Baron Discovery 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

• Leading defense technology provider Kratos Defense & Security Solutions, Inc. contributed to performance during the quarter amid growing momentum across the business. We believe Kratos is well positioned for accelerated multi-year growth, as prior investments in high-growth areas of defense—such as hypersonics, drone engines and small missile engines, space, microwave electronics, and unmanned systems—are translating into larger contract awards. Demand is being driven by increased funding from the Department of Defense and other global militaries. In our view, the current operating environment has never been better, and few companies are as well equipped as Kratos to deliver the advanced solutions required for modern warfare.
• Shares of Montrose Environmental Group, Inc., a leading environmental services company, rebounded during the quarter. The stock had fallen sharply earlier in the year due to concerns that environmental policy changes and new leadership at the Environmental Protection Agency under President Trump would reduce enforcement of regulations underpinning Montrose’s testing and monitoring services. These concerns ultimately did not materialize, and the company continues to grow, supported by strong secular tailwinds such as rising industrial activity and increased regulatory oversight at the state level. Montrose’s decision to pause acquisition spending has also allowed its organic growth profile to stand out, while the payoff of its convertible debt has increased transparency, helping unlock value for shareholders. We remain invested in Montrose, as we believe the company retains its competitive advantage, stands to benefit from secular growth trends, and trades at an attractive valuation.
• Shares of Karman Holdings Inc., a best-in-class supplier of defense systems, rose during the quarter after the company reported strong earnings results that exceeded investor expectations. The company is well positioned across nearly all of the fastest-growing areas within the upcoming $1 trillion-plus U.S. defense budget and is likely to play a pivotal role in supporting U.S. involvement in an expanding number of global conflicts. We believe Karman’s position as the go-to outsourced solutions provider for the largest and most dominant defense companies should enable it to outpace overall defense budget growth and continue to earn exceptional margins.

DETRACTORS

• Clearwater Analytics Holdings, Inc. provides portfolio accounting and reporting software. While the company reported strong quarterly earnings and its business fundamentals remain solid, shares fell as investors sought evidence that management can successfully integrate its three recent acquisitions without disrupting the core business. Insider selling also weighed on sentiment, though that overhang now appears largely resolved. We retain conviction in the stock. We believe Clearwater has meaningful competitive advantages and the potential to compound revenue at a high-teens to 20% rate for several years. The company has an efficient business model that should drive 40%-plus adjusted EBITDA margins over time.
• Inspire Medical Systems, Inc. is a medical device company offering a treatment option called hypoglossal nerve stimulation for patients with moderate-to-severe obstructive sleep apnea. Shares declined during the second quarter. The company is in the early stages of commercializing its fifth-generation device, Inspire 5, which reduces procedure time and simplifies the process for surgeons. Management noted that some patients delayed surgery in anticipation of the new device, leading to a slowdown in procedures during the quarter. Shares were also pressured by concerns about new competitors entering the market and the potential long-term impact of GLP-1 weight loss drugs on business, given the link between obesity and sleep apnea. Despite these headwinds, we believe Inspire remains well positioned to grow at a healthy rate, supported by its market leadership and the substantial size of the addressable patient population. We believe the current valuation presents a compelling entry point given the company’s long-term growth potential.
• The Macerich Company is a REIT that owns and operates a high-quality portfolio of malls and shopping centers across the U.S. Shares declined during the quarter amid concerns that strong retail leasing demand could soften due to tariff-related pressures and broader macroeconomic uncertainty. While we remain optimistic about the company’s longer-term prospects and the potential for valuation multiple expansion under new CEO Jackson Hsieh, we chose to exit the position during the quarter given ongoing headwinds and the opportunity to reallocate capital to higher-conviction ideas.

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 Discovery Fund (the Fund) outperformed the Russell 2000 Growth Index (the Index) for a fourth straight quarter. The Fund appreciated 14.76% (Institutional Shares) for the three months ended June 30, 2025, beating the Index by 279 basis points. The outperformance stemmed from a combination of stock selection and differences in sector exposures. 

Stock selection in Industrials, Consumer Discretionary, and Health Care accounted for most of the outperformance in the period. Strength in Industrials was partly driven by a bounce back quarter for environmental services company Montrose Environmental Group, Inc. Montrose’s stock had fallen sharply earlier in the year due to concerns that environmental policy changes and new leadership at the Environmental Protection Agency under President Trump would reduce enforcement of regulations underpinning the company’s testing and monitoring services. These concerns ultimately did not materialize, and the company continues to grow, supported by strong secular tailwinds such as rising industrial activity and increased regulatory oversight at the state level. Montrose’s decision to pause acquisition spending has also allowed its organic growth profile to stand out, while the payoff of its convertible debt has increased transparency, helping unlock value for shareholders. Stock selection was further enhanced by having meaningful exposure to strong performing aerospace & defense stocks via positions in Kratos Defense & Security Solutions, Inc., Karman Holdings Inc., Mercury Systems, Inc., and Loar Holdings Inc. These holdings were up 40.9% as a group, contributing a significant portion of the relative gains in the sector.

