Baron Asset Fund: Latest Insights and Commentary

After selling off in March due to the U.S.-Iran conflict and disruptions in the Strait of Hormuz, U.S. equities rallied to new record highs during the second quarter, with most of the gains coming in April and May. Given narrow market breadth and concentrated position sizes in recent years, the gap in performance between the market cap-weighted S&P 500 Index and the equal-weighted version has reached extremes not seen since the dotcom bubble era (based on rolling three-year results). 

U.S. stocks saw a comeback after ending the prior quarter slightly down. The AI secular growth narrative was the principal driver of market returns, overshadowing uncertainty about a potential resolution to the U.S.-Iran conflict, shifting Federal Reserve rate expectations, and depressed consumer sentiment from high living costs, persistent inflation, and elevated borrowing rates. 

The S&P 500 posted one of its strongest quarterly profit prints in five years, thanks largely to the Magnificent Seven cohort, which reported blended earnings growth in excess of 60% (versus low double digits for other constituents in the Index). The other contributors were primarily Information Technology (IT) stocks—specifically companies that are perceived to be direct beneficiaries of AI capital spending and electrification and what the market has come to call “AI winners." 

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) develops and launches advanced rockets, satellites, and spacecraft, with the long-term goal of making humanity multi-planetary. Shares rose as the company successfully completed the largest initial public offering in history, raising more than $85 billion. The proceeds are expected to accelerate growth across massive addressable markets, such as connectivity, launch, terrestrial and space infrastructure, and AI. Fundamental momentum was further reinforced by landmark compute hosting deals totaling tens of billions of dollars annually, including agreements with market leaders Anthropic and Google. SpaceX also announced its acquisition of Cursor, a premier enterprise AI-powered coding platform. Integrating Cursor’s technology, talent, and customer base provides another strategic stepping stone into the vast opportunities within AI applications and agentic systems. Lastly, the company conducted a successful test flight of the latest version of Starship, demonstrating meaningful advancements in rapid and full reusability. We believe these developments support sustained long-term revenue and profit growth well beyond current levels.
• Amphenol Corporation is a leading provider of high-technology interconnect, sensor, and antenna solutions serving a diverse set of end markets. The company operates a highly decentralized, entrepreneurial model, with more than 140 general managers exercising autonomy over their individual business units. Amphenol is also highly acquisitive, having completed more than 50 acquisitions over the past decade, including its largest transaction to date. Shares rose during the quarter after selling off in the prior period amid concerns that copper interconnect products, where Amphenol maintains a strong competitive position, could eventually be displaced by optical interconnects, where its market position is less established today. Nevertheless, management remains confident that the company can capture more than its fair share of the optical market, just as it did in copper, aided by the recent acquisition of CommScope's connectivity and cable solutions business. We believe Amphenol is well positioned to maintain a leading role even as interconnect technologies evolve from copper to optical, reinforcing our conviction in the company's long-term growth opportunity.
• Quanta Services, Inc. is a leading specialty contracting company that provides comprehensive infrastructure solutions across the electric and gas utility, renewable energy, communications, pipeline, and energy industries. Shares rose during the quarter, driven by broad optimism around AI, data center and power infrastructure construction, as well as strong first-quarter earnings that exceeded expectations across the board and prompted management to substantially raise full-year guidance. Management reiterated its view that the business can grow earnings at a mid-to-high teens rate or better through at least the end of the decade, supported by secular trends including grid modernization, electrification, the energy transition, industrial reshoring, and communications infrastructure upgrades. We continue to believe this level of growth is achievable and take further comfort in Quanta’s 25% earnings CAGR since 2015, a period during which the market backdrop was considerably less favorable than it is today. We remain long-term shareholders in Quanta and continue to see compelling growth prospects for the business.

