Baron Focused Growth Fund | Q1 2025

One of my favorite executive quotes is from Chris Nassetta, the CEO of Hilton Hotels. When asked by an analyst on one of his quarterly earnings conference calls why he is always so optimistic, he replied “No one ever got rich by being a pessimist.” I agree with that and always try to look on the bright side of things.

Challenges and uncertainty create opportunity. Some of the best businesses in the world were founded during periods of uncertainty and distress. These include Airbnb, Inc. (current holding), Uber and Venmo demonstrating that economic downturns and/or periods of uncertainty can also be great times for innovation and entrepreneurship.

We see increased innovation and entrepreneurship in many of the companies we are speaking to today with executives continuing to invest in their businesses for further growth. While they are taking their time to think through what exactly tariffs mean for their businesses and how they are going to react, we believe this is prudent and think our portfolio companies should continue to grow even during a period of higher costs and potential economic uncertainty.

We find the current portfolio unusually attractive after the recent market declines and believe now is the right time to allocate capital for five reasons.

1. This is not the first time the executives of our portfolio companies have had to deal with uncertainty and challenges as many have been leading their companies for years and have had to deal with crisis before including COVID, the Great Financial Crisis, and numerous periods of uncertainty. They successfully navigated their companies then and came through it stronger and we believe they should be able to do the same now.
2. Two-thirds of the portfolio are led by founders whose interests are significantly aligned with ours, giving us further confidence in the investments and decisions they make.
3. While periods of uncertainty can be distressing for investors, we believe our companies should be able to better weather the storm and come out stronger as 70% of the portfolio has some form of recurring revenue adding stability to our portfolio companies’ earnings and cash flow.
4. Our portfolio company balance sheets are stronger today than they have been historically with 75% of the portfolio having financial leverage below company targeted levels, giving them added liquidity during this uncertain time.
5. Finally, while the almost 20% decline in the S&P 500 Index from peak levels reached in February can be unnerving to investors, we are finding attractive opportunities in both existing and new names and are adding them to the portfolio. We believe the risk/reward in many investments skews positive.

As far as the portfolio goes, it was a rough start to the year. Baron Focused Growth Fund® (the Fund) declined 7.95% (Institutional Shares) in the first quarter compared to the Russell 2500 Growth Index (the Benchmark), which lost 10.80%. The Fund was weak in the quarter as our Real/Irreplaceable Assets investments that comprise 18.6% of the Fund’s net assets declined as many have a cyclical element to them and investors were concerned about a potential recession from the implementation of President Trump’s tariffs. This combined with lowered expectations for the Federal Reserve to continue to lower interest rates over the next year given the inflationary impact of tariffs led to additional declines across the portfolio.

However, despite the tough stock price performance in the quarter, our portfolio companies continue to generate strong financial results. While there continues to be concerns of a slowdown in consumer spending and capital investments due to higher interest rates, inflation, and Trump’s tariff policies, the executives of our businesses are navigating it well. Their businesses have yet to experience changes in customer demographics or spending habits. While inflation has impacted company operating expenses, including labor, insurance and utilities, most of our portfolio companies have been able to offset these cost increases with higher prices without impacting demand.

We believe the same should be the case with the tariffs and companies should be able to either partially or fully offset the higher cost of goods sold through an increase in prices. This should lead to stable margins and cash flow for businesses held in the Fund, which when combined with some of the strongest balance sheets in their respective industries, should continue to create a less volatile portfolio with strong risk-adjusted returns for our shareholders.

We continue to believe these businesses have strong competitive advantages with underpenetrated growth opportunities ahead of them and robust balance sheets to fund their growth. We believe valuations are attractive at current levels and continue to see an acceleration in insider buying activity, a key pillar that gives us stronger confidence in our investment theses for these companies and expected stock returns over time.

In the near term, we continue to believe that inflation will remain at or below the historic 3% to 4% annualized levels and interest rates will approximate the rate of inflation. This has been the case since World War II. We believe that is a favorable environment for businesses that are growing significantly faster than the rate of inflation and the 7% nominal annualized growth rate of our economy.

The Fund has continued to generate strong returns with less than market risk. Over the trailing 3, 5, and 10 years, the Fund has captured 89%, 123%, and 113%, respectively, of the upside when the market increased. When markets declined, the Fund lost less with 73%, 76%, and 81% downside capture, respectively. As a result, the Fund’s Sharpe ratio, a measure of risk-adjusted return, was significantly higher than the Benchmark for each of these periods.

