Baron Durable Advantage Fund: Latest Insights and Commentary

U.S. equities delivered a steady finish to an otherwise turbulent year in the fourth quarter of 2025, with moderate gains across most indexes amid easing economic pressures and holiday-season stability. Large caps outperformed, while mid caps lagged and small caps delivered more modest advances. Market participation broadened beyond technology, with value stocks faring better than growth across all size segments. Multiple record highs were reached during the quarter, with the S&P 500 Index and Dow Jones Industrial Average peaking on December 24, the NASDAQ Composite reaching several all-time highs earlier in the quarter, and the Russell 2000 hitting a fresh peak on December 11. Volatility spikes in mid-October and mid-November proved short-lived, and the CBOE Volatility Index reached a 2025 low by late December, supported by resilient economic data.

Fourth-quarter gains were underpinned by moderating tariff impacts, robust corporate earnings, and continued monetary easing. Following a 25-basis-point rate cut in September, the Federal Reserve lowered rates twice more during the quarter, with additional 25-basis-point cuts in October and December. Investor sentiment reflected optimism, as Bank of America’s mid-December Global Fund Manager Survey showed the most bullish outlook in three-and-a-half years, with record-low cash levels and elevated allocations to equities and commodities, though concerns persisted around AI bubbles, private credit events, and elevated hyperscaler capital spending. While a prolonged government shutdown introduced some uncertainty, resilient labor market conditions and the absence of major inflation spikes helped support the rally.

The Magnificent Seven complex posted another positive quarter, rising 3.6%, though gains moderated meaningfully from prior quarters. The group outperformed the broader S&P 500 Index and accounted for nearly half of the Index’s gains. Performance within the group was mixed, led by Alphabet, which surged 28.8%, followed by Apple and Amazon. Tesla edged higher but trailed the broader market, while Meta, Microsoft, and NVIDIA declined during the period.

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

CONTRIBUTORS

• Alphabet Inc. is the parent company of Google, the world’s largest search and online advertising company. Shares rose on strength in the company’s core businesses, as well as in Google Cloud and Other Bets. Despite rising usage of AI competitors such as ChatGPT, both Search and YouTube delivered double-digit revenue growth year over year. Additionally, Google Search paid clicks increased compared to the prior year. Google also released the latest version of its AI assistant Gemini, which currently sits at the top of most AI leaderboards, suggesting the company’s frontier AI research capabilities have improved significantly since the launch of ChatGPT. Meanwhile, Cloud revenue growth also accelerated 34% year over year, driven by demand for AI cloud services. We believe there is further runway for cloud acceleration given a significant increase in backlog and a large deal announced with leading AI startup Anthropic. Long term, we believe AI innovation could lead to strength in adjacent fields (e.g., travel) and a continued healthy cloud infrastructure business in Google Cloud Platform (GCP), though we continue to monitor competitive pressures in search and monetization.

• Semiconductor giant Taiwan Semiconductor Manufacturing Company Limited (TSMC) contributed to performance during the quarter, driven by robust demand for AI chips. We retain conviction that TSMC’s technological leadership, pricing power, and exposure to secular growth markets—including AI and high-performance computing, automotive, 5G, and Internet of Things—will allow the company to sustain strong double-digit earnings growth over the next several years.

• Broadcom Inc. is a leading fabless semiconductor and enterprise software company, generating approximately 60% of revenue from semiconductors and 40% from software. The company is strategically positioned at the intersection of high-performance AI compute and networking infrastructure, while also demonstrating disciplined execution in software. Broadcom has extended its leadership in merchant networking silicon from the cloud era into the AI era and is regarded as the most reliable silicon partner for AI foundational model builders designing custom chips to train frontier models. Shares rose as Broadcom provided increased visibility into its customer pipeline and shared details on revenue contributions from Anthropic and its overall backlog. The company continues to execute on its custom silicon programs, including its core customer Google, ongoing programs rumored to include Meta and ByteDance, and newer engagements such as Anthropic. Broadcom is also advancing VMWare integration, while its non-AI semiconductor businesses appear to be bottoming and may gradually recover in the coming quarters. We retain our long-term conviction in Broadcom's positioning within the AI ecosystem.

DETRACTORS

• Meta Platforms, Inc., the world’s largest social network, detracted from performance. While Meta reported strong quarterly results and forward revenue guidance, management guided to 2026 capital and operating expenditures above Street expectations, raising concerns that it may be overspending in AI for less certain returns relative to competitors. Still, we believe Meta continues to benefit from its AI investments across the core business, driving improvements in content recommendations (with rising time spent) and in ad targeting and ranking (leading to higher conversions and better return on ad spend). Our industry checks also validate strong advertiser adoption and satisfaction, including in newer areas such as easy-to-use AI creative tools and business messaging. We believe Meta will begin to realize returns from its AI investment or rationalize spending over time. Longer term, Meta’s leadership in mobile advertising, massive user base, innovative culture, leading generative AI research and distribution, and technological scale position it well for continued performance, with additional monetization opportunities ahead in areas such as smart glasses and commerce.

• CoStar Group, Inc. is the leading provider of information and marketing services to the commercial and residential real estate industries. Shares fell as the company’s net new sales came in below expectations. The stock has been weighed down by significant growth investment in CoStar’s residential product, where sales performance has remained modest. That said, we are encouraged by improving momentum as the company builds out its dedicated residential sales force, enhances its customer targeting, and potentially benefits from changes in Multiple Listing Service practices. We also expect growth in CoStar’s non-residential business to accelerate as sales productivity ramps and the sales team refocuses on core offerings, a trend likely to be amplified by 20% sales force growth in 2025 alone. We believe the value of CoStar’s core non-residential business exceeds the current share price of the stock, suggesting that investors are ascribing little value to the long-term residential opportunity.

• Shares of software leader Microsoft Corporation fell during the quarter. Management highlighted accelerating demand signals across bookings, remaining performance obligations, and product usage, but pointed to supply constraints extending at least through fiscal 2026. We retain conviction in the stock. Microsoft reported slightly accelerating year-over-year constant currency revenue growth in fiscal Q1, alongside stable gross margins and expanding operating margins. The company ended the quarter with current remaining performance obligations (cRPO) of $157 billion, up 35% year over year, and expects cRPO to rise to roughly $167 billion in the second quarter. Assuming Microsoft’s recently announced $250 billion OpenAI agreement spans five years, it would add about $50 billion to cRPO, implying a potential balance of roughly $217 billion early next year. cRPO is a key forward-looking indicator of commercial revenue growth and now represents approximately 80% of total revenue. We are confident in the durability of Microsoft’s revenue growth profile, while the company’s strong operating expense discipline suggests there is additional room for margin expansion.