Baron Durable Advantage 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

• 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. Shares rose during the quarter on continued momentum in Broadcom’s AI-related revenue and growing investor confidence in its capabilities in AI application-specific integrated circuits and networking. Improved visibility into 2026 revenue further supports our view. VMware, Broadcom’s recently acquired cloud infrastructure software business, is performing in line with expectations, while the non-AI semiconductor segment appears to have bottomed and is poised for a recovery over the next 12 months. We retain strong conviction in Broadcom's long-term outlook, as the company is well positioned to capture a majority share of the $60 to $90 billion serviceable addressable market by 2027, driven by demand from key customers such as Google, Meta, and ByteDance.
• NVIDIA Corporation is a fabless semiconductor company specializing in compute and networking platforms for accelerated computing. The company's dominant position in AI infrastructure—with a comprehensive portfolio spanning GPUs, systems, software, and high-performance networking solutions—continues to drive strong performance. Shares rose during the quarter as signs emerged that the AI cluster buildout is likely to extend into 2026, with NVIDIA maintaining its leadership. The company also removed all AI-related revenue contributions from China, effectively de-risking that part of the business. We maintain a long-term constructive view, as leading AI labs show growing confidence in their ability to achieve human-level intelligence and deploy AI products in enterprise settings. Many top labs are significantly expanding their compute budgets, particularly to advance reinforcement learning for AI agents operating in real-world environments. We believe these labs will begin capturing meaningful value as large-scale use cases are identified and monetized. This, in turn, should further support investment in AI infrastructure as confidence in long-term returns grows.
• Shares of Meta Platforms, Inc., the world’s largest social network, rose this quarter on impressive top-line growth and solid forward guidance. Meta is already seeing returns on its AI investments across its core business, with improved content recommendations driving increased time spent on the platform, and enhanced ad targeting and ranking delivering higher conversion rates and stronger return on ad spend. Our industry checks also suggest strong advertiser adoption and satisfaction, including in newer areas such as AI-powered creative tools and business messaging. Meta continues to manage costs effectively and remains focused on profitable growth. We believe the company is well positioned to drive long-term growth by leveraging its leadership in mobile advertising, massive global user base, innovative culture, strength in generative AI research, broad distribution reach, and unmatched technological scale.

DETRACTORS

• UnitedHealth Group Incorporated is a diversified health and well-being company with $450 billion in annual revenue, operating across four segments: UnitedHealthcare, Optum Health, Optum lnsight, and Optum Rx. Shares fell sharply during the quarter after the company missed earnings estimates and cut its 2025 earnings per share guidance, citing higher-than-expected medical costs in its Medicare Advantage (MA) business. Investor confidence was further shaken in early May by the abrupt departure of CEO Andrew Witty and the suspension of 2025 guidance. The company also mispriced its MA business for 2025—a challenge compounded by reimbursement changes and an influx of newly acquired members who had not been properly risk coded. While we acknowledge UnitedHealth’s potential to restore profitability in this segment over time through disciplined pricing and benefit adjustments, we chose to exit our position during the quarter in favor of other opportunities.
• Thermo Fisher Scientific Inc. is a life sciences company that offers instruments and consumables for research, tools for bioproduction, specialty diagnostics, and contract research and manufacturing services. Shares detracted from performance during the quarter. The life sciences segment remains under pressure due to continued grant cancellations by the National Institutes of Health and persistent funding constraints at universities. We retain conviction as Thermo Fisher is dominant across multiple end markets and its scale gives it resilience. Once the macroeconomic environment stabilizes, we expect the company to resume organic growth in the high single-digit range and deliver double-digit earnings-per-share growth.
• Shares of Texas Instruments Incorporated (TI), the leading global analog semiconductor company, fell during the quarter amid investor concerns about the impact of tariffs on semiconductors and their end markets, as well as a potential delay in the industry’s cyclical recovery. The company has been investing heavily in 300-millimeter wafer capacity to support revenue growth over the next 10 to 15 years and is now nearing the end of this investment cycle. While 300-millimeter capacity offers significant cost advantages over the 200-millimeter wafers used by many competitors, TI's free cash flow has been meaningfully pressured in the near term. We expect free cash flow to improve as the industry rebounds, revenue grows, and capital expenditures decline; however, we believe this upside is already reflected in the stock’s valuation. We exited the position in favor of opportunities with more attractive risk-reward profiles.