We believe these strong returns with downside protection are due to our research-based investment process. Our research enables us to identify and understand businesses’ competitive advantages, differentiation, long-term growth prospects, and exceptional people; and it allows us to invest in these businesses for the long term at what we believe are attractive valuations relative to what these businesses can become. As a result, as shown in the table below, the Fund has outperformed its Benchmark for all respective periods including since its inception on May 31, 1996. Since its inception as a private partnership almost 29 years ago, the Fund has increased 13.43% annually. This compares to a 7.73% annualized return for the Benchmark and a 9.52% annualized return for the Russell 3000 Index that measures the performance of the largest 3,000 U.S. companies.

Performance was led by our Core Growth investments, the majority of which are software and data companies that are more immune to President Trump’s tariff policies. Included in this category of investments are Guidewire Software, Inc. (as seen below in the list of top contributors), CoStar Group, Inc., and Verisk Analytics, Inc.

Real estate data and marketing platform CoStar increased 10.6% in the quarter and helped performance by 33 bps. CoStar’s share price increase was due to an acceleration in daily active users on its Homes.com platform as its marketing investments begin to generate returns. Its monthly active users have already reached 110 million and compares to Zillow’s 204 million users. This is very positive as CoStar is demonstrating that it can drive meaningful traffic growth to its platform. We believe the acceleration in investment over the past two years is helping drive organic growth on its Homes.com platform and expand the company’s addressable market. We believe investors are currently attributing negative equity value to this. Over the next five years, we believe CoStar’s residential investment could add at least $1 billion to annualized revenue at a significantly accretive margin. This would result in a 33% increase in today’s $3 billion in revenue and an approximate 50% increase in EBITDA. Longer term, we believe this investment opportunity is several multiples of $1 billion of revenue. CoStar is seeing a rebound in net new bookings in its commercial real estate businesses and strength in its retention rates, despite implementing price increases across its suite of products. It continues to have a strong balance sheet, with $5 billion of cash and just $1 billion of debt. We are not concerned with its residential investment and believe it should generate strong returns over time.

Our Financials investments were also relatively strong in the quarter, beating the Benchmark as this category of investments was more defensive in nature given these companies generate more recurring revenue with high retention rates that are also more immune to President Trump’s tariff policies. These companies included Arch Capital Group Ltd., FactSet Research Systems Inc., and MSCI Inc.

Shares of diversified property, casualty, and mortgage insurer Arch increased 4.1% and helped performance by 18 bps in the quarter. The company continued to increase premiums written while raising prices. This strong pricing is resulting in robust returns on investments with increased earnings and cash flow that the company continues to use to repurchase its shares. We believe that Arch will continue to generate mid-teens returns on capital and that the company’s valuation remains attractive. Its stock is trading at a low double-digit multiple of earnings, which are growing at a mid-teens annual growth rate.

This was offset by declines in our Real/Irreplaceable Assets investments, which are more cyclical in nature and could be impacted by a U.S. recession if we enter one. These included investments in Las Vegas Sands Corporation, Hyatt Hotels Corporation (as indicated in top detractors table below), and Vail Resorts, Inc.

Las Vegas Sands shares underperformed in the first quarter, declining 22.6% and hurting performance by 41 bps as investors were concerned with growth in the Macau market given the expected deceleration in the Chinese economy due to President Trump’s tariffs. This created uncertainty about the potential return the company would see from its recent almost $2 billion investment in the market. However, while this is a concern and something to monitor, we believe the company is still experiencing some disruption from its projects, but this is coming to an end starting in May when the work is expected to be completed. Once finished, we believe the company should capture additional market share and generate a respectable return on capital over the following year. The company is still generating strong cash flow and has the best balance sheet in the gaming industry with leverage of just 2x. This is giving the company additional liquidity to increase its capital returns to shareholders while they wait for the EBITDA returns. The company is currently buying back $2 billion of its stock a year, 8% of the company, while paying out a well-covered and respectable 3% yielding dividend. The stock is currently trading at a 6 multiple point discount to its historical valuation which we believe should narrow as investors begin to see the return from its recent capital projects and the Macau market reaccelerates again.

Shares of global ski resort operator Vail declined 13.4% in the first quarter and hurt performance by 51 bps. This was due to concerns that a potential recession would result in a slowdown in visitation and spending levels. While we are closely monitoring economic conditions, Vail has not experienced significant declines in visitation or spending levels at its resorts. Favorable late-season ski conditions produced an uptick in destination skiers, who tend to stay longer and spend more. In addition, a base of recurring revenue from season pass sales provides visibility into earnings and cash flow. We expect to see EBITDA growth this year with enough free cash flow to fund Vail’s well-covered 6% yielding dividend. A strong balance sheet and high-end customer base should provide resiliency in the event of an economic slowdown. Vail continues to have a captive high-end consumer who is willing to pay for its services even if it means paying a higher price. The company continues to have significant pricing power, which, when combined with a new two-year, $100 million cost-cutting plan from increased synergies within the business, should lead to strong growth over the coming years. The CFO recently bought stock personally at higher than current stock price levels, giving us further confidence in our view that the stock is attractively valued.

