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    Baron Health Care Fund: Latest Insights and Commentary

    Review & Outlook

    As of 12/31/2024

    Health care stocks underperformed the broader market for the second year in a row. The major event for health care in the fourth quarter was President-elect Trump’s nomination of Robert F. Kennedy Jr. to head Health and Human Services, which sparked investor fears about disruptive health care policies, leading to a sharp decline in health care stocks in the last two months of 2024.

    We remain substantially underweight mega-cap pharmaceuticals and biotechnology, despite low valuations, due to patent cliffs and pricing pressure. We think the Trump administration could try to use the IRA Medicare drug pricing negotiation program to narrow the price differential between the U.S. and Europe. This was a goal of the first Trump administration, and now there is a mechanism to implement it.

    Regarding non-mega-cap biotechnology companies, we think the new Republican administration and new FTC leadership could help accelerate M&A activity as large pharmaceuticals look to replenish their pipelines as key products lose patent protection.

    Business trends for certain medical device companies remain strong, driven by new product cycles and healthy procedure volumes. We think these companies face relatively low risk from potential health care policy changes.

    After two years of nominal growth, we expect growth to accelerate in the life sciences tools industry. Customer inventory destocking is largely over, biotechnology funding was up around 40% in 2024, innovation in biotechnology continues to advance, and demand in China has stabilized. While new concerns have arisen regarding the NIH budget, tariffs, and foreign currency headwinds, we think the long-term outlook is positive.

    The outlook for managed care companies is mixed. Near term, these companies face elevated cost trends and insufficient rate increases in the Medicare Advantage business, a mismatch between rates and acuity in the Medicaid business, and potential policy changes. Long term, we believe managed care companies will remain embedded in the U.S. health care system and will continue to grow.

    Policy uncertainty has weighed on hospital stocks. Enhanced Affordable Care Act subsidies are set to expire at the end of 2025. Unless they are renewed, roughly four million people would become uninsured, pressuring the earnings of hospitals serving these people. Potential Medicaid reform is another risk for hospitals getting state-directed payments/supplemental payments over the past few years. Given these risks, we have reduced our hospital positions.

    Despite near-term policy uncertainty, we think fundamentals are stabilizing, and our long-term outlook for Health Care remains bullish. Innovation in the sector is robust. Advances in science and technology are leading to new ways to diagnose, monitor, and treat diseases in more cost-effective ways. Favorable demographic trends should drive increased demand for quality health care. We continue to follow our process for identifying investment opportunities and creating a portfolio of competitively advantaged growth companies with strong management teams.

    Top Contributors/Detractors to Performance

    As of 12/31/2024

    CONTRIBUTORS

    • Argenx SE is a biotechnology company best known for developing Vyvgart, the leading FcRn inhibitor for the treatment of autoimmune conditions. Shares increased as Vyvgart continued its launch in generalized myasthenia gravis and got off to a strong start in chronic inflammatory demyelinating polyneuropathy. In addition, argenx recently announced that Vyvgart appears to be efficacious in three subsets of myositis (a group of rare autoimmune conditions that cause muscle inflammation) in a Phase 2 clinical trial and moved the drug into Phase 3. Over time, we expect Vyvgart to demonstrate efficacy in an ever-expanding range of autoantibody-driven autoimmune conditions. We expect Vyvgart to continue to launch well in its existing indications and the addressable market to expand as the drug is developed in additional indications.
    • Natera, Inc. is a diagnostics company for women’s health, organ transplant diagnostics, and oncology. Natera offers a personalized blood-based DNA test called Signatera, which, by detecting how much residual cancer DNA remains in the body, helps doctors determine whether post-surgery chemotherapy is needed and monitor for cancer recurrence before it is detectable with standard imaging. Shares increased on blowout quarterly results, with outsized growth in the Signatera business and robust gross margin progression overall. We think Signatera is in the early innings of adoption in a market estimated at more than $20 billion and will ultimately change the standard of care. We see a long runway for growth with expanding margins and profitability.
    • Boston Scientific Corporation is a global manufacturer of devices used in a broad range of interventional medical specialties. Shares climbed steadily throughout the quarter on solid company fundamentals, including a double-digit EPS growth profile and cost discipline that produces more than 50 basis points of annual operating margin expansion. We believe Boston Scientific can see sustainable organic growth in the high single-digits, driven by differentiated products in electrophysiology and structural heart, in particular, the emerging field of pulsed field ablation (PFA), where the company is well positioned. Temperature-based methods (either hot or cold) to disable heart tissue responsible for irregular heartbeats can damage surrounding tissue. PFA relies on electricity to damage aberrant tissue, and because different types of tissue have different electrical thresholds, the surrounding tissue can be selectively spared. In our opinion, Boston Scientific is a compelling name within the large-cap medical device universe.

