacturing Company (TSMC) and Lam Research cost us approximately 50bps each.

We believe AI will transform all industries and companies over time. For now, the biggest beneficiaries fall into three groups: companies involved in the AI buildout, including the semiconductor value chain and relevant industrial businesses; companies operating AI factories, such as cloud providers; and companies already using AI to create real-world value at scale in their core businesses. Our AI buildout investments include NVIDIA, Broadcom, TSMC, Monolithic Power Systems, Amphenol, Lam Research, and Quanta Services. Among cloud providers, we own the big three: Microsoft, Amazon, and Alphabet. Digital advertising illustrates the third group, as seen in the accelerating core businesses of Meta and Google, and Amazon’s advertising segment.

The correlations within “themes” continue to converge, especially anything related to AI. The market’s herd-like behavior is causing entire sectors to go in and out of favor seemingly overnight. Meta is looking into renting out some of its AI infrastructure? They must have excess capacity or see declining demand. Sell! SpaceX announces large AI hosting deals with ROI payback of less than 12 months at much higher prices than previously heard of – Buy! Open-source models gaining market share? Sell! Sell! Hyperscalers reporting accelerating growth at massive scale – cloud revenue run rate accelerated to 50% growth in the second quarter to $420 billion⁵ - Buy! Buy! Anthropic announces that third quarter revenues were $16.8 billion, up around 12 times from last year. This is a company that started selling anything less than three years ago. Think about this for a moment… The number disappointed investors because second quarter’s revenues of $11.5 billion were up about 14 times and the company’s revenue growth at “only” 12 times, has decelerated. Sell! Sell! Sell!

Sarcasm notwithstanding, in the early stages of disruptive change high volatility is neither unusual nor unjustified! During the steep parts of technological disruption S-curves small changes to key inputs, create large changes in actual/eventual outcomes. It is far more difficult to predict the ultimate winners and losers in the early stages when uncertainty is at its highest. The world is becoming more capital intensive and asset heavy. According to Coatue, AI data centers capex as a percent of GDP, has already exceeded the peak build out for Railroads in the early 1900s, Oil & Gas pipelines in the 70s and 80s, Fiber in the late 90s, and Shale gas in the 2010s. So, the stakes are high and rising. Like in the butterfly effect, because the range of outcomes is the widest during the early parts of a paradigm shift any change, no matter how small or seemingly immaterial, must be assessed by investors with a healthy dose of humility and a realization that the future is inherently uncertain.

We continue to encourage investors in the Fund to assess its performance over full market cycles. Since the inception of the Fund in December 2017, it has generated an annualized rate of return of 15.6% (net of all fees and expenses) – 105bps ahead of the Index. We believe that rolling monthly returns can be insightful in analyzing whether the process we employ works and whether it is repeatable. This analysis shows that on an annual basis, the Fund has outperformed the Index and the Morningstar Large Growth Category Average (the Peer Group) 55% and 62% of the time, respectively. But as the time horizon extends, so does the Fund’s winning percentage. On a three-year rolling basis, the Fund outperformed the Index and Peer Group 80% and 84% of the time, respectively, while on a five-year rolling basis, the Fund outperformed 93% and 100% of the time, respectively. Of course, past performance does not guarantee future results. It is the opposite story for our average competitor, especially over the long term. On a five-year rolling return basis, the Peer Group outperformed the Index an astounding… 2% of the time!

The performance data quoted represents past performance. Current performance may be lower or higher than the performance data quoted.
Unless otherwise noted, all performance calculations are based on the Institutional Shares.
Sources: Baron Capital, S&P Global Inc., and Morningstar Direct.

Software leader Microsoft Corporation contributed to performance with shares up 37.8%, recovering from their decline to start the year (shares are now up 7.4% year-to-date) driven by the broader recovery in software stocks during the quarter and buoyed by its strong quarterly results and the outlook management has provided. The company reported June quarter year-on-year revenue, operating income, and EPS growth of 18%, 18%, and 32% (+23% excluding one-offs), respectively. Growth was broad-based though Cloud in general and AI in particular were again the highlights – Microsoft Cloud, which now represents nearly two-thirds of total revenues, grew 27% year-on-year, and Azure growth accelerated to +43% year-on-year, as management was able to increase effective supply via efficiency gains and process improvements. Microsoft also reported strong growth in Foundry, its enterprise AI platform for building and running AI applications and agents, with a doubling of revenues year-on-year as it now has over 100,000 customers using the service. The company also reached 30 million co-pilot seats, with net seat additions doubling sequentially. Lastly, the company continues to see AI demand outpacing supply and is therefore rapidly adding AI capacity, having added 1GW in the last quarter and remaining on track to double capacity through 2027. We believe Microsoft remains well positioned over the medium to long term to benefit from the diffusion of AI across the economy as it provides a broad and deep offering across its infrastructure and application stack.