Sources: Baron Capital, FTSE Russell, and FactSet PA.
* Individual weights may not sum to displayed total due to rounding.
** Represents the blended return of all share classes of the Fund.

X.AI Holdings Corp. (xAI) is developing an AI model "to understand the true nature of the universe." In a short period since its inception, xAI launched its AI model and product, including the third version of the model, Grok 3, which demonstrated top scores in evaluation tests, ahead of other industry-leading AI models. The company also opened the Colossus data center, operating more than 100,000 Graphical Processing Units and considered at the time to be the largest coherent training center in the world. Grok 3 was the first model trained on xAI's Colossus, leveraging more than 10 times the compute used to train Grok 2. Most recently, xAI acquired X, formerly Twitter. The acquisition is expected to improve alignment of corporate objectives, enhance resource allocation, and integrate data, compute, and products. In addition, it provides xAI access to X’s vast, real-time, multimodal data generated by 600 million users worldwide. We value the stock based on recent share transactions, including the recently announced merger.

Spotify Technology S.A. is a leading global digital music service offering on-demand audio streaming through paid premium subscriptions and an ad-supported model. Shares were up, once again attributable to another impressive beat in gross margins and a healthy increase in operating margins. Spotify has been on a path to structurally increase gross margins, aided by its high-margin artist promotions marketplace, growing contribution from podcasts, and structural investments in advertising. Users continued to grow at a double-digit pace despite price hikes. Spotify also continued to innovate on the product side, calling 2025 the "year of accelerated execution," with priorities in improving advertising, expanding into video, developing a Super Premium tier, and taking more market share. We view Spotify as a long-term winner in music streaming with potential to reach 1 billion-plus monthly active users.

Shares of property and casualty (P&C) insurance software vendor Guidewire Software, Inc. contributed to performance in the quarter. After a multi-year period, we believe Guidewire's cloud transition is substantially over, and cloud will be the sole path forward, with annual recurring revenue (ARR) benefiting from new customer wins and migrations of the existing customer base to InsuranceSuite Cloud. We also expect the company to shift R&D resources to product development from infrastructure investment, which will help drive cross-sales into its sticky installed base and potentially accelerate ARR over time. We are also encouraged by Guidewire’s subscription-based gross margin expansion, which improved by more than 1,000 basis points in its most recently reported quarter. We believe Guidewire will be the critical software vendor for the global P&C insurance industry, capturing 30% to 50% of its $15 billion to $30 billion total addressable market and generating margins above 40%.

Tesla, Inc. manufactures electric vehicles (EVs), solar products, and energy storage solutions alongside the development of advanced real-world AI technologies. Shares fell due to declining analyst expectations for auto delivery volume and margins in 2025 as a result of 1) a refresh of the Model Y, its highest volume vehicle and the world's best selling car in 2024; 2) Elon Musk’s controversial role in the Trump administration; and 3) regulatory changes that could pose potential operational challenges. Despite these headwinds, we remain confident in Tesla’s long-term growth, underpinned by secular trends in EVs and energy storage adoption, a compelling product line, its leading cost structure, and cutting-edge technology. A Model Y refresh alongside the debut of new mass-market models should boost demand. Over time, we expect the political pressure to fade, while Tesla’s AI ambitions—a robotaxi service launching this year and a fast-growing humanoid program—hold the promise of transforming its growth story.

Shares of global hotelier Hyatt Hotels Corporation detracted as Trump's tariff policies generated heightened uncertainty around the macroeconomic environment. While the volatility during the first quarter is a concern, we believe it will be short term. Business fundamentals were strong, with solid forward bookings numbers as the business transient segment continued its post-pandemic recovery and the group business segment paced up by mid-single-digits. We expect double-digit EBITDA growth in 2025. The company has a strong balance sheet. The planned acquisition of Playa Hotels should be accretive to earnings, especially after Hyatt sells the underlying real estate properties. Once the sale is complete, over 90% of revenue will be fee-based, which should help close Hyatt's multiple discount to peers.

Shares of Krispy Kreme, Inc. traded down following softer-than-expected quarterly earnings as a result of a cybersecurity incident that disrupted its online ordering system, a decline in U.S. retail sales, and weak international EBITDA margins due to disappointing performance in the U.K. 2025 guidance also missed expectations. We remain investors. Management is taking a conservative approach as it continues the national rollout with McDonald's, which will significantly increase Krispy Kreme's points of distribution and provide additional consumer awareness for the brand throughout the U.S.

