Baron Asset Fund: Latest Insights and Commentary

U.S. equity markets managed gains in a period of heightened volatility, with the CBOE Volatility Index (VIX) briefly spiking above 50 for the first time in over five years before settling back below its long-term average of 20 by quarter end as tariff policy uncertainty and war in the Middle East failed to unnerve investors. Risk-off sentiment early in the quarter centered around President Trump’s “Liberation Day” tariff announcement, which Wall Street strategists viewed as more severe than expected and likely to slow economic growth, boost inflation, and increase the odds of a recession this year. On April 2, President Trump unveiled an unprecedented global tariff regime, placing a 10% baseline tax on imports from all countries, a 34% tariff on Chinese goods, a 25% tariff on all car imports, and a 20% tariff on EU goods. In retaliation, China imposed 34% tariffs on U.S. goods and the EU announced its own countermeasures. The S&P 500 Index fell more than 12% over the next four days, nearly entering bear market territory from its all-time high on February 19, 2025 (down almost 19%). Other prominent benchmarks, such as the NASDAQ Composite Index and Russell 2000 Index, officially entered a bear market in early April, declining more than 20% from their respective all-time highs reached late last year.

After bottoming on April 8, U.S. equities rebounded due to positive trade developments. On April 9, Trump announced a 90-day pause on most reciprocal tariffs to allow for negotiations. China was the only country excluded from the pause, with Trump instead raising tariffs on China to 145%, prompting Chinese officials to increase tariffs on U.S. goods to 125%. However, U.S. and Chinese officials eventually agreed to a de-escalation of tariffs on May 12, alleviating investor concerns and contributing to additional market gains. Other market catalysts were resilient corporate earnings amid tariff-driven pressures, dovish Federal Reserve commentary following muted May inflation, AI tailwinds from NVIDIA’s strong earnings results and Middle East deals, improving consumer sentiment, and a recent ramp in M&A and IPO activity. The sudden Israel-Iran war and subsequent involvement of the U.S. via the bombing of various Iranian nuclear sites threatened to upend market momentum, but a fragile ceasefire was quickly brokered, and the market resumed its advance to close the quarter at a record high.

The Magnificent Seven complex resumed its leadership role during the quarter, accounting for nearly 60% of the S&P 500 Index’s gains. The group appreciated more than 20% in the period, outpacing the Index, which was up 10.9%. NVIDIA (+45.8%), Microsoft (+32.7%), Meta (+28.2%), and Tesla (+22.6%) posted the largest gains. Apple (-7.5%) was the only member of the group to decline and trail the broader Index.

Sector performance mirrored the influence of the Magnificent Seven, as Information Technology, Communication Services, and Consumer Discretionary were among the top performing sectors. Industrials was the only other sector to outperform the Index, helped by strong gains from aerospace & defense companies. Health Care experienced a severe reversal of fortunes during the quarter, as the sector’s 7.2% decline wiped out all year-to-date outperformance versus the broad market. After trailing the S&P 500 Index by more than 50% over the prior two calendar years, Health Care was tracking ahead of the Index this year, outperforming by 750-plus basis points through the end of April. But that all changed in May and June when the sector trailed the Index by approximately 15%. Health Care performance was hampered by multiple factors, including regulatory uncertainty, particularly around drug pricing and Medicare Advantage reimbursement rates, federal investigations involving sector heavyweight UnitedHealth, disruption at the FDA and cancellations/delays of NIH grants for academic research, concerns about tariffs on the pharmaceutical industry, and renewed investor interest in AI-driven technology companies. Energy was another notable laggard, pressured by the sharp decline in oil prices during the quarter.

From a style perspective, small caps failed to lead the way in the market recovery during the quarter, trailing mid- and large-cap stocks. Small caps remain in negative territory this year, down 1.8%, while larger-cap stocks are up about 6%, having recovered all losses from early in the year. Growth stocks outperformed for a third consecutive month to finish the quarter ahead of value by between 400 and 1,400 basis points. The largest differential was in mid and large cap, where sizeable weights in Palantir/AppLovin and Magnificent Seven factored heavily into the strong showing for these growth benchmarks. Growth is now outperforming in most size segments this year, representing a meaningful turnaround from the end of March when value was ahead by a wide margin across the board.

