Baron Discovery 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

• Exact Sciences Corporation is a molecular diagnostics company focused on the early detection of colorectal cancer. The company is best known for Cologuard, its non-invasive, stool-based colorectal cancer screening test. Shares contributed to performance after Abbott Laboratories announced an agreement to acquire Exact Sciences for approximately $23 billion in November, representing a premium of more than 50% to the prior closing price. Long term, roughly half of the 106 million adults in the U.S. recommended for colorectal cancer screening are not up to date, and we believe Cologuard offers a compelling combination of non-invasiveness and strong sensitivity and specificity to address this unmet need.
• Establishment Labs Holdings Inc. 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 a softer feel and the potential for smaller scars. Shares rose during the quarter as Motiva implants continued to gain significant share across international markets, while the U.S. launch is now underway and progressing well, with early penetration of roughly 20% of the U.S. breast augmentation market. We believe Establishment Labs can capture a leading share 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.
• Clearwater Analytics Holdings, Inc., a provider of portfolio accounting and reporting software, contributed to performance. The company reported solid Q3 2025 earnings and raised 2025 guidance. Clearwater also announced that a consortium of private equity investors intends to acquire the company, which drove a sharp positive market reaction. We retain conviction and believe Clearwater has meaningful competitive advantages and the potential to compound revenue at attractive rates for several years. The company has an efficient business model that should drive 40%-plus adjusted EBITDA margins over time.

DETRACTORS

• Varonis Systems, Inc. is a cybersecurity company focused on classifying and protecting corporate data. Shares detracted from performance. While the company’s core software-as-a-service business (76% of total revenue) remained strong, growing more than 100% year over year on the back of new customer wins and increased data protection by existing customers, results were offset by higher-than-expected churn among on-premise commercial and U.S. federal government customers toward the end of September. This led management to lower its full-year outlook. During the quarter, Varonis also announced plans to sunset its on-premise software by the end of next year. Management believes the transition to a single codebase and subscription revenue model will improve security outcomes, lower customers’ total cost of ownership, and simplify the sales motion, driving greater efficiency for the company over time. While the ongoing transition introduces some uncertainty around 2026 revenue, we believe Varonis will ultimately emerge with accelerating growth, better profitability, and a more predictable business model.
• Liberty Live Holdings, Inc. consists of Liberty Media Corporation's significant interest in Live Nation Entertainment, the world's leading live entertainment and ticketing company. The stock detracted from performance as shares traded sharply lower following Live Nation's third-quarter earnings release. During the quarter, concert segment earnings fell short of investor expectations, marking a departure from a recent string of significant earnings beats in the business. Management also lowered its outlook for ticketing in 2026 due to measures taken in response to regulatory actions around bots, as well as costs associated with the Federal Trade Commission lawsuit. Stepping back from near-term results, Live Nation continues to execute well on owned venue development and the long-term growth opportunity remains attractive. Strong demand for live entertainment and ongoing organic investment in the company’s footprint support steady double-digit earnings compounding. We continue to own the stock due to our favorable view of the Live Nation business and the attractively valued entry point provided at the Liberty holding company level.
• Primo Brands Corporation is a leading seller of bottled water across both retail and home-and-office delivery channels, formed through the merger of BlueTriton and Primo Water. The stock detracted from performance following third-quarter earnings, which revealed a decline in the home-and-office delivery business due to unexpected service disruptions stemming from the execution of merger-related cost-saving efforts. These initiatives included the elimination of redundant manufacturing plants and distribution branches during the first half of 2025. As a result, the company experienced issues with 5-gallon jug availability and challenges related to the rollout of new technology systems used by drivers to manage deliveries, which negatively affected route timing and temporarily reduced on-time, in-full delivery rates. The magnitude of the disruption and associated revenue impact proved greater than expected. We believe Primo Brands will return to its normal growth trajectory in the coming quarters and that the stock will warrant a materially higher valuation once these operational issues are resolved.

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) was essentially unchanged in the fourth quarter, trailing the Russell 2000 Growth Index (the Index), which rose 1.22%, by 103 basis points (Institutional Shares). The shortfall stemmed from a combination of poor stock selection and detrimental impacts from active sector weights.

Disappointing stock selection in Industrials was the main reason why the Fund trailed the Index during the quarter. Weakness was broad based, led by declines from a handful of the Fund’s aerospace & defense and building products holdings. Niche aerospace system and parts maker Loar Holdings Inc. and wood-alternative composite decking and railing manufacturer Trex Company, Inc. were the top detractors in these segments. Loar’s shares declined due to uncertainty around the durability of the company’s aftermarket franchise and its inability to close a large acquisition announced earlier. We continue to believe the company will display far more sustainable growth in its high margin aftermarket parts business as original equipment manufacturers cannot ramp production quickly enough to satisfy market demand and growth. At the end of December, management announced the closure of the long-delayed LMB acquisition and was able to announce another solid acquisition in February, showing that the M&A engine is humming again. With strong organic growth and reaccelerating M&A activity, we continue to believe Loar can compound EBITDA at a best-in-class CAGR in excess of 20% for the foreseeable future. In our opinion, Loar remains one of the best companies across the Industrials space. 

Trex shares fell during the quarter, driven by disappointing business performance due to a more cautious consumer, heightened competitive intensity, and unexpected margin pressure. We exited