Shares of Meta Platforms, Inc., the owner of Facebook, Instagram, WhatsApp, and Threads, contributed during the quarter, rising 28.8%. Second quarter results showed the core ad engine is getting stronger: U.S. advertising revenue growth accelerated to 31% as new AI ranking and recommendation models lifted conversions, and Advantage+, its AI-driven ad suite, passed $75 billion in annual revenue run-rate. The bigger catalyst came in September with the launch of Muse, Meta's personal AI agent, which reached No. 1 on the U.S. App Store within days. At its conference, Meta Connect, the company introduced real-time voice, a Mac app with computer use, and commerce partners including Stripe, Shopify, PayPal, Walmart and Best Buy, so that Muse can complete purchases. This further strengthened Meta’s positioning and added new potential avenues for monetization, while also improving its contextual understanding of users, which should further advance Meta’s ability to match the right ad to the right user at the right time. Meta also brought Muse to its smart glasses and to Charm, a new handheld device. We believe current earnings understate Meta's earnings power as it invests ahead of revenue, and we retain strong conviction that its data, compute, distribution and founder leadership will make it a leader in consumer AI. We also believe AI will remain a tailwind for Meta’s core business, helping the company sustain a long duration of growth.

NVIDIA Corporation is a global leader in accelerated computing designing the semiconductors, software, networking, and systems used to build and deploy AI. Shares rose 14.3% during the quarter, gaining ground even amid a broader sell-off in semiconductor stocks. NVIDIA reported another excellent quarter with revenue growth accelerating to over 100% year-on-year at a massive scale of $96 billion, with the company guiding to 70% revenue growth for next fiscal year, far ahead of analyst expectations. Notably, management characterized this outlook as supply-constrained, with customers’ own forecasts pointing to a growth rate of approximately 100% year-on-year. Demand has also broadened, with customers beyond the largest hyperscalers, from sovereign AI and neoclouds to enterprises, now accounting for nearly half of data center revenue and growing faster than hyperscalers (though hyperscalers also continue to grow rapidly). In addition, each new platform captures more revenue per gigawatt as NVIDIA sells central processing units, networking, and inference systems alongside its graphics processing units and as each generation provides a higher throughput of tokens per MW of power. We retain conviction in NVIDIA as a core long-term holding. We continue to view its rapid innovation velocity, full-stack platform, extreme co-design capabilities, software, eco-system and supply chain management, as durable advantages that support continued growth in earnings power over time as AI adoption diffuses across the economy.

Lam Research Corporation is a leading global supplier of semiconductor wafer fabrication equipment, specializing in etch, deposition, and clean technologies used in the manufacturing of semiconductors. Shares of Lam declined 24.3% in the quarter along with the broader sell-off in shares of companies benefiting from the AI buildout as investors became increasingly concerned of a possible air pocket in the buildout. This, despite the company reporting strong quarterly results underlined by accelerating revenue and operating income growth to 30% and 41%, year-on-year, respectively, guiding for further acceleration into next quarter with revenue growth of over 50%. Management also reported having an “unprecedented long-term demand visibility” as a result of AI-related demand, which is driving new fab project announcements by Lam’s customers with capacity expansion on top of technology node transitions. We remain shareholders and believe that Lam is well positioned to benefit from several robust secular tailwinds – from the AI buildout which is driving broad demand for semiconductors, to the increasing complexity and verticalization of chips over time, which raises the number of etch and deposition steps, increasing the demand for Lam’s tools.

