Baron Asset Fund: Latest Insights and Commentary

U.S. equity markets were volatile during the quarter, as positive sentiment and strong performance in January were undermined by AI-related disruption fears and geopolitical tensions. Small and mid caps generated positive returns in the first quarter while large caps declined, a margin of outperformance for small and mid caps not seen since the COVID rally in late 2020 and early 2021. 

The year began with positive momentum for U.S. stocks, supported by easing inflation, resilient economic trends, strong corporate earnings, and investor optimism about the Trump administration’s stimulative economic strategy. Market sentiment began to shift in February, with the early catalyst being widespread losses across a range of industries due to fears about AI-driven disruption. Technology and software companies experienced notable pressure as investors worried AI agents could directly replace human-led business workflows. The sell-off worsened after the U.S. and Israel attacked Iran on February 28. Investors became concerned about the potential for sustained inflation and reduced economic growth from surging oil prices and supply chain disruptions. 

Against this backdrop, the dominant market trend was the continued rotation out of the Magnificent Seven, software, and other growth-oriented stocks. The Magnificent Seven complex declined 11.3%, accounting for about 90% of the cap-weighted S&P 500 Index’s losses. Microsoft (-23.3%), Tesla (-17.3%), Meta (-13.3%), Amazon (-9.8%), and Alphabet (-8.1%) suffered the largest losses. The non-Magnificent Seven stocks in the Index were down only 0.6% for the month. 

Looking ahead, we remain focused on well-managed companies with durable competitive advantages and attractive growth prospects. While macroeconomic and policy uncertainty persist, we believe maintaining a disciplined, long-term perspective and emphasizing company fundamentals will be essential to navigating the evolving landscape. 

CONTRIBUTORS

• Space Exploration Technologies Corp. (SpaceX) is a high-profile private company founded by Elon Musk. The company's primary focus is on developing and launching advanced rockets, satellites, and spacecrafts, with the ambitious long-term goal of making life multi-planetary. SpaceX is generating significant value with the rapid expansion of its Starlink broadband service. The company is successfully deploying a vast constellation of Starlink satellites in Earth's orbit, reporting substantial growth in active users, and regularly deploying new and more efficient hardware technology. Furthermore, SpaceX has established itself as a leading launch provider by offering highly reliable and cost-effective launches, leveraging the company's reusable launch technology. SpaceX capabilities extend to strategic services such as human spaceflight missions. Moreover, SpaceX is making tremendous progress on its newest rocket, Starship, which is the largest, most powerful rocket ever flown. This next-generation vehicle represents a significant leap forward in reusability and space exploration capabilities. We value SpaceX using prices of recent financing transactions.
• Quanta Services, Inc. is a leading specialty contracting company that provides comprehensive infrastructure solutions for the electric and gas utility, renewable energy, communications, pipeline, and energy industries. Shares rose during the quarter, driven by broad optimism around AI and data-center-related companies, as well as Quanta’s strong quarterly earnings results, which beat Street expectations and demonstrated continued robust demand for its services. Management reiterated its view that the business can grow earnings in the mid-to-high teens or better through at least the end of the decade, supported by secular trends including grid modernization, electrification, the energy transition, industrial reshoring, communications infrastructure upgrades, and more. We believe this level of earnings growth is achievable, and we take further comfort in Quanta’s 25% earnings CAGR since 2015, a period during which the market backdrop was considerably weaker. We remain excited about Quanta’s growth prospects and continue to be long-term shareholders.
• Vertiv Holdings Co is a leading global provider of critical digital infrastructure solutions for data centers, communication networks, and commercial and industrial environments, with one of the broadest offerings in electrical and thermal management equipment and services within the data center infrastructure industry. Shares increased after Vertiv reported robust quarterly results, with fourth-quarter bookings well above expectations, driving backlog meaningfully higher and supporting stronger-than-expected growth into 2027. The company is benefiting from the industry’s shift toward integrated and modular solutions, which help alleviate labor constraints and accelerate deployment timelines at data centers. Vertiv is a leading provider of these solutions, backed by industry-leading servicing capabilities, and is also well positioned to support key technology transitions, including liquid cooling and direct current architectures. Combined with the company’s internal focus on margin improvement, this positioning should drive better-than-expected earnings growth and continued upside over the coming years.