     

    DETRACTORS

    • Shares of UnitedHealth Group Incorporated, the largest health care company by revenue, were volatile before ending lower in the quarter. Quarterly medical cost trends ran higher than expected, the high end of quarterly guidance was cut, and the preliminary 2025 outlook missed consensus. The Republican November election sweep drove shares up, as Republicans have historically been more supportive of managed care, which bodes especially well for Medicare Advantage, the industry's main growth engine. In December, UnitedHealth's CEO was shot and killed, and the subsequent outpouring of public anger over the managed care industry's history of claims denials sparked concern about the industry's ability to control health care spend. The specter of pharmacy benefit manager legislation was an additional pressure along with multiple press pieces questioning managed care practices and profit drivers. Longer term, we believe managed care will remain embedded in the U.S. health care system and UnitedHealth, as the largest, best-managed, and most disciplined and forward-thinking company in the industry, will continue to grow.
    • Eli Lilly and Company is a global pharmaceutical company best known for developing and selling GLP-1 medications for diabetes and obesity. Shares detracted from performance as recent GLP-1 revenue results missed heightened expectations. We view Lilly's Mounjaro/Zepbound GLP-1/GIP drug as an important treatment for diabetic and non-diabetic obese patients and see Lilly continuing to innovate and develop more effective and convenient next-generation medications. Although manufacturing supply and access is limited in the near term, we think this class of drug should be the standard of care for both diabetes and obesity and will become a $150 billion category. We think the recent revenue miss related to mistiming of demand-generation activities with supply increases and elevated investor expectations after a very strong result in the prior quarter. We think this market is in the early innings of uptake and the adoption of GLP-1s will triple Lilly's total revenues by 2030.
    • Thermo Fisher Scientific Inc. is a life sciences company that offers instruments/consumables for research, tools for bioproduction, specialty diagnostics, and contract research and manufacturing services. Shares fell on underwhelming quarterly results marked by cautious commentary around China, biopharmaceutical project progression, and equipment purchases. The election of Trump and his selection of Robert F. Kennedy, Jr. to head Health and Human Services also pressured shares as they introduced an element of uncertainty into health care regulation and life science funding. We retain conviction as Thermo Fisher is dominant across multiple end markets and its scale gives it resilience. Once the macro environment normalizes, we expect an organic growth profile in the high single-digit range along with double-digit EPS growth.

    Quarterly Attribution Analysis (Institutional Shares)

    As of 12/31/2024

    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.

    In a difficult quarter for the broader Health Care sector, Baron Health Care Fund (the Fund) declined 9.58% (Institutional Shares), performing similarly to the Russell 3000 Health Care Index (the Index), which fell 9.75%. The Fund failed to separate itself from the Index because favorable impacts from stock selection and cash exposure in a down market were mostly offset by adverse impacts from differences in sub-industry weights.

    Apart from cash, stock selection was positive overall due to solid gains from a handful of holdings in health care equipment, biotechnology, life sciences tools & services, and health care services. Stock selection in health care equipment was an 80-plus basis point tailwind to performance owing to modest gains from the Fund’s large positions in global medical device manufacturer Boston Scientific Corporation and robotic surgical system leader Intuitive Surgical, Inc. Boston Scientific was a material contributor after reporting solid company fundamentals, including a double-digit EPS growth profile and cost discipline that produces more than 50 basis points of annual operating margin expansion. Similarly, Intuitive’s quarterly revenue and earnings surpassed Street expectations due to strong systems placements and procedure growth. The company remains in the early stages of a new product cycle with its new da Vinci 5 system, and we continue to believe the company has a long runway for growth driven by continued adoption and expansion of robotic surgery.

