Baron WealthBuilder Fund | Q2 2024

Baron WealthBuilder Fund® (the Fund) declined 2.62% (Institutional Shares) in the second quarter of 2024, trailing its benchmarks, the S&P 500 Index (the Index), which rose 4.28%, and the MSCI ACWI Index (the Global Index), which appreciated 2.87% during the period. The Morningstar Aggressive Allocation Category Average increased 0.95%.*

The Fund has made little progress in the past three years, with an annualized return of (2.62)% compared to the Index’s annualized gain of 10.01%.

Following prior periods when Baron has underperformed, like 2014 to 2016, we have significantly outperformed soon afterwards. We hope this will again be the case although we cannot assure you that will be so.

Over the longer term, the Fund’s annualized return since its inception over six years ago is 12.11%. This return modestly trails the Index’s annualized gain of 13.55% and exceeds the Global Index’s annualized gain of 9.04%.

As we have stated previously, our consistent investment strategy has not changed since the Fund’s inception. And this investment strategy has remained consistent during the recent turbulent market. We believe Baron Funds has the best long-term track record of major mutual fund families. Since their respective inceptions, 16 of 19 Baron mutual funds, representing 96.6% of Baron Funds’ AUM, have outperformed their primary benchmarks and 12 Funds representing 94.1% of Baron Funds’ AUM, rank in the top 20% of their respective Morningstar categories. 10 Funds, representing 70.1% of Baron Funds’ AUM, rank in the top 10% of their categories. 8 Funds, representing 53.0% of Baron Funds’ AUM, rank in the top 5% of their categories, including the Fund, which is the top fund in its Morningstar category since its inception.

These impressive long-term stats beg the question: “How can the top-performing fund in its category still underperform its benchmark?” In our opinion, the Index has transformed from a diversified composition of companies across segments of the economy into a concentrated bet on a few highly correlated mega-cap technology growth businesses. The Magnificent Seven (Alphabet Inc., Amazon.com, Inc., Apple Inc., Meta Platforms, Inc., Microsoft Corporation, NVIDIA Corporation, and Tesla, Inc.) accounted for 30.4% of the Index during the second quarter, contributing 4.96% out of the 4.28% returns. In other words, the remaining positions in the S&P 500 Index detracted 0.67%. Our diversified Fund is underweight six out of seven of these positions. The impact of the Magnificent Seven was even more pronounced in some other commonly cited market indices, like the Russell 3000 Growth and NASDAQ Composite Indexes.

Since the markets peaked in November 2021, stocks of small and mid-cap growth businesses have been challenged. High inflation, increasing interest rates, and lower consumer and corporate confidence have disproportionately impacted these businesses.

Our higher growth and larger-cap portfolios had the greatest appreciation in the quarter. They include Baron Opportunity, Global Advantage, Partners, Fifth Avenue Growth, and Durable Advantage Funds. Returns were led by NVIDIA, Tesla, and Space Exploration Technologies Corp. (SpaceX). All three companies rose double digits in the period. As discussed in the Fund’s prior shareholder letter, the fears about Tesla’s products were misplaced. Instead of the company being exclusively dependent on limited vehicle models and software advancement, the company announced it will more rapidly introduce products that appeal to a wider audience. It also demonstrated that its price reductions were the result of efficiencies not to spur demand. Margins exceeded expectations. And the company’s integration of its hardware with proprietary AI software should facilitate full self-driving capabilities and subsequent new revenue streams. This integration of hardware with software creates a dynamic growth company as it more fully explores its potential with Optimus, humanoid robotics. The combination of these catalysts resulted in Tesla’s stock increasing meaningfully and rapidly in the second half of the quarter. This stock price momentum has continued into the third quarter.

Our small- and mid-cap portfolios had weaker performance in the period. They include Baron Discovery, Small Cap, Growth, and Asset Funds. The companies are being penalized by a perceived challenging macroeconomic backdrop. Higher interest rates and cautious consumers impacted property valuations and travel at many of our real estate-related holdings, like CoStar Group, Inc. and Vail Resorts, Inc. Attractive valuations for financial buyers as well as limited new supply of competing properties gives us confidence in a recovery for this group. Corporate customers of financial technology companies, like FactSet Research Systems Inc. and MSCI Inc., remained cautious. Prolonged sales cycles impacted growth for both companies. We believe this phenomenon is temporary as their products are increasingly critical in enabling clients expanding into new categories. Small-cap businesses like SentinelOne, Inc. and Couchbase, Inc. had shortfalls in earnings that disproportionately impacted their stocks. Higher acquisition integration expenses and lower new client sales were extrapolated. We believe these are temporary issues and the competitive advantages of these smaller businesses remain robust.

