Baron WealthBuilder Fund | Q3 2024

Baron WealthBuilder Fund® (the Fund) had very good results over the prior quarter. In the past three months, the Fund gained 10.17% (Institutional Shares). This result significantly exceeded its large-cap dominated benchmark, the S&P 500 Index (the Index), and the global MSCI ACWI Index (the Global Index). Those two indexes gained 5.89% and 6.61%, respectively. The Morningstar Aggressive Allocation Category Average (the Peer Group) increased 6.42%.*

The Fund has gained 12.51% since the start of 2024. While this return is respectable in most nine-month periods, it does meaningfully trail both the Index and the Global Index’s returns. Those two Indexes have gained 22.08% and 18.66%, respectively.

The Fund’s performance has stagnated over the prior three years, with an annual return of only 0.39%. Over the longer term, however, the Fund’s absolute performance is respectable. The Fund’s annualized return since its inception nearly seven years ago was 13.25%. However, this return trails the Index’s gain of 13.98%, but exceeds the Global Index’s increase of only 9.72%. The Fund remains the top fund in its Peer Group since inception.

As we have stated previously, our unique and consistent investment strategy has not changed since Baron WealthBuilder Fund’s or Baron Funds’ inception. And this investment strategy has remained consistent during the recent difficult market. We believe Baron Funds has the best long term track record out of major mutual fund families. Since their inceptions, 16 of 19 Baron mutual funds, representing 96.7% of Baron Funds’ AUM, have outperformed their primary benchmarks. And they compare favorably amongst their peer categories. Thirteen Funds, representing 95.6% of Baron Funds’ AUM, rank in the top 20% of their respective Morningstar categories. Eleven Funds, representing 82.3% of Baron Funds’ AUM, rank in the top 10% of their categories. This group includes Baron WealthBuilder Fund, which is the top fund in its Peer Group since its inception. We believe combining these Baron Funds into a single product should create a diversified growth equity portfolio that can produce impressive long-term results.

While we are pleased with Baron Funds’ historical results, we are disappointed, although not alarmed, by the recent 3-year performance. The low turnover strategy implemented by Baron Funds has previously resulted in similar stretches. However, we have not only endured analogous periods throughout many of the Baron Funds’ histories but have typically emerged with strong absolute and relative performance in subsequent years. Although there is no guarantee of future success, we believe this trend will continue.

The previous nearly two years have been exceedingly difficult for our style of investing as long-term owners of quality growth businesses. The Fund holds a balanced portfolio of quality growth businesses across market caps, sectors, and geographies. The U.S. economy has been challenged since the start of 2023. There have been high interest rates, high inflation, global unrest, and military conflicts. That macro backdrop has been harsh for the businesses held in the underlying Baron Funds. Customers at many service businesses had retreated causing revenue growth to moderate.

Suppliers had increased prices causing margins to be pressured. Higher interest rates have resulted in increased financing costs and raised the discount on future earnings. Investors gravitated towards mega-cap companies with AI opportunities. These businesses are largely underweighted in the Fund compared to the market cap weighted Index.

We believe these phenomena are temporary and we are beginning to see signs of a more typical macro environment that is favorable to our investment style. Inflation appears to have moderated. Interest rates were cut by 50 bps, and the Federal Reserve Chair has indicated steady cuts will persist. The soft landing the government is attempting to orchestrate may just occur.

As a result, we believe that company fundamentals and opportunities will again drive stock prices rather than macro concerns and a singular mega trend. In the current period, we had large gains from a diverse set of underlying Baron Funds. Our small-cap portfolios, led by Baron Growth and Discovery Funds, had some of our strongest returns. This small-cap portfolio category is the largest segment and accounts for 32.1% of net assets. Our more concentrated portfolios, like Baron Partners and Focused Growth Funds, also performed well as company specific results led to outsized gains. And the Fund’s largest returns came from its real estate portfolios, Baron Real Estate and Real Estate Income Funds. Lower rates should spur increased lease activity, deals, and valuations.

The Fund’s largest underlying holding, Tesla, Inc., appreciated 32% in the quarter. Investors are again looking at the company’s potential rather than the near-term impact of the current macro environment. Investors have become comfortable that the previous periods’ vehicle delivery shortfalls were the result of affordability (financing related) rather than desirability. Purchases improved in the quarter as the Chinese economy improved. Investors have increased confidence that new model introductions next year will again spur a meaningful increase in units. We do not believe other traditional original equipment manufacturers (that have historically made only internal combustion engines) can compete with the functionality and price of the upcoming models. Additionally, the dynamic company has remarkably improved on new services and products related to autonomous driving, robotics, and energy storage. We remain very optimistic about the future for Tesla.

But other financial and steady growth businesses like Guidewire Software, Inc., Gartner, Inc., Arch Capital Group Ltd., MSCI Inc., and Kinsale Capital Group, Inc. are large underlying holdings in the Fund and each appreciated double digits in the period. These five underlying positions combined for approximately 15% weighting of the Fund.

The three underlying companies that detracted the most from performance were The Charles Schwab Corporation, DexCom, Inc., and CrowdStrike Holdings, Inc. Schwab has an ending weight of 0.9% while DexCom and CrowdStrike have a combined weight of only 0.3%. Schwab had been too aggressive during the COVID-19 pandemic’s (COVID) extraordinarily low-rate environment. Believing the rapid increase in client cash during the pandemic would be retained, the company purchased long-dated bonds. The subsequent swift rise in rates and clients seeking higher yielding alternatives caused Schwab to increase its short-term borrowings to meet client needs. Net interest margin was pressured. Today, the company is unwinding these borrowings. It has been a slower process than anticipated with clients having lower idle cash levels. But organic asset growth has continued, and we believe the net interest margin will eventually rebound to more normalized levels. The timing, however, may be slightly extended beyond previously stated expectations. CrowdStrike, a leading cybersecurity software company, declined because of a glitch related to the software’s configuration update for Microsoft systems. While the issue may pressure near-term results, we believe the company can maintain its premium positioning.

We encourage you to read the various Baron Funds’ quarterly letters to gain a deeper understanding of the underlying holdings and strategies that comprise Baron WealthBuilder 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 64.7% of the Fund (compared to only 18.8% 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. The past few years have been one of these environments. 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 nearly 7 years ago the 1-year rolling monthly returns of the Russell 1000 Growth Index have outperformed the Russell 2000 Growth Index 79% 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. 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. Markets first peaked in late February 2020 before rapidly dropping as the economy braced for COVID. It recovered quickly followed by another sizable drop based on macroeconomic factors. 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 the pandemic and its aftermath.

We do not yet know if the challenges caused by COVID will persist. Volatility has remained high, but we are hopeful that interest rate increases, policy factors, and COVID hangovers are ending. Global conflict has increased and geopolitics remains uncertain. But growth companies have recently begun to outperform value. 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. This divergence of returns, we believe, 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. The 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.

* Rounds to less than 0.1%.

Thank you for joining us as fellow shareholders in Baron WealthBuilder Fund. We continue to work hard to justify your confidence and trust in our stewardship of your hard-earned savings. We remain dedicated to giving you the information we would want 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,

Baron Funds (Institutional Shares) and Benchmark Performance 9/30/2024