We remain steadfast in our commitment to long-term investing in competitively advantaged growth businesses. We believe these investments are an effective way to protect and increase the purchasing power of your savings. Wars, pandemics, financial panics, higher-than-normal inflation, and interest rate increases can cause significant market declines, but when these negative influences abate, interest rates stabilize and decline, stock prices in the past have increased substantially. We believe this will happen again, although the timing remains uncertain.

As of March 31, 2025, the Fund owned 28 investments. The Fund’s average portfolio turnover for the past three years was 8.8%. This means the Fund has an average holding period for its investments of over 11 years. This compares to the average mid-cap growth mutual fund that typically turns over its entire portfolio every 16 months. From a quality standpoint, the Fund’s investments have generally stronger sales growth; higher EBITDA, operating, and free-cash-flow margins; and stronger returns on invested capital than the Benchmark. We believe these metrics help limit risk in this focused portfolio and are why the portfolio has generated strong risk-adjusted returns over time.

While focused, the Fund is diversified by sector. The Fund’s weightings are significantly different than those of the Benchmark. For example, the Fund is heavily weighted to Consumer Discretionary businesses with 35.2% of net assets in this sector versus 13.9% for the Benchmark. The Fund has no exposure to Energy, Materials, or Utilities. We believe companies in these sectors can be cyclical, linked to commodity prices, and/or have little if any competitive advantage. This compares to the Benchmark that had 8.4% cumulative exposure to these sectors. The Fund also has lower exposure to Health Care stocks at 4.4% versus 21.6% for the Benchmark. The performance of many stocks in the Health Care sector can change quickly due to exogenous events or binary outcomes (e.g., biotechnology and pharmaceuticals). As a result, we do not invest a large amount in these stocks in this focused portfolio. In Health Care, we invest in competitively advantaged companies that are leaders in their industries such as IDEXX Laboratories, Inc., the leading provider of diagnostics to the veterinary industry and who is benefiting from the increase in pets that people acquired during the COVID pandemic, especially as these pets age. The Fund is further diversified by investments in businesses at different stages of growth and development.

Disruptive Growth firms accounted for 40.8% of the Fund’s net assets. On current metrics, these businesses may appear expensive; however, we think they will continue to grow significantly and, if we are correct, they have the potential to generate exceptional returns over time. Examples of these companies include electric vehicle leader Tesla, Inc., commercial satellite and launch company Space Exploration Technologies Corp., and audio streaming service provider Spotify Technology S.A. These companies all have large underpenetrated addressable markets, are well financed with significant equity stakes by these founder-led companies, giving us further conviction in our investment.

Core Growth investments, steady growers that continually invest in their businesses for growth and return excess free-cash-flow to shareholders, represented 21.9% of net assets. An example would be CoStar Group, Inc., a marketing and data analytics provider to the real estate industry. The company continues to add new services in commercial and residential real estate, which have grown its addressable market and enhanced services for its clients. This has improved client retention and cash flow. CoStar continues to invest its cash flow in its business to accelerate growth, which we believe should generate strong returns over time.

Companies that own what we believe are Real/Irreplaceable Assets represented 18.6% of net assets. Vail Resorts, Inc., owner of the premier ski resort portfolio in the world, Hyatt Hotels Corporation, upscale lodging brand, and Red Rock Resorts, Inc., the largest player in the Las Vegas locals casino gaming market, are examples of companies we believe possess meaningful brand equity and barriers to entry that equate to pricing power.

Financials investments accounted for 15.9% of the Fund’s net assets. These businesses generate strong recurring earnings through subscriptions and premiums that generate highly predictable earnings and cash flow. These businesses use cash flows to continue to invest in new products and services, while returning capital to shareholders through share buybacks and dividends. These companies include Arch Capital Group Ltd., FactSet Research Systems Inc., and MSCI Inc.

As of March 31, 2025, the Fund’s top 10 holdings represented 56.7% of net assets. Many of these investments have been successful and were purchased when they were much smaller businesses. We believe they continue to offer significant appreciation potential, although we cannot guarantee that will be the case.

The top five positions in the portfolio, Space Exploration Technologies Corp., Tesla, Inc., Spotify Technology S.A., Guidewire Software, Inc., and On Holding AG all have, in our view, significant competitive advantages due to irreplaceable assets, strong brand awareness, technologically superior industry expertise, or exclusive data that is integral to their operations. We think these businesses cannot be easily duplicated and have large market opportunities to penetrate further, which enhances their potential for superior earnings growth and returns over time.

Thank you for investing in Baron Focused Growth Fund. We continue to work hard to justify your confidence and trust in our stewardship of your family’s hard-earned savings. We also continue to try to provide you with information we would like to have if our roles were reversed. This is so you can make an informed judgment about whether the Fund remains an appropriate investment for your family.

Respectfully,