Baron Durable Advantage Fund: Latest Insights and Commentary

U.S. equity markets were volatile during the quarter, as positive sentiment and strong performance in January were undermined by AI-related disruption fears and geopolitical tensions. Small and mid caps generated positive returns in the first quarter while large caps declined, a margin of outperformance for small and mid caps not seen since the COVID rally in late 2020 and early 2021. 

The year began with positive momentum for U.S. stocks, supported by easing inflation, resilient economic trends, strong corporate earnings, and investor optimism about the Trump administration’s stimulative economic strategy. Market sentiment began to shift in February, with the early catalyst being widespread losses across a range of industries due to fears about AI-driven disruption. Technology and software companies experienced notable pressure as investors worried AI agents could directly replace human-led business workflows. The sell-off worsened after the U.S. and Israel attacked Iran on February 28. Investors became concerned about the potential for sustained inflation and reduced economic growth from surging oil prices and supply chain disruptions. 

Against this backdrop, the dominant market trend was the continued rotation out of the Magnificent Seven, software, and other growth-oriented stocks. The Magnificent Seven complex declined 11.3%, accounting for about 90% of the cap-weighted S&P 500 Index’s losses. Microsoft (-23.3%), Tesla (-17.3%), Meta (-13.3%), Amazon (-9.8%), and Alphabet (-8.1%) suffered the largest losses. The non-Magnificent Seven stocks in the Index were down only 0.6% for the month. 

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

• Monolithic Power Systems, Inc. (MPS) designs chips that deliver precise, safe, and efficient power to processors, memory, and sensors in electronic systems. With deep system-level expertise and highly integrated solutions, MPS has established a strong leadership position in power management. Shares rose during the quarter following raised full-year guidance and expectations for further upward revisions. The company is poised to benefit from two major secular trends: AI-driven data center redesigns and automotive electrification. AI is fueling exponential growth in data center power needs, forcing a fundamental rethink in how power is distributed. While server shipments are experiencing unprecedented growth, power content per system is also rising, creating a durable multi-year tailwind. At the same time, vehicles are shifting to centralized computing and higher-voltage architectures, significantly increasing the need for advanced power management content per vehicle. MPS’ leadership positions it to directly benefit from both the AI infrastructure buildout and long-term automotive electrification.
• Semiconductor giant Taiwan Semiconductor Manufacturing Company Limited (TSMC) contributed to performance as revenue growth exceeded expectations due to surging demand for AI chips. TSMC dominates the advanced semiconductor foundry market, controlling over 90% share of cutting-edge sub-7 nanometer (nm) nodes that power AI servers, flagship smartphones, and autonomous vehicles. The company benefits from a virtuous cycle in which its massive scale and profitability generate the capital necessary to fund industry-leading R&D and capex, in turn widening its technological moat and reinforcing its pricing power. As the ultimate "picks and shovels" provider of the AI era, TSMC remains insulated from the competitive dynamics of the AI chip design ecosystem. Whether hyperscalers develop custom accelerators or deploy merchant graphics processing units from companies like NVIDIA and AMD, nearly all advanced AI accelerators are manufactured exclusively at TSMC’s 3nm and 5nm nodes. We believe TSMC will deliver 20% earnings growth over the next several years, supported by secular AI-driven demand for leading-edge manufacturing capacity.
• CME Group, Inc. operates the world’s largest and most diversified derivatives marketplace. Shares rose due to higher trading volumes amid elevated market volatility. Average daily trading volume increased at a robust 22% pace during the first quarter, reflecting concerns over higher energy prices tied to the war in Iran, persistent inflation, and an uncertain outlook for interest rates. We continue to own the stock because we believe CME enjoys significant competitive advantages and should benefit from the growing adoption of exchange-traded derivatives and periodic spikes in market volatility.

DETRACTORS

• Software leader Microsoft Corporation detracted from performance despite reporting slightly better-than-expected revenue, margins, and earnings per share, with cloud revenue up 24% year over year in constant currency and commercial bookings up 228%, driven by commitments from OpenAI and Anthropic. Two factors pressured shares. First, Azure growth of 38% year over year in constant currency was slightly below expectations, reflecting capacity allocation across first- and third-party applications. Management continues to emphasize that Microsoft remains capacity constrained and is optimizing usage for long-term value, prioritizing applications such as Microsoft 365 Copilot to support future adoption. Second, investors are focused on the company’s reliance on first-party models from OpenAI and Anthropic, which plan to expand into the broader enterprise software market and account for a meaningful portion of remaining performance obligations (with OpenAI representing roughly 45%). We believe Microsoft is well positioned over the medium to long term, though we see a need for continued improvement in the pace of innovation in Microsoft 365 Copilot and in advancing model capabilities.
• 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 operating expenses above Street expectations, raising concerns that it may be overspending on AI for less clear returns relative to competitors. Near the end of the quarter, Meta also lost a jury verdict finding that its design choices led to user harm. Additionally, broader ad budgets became more uncertain due to the conflict in Iran. While we continue to monitor the regulatory landscape, we believe the company can drive premium revenue and profit growth in the foreseeable future. Meta benefits from AI investments across its 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). Longer term, Meta’s leadership in mobile advertising, massive user base, innovative culture, leading generative AI capabilities, and technological scale position it well for continued strong performance, with additional monetization opportunities ahead in areas such as smart glasses and commerce.
• Amazon.com, Inc. is the world’s largest retailer and cloud services provider. Shares detracted from performance during the quarter after the company guided to $200 billion in fiscal year 2026 capital expenditures, above Street expectations. While we believe Amazon Web Services (AWS) revenue growth will accelerate meaningfully over the next two years, particularly as leading AI companies increase AWS usage, the path to returns on invested capital remains uncertain in the near term. The company continues to expand operating margins across core North American retail, AWS, and international retail, driven by improved cost discipline and operational efficiencies. Over the longer term, Amazon has substantial room 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 growing cloud infrastructure market, with significant opportunities in application software, including enabling generative AI workloads.

The Quarterly Attribution Analysis for period ending March 31, 2026, is not yet available.