Beyond the U.S., developed and emerging market (EM) equities were up double digits for the quarter, benefiting from the significant allocation shift away from U.S. equities early in the period. Despite modest underperformance in June, developed Europe was a standout for the quarter, bolstered by sharp gains in the Netherlands, Spain, Ireland, Germany, Italy, Finland, and Sweden. Securities in Israel, Hong Kong, Australia, and Canada also contributed to strength in developed markets. EM equities were lifted from semiconductor-related strength in Taiwan and Korea (SK hynix). Solid gains in Mexico and Brazil also contributed to EM outperformance, as investors were relieved about the relatively less punitive tariff approach announced by the U.S. administration.

CONTRIBUTORS

• Shares of veterinary diagnostics leader IDEXX Laboratories, Inc. contributed to performance for the quarter after reporting better-than-expected financial results. Foot traffic to veterinary clinics in the U.S. remains under pressure, which has continued to hamper aggregate revenue growth. Despite macroeconomic challenges, IDEXX’s excellent execution has enabled the company to maintain strong performance. We believe competitive trends are outstanding, and we expect new proprietary innovations and field sales force expansion to be meaningful contributors to growth in 2025. We 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.
• Amphenol Corporation, a leading global supplier of advanced interconnect systems, contributed to performance during the quarter. The company reported robust results in April, with organic growth exceeding prior guidance due to strength in the data center end market. Shares continued to perform well as investors became more optimistic about increased capital spending in data infrastructure. We view Amphenol as a best-in-class industrial technology company with a strong track record of creating value through both organic and inorganic growth over time.
• Shares of property and casualty (P&C) insurance software vendor Guidewire Software, Inc. contributed to performance on strong fiscal Q3 2025 financial results and an upward revision to full-year guidance. After a multi-year transition, we think Guidewire’s cloud migration is largely complete. We believe 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 from infrastructure investment to product development, which should help drive cross-sales into its sticky installed base and potentially accelerate ARR growth over time. We are further encouraged by Guidewire’s subscription-based gross margin expansion, which improved by more than 600 basis points in the 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%.

DETRACTORS

• Specialty insurer Arch Capital Group Ltd. gave back some of its gains from earlier in the year, following slower growth and broader weakness across insurance stocks during the second quarter. In the first quarter, premium growth came in below forecasts and slowed relative to the prior quarter due to rising competition and lower pricing in certain business lines. Even so, earnings beat expectations due to stronger underwriting margins and lower tax rates. We continue to own the stock due to Arch’s strong management team and our expectation of significant growth in earnings and book value over time.
• The Cooper Companies, Inc. is a global medical device company with two business units: CooperVision, a leading manufacturer of soft contact lenses; and CooperSurgical, which focuses on women's health care and fertility. The stock detracted from performance following mixed fiscal Q2 results. While Cooper reported an earnings-per-share beat—supported by 7% organic growth at CooperVision versus the Street’s 5.5% estimate—the results were overshadowed by management’s acknowledgment of softening contact lens end markets due to macroeconomic headwinds and tighter channel inventories across the industry. Still, CooperCompanies maintained that it is positioned to outpace the market by approximately 150 basis points in fiscal 2025, driven by robust contact lens demand and stable pricing. Management cited ongoing margin expansion as another bright spot and projected continued strength throughout the year due to efficiency gains and favorable product mix. The global contact lens market benefits from long-term secular trends, including sustained demand for premium lenses, and CooperCompanies, which offers the industry’s broadest portfolio of specialty lenses, continues to gain share.
• Bio-Techne Corporation is a leading developer and manufacturer of reagents, instruments, and services for the life sciences research, diagnostics, and bioprocessing markets. The stock fell due to weakness in academic research spending following cuts to National Institutes of Health (NIH) funding. The U.S. academic research market accounts for roughly 12% of Bio-Techne’s revenue, with about half of that tied to NIH grants. Broader biotechnology funding has also been soft amid policy uncertainty and weak capital markets. As a result, management guided to low single-digit organic revenue growth for the June quarter, down from its prior expectation of high single-digit growth. While the challenging environment for U.S. academic research is likely to persist for the foreseeable future, we retain conviction in the stock. Bio-Techne’s overall exposure to this end market remains limited, and we believe the current valuation is attractive.

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) relinquished the entirety of its outperformance from the prior quarter as the Russell Midcap Growth Index (the Index) rebounded sharply from its April 8 low. The Fund was up 7.85% (Institutional Shares) in the second quarter, trailing the Index, which appreciated 18.20%, by 10.35%. The shortfall was mostly style-related, with the Fund’s underexposure to higher beta stocks proving especially damaging as the Beta factor experienced one of its best three-month periods of performance in the last 25 years. The only time Beta performed better was the initial market rally coming out of the COVID downturn. Sustained strong performance from Index heavyweight Palantir Technologies Inc. also played a major role in the Fund’s underperformance during the period.

