Baron Discovery 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

• Arcellx, Inc. is a biotechnology company focused on cellular therapies. In partnership with Gilead, Arcellx is developing anito-cel, a BCMA-targeted CAR-T therapy similar to Legend Biotech and Johnson & Johnson’s Carvykti. Compared to Carvykti, anito-cel appears to demonstrate similar efficacy with a more benign neurological side-effect profile. Shares rose during the quarter as Gilead announced plans to acquire Arcellx for $115 per share, plus a $5 per share contingent value right tied to cumulative revenues through year-end 2029. 

DETRACTORS

• Intapp, Inc. offers a cloud software platform for professional verticals such as private equity, legal, and consulting firms. Shares fell due to sector-wide AI disruption concerns that hit legal-adjacent software stocks particularly hard, with Intapp declining sharply through mid-February after Anthropic announced new legal tools. These fears ultimately proved overstated. In March, Intapp hosted a compelling Investor Day that outlined a path to $1 billion in annual recurring revenue (ARR) by fiscal year 2029 and announced agreements with both Anthropic and Harvey, underscoring that AI hyperscalers see Intapp as a distribution partner rather than a target. Intapp also launched Celeste, a new agentic AI platform for regulated firms, opening a consumption-based pricing vector that taps into labor budgets beyond traditional IT spend. The underlying results were strong—fiscal second-quarter ARR grew 22% year over year, Cloud net revenue retention hit a record 124%, and the company authorized a $200 million buyback to capitalize on the dislocation. We retain conviction and believe Intapp's compliance moat and vertical depth position it well to monetize AI across its customer base.
• DraftKings Inc. is a leading U.S. digital sports betting and iCasino operator. Shares declined during the quarter as investors grappled with a guidance range that implied a slowdown in betting activity, elevated investment in prediction markets, and lingering debate around the sustainability of structural hold (the percentage of wagers retained as revenue). These headline concerns obscure what we believe are strong fundamentals in the core sports betting customer cohorts. Management built fiscal 2026 guidance on flat actual hold, even though hold has expanded every year in the industry's history. Parlay mix, the primary mechanical driver of hold, increased 500 basis points during NFL season and 200 basis points year to date. The $800 million EBITDA midpoint also embeds a $200 million headwind from prediction markets investment, which currently carries no associated revenue. Excluding that impact, implied core business EBITDA exceeds $1 billion. We believe the stock is trading at attractive multiples relative to the company’s long-term earnings potential and think the total addressable market for prediction markets, while nascent, has the potential to accelerate growth.

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) fell 10.65% (Institutional Shares) in the first quarter, trailing the Russell 2000 Growth Index (the Index) by 784 basis points principally due to adverse impacts from active industry exposures. According to MSCI’s Barra factor attribution, the Fund’s overexposure to Software and Health Care Equipment and Technology, which faced headwinds from concerns about AI-driven disruption, detracted approximately 250 basis points from relative results. Limited exposure to AI beneficiaries in Electrical Equipment and Communications Equipment, which were up sharply in the period, also weighed heavily on relative results. Finally, the Fund was hurt by having minimal exposure to various cyclical/commodity sensitive industries (Construction and Engineering, Oil and Gas Equipment and Services, Oil Gas and Consumable Fuels, and Chemicals) that were among the top performers in the period. Most of the remaining underperformance was style specific, with significant underexposure to Momentum being a major drag on relative performance, as the factor continued its strong run of performance to begin the year.

From a sector perspective, Information Technology holdings were responsible for about a third of the underperformance in the period, with the vast majority of losses coming from higher exposure to software stocks, which were down 23.8% in the Index. Following Anthropic's release of specialized Claude Cowork plugins, enabling AI to function as domain-specific analysts across legal, finance/accounting, sales/marketing, and customer support, the market decided that all software companies are AI losers and, as a result, every one of the Fund’s software holdings saw significant declines in the quarter. Despite generally strong fourth quarter earnings, the sharp losses have pushed software valuations to levels not seen in more than 15 years. Although the short-term results have been difficult, we see this environment as a chance to invest in truly attractive opportunities across software companies that in our view have strong and sustainable competitive advantages. There are multiple potential catalysts that could quickly change the market’s thinking on these software companies, and we want to be there to reap the benefits when that happens. 

Disappointing stock selection in Consumer Discretionary, Health Care, and Financials together with lack of exposure to the top performing Energy sector also hampered performance. Weakness in Consumer Discretionary was widespread, led by sharp losses from digital sports entertainment and gaming company DraftKings Inc. and fast-casual restaurant chain Wingstop Inc. DraftKings shares declined during the quarter as investors grappled with a guidance range that implied a slowdown in betting activity, elevated investment in prediction markets, and lingering debate around the sustainability of structural hold (the percentage of wagers retained as revenue). These headline concerns obscure what we believe are strong fundamentals in the core sports betting customer cohorts. Management built fiscal 2026 guidance on flat actual hold, even though hold has expanded every year in the industry's history. Parlay mix, the primary mechanical driver of hold, increased 500 basis points during NFL season and 200 basis points year to date. The $800 million EBITDA midpoint also embeds a $200 million headwind from prediction markets investment, which currently carries no associated revenue. Excluding that impact, implied core business EBITDA exceeds $1 billion. We believe the stock is trading at attractive multiples relative to the company’s long-term earnings potential and think the total addressable market for prediction markets, while nascent, has the potential to accelerate growth.