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 Durable Advantage Fund (the Fund) rebounded in the second quarter, recovering all absolute and relative losses from the prior quarter. The Fund appreciated 15.63% (Institutional Shares) for the three months ended June 30, 2025, beating the S&P 500 Index (the Index) by 469 basis points. The principal driver of outperformance was stock selection, though the Fund also benefited from its overexposure to higher beta stocks. The Beta factor experienced one of its best three-month periods of performance in the last quarter century, serving as a material tailwind to performance.

From a sector perspective, strong stock selection in Information Technology (IT) contributed 400-plus basis points of relative gains or the vast majority of outperformance in the period. Semiconductor holdings Broadcom Inc. and Taiwan Semiconductor Manufacturing Company Limited (TSMC) led the way in the sector after their share prices increased 65.0% and 36.8%, respectively. Broadcom was the top contributor due to continued momentum in the company’s AI-related revenue and growing investor confidence in its capabilities in AI application-specific integrated circuits and networking. TSMC’s stock performed well during the second quarter, driven by robust demand for AI chips and easing investor concerns about tariffs and macroeconomic risks. Accounting software provider Intuit Inc. was another standout in the sector after reporting better-than-expected financial results and raising full-year guidance. In the most recent quarter, revenue grew 15% and earnings per share grew 18%, with TurboTax revenue exceeding Street expectations due to greater adoption of higher-priced Live assisted services. Revenue growth remained strong in the small business segment despite macroeconomic concerns, and the Credit Karma segment also delivered solid growth.

Stock-specific strength in IT was enhanced by the Fund’s lack of exposure to Index heavyweight Apple Inc., whose share price declined 7.5% when the broader market was up double digits. Not owning Apple accounted for about a third of the gains in the sector.

Favorable stock selection in Communication Services and lack of or lower exposure to the lagging Energy, Health Care, Consumer Staples, Utilities, and Materials sectors accounted for most of the remaining relative gains. Social network Meta Platforms, Inc. was the largest contributor in Communication Services after reporting impressive top-line growth and solid forward guidance. Meta is already seeing returns on its AI investments across its core business, with improved content recommendations driving increased time spent on the platform, and enhanced ad targeting and ranking delivering higher conversion rates and stronger return on ad spend. Our industry checks also suggest strong advertiser adoption and satisfaction, including in newer areas such as AI-powered creative tools and business messaging. Meta continues to manage costs effectively and remains focused on profitable growth.

Somewhat offsetting the above was disappointing stock selection in Health Care, where weakness was broad based, led by double-digit declines from diversified health and well-being company UnitedHealth Group Incorporated and life sciences leader Thermo Fisher Scientific Inc. UnitedHealth’s shares fell sharply for the period held after the company missed earnings estimates and cut its 2025 earnings per share guidance, citing higher-than-expected medical costs in its Medicare Advantage business. Investor confidence was further shaken in early May by the abrupt departure of CEO Andrew Witty and the suspension of 2025 guidance. The company also mispriced its Medicare Advantage business for 2025—a challenge compounded by reimbursement changes and an influx of newly acquired members who had not been properly risk coded. While we acknowledge UnitedHealth’s potential to restore profitability in this segment over time through disciplined pricing and benefit adjustments, we chose to exit our position during the quarter in favor of other opportunities.

Thermo Fisher was a top detractor as the company’s life sciences segment continued to face headwinds from grant cancellations by the National Institutes of Health and persistent funding constraints at universities. We retain conviction as Thermo Fisher is dominant across multiple end markets and its scale gives it resilience. Once the macroeconomic environment stabilizes, we expect the company to resume organic growth in the high single-digit range and deliver double-digit earnings-per-share growth.

Significantly higher exposure to the lagging Financials and Real Estate sectors detracted another 130-plus basis points from relative results.