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 increasingly come to view AI as an existential risk for a growing number of industries, including software, business services, information services, and video games. While there is little evidence of any fundamental impact on these sectors, investors have largely adopted a “shoot first and ask questions later” approach, leading to significant stock price declines. We continue to own CoStar due to its enviable business model, differentiated data assets, and meaningful growth opportunities in providing enhanced real estate information, analytics, and marketplace offerings. The company also maintains a substantial cash balance, which we are hopeful will be used to aggressively repurchase shares at current depressed valuation levels.
• Shares of property and casualty (P&C) insurance software vendor Guidewire Software, Inc. declined after a handful of deals slipped from the fiscal third quarter into the fiscal fourth quarter. We believe this is purely a timing issue, with these deals having since closed in the current period. Guidewire’s InsuranceSuite platform serves as the core system of record for insurance carriers, functioning as the single source of truth for the policies an insurer writes, the claims it processes, the premiums it collects, and the payments it makes. We think the core-system opportunity alone represents nearly $20 billion of annual recurring revenue, or roughly 20 times Guidewire’s current size. In our view, AI will meaningfully expand this opportunity by enabling automation and intelligence on top of the core system of record. Guidewire is already bringing new AI-enabled capabilities to market and signing customers, and we expect adoption to accelerate over the coming year. Finally, we expect Guidewire to benefit from the same internal productivity enhancements AI is driving across enterprises, which should help it grow faster with lower costs and ultimately improve profitability.
• Syndicated research provider Gartner, Inc. detracted from performance due to multiple compression driven by rising AI fears.  The market has increasingly come to view AI as an existential risk for a growing number of industries, including software, business services, information services, and video games. While there is little evidence of any fundamental impact on these sectors, investors have largely adopted a “shoot first and ask questions later” approach, leading to significant stock price declines. We continue to own Gartner given its large addressable market, significant competitive advantage, and robust free cash flow generation, which we expect management to deploy toward share repurchases at depressed valuation levels.

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) rose 18.98% (Institutional Shares) in the second quarter, outperforming the Russell Midcap Growth Index (the Index) by 443 basis points due to favorable stock selection. According to MSCI’s Barra factor attribution, strong stock selection was enough to overcome material headwinds from style factors, principally Beta and Momentum. The Fund’s underexposure to Beta was detrimental given the factor’s favorable performance in a period of notable market strength. The Beta factor posted its best three-month performance on record during the period, with the factor’s performance rivaling prior sharp market rallies that followed bear markets, such as “Black Monday”, the dotcom collapse, the Great Recession, and the COVID pandemic. 

Underexposure to Momentum was also problematic as the factor continued its strong run of performance, powered by investor sentiment regarding AI. Many of the top contributors in the Index were what the market calls “AI winners” with elevated exposure to the Beta and Momentum factors. In other words, it was the AI winners that drove outsized factor performance, especially when it comes to Beta and Momentum, preventing the Fund from outperforming by a wider margin in the period. We managed to overcome style-related headwinds because of strong stock selection associated with the Fund’s sizable position in Space Exploration Technologies Corp. (SpaceX), which completed its highly successful public offering during the quarter.

From a sector perspective, stock selection in Communication Services contributed most of the gains thanks to the Fund’s significant position in rocket, satellite, and spacecraft manufacturer SpaceX. The company completed the largest initial public offering in history during the quarter, raising more than $85 billion. The proceeds are expected to accelerate growth across massive addressable markets, such as connectivity, launch, terrestrial and space infrastructure, and AI. Fundamental momentum was further reinforced by landmark compute hosting deals totaling tens of billions of dollars annually, including agreements with market leaders Anthropic and Google. SpaceX also announced its acquisition of Cursor, a premier enterprise AI-powered coding platform. Integrating Cursor’s technology, talent, and customer base provides another strategic stepping stone into the vast opportunities within AI applications and agentic systems. Lastly, the company conducted a successful test flight of the latest version of Starship, demonstrating meaningful advancements in rapid and full reusability. We believe these developments support sustained long-term revenue and profit growth well beyond current levels.