Taiwan Semiconductor Manufacturing Company Limited is the world's largest contract chipmaker and the leading manufacturer of advanced logic semiconductors used in modern AI accelerators. Shares corrected 4.3% during the quarter as a result of the broader correction in AI buildout stocks and as investors took profits after the stock’s strong first half performance. Additionally, investor focus shifted to near-term headwinds in the shape of increasing capex and a potential margin dilution from the steep ramp of TSMC’s 2-nanometer node. Despite these concerns, underlying business performance remained strong. Second quarter net income rose nearly 80% year-over-year on very strong gross margins, and management raised its full-year outlook to dollar revenue growth of slightly above 40%. We retain conviction in TSMC as a core long-term holding and view its near-monopoly positioning in leading-edge chip manufacturing, pricing power, deep and diverse customer relationships, ability to innovate rapidly as chip complexity continues to rise, and its economies of scale as durable competitive advantages that support a long duration of growth.

TransDigm Group Incorporated designs, manufactures, and supplies highly engineered aerospace components, systems, and subsystems used on nearly all commercial and military aircraft worldwide. Shares declined 18.7% as negative sentiment toward the aerospace aftermarket grew, with fuel prices remaining elevated due to the Iran war. We retain long-term conviction in the stock as the company remains a leader in an attractive industry, with secular growth tailwinds driven by expanding global access to travel, pricing power as aerospace after-market parts represent a small fraction of its customer’s cost basis and yet are critical, and robust long-term M&A opportunities in a fragmented industry. Moreover, TransDigm has de-rated to a below-peer multiple despite having what we believe is the industry’s strongest pricing engine, which should support above-peer growth at leading margins even if industry conditions soften. The company has also worked through recent company-specific destocking issues which should support volumes.

The portfolio is constructed on a bottom-up basis with the quality of ideas and conviction level, rather than benchmark composition and weights, determining the size of each individual investment. Sector weights tend to be an outcome of the stock selection process and are not meant to indicate a positive or a negative view.

As of September 30, 2026, our top 10 positions represented 64.5% of the Fund’s net assets, the top 20 represented 87.6%, and we exited the quarter with 29 investments.

IT and Financials represented 64.8% of the Fund, while Communication Services, Consumer Discretionary, Industrials, Real Estate, and Health Care represented another 33.1%, with the remaining 2.1% held in Consumer Staples (Costco) and cash.

During the third quarter, we took advantage of market volatility to add to our position in the leading energy-focused specialty contracting company Quanta Services, as well as to the etch and deposition focused semiconductor equipment manufacturer Lam Research.

We exited the stub position in Mobility Global, which was spun out during the quarter by S&P Global. We also slightly reduced eight existing investments: LPL Financial, Amazon, Alphabet, Apollo Global Management, Blackstone, Moody’s, Mastercard, and TSMC.

We took advantage of the stock price volatility to add to our investment in Quanta Services, Inc., a leading specialty contracting company that provides comprehensive engineering, procurement, construction and repair, and maintenance services for electric and gas utilities, renewable energy projects, telecom projects, and other types of infrastructure. While its stock has been volatile, the company continued reporting outstanding quarterly results. Q2 results saw the business accelerate meaningfully across all key metrics with management citing broad-based strength across its segments, service lines, and end markets. Management raised guidance significantly across the board and now expects 39% revenue, 44% adjusted EBITDA, and 55% adjusted EPS growth at the midpoints this year. The comments on the multi-year outlook were very bullish as well, with management saying that some of the biggest growth drivers, such as the high-voltage transmission and power generation buildouts, are almost entirely still ahead and point to continued stacking of growth for years to come. Despite the recent stock volatility, Quanta’s business continues to be set up for growth to accelerate compared to historical levels.

We believe that Quanta is well positioned to benefit from strong secular tailwinds due to increasing demand for energy-related infrastructure. While the growth of AI data centers and the resulting increase in load (electricity demand) is certainly a material part of the story, additional growth tailwinds include investments in modernization and grid resilience, electrification and the energy transition, industrial reshoring, and continued investment in communications infrastructure. The utility capex cycle is accelerating through at least the end of the decade, which should lead to strong and consistent growth for years to come.

During the quarter, we also added to our investment in Lam Research Corporation, a leading global supplier of semiconductor wafer fabrication equipment. While the stock has been volatile in the quarter, driven by the changing investor attitudes towards stocks that are benefiting from the AI buildout, our investment in Lam is driven by its long-term competitive positioning and the robust secular tailwinds we expect it to benefit from. These include the growing demand for semiconductors due to electrification trends in general and AI in particular; the accelerating demand for memory and storage as a result of agentic AI increasingly becoming viable for long-horizon tasks, which lead to both an expanding key-value-cache (requiring more memory and storage) and a greater demand for high bandwidth memory (as more internal tokens are generated for every external, customer-facing token); and the increasing complexity and verticalization of chips over time, which raises the number of etch and deposition steps, increasing the demand for Lam’s tools.