From a sector perspective, stock selection in Information Technology (IT) was responsible for about 40% of the underperformance in the period, with a portion of the shortfall being driven by modest declines from Gartner, Inc. and Roper Technologies, Inc. Syndicated research provider Gartner was a top detractoras reductions in government spending negatively impacted the company's public sector business. We estimate U.S. federal exposure accounts for about 5% of Gartner’s total research contract value, with about half from the Department of Defense and intelligence organizations, and half from civilian agencies. While federal budget scrutiny remains high, we believe Gartner’s services deliver significant value to users, including the potential for hard dollar savings. The private sector business appears well positioned for sustained growth, and management is adept at exercising cost controls to support margins and free cash flow generation. The company’s balance sheet is in excellent shape, and we expect management to take advantage of this drawdown through aggressive share repurchases.

Roper owns a portfolio of businesses with market-leading software and technology-enabled products with the goal of compounding cash flow over time. The company has a high percentage of recurring revenue and maintains high cash returns on investment in defensible niche businesses. After outperforming in the first quarter when investors rotated into more defensible growth businesses in a period of heightened market volatility, Roper’s shares underperformed as certain higher growth segments of the market recovered swiftly during the second quarter. We remain investors based on Roper's competitive advantage and strong track record of compounding cash flow through acquisitions and organic growth.

Poor stock selection in IT was exacerbated by not owning the largest company in the Index, Palantir, whose share price increased 55% during the quarter, accounting for over half of the relative losses in the sector (and about a quarter of the Fund’s overall underperformance). The impact on relative performance from Palantir was over six times higher than we have seen historically for a single security unique to the Index. This marks the second time in three quarters that a single security (Palantir) has had such an outsized detrimental impact on the Fund’s relative performance and is something never previously witnessed in the Fund’s long history.

The remaining underperformance came from disappointing stock selection in Financials, Industrials, Communication Services, and Real Estate. Specialty insurer Arch Capital Group Ltd. was the principal detractor in Financials following slower growth and broader weakness across insurance stocks during the second quarter. In the first quarter, premium growth came in below forecasts and slowed relative to the prior quarter due to rising competition and lower pricing in certain business lines. Even so, earnings beat expectations due to stronger underwriting margins and lower tax rates. We continue to own the stock due to Arch’s strong management team and our expectation of significant growth in earnings and book value over time.

Weakness in Industrials was broad based, led by poor performance from Fund’s sizeable positions in private rocket and spacecraft manufacturer Space Exploration Technologies Corp. (SpaceX) and data and analytics vendor Verisk Analytics, Inc. SpaceX shares were unchanged for the quarter, hampering performance in a rising market. We value SpaceX using prices of recent financing transactions. Verisk’s stock lagged alongside other defensive stocks during the quarter. There was no materially negative company specific news in the period. Verisk reported solid Q1 2025 earnings and CEO Lee Shavel sounded upbeat about the company’s growth potential. We maintain conviction in the competitive positioning, long-term growth, margin expansion, and capital deployment prospects for the business.

Performance in Communication Services was hindered by another private investment, AI and social media company X.AI Holdings Corp. (xAI), whose share price was unchanged in the period, causing a 50-plus basis point drag on relative performance. We value xAI based on recent share transactions. Real estate information and marketing services platform CoStar Group, Inc. was responsible for most of the relative losses in Real Estate after the company’s shares failed to keep pace with the Index and peers during the quarter. The company’s recent performance has been tempered by significant investment in its residential product, Homes.com, and mixed net new sales. We remain encouraged by growth in both traffic and brand awareness for the new product and are optimistic that momentum will build as the company expands its dedicated residential sales force, enhances its customer targeting, and potentially benefits from changes in Multiple Listing Service practices. Growth in CoStar’s non-residential business also appears poised to accelerate as the sales team refocuses on core offerings—a trend we expect to continue as headcount increases by 20% or more this year. We believe the value of CoStar’s core non-residential business alone exceeds the current share price of the stock, suggesting that investors are ascribing little value to the long-term residential opportunity. 

Somewhat offsetting the above were favorable impacts from active sector weights, which contributed approximately 125 basis points of relative gains. The Fund benefited from being underexposed to the lagging Energy, Consumer Discretionary, Consumer Staples, and Materials sectors.