Partially offsetting the above was adverse stock selection in Information Technology (IT), Financials, Real Estate, and Industrials, where concerns about AI-driven disruption remained an overhang for several of the Fund’s holdings. A portion of the weakness in IT was attributable to double-digit losses from property and casualty (P&C) insurance software vendor Guidewire Software, Inc. and syndicate research provider Gartner, Inc. Both companies underperformed as investors continued to rotate out of stocks perceived as at risk of being disrupted by AI. We believe this characterization is misplaced and that AI will ultimately be a significant tailwind for both companies. Guidewire’s InsuranceSuite platform serves as the core system of record for insurance carriers, functioning as the single source of truth for the policies an insurer writes, the claims it processes, the premiums it collects, and the payments it makes. Insurance policies are complex, highly regulated, and stored exclusively in digital form within Guidewire, which makes the system of record particularly critical and therefore highly valuable. We believe the core system opportunity alone represents nearly $20 billion of annual recurring revenue, or roughly 20 times Guidewire’s current size. In our view, AI meaningfully expands this opportunity by enabling automation and intelligence on top of the core system of record. Guidewire is already bringing new AI enabled capabilities to market and signing customers, and we expect adoption to accelerate over the coming year. Finally, we expect Guidewire to benefit from the same internal productivity enhancements AI is driving across enterprises, helping the company support faster growth with lower costs and ultimately improving profitability.

While the market has expressed concern about the impact of AI on Gartner’s insights business, we see no evidence that it is negatively impacting the company’s value proposition. We believe Gartner has a vast and growing set of proprietary data, generated by hundreds of thousands of interactions with buyers, sellers, and consumers of technology. Gartner’s proprietary insights extend to corporate technology roadmaps, enabling the company to assess future trends, and its contract review program delivers tangible returns on investment for customers. We expect growth trends to improve as U.S. public sector headwinds abate and the company’s sales force productivity strengthens. We also think Gartner is being extremely aggressive in repurchasing stock to take advantage of what we view as a discounted valuation.

Poor stock selection in IT was exacerbated by having minimal exposure to semiconductor stocks, which nearly doubled in the Index, accounting for about half of the losses in the sector.

Stock-specific weakness in Financials was driven by poor performance from specialty insurer Arch Capital Group Ltd. and discount brokerage house The Charles Schwab Corporation. Arch’s stock failed to participate in the market rally during the quarter, reflecting a rotation away from resilient insurance stocks as market volatility eased. Soft pricing trends in the insurance industry also pressured shares. Rates for property insurance are falling due to strong profitability and elevated capital levels following last year’s benign hurricane season. This cyclicality is normal, and 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.

Schwab detracted from performance because improving frontier AI models caused investors to grow concerned that AI-powered cash optimization tools could erode the sweep cash balances that generate spread income, a meaningful contributor to the company's revenue and margins. These concerns weighed on the stock even though the underlying business performed well, with strong net new asset growth and rising trading volumes. Schwab already offers clients a range of higher-yielding cash alternatives, allowing rate-sensitive balances to move within the platform. Most remaining sweep cash is operational and used for trading, settlement, and fees. Moreover, most yield-seeking balances were already relocated during the last rate-hiking cycle, and sweep cash has since stabilized and grown, suggesting clients have largely optimized their cash allocations. Cash yield is not the primary basis on which Schwab competes; clients choose the firm for its scale, low costs, and breadth of services and advice. We view the market's reaction as a sentiment-driven overhang rather than a reflection of any meaningful deterioration in the company's long-term earnings power.

Performance in Real Estate and Industrials was hindered by losses from real estate data and marketing platform CoStar Group, Inc. and data and analytics vendor Verisk Analytics, Inc., respectively. Both companies were pressured by the broader market rotation out of information services names amid industry-wide AI fears. A softening P&C insurance pricing backdrop also weighed on Verisk’s stock price. We continue to own CoStar due to its enviable business model, differentiated data assets, and meaningful growth opportunities in providing enhanced real estate information, analytics, and marketplace offerings. The company also maintains a substantial cash balance, which we are hopeful will be used to aggressively repurchase shares at current depressed valuation levels. Similarly, we remain Verisk shareholders because of the competitive positioning, long-term growth, margin expansion, and capital deployment prospects for the business.