Baron Discovery Fund: Latest Insights and Commentary

U.S. stocks struggled during the first quarter of 2025 as the shock of Trump’s tariff war erased any optimism that the U.S. stock market or economy would continue to flourish under the new administration, replaced by heightened concerns of a possible recession. The mass layoffs of federal workers added to the confusion. The Magnificent Seven, which had led the market on AI-driven enthusiasm, were even harder hit by tariff uncertainties, as their relatively high valuations made them more exposed to a slowdown. In addition, the January launch of Chinese AI app DeepSeek as a less expensive alternative to U.S.-based AI models had investors questioning whether the massive investments in AI would ultimately produce the expected outsized returns. The Russell 2000 Growth Index declined 11.1%.

GDP growth is widely predicted to slow during 2025, reflecting weakening consumer demand and more cautious corporate spending. Consumer confidence has plummeted. The March 2025 inflation figure came in above the U.S. Federal Reserve’s target of 2%, as measured by the Consumer Price Index. The Fed has taken a wait-and-see approach as the effects of heightened U.S. policy uncertainty on growth, inflation, and employment play out. It left interest rates unchanged in its first meeting of the year.

Against this challenging backdrop, Baron Discovery Fund declined in the quarter. Investments within Communication Services and Financials contributed. Holdings within Information Technology (IT), Consumer Discretionary, and Health Care were the top detractors. Forum-based social media platform Reddit, Inc. drove gains within Communication Services. After a substantial run up, Reddit’s valuation had reached our projected price and we exited our position. Appreciation within Financials was driven by specialty insurer Kinsale Capital Group, Inc. IT had a difficult quarter, with broad losses led by second largest detractor indie Semiconductor, Inc. Sports betting and gaming app DraftKings Inc. led declines within Consumer Discretionary. Depreciation within Health Care was led by top detractor Exact Sciences Corporation.

The second quarter may bring with it as much doubt and volatility as the first quarter, given continued elevated uncertainty around tariffs. After reaching a record high of more than $3.3 trillion in corporate profits in the fourth quarter of 2024, U.S. companies are scrambling to estimate the potential impact of the tariff war. As first quarter earnings season approaches, many observers expect businesses to offer weaker earnings guidance for the rest of the year or withdraw guidance completely.

We are closely monitoring current market conditions while staying focused on company fundamentals -- well-managed businesses with durable competitive advantages and compelling growth prospects at attractive prices -- as we believe this is the best way to generate alpha over the long term, although there are no guarantees.

CONTRIBUTORS

• Inari Medical, Inc. offers catheter-based devices to remove clots from venous thromboembolism (VTE). VTE is the third most common vascular condition in the U.S. after heart attacks and strokes and can be fatal if left untreated. The market is still mostly greenfield, with patients receiving only ineffective drugs, and we believe there is room for multiple devices to win. Shares contributed to performance after Inari was acquired by Stryker in early January.
• Tempus AI, Inc. is an intelligent diagnostics and health care data company with two synergistic business units: Genomics and Data. Although shares have been volatile since its June 2024 IPO, we attribute these fluctuations to trading dynamics that do not reflect business fundamentals and have managed position size accordingly. We expect the company's cancer treatment selection Genomics business to continue to grow rapidly as the market develops. The Genomics data also enhances the Data business, as Tempus combines the genomics and clinical patient data to generate an enormous proprietary multimodal dataset. Tempus licenses this dataset to biopharmaceutical companies for use in designing smarter clinical trials and identifying new drug targets. We think this proprietary dataset is unique with meaningful barriers to entry and brings meaningful value to biopharmaceutical R&D.
• Shares of Kratos Defense & Security Solutions, Inc., a disruptive defense technology provider, rose following a strong quarterly earnings report that demonstrated notable strength across multiple segments and guided to faster-than-baseline growth in fiscal 2026. We believe Kratos is increasingly well positioned to accelerate growth with its exposure to what are arguably the fastest growing segments of the defense ecosystem, from hypersonics to solid rocket motors to unmanned solutions. The company is hitting its stride and making the requisite investments now to ramp production to satisfy future demand.

 

DETRACTORS

• Exact Sciences Corporation is a cancer diagnostics company whose flagship product is Cologuard, a stool-based screening test for colon cancer. Shares detracted for the quarter. We believe there is increasing investor concern around the terminal value of stool-based screening if blood-based screening proves more convenient in the long term. However, we would note that pre-cancer sensitivity is weak for blood-based screening, and Cologuard is significantly better at detecting pre-cancerous growths. In addition, with 60 million Americans not receiving any screening at all, we see opportunity for multiple players to win.
• Indie Semiconductor, Inc. makes fabless automotive semiconductors for advanced driver assistance (ADAS), in-cabin features, and other applications. Shares fell during the quarter on a miss in forward revenue guidance due to an inventory correction in the broader automotive semiconductor industry that was exacerbated by continued automotive uncertainty. We retain conviction. Revenue growth continued to outperform peers, and the company is winning new sockets in future platforms. Indie remains well positioned over the medium and long term, supported by its $7.1 billion strategic backlog and its radar, vision, and other programs that will ramp through 2025 and more meaningfully into 2026. We believe indie will return to outsized growth by the end of 2025 and significantly outpace the broader industry on its path to $1 billion in revenue by the end of this decade supported by contracted visibility. As its product mix shifts to ADAS, its margins should meaningfully improve as well.
• Montrose Environmental Group, Inc., a leading environmental solutions company, detracted during the quarter due to concerns regarding the Trump administration and reduced enforcement of environmental regulations that require the type of testing and monitoring the Montrose provides. We remain investors. Montrose's business is driven by state regulations as well as contaminants that have a long regulated history and bipartisan support. In addition, roughly 20% of Montrose's revenue comes from outside the U.S. Montrose has successfully grown through both Democratic and Republican administrations, and the company believes the Trump administration's initiatives on cost efficiency, U.S. manufacturing, and domestic energy production could create opportunities. We believe Montrose retains its competitive advantage and the sell-off is disproportionate to the potential magnitude of the impact.