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.

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) appreciated 2.65% (Institutional Shares) in the fourth quarter, performing similarly to the S&P 500 Index (the Index), which rose 2.66%. The Fund failed to distance itself from the Index because favorable stock selection was largely offset by differences in sector weights. 

Solid stock selection in Consumer Discretionary and Financials added the most value in the period. Strength in Consumer Discretionary came from the Fund’s sizable position in retailer and cloud service provider Amazon.com, Inc., whose shares rose due to a reacceleration in Amazon Web Services (AWS) growth. As we continue to monitor progress across the cloud hyperscalers, we believe AWS is well positioned to benefit from increased AI-related spending as capacity constraints ease in the coming quarters. Amazon is also improving profitability across its core North American retail, AWS, and international retail segments, driven by greater cost discipline and operational optimization. Over the long term, the company retains substantial runway for growth in e-commerce, where it has less than 15% penetration of its total addressable market. Amazon also remains the clear leader in the large and expanding cloud infrastructure market, with significant opportunities in application software, including enabling generative AI workloads. 

The Fund also benefited from not owning home improvement retailer Home Depot, Inc., whose stock fell nearly 15% in the period.

Several holdings performed well in Financials, with alternative asset manager Apollo Global Management, Inc., independent broker-dealer LPL Financial Holdings Inc., and credit rating and data providers Moody’s Corporation and S&P Global Inc. accounting for most of the gains.

Mostly offsetting the above was the adverse impact of being underexposed to Health Care, which was top performing sector in the Index thanks to strong gains from Eli Lilly and Company, Merck & Co., Inc., and other large-cap pharmaceutical stocks.

Yearly Attribution Analysis (for year ended 12/31/2025)

Baron Durable Advantage Fund (the Fund) appreciated 16.56% (Institutional Shares) for the year, modestly trailing the S&P 500 Index (the Index) by 132 basis points as disappointing stock selection overshadowed the favorable impact of active sector weights.

Strong stock selection in Information Technology (IT) was a major highlight in the period, contributing 400-plus basis points of relative gains. Semiconductor holdings Taiwan Semiconductor Manufacturing Company Limited (TSMC), Monolithic Power Systems, Inc., and Broadcom Inc. led the way in the sector after their share prices appreciated more than 50% during the year. TSMC performed well because robust AI chip demand drove stronger-than-expected revenue growth. MPS’s shares rose as concerns over potential share loss at NVIDIA eased following robust earnings results, with growth from other AI-related customers offsetting early-year NIVIDA softness and management reiterating that its position within the NVIDIA ecosystem is expected to remain strong over the long term. Broadcom’s stock benefited from increased investor confidence in the company’s central role in the AI infrastructure build-out. As leading hyperscalers and frontier AI labs increasingly seek greater control over their technology stacks to improve performance and cost efficiency, Broadcom has emerged as the only scaled merchant supplier capable of co-designing custom accelerators and networking platforms and delivering them reliably at volume.

Stock-specific strength in IT was enhanced by the Fund’s lack of exposure to Index heavyweight Apple Inc., whose share price performance trailed the broader market during the period.

The Fund’s lower exposure to Consumer Staples, overexposure to Communication Services, and lack of exposure to Energy added another 118 basis points of relative gains.

Entirely offsetting the above was poor stock selection in Financials and Health Care. Weakness in Financials was wholly responsible for the relative shortfall in the period, owing to disappointing stock selection and, to a lesser degree, significantly higher exposure to this lagging sector. Stock-specific weakness was widespread, with alternative asset managers Apollo Global Management, Inc. and Blackstone Inc. being among the top detractors. Apollo and Blackstone shares detracted from performance amid a difficult year for the industry, with most alternative managers underperforming. There were three key drivers of the weakness. First, the industry benefited from strong performance at the end of 2024, which drove elevated expectations for a capital markets rebound in 2025 following the election of Donald Trump. However, the environment proved more muted than anticipated, in part due to heightened market volatility. Second, several prominent bankruptcies raised concerns around private credit markets, pressuring private credit-exposed stocks. Lastly, company-specific issues weighed on their respective share prices. Apollo faced headwinds in its Retirement Services business, as falling interest rates, tight credit spreads, and elevated prepayments weighed on growth in spread-related earnings, while Blackstone reported lower-than-expected asset monetizations and slightly weaker-than-anticipated fee growth. We remain invested in both companies.

Weakness in Health Care was broad-based led by poor performance from UnitedHealth Group Incorporated, whose shares fell sharply alongside other managed care companies amid elevated medical cost trends, particularly within Medicare Advantage, as government reimbursement cuts, inadequate state Medicaid payments, and broader reimbursement uncertainty pressured the sector. UnitedHealth’s reputation for highly predictable earnings was disrupted in the second quarter following unfavorable utilization trends, the subsequent resignation of its CEO and CFO, and the withdrawal of annual guidance, which rattled investors. We view the return of the company’s former, well-regarded CEO positively and believe management is taking steps to stabilize the business. While we expect earnings to recover over time through repricing initiatives, benefit adjustments and network redesigns, strategic exits from unprofitable markets, gradual improvement in Medicaid rate environments, and efficiency gains from investments in AI and technology, we exited our position in favor of other opportunities.