Wingstop’s stock fell during the quarter as revenue trends were weighed down by macroeconomic challenges impacting Wingstop’s core customers. While near-term results remain pressured, we continue to believe Wingstop is a unique restaurant concept with a long growth runway supported by best-in-class unit economics. The company’s recent technological enhancements should also reduce wait times for consumers, which we expect will support improved topline performance. 

Within Health Care, a handful of holdings weighed heavily on performance, with the principal detractors being Repligen Corporation, a life sciences company focused on bioprocessing technology leadership, and Establishment Labs Holdings Inc., a medical device company focused on women's health. Repligen shares declined during the quarter as the life sciences sector came under pressure following a weak round of fourth-quarter earnings reports. We are still awaiting stabilization across multiple fronts, including biotechnology spending, National Institutes of Health funding, U.S. Food and Drug Administration disruptions, and budget pressure across the pharmaceutical industry related to the Most Favored Nation drug-pricing rule. Despite these near-term headwinds, we continue to have high conviction in Repligen’s long-term growth story. We view Repligen as a high-quality compounder with a best-in-class mix of growth and margins, and a path to doubling its revenue base over the next five years while expanding EBITDA margins by roughly 1,000 basis points.

Establishment Labs sells next-generation Motiva breast implants designed to offer meaningful safety improvements and aesthetic benefits compared to competing products. Motiva implants are associated with significantly lower rates of capsular contracture, have no known cancer risk, and offer a more natural Ergonomix shape with softer fill and the potential for smaller scars. Shares fell following robust full-year 2025 and fourth-quarter results, as rising oil prices and broader macroeconomic uncertainty weighed on consumer demand for what is ultimately a big-ticket discretionary purchase. Investors also remain focused on upcoming negotiations with the company's silicone supplier, though Establishment Labs is a top customer and we expect the contract renewal to result in only modest margin pressure. Motiva implants have gained significant share across international markets, and the U.S. launch is underway and progressing well, with early penetration of roughly 20% of the U.S. breast augmentation market. Big picture, we believe Establishment Labs can capture a leading position in the U.S. over the next several years, driving strong revenue growth, improving profitability (free cash flow positive in 2026), and meaningful long-term value creation.

Performance in Financials was hindered by declines from insurance distribution company TWFG, Inc. and global private markets investment firm StepStone Group Inc. TWFG’s shares fell on market fears that AI will disrupt insurance agents, particularly if insurance is sold through large language models rather than independent agents. We think any disruption, if it occurs, will unfold over a long period. TWFG’s agents are deeply embedded in their communities, support policyholders through the complex buying process, and remain available to help with servicing and claims. Policyholders are also likely to want the reassurance of a human agent when insuring their homes, typically one of their most valuable assets. Additionally, TWFG is using AI to improve agent productivity. We believe consumer behaviors shift gradually, which should allow the company to continue executing and growing earnings.

StepStone detracted from performance due to concerns sweeping the private markets space, particularly around exposure to private credit. Fears over credit quality and future fundraising drove a broad sell-off across the sector. Additional volatility related to AI and the conflict in Iran also raised concerns that capital markets activity could be weaker than expected in 2026. StepStone remains a well-diversified manager, and the company has not seen any signs of credit issues as of yet. As a solutions provider, StepStone has access to fund- and investment-level data from a wide range of general partners, giving it a uniquely broad view into market health. The company also has limited exposure to retail credit, and retail flows outside of credit (which represents roughly 90% of StepStone’s retail business) have remained resilient, suggesting the company can continue to fundraise effectively in the retail channel alongside its strong institutional business.

Partially offsetting the losses above was solid stock selection in Consumer Staples along with the benefit of having a modest cash position in worsening marketing conditions. Strength in Consumer Staples came from Primo Brands Corporation, the leading North American water solutions company. Primo Brands’ stock performed well after the company’s fourth-quarter results exceeded expectations on both the top and bottom line. Direct-delivery volume declined only 5.3% year over year—significantly better than buy-side expectations for a 10% to 12% decline—and EBITDA of $334 million came in ahead of consensus, with margins expanding 260 basis points to 21.5%. The direct delivery outperformance implies a meaningfully stronger starting point for the 2026 recovery, and management reiterated its expectation for a return to positive volume growth as integration-related disruptions are lapped in the second half of the year. Premium brands Mountain Valley Spring and Saratoga grew 39% in the fourth quarter and 44% for the full year, though growth remained constrained by capacity. Management is adding capacity for Mountain Valley Spring in mid-2026, signaling a revenue unlock in 2027 and beyond. We recently met with the new CEO and retain conviction in the delivery recovery timeline and the long-term prospects for the business.