DETRACTORS

• CoStar Group, Inc. is the leading provider of information and marketing services to the commercial and residential real estate industries. Shares fell due to multiple compression driven by rising AI fears. The market has come to view AI as an existential risk for a growing number of industries—including software, business services, information services, and video games—despite no evidence of any fundamental impact to these sectors. This “shoot first and ask questions later” dynamic has resulted in meaningful share price declines. We continue to own CoStar given its differentiated data assets and significant growth opportunities in providing enhanced real estate information, analytics, and marketplace offerings. CoStar boasts an enviable business model with high levels of recurring revenue and meaningful cash flow generation potential. While near-term cash flow is obscured by elevated investment in Homes.com, we expect spending to moderate and cash flow to improve over the next several years. The company also maintains a substantial cash balance, which we are hopeful will be used to aggressively repurchase shares at current depressed valuation levels.
• Syndicated research provider Gartner, Inc. detracted from performance as valuation multiples compressed amid rising concerns around AI. Investors have increasingly viewed AI as a potential existential risk across a widening range of industries—including software, business services, information services, and video games—despite no evidence of any fundamental impact to these sectors. This “shoot first and ask questions later” dynamic has driven meaningful share price declines across the group. Against this backdrop, shares of Gartner came under pressure after the company reported contract value growth that was just 0.5% below expectations, underscoring the dramatic valuation compression at play. We continue to own Gartner given its large addressable market, significant competitive advantages, and robust free cash flow generation, which we expect management to deploy toward share repurchases at depressed valuation levels. We also view Gartner as an AI beneficiary, as it can leverage emerging tools to extract deeper insights from its vast trove of proprietary data and deliver it to customers in chatbot-type formats that meaningfully enhance its value proposition.
• Shares of property and casualty (P&C) insurance software vendor Guidewire Software, Inc. declined during the quarter amid concerns about the disruptive impact of AI, which weighed broadly on software stocks. We retain conviction in Guidewire and believe its fundamentals remain robust. The company's cloud sales are accelerating, with annual recurring revenue benefiting from new customer wins, expansions, and migrations of its existing customer base. The ongoing shift away from on-premise deployments, along with strong customer references from insurers such as Liberty Mutual, The Hartford, and Sompo, should further accelerate customer migration to the cloud. Additionally, Guidewire is ramping investment in product development, which should facilitate cross-selling into its sticky installed base. AI should act as a tailwind, helping the company accelerate product releases, create products that were previously out of reach, and reduce the cost of customer implementations (a historical impediment to adoption). We believe these dynamics position Guidewire for sustained growth over the long term.

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.

Baron Asset Fund (the Fund) declined 7.81% (Institutional Shares) in the first quarter, trailing the Russell Midcap Growth Index (the Index) by 146 basis points. Much of the underperformance occurred in the first half of January when the Index rallied more than 3% before recovering a portion of the losses as the market moved lower over the remainder of the quarter. The Fund underperformed for the quarter because solid stock selection was negated by industry-specific headwinds. According to MSCI’s Barra factor attribution, the Fund’s overexposure to various software and services related industries (Commercial and Professional Services, Insurance Brokers and Reinsurance, Software, and Internet Software and IT Services) weighed heavily on performance, as these segments faced significant selling pressure due to investor fears that AI will disrupt their businesses. The Fund was also punished for not having exposure to Oil Gas and Consumable Fuels and Oil and Gas Exploration and Production stocks, which were up sharply alongside the price of oil during the quarter.

From a sector standpoint, Information Technology holdings were almost entirely responsible for the relative shortfall in the period, detracting nearly 250 basis points. Most of the losses came from being overexposed to application software and IT consulting & other services (Gartner, Inc.) stocks, which were pressured by the AI disruption narrative that gained steam following Anthropic's release of specialized sector-specific plugins for Claude Cowork. The plugins, which enable AI to function as domain-specific analysts across legal, finance/accounting, sales/marketing, and customer support, caused investors to worry that AI agents could directly replace expensive human-led, subscription-based business workflows. We believe the various software businesses held in the Fund sit on the right side of the AI disruption divide—companies whose moats are being strengthened, not eroded, by the shift toward AI. We expect patient, selective investing in this environment to generate attractive long-term returns as the market eventually distinguishes between the genuine AI losers and the misperceived ones.