We do not believe the last three years’ performance results are indicative of the quality composition of this portfolio. Over the prior three years, the portfolio’s holdings have had sales growth of 18.5%. That compares to only 15.4% for the S&P 500 Index. The gap is even greater over the past year where the Fund’s sales growth has been 13.9% compared to the Index’s 6.8%. Yet, its earnings per share growth is more in line with the Index’s for the period. These portfolio companies continue to penalize short-term earnings for longer-term opportunities. Once these investments are realized or stock market sentiment changes, we believe the Fund will perform quite well, as we are starting to see “green shoots” signs of this absolute and relative performance. The strong results in the second half of the second quarter have continued into the first few weeks of July.

We encourage you to read the various Baron Funds’ quarterly letters to gain a deeper understanding of the underlying holdings and strategies that constitute the Fund.

*Not annualized.

†Performance is calculated from the time the Fund was added to Baron WealthBuilder Fund: Baron Durable Advantage Fund – 3/13/2018; Baron Global Advantage Fund – 1/9/2018; Baron FinTech Fund – 2/27/2020; Baron Health Care Fund – 10/18/2018; and Baron Real Estate Income Fund – 5/17/2021.

Performance data quoted represents past performance. Past performance is no guarantee of future results. The indexes are unmanaged. The index performance is not Fund performance; one cannot invest directly into an index.

The Fund is a compilation of our Baron Funds and provides broad equity exposure. All underlying Baron Funds follow a consistent investment philosophy and process. We do not try to mimic the indexes, and we do not alter our strategy to coincide with short-term macro events that we regard as unpredictable. We remain focused on underlying business fundamentals.

We believe small- and mid-cap growth stocks offer attractive return potential relative to their risk over the long term. Small- and mid-cap businesses represent 65.4% of the Fund (compared to only 18.7% for the Index). While our small- and mid-cap growth investments have been successful over our Firm’s 42-year history, these styles are occasionally out of favor. Today’s environment is one of those times. Large-cap growth companies have outperformed small-cap growth companies this year and in many instances over the last decade. Since the Fund’s inception over 6 years ago, the 1-year rolling monthly returns of the Russell 1000 Growth Index have outperformed the Russell 2000 Growth Index 77% of the time including 5 out of the past 6 calendar years.

Rather than only examining the Fund’s performance over a quarter or a year, we believe it is equally important to understand how the Fund has performed over the course of an economic cycle. The COVID-19 Pandemic (COVID) and subsequent macro-induced market rotation has been very difficult for small- and mid-sized growth companies. Investors have favored larger-cap, value-oriented businesses that are deemed safer during a time of uncertainty. We believe this offers a great opportunity for long-term investors to invest in small- and mid-cap growth businesses at attractive prices. Over the three years of COVID ended 12/31/2022, the Russell 2000 Growth Index, a small-cap growth index, gained only 1.96% on a cumulative basis. The Russell Midcap Growth Index fared better with a cumulative 3-year return of 12.00%. With that backdrop, the Fund performed better and appreciated 28.11%. We believe protecting and growing clients’ assets during this challenging period positions long-term investors well for meaningful appreciation once the macro landscape changes. Table III provides a more complete look at how the Fund and various indexes performed during COVID and its aftermath.

Volatility has remained high, but we are hopeful that interest rate increases, policy factors, and COVID-19 hangovers are ending. Global conflict has increased and geopolitics remain uncertain, but growth companies have begun to outperform value. Perceived safer large caps have continued to perform better than smaller companies. So far, we are optimistic that companies will again be valued on their fundamentals rather than on macroeconomic concerns. We have started to see the performance of some individual securities diverge, and we believe this divergence should favor growth investors. Given our weightings, the Fund’s performance has trailed the large-cap Benchmark since the start of this cycle. However, the Fund’s return has continued to meaningfully exceed small-cap growth indexes.

Performance data quoted represents past performance. Past performance is no guarantee of future results. The indexes are unmanaged. Index performance is not Fund performance. Investors cannot invest directly in an index.

Source: FactSet SPAR. Except for Standard Deviation and Sharpe Ratio, the performance based characteristics above were calculated relative to the S&P 500 Index.

Thank you for joining us as fellow shareholders in the Fund. We continue to work hard to justify your confidence and trust in our stewardship of your hard-earned savings. We remain dedicated to providing you with the information we would like to have if our roles were reversed. We hope this letter enables you to make an informed decision about whether this Fund remains an appropriate investment.

Respectfully,