Performance in Consumer Discretionary was bolstered by fast-casual restaurant chain Wingstop Inc. and online sportsbook and gaming operator DraftKings Inc. Wingstop’s shares rebounded sharply during the quarter, driven by growing investor confidence in a recovery in sales growth as the year progresses, improving fundamentals, and a compelling valuation. Additionally, Wingstop reported strong quarterly results and saw positive momentum following the announcement of new kitchen technology expected to accelerate sales beginning in the second half of 2025 and beyond. DraftKings stock rose during the quarter on improved business fundamentals and easing regulatory and tax uncertainty. At the start of the quarter, investor concerns about tariffs and their potential impact on consumer spending initially weighed on the stock. However, state-reported data later showed accelerating betting volumes and rising win rates, alleviating fears of a slowdown in online sports betting demand. DraftKings also responded to an unexpected tax increase in Illinois by implementing surcharges to offset higher costs, while New Jersey finalized a new tax rate below the governor’s initial proposal—at a level we view as favorable for operating margins.

Within Health Care, strong performance from Exact Sciences Corporation and limited exposure to lagging biotechnology and pharmaceutical stocks were material contributors. Exact Sciences is a molecular diagnostics company focused on the early detection of colorectal cancer. The company is best known for its non-invasive colorectal cancer stool tests, Cologuard and Cologuard Plus. Shares underperformed last year due to slowing Cologuard adoption, anticipated competition from Guardant Health which launched a colorectal cancer blood test, and fears about a worst-case outcome from a Supreme Court case that had potential implications for insurance coverage mandates for Cologuard. Exact Sciences shares re-rated in the quarter after the restructuring of the commercial team contributed to a reacceleration in Cologuard volume growth and the Supreme Court issued its decision in the Braidwood case that preserved the insurance coverage mandate.

Outside of stock selection, the Fund’s lack of exposure to the lagging Consumer Staples and Energy sectors and meaningfully higher exposure to the top performing Information Technology (IT) sector added another 180-plus basis points of relative gains.

Somewhat offsetting the above were adverse impacts from Fund’s cash position in a rising market and disappointing stock selection in IT, Real Estate, and Financials. The Fund’s IT holdings were up 15.9% in the period, failing to keep pace with their counterparts in the Index due to double-digit declines from application software companies Clearwater Analytics Holdings, Inc. and Intapp, Inc. Investment accounting software provider Clearwater was the largest detractor despite reporting strong quarterly results as investors sought evidence that management can successfully integrate its three recent acquisitions without disrupting the core business. Insider selling also weighed on sentiment, though that overhang now appears largely resolved. We remain shareholders.

Intapp offers a cloud software platform for professional services firms across the legal, consulting, and financial sectors. The company reported annual recurring revenue up 19% year over year, trailing 12-month free cash flow margins above 21%, and a modest increase in its fiscal year guidance. However, shares detracted from performance amid macroeconomic uncertainty and concerns that a slowdown in global M&A and capital markets activity could temporarily pressure budgets in Intapp’s high-growth investment banking and private equity verticals. Additionally, a portion of Intapp’s customer base is transitioning from on-premise licenses to cloud contracts. While this shift is positive over the long term, as cloud customers typically spend more, it may weigh on near-term GAAP revenue. We view these headwinds as temporary. We continue to believe Intapp has a long runway for growth and margin expansion as its deal management, compliance, and collaboration solutions continue to gain share. We are also encouraged by its expansion into adjacent verticals like real estate, which meaningfully broadens its addressable market.

Weakness in Real Estate and Financials was driven by declines from apartment REIT Independence Realty Trust, Inc. (IRT) and specialty insurer Kinsale Capital Group, Inc., respectively. IRT’s shares declined during the quarter due to broader economic concerns, including the potential impact of tariff polices on lower-income consumers, softer-than-expected pricing power on new leases, and mixed investor reception of select strategic acquisitions. We retain conviction in IRT due to its superior management team, high-quality portfolio in select markets, and demonstrated ability to drive outsized earnings growth through its value-add program. Kinsale gave back some gains from earlier in the year after reporting premium growth below Street expectations and slowed from the prior quarter due to lower pricing for large property policies. Nevertheless, earnings beat expectations due to better underwriting margins, more favorable reserve development, and smaller catastrophe losses. We continue to own the stock because we believe Kinsale is well managed and has a long runway for growth in an attractive segment of the insurance market.