    Argenx SE contributed the vast majority of relative gains in biotechnology after the company’s shares appreciated double digits in the period. Argenx is best known for developing Vyvgart, the leading FcRn inhibitor for the treatment of autoimmune conditions. Shares increased as Vyvgart continued its launch in generalized myasthenia gravis and got off to a strong start in chronic inflammatory demyelinating polyneuropathy. In addition, argenx recently announced that Vyvgart appears to be efficacious in three subsets of myositis (a group of rare autoimmune conditions that cause muscle inflammation) in a Phase 2 clinical trial and moved the drug into Phase 3.

    Strength in life sciences tools & services and health care services came from cell-free DNA testing leader Natera, Inc. and diagnostic imaging services provider RadNet, Inc., respectively. Natera was a top contributor after reporting blowout quarterly results, while RadNet’s shares outperformed in response to solid quarterly results, raised full-year guidance, and the announcement of an attractive strategic collaboration with GE HealthCare to further the innovation and adoption of AI-powered solutions in imaging through RadNet’s DeepHealth platform.

    Mostly offsetting the above was weakness in pharmaceuticals related to not owning shares of Index heavyweight Bristol-Myers Squibb Company, whose shares increased 10.5% in the period, accounting for about half of the relative shortfall in the sub-industry. Poor performance from AstraZeneca PLC also factored into the underperformance in pharmaceuticals. The company is currently dealing with several ongoing investigations into employees in its China business. We believe shares are undervalued relative to what remains an attractive long-term growth outlook driven by indication expansion for current products (Tagrisso and Enhertu) as well as a range of pipeline assets.

    Disappointing stock selection in health care facilities coupled with higher exposure to this lagging sub-industry also weighed on performance. HCA Healthcare, Inc. and Tenet Healthcare Corporation were mostly responsible for relative losses in health care facilities after their share prices declined alongside other hospital operators following Donald Trump’s victory in the U.S. presidential election. Health care policy uncertainty was a headwind for HCA, Tenet, and other hospital stocks during the quarter. Enhanced ACA subsidies are set to expire at the end of 2025. If Congress does not renew the enhanced ACA subsidies, an estimated four million people would become uninsured, which would negatively impact the earnings of the hospital companies that serve those people. In addition, potential Medicaid reform is another risk for hospitals which have benefited from state-directed payments/supplemental payments over the past few years. As a result of these risks, we reduced our hospital positions.

    Yearly Attribution Analysis (for year ended 12/31/2024)

    Baron Health Care Fund appreciated 1.55% (Institutional Shares) for the year, trailing the Russell 3000 Health Care Index by 193 basis points as positive stock selection was offset by adverse impacts from active sub-industry weights.

    Stock selection was positive in general thanks to strength in health care equipment and health care services, which together added 240-plus basis points of relative gains. A handful of holdings performed well in health care equipment, led by global medical device manufacturer Boston Scientific Corporation and robotic surgical system leader Intuitive Surgical, Inc. Boston Scientific’s shares benefited from excitement around the emerging field of pulsed field ablation (PFA), where the company is well positioned. Traditionally, physicians have used temperature-based methods (either hot or cold) to disable heart tissue responsible for irregular heartbeats. Temperature-based methods may damage surrounding tissue, however. PFA, in comparison, relies on electricity to damage aberrant tissue, and because different types of tissue have different electrical thresholds, the surrounding tissue can be selectively spared. We remain positive about Boston Scientific because of the company’s differentiated products in electrophysiology and structural heart, double-digit EPS growth profile, proven track record of cost discipline, and consistent annual operating margin expansion. Intuitive’s stock was lifted by excitement about the company's new robotic surgical system, the da Vinci 5, which offers enhanced imaging, force feedback, and other improvements. The company also reported robust systems placements and procedure growth throughout the year, which drove strong revenue and earnings.