"The stock market is a device for transferring money from the impatient to the patient."
— Warren Buffett

“Successful investing is about managing risk, not avoiding it.” 
— Benjamin Graham

Baron Durable Advantage Fund takes a unique approach to GARP, or quality growth investing. Whereas many of our peers blend aggressive growth companies with value stocks, we focus exclusively on the middle – the highest quality durable compounders. This approach is expected to lag when either of the extremes drives the Index, so our struggles to keep pace in the fourth year of a bull market are not entirely surprising. This year, that challenge is compounded by the widest outperformance of value stocks over growth stocks, as measured by the Russell 1000 Value and Russell 1000 Growth Indexes, respectively, since 2022.

As we enter the last quarter of 2026, we find ourselves in an environment where headlines are dominated by macro and AI. Elections, geopolitics, price of oil, inflation, and interest rates will undoubtedly influence the direction of the market and the prices of the companies we own over the short term. However, as long-term investors, we remain purposefully indifferent to the macro prognostications that occupy so much of the financial media’s attention. Our focus remains squarely on identifying and investing in high quality, competitively advantaged, well-managed businesses over full market cycles. In other words, for the long term. It is different with respect to AI where, if we zoom out, the current debate can be viewed as a “Big Boom versus the Doom and Gloom.” No investor, regardless of time horizon, can be indifferent to this one. We are squarely and committedly on the side of the Big Boom! We believe we are in the early stages of one of the biggest technological and economic transformations we have witnessed in our careers and perhaps in all human history. We further believe the benefits will be tangible, visible, and enormous. But they will not come in a straight line, and investors will have to deal with significant volatility along the way. We do not know what is priced in or how the market would react to the events in the short term as they unfold. We do not know where the S&P 500 Index will trade a month or a quarter from now. However, we own a portfolio of great businesses that we expect will create and realize a lot of value from this transformation over long periods of time.

Each quarter, we break down the Fund’s performance into fundamentals and valuation multiples. Comparing the two can offer an insight into prospective stock returns. When fundamentals are revised higher, intrinsic values are expanding. That was the case once again, in the third quarter.

The Fund’s weighted average multiple declined 6.1% during the quarter and is down 17.4% year-to-date (excluding the recent IPO of Arxis). This implies that over 100% of the Fund’s gain in the quarter and year-to-date was attributable to fundamentals, which bodes well for prospective returns. Fundamentals also improved as weighted-average revenue expectations for 2026 rose 2.6% during the quarter and 11.2% year-to-date, while operating income expectations increased 3.8% and 14.5%, respectively.

Every day, we live and invest in an uncertain world. Well-known conditions and widely anticipated events, such as Federal Reserve rate changes, ongoing trade disputes, government shutdowns, and the unpredictable behavior of important politicians the world over, are shrugged off by the financial markets one day and seem to drive them up or down the next. We often find it difficult to know why market participants do what they do over the short term. The constant challenges we face are real and serious, with clearly uncertain outcomes. History would suggest that most will prove passing or manageable. The business of capital allocation (or investing) is the business of taking risk, managing the uncertainty, and taking advantage of the long-term opportunities that those risks and uncertainties create. We are confident that our process is the right one, and we believe that it will enable us to make good investment decisions over time.

Our goal is to invest in large-cap companies with, in our view, strong and durable competitive advantages, proven track records of successful capital allocation, high returns on invested capital, and high free-cash-flow generation, a significant portion of which is regularly returned to shareholders in the form of dividends or share repurchases. We intentionally avoid the lower quality businesses that may benefit from a temporary regulatory or macro tailwind, as well as the high-flying growth stocks that benefit from the narrative de jour. It is our belief that investing in great businesses at attractive valuations will enable us to earn excess risk-adjusted returns for our shareholders over the long term. It is the better path to wealth creation over full market cycles when one of your key goals is to minimize the probability of permanent loss of capital. We are optimistic about the prospects of the companies in which we are invested and continue to search for new ideas and investment opportunities.

We thank you for your continued trust and for being our partners on this journey.

Sincerely,