Regarding Gartner, we continue to own the stock given the company’s large addressable market, significant competitive advantages, and robust free cash flow generation, which we expect management to deploy toward share repurchases at depressed valuation levels. We also view Gartner as an AI beneficiary, as it can leverage emerging tools to extract deeper insights from its vast trove of proprietary data and deliver it to customers in chatbot-type formats that meaningfully enhance its value proposition.

Lack of exposure to the top performing Energy sector combined with disappointing stock selection in Real Estate and Health Care also hampered relative results. Weaknesses in Real Estate came from CoStar Group, Inc., the leading provider of information and marketing services to the commercial and residential real estate industries. CoStar’s shares fell due to multiple compression driven by rising AI fears. We continue to own CoStar given its differentiated data assets and significant growth opportunities in providing enhanced real estate information, analytics, and marketplace offerings. CoStar boasts an enviable business model with high levels of recurring revenue and meaningful cash flow generation potential. While near-term cash flow is obscured by elevated investment in Homes.com, we expect spending to moderate and cash flow to improve over the next several years. The company also maintains a substantial cash balance, which we are hopeful will be used to aggressively repurchase shares at current depressed valuation levels.

Performance in Health Care was hindered by veterinary diagnostics leader IDEXX Laboratories, Inc., whose shares price declined despite reporting better-than-expected financial results. Foot traffic to veterinary clinics in the U.S. remains modestly negative but is poised to recover over the next several years. Even so, IDEXX’s excellent execution has enabled the company to continue delivering robust performance. We believe IDEXX’s competitive trends are outstanding, and we expect new proprietary innovations—such as InVue, MultiCue, and CancerDX—to be meaningful contributors to growth in the years ahead. We also see increasing evidence that long-term secular trends around pet ownership and pet care spending have structurally accelerated, which should help support IDEXX’s long-term growth rate.

Partially offsetting the above was strong stock selection in Industrials coupled with meaningfully higher exposure to this better performing sector, which added 200-plus basis points of relative gains. Strength in Industrials was driven by the Fund’s sizable positions in Space Exploration Technologies Corp. (SpaceX), a high-profile private company founded by Elon Musk, and Quanta Services, Inc., a leading specialty contracting company that provides comprehensive infrastructure solutions for the electric and gas utility, renewable energy, communications, pipeline, and energy industries.

SpaceX’s primary focus is on developing and launching advanced rockets, satellites, and spacecrafts, with the ambitious long-term goal of making life multi-planetary. SpaceX is generating significant value with the rapid expansion of its Starlink broadband service. The company is successfully deploying a vast constellation of Starlink satellites in Earth's orbit, reporting substantial growth in active users, and regularly deploying new and more efficient hardware technology. Furthermore, SpaceX has established itself as a leading launch provider by offering highly reliable and cost-effective launches, leveraging the company's reusable launch technology. SpaceX capabilities extend to strategic services such as human spaceflight missions. Moreover, SpaceX is making tremendous progress on its newest rocket, Starship, which is the largest, most powerful rocket ever flown. This next-generation vehicle represents a significant leap forward in reusability and space exploration capabilities. We value SpaceX using prices of recent financing transactions.

Quanta shares rose during the quarter, driven by broad optimism around AI and data-center-related companies, as well as Quanta’s strong quarterly earnings results, which beat Street expectations and demonstrated continued robust demand for its services. Management reiterated its view that the business can grow earnings in the mid-to-high teens or better through at least the end of the decade, supported by secular trends including grid modernization, electrification, the energy transition, industrial reshoring, communications infrastructure upgrades, and more. We believe this level of earnings growth is achievable, and we take further comfort in Quanta’s 25% earnings CAGR since 2015, a period during which the market backdrop was considerably weaker. We remain excited about Quanta’s growth prospects and continue to be long-term shareholders.

Favorable stock selection in Financials also added value during the period, with specialty insurer Arch Capital Group Ltd. leading the way in the sector. Arch and other property and casualty (P&C) insurance stocks broadly outpaced the market amid heightened volatility. P&C insurance stocks tend to be resilient during turbulent markets and are less exposed to the AI-related concerns weighing on other sectors. In addition, Arch reported better-than-expected quarterly earnings, and management expects a continuation of double-digit growth in book value per share. We continue to own the stock due to Arch’s strong management team and our expectation of continued growth in earnings and book value over time.