    Shockwave Medical, Inc. and Glaukos Corporation also added value in health care equipment after their share prices increased 75.4% and 59.6%, respectively, in the period. Shockwave is a medical device company focused on developing and commercializing products intended to transform the way calcified cardiovascular disease is treated. The company is best known for its intravascular lithotripsy technology, which targets severely calcified plaques in the coronary and peripheral arteries with shockwaves, clearing the way for cardiologists before percutaneous coronary intervention. Shockwave’s shares moved sharply higher in late March on reports that Johnson & Johnson was considering a deal to acquire the company. We sold our Shockwave position after the deal was announced. Glaukos develops and sells interventional glaucoma treatments, including iDose, a minimally invasive drug-delivery device launched in early 2024. An iDose is implanted in a five minute procedure and delivers a highly concentrated prostaglandin inside the eye that is effective for up to three years. The company’s stock was up in response to the successful initial launch of iDose, which is progressing well in recent quarters. Medicare coverage has been solidifying, and we think uptake will accelerate over the coming quarters as the reimbursement process becomes more streamlined.

    Solid stock selection in health care services came from RadNet, Inc., a leading provider of outpatient diagnostic imaging services. The company’s shares rose on strong operational results and continued success in consolidating the highly fragmented imaging industry in select fast growing urban markets. The vast majority of RadNet’s 366 outpatient centers offer all imaging modalities in patient and physician friendly one-stop shop settings. RadNet is a beneficiary of procedures shifting from costly inpatient settings to lower cost outpatient locations. Integral to RadNet’s imaging center business is its software arm, eRad, which sells programs for distributing, displaying, storing and retrieving digital images. Finally, investors were excited about RadNet’s AI division, which develops and deploys AI solutions to enhance radiological interpretations of breast, lung, and prostate images.

    Entirely offsetting the above were adverse impacts from active sub-industry exposures, namely higher exposure to the lagging life sciences tools & services, biotechnology, health care distributors, and health care supplies sub-industries. Meaningfully lower exposure to strong performing pharmaceutical stocks also proved costly, detracting 50-plus basis points from relative results. From a stock selection standpoint, offsetting a portion of the strength in health care equipment and health care services was weakness in biotechnology, where Rocket Pharmaceuticals, Inc. and Legend Biotech Corporation weighed heavily on performance. Shares of Rocket, which develops gene therapies for rare diseases, fell due to limited near-term potential upside data catalysts and concerns around possible unexpected safety events in the Danon Phase 3 trial. We believe the Danon disease gene therapy will work and has the potential to be a $1 billion-plus product. We are also looking forward to initial PKP2 arrhythmogenic cardiomyopathy gene therapy data in 2025. We think success in the Danon disease gene therapy alone could justify more than a doubling of the share price.

    Legend manufactures and, together with partner Johnson & Johnson, sells Carvykti, the leading BCMA CAR-T treatment for multiple myeloma. The company’s shares declined as physicians are becoming more concerned about the rate of delayed neurotoxicity seen with Carvykti, including rare cases of Parkinson’s-like symptoms. Furthermore, data presented at the American Society of Hematology conference suggested that competitor Arcellx's new BCMA CAR-T treatment likely has similar efficacy and better delayed neurotoxicity safety than Carvykti. As a result, we decided sell Legend and acquire additional Arcellx shares because we have become more bullish on Arcellx's drug.

    Investors should consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The prospectus and summary prospectuses contain this and other information about the Funds. You may obtain them from the Funds’ distributor, Baron Capital, Inc., by calling 1-800-99BARON or visiting www.BaronFunds.com. Please read them carefully before investing.

    The performance data quoted represents past performance. Past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate; an investor's shares, when redeemed, may be worth more or less than their original cost. The Fund’s transfer agency expenses may be reduced by expense offsets from an unaffiliated transfer agent, without which performance would have been lower. Current performance may be lower or higher than the performance data quoted.

    Risks: All investments are subject to risk and may lose value.

    The discussion of market trends is not intended as advice to any person regarding the advisability of investing in any particular security. The views expressed on this page reflect those of the respective writer. Some of our comments are based on management expectations and are considered “forward-looking statements.” Actual future results, however, may prove to be different from our expectations. Our views are a reflection of our best judgment at the time and are subject to change at any time based on market and other conditions and Baron has no obligation to update them

    Portfolio holdings are subject to change. Current and future portfolio holdings are subject to risk.

    The index performance is not fund performance; one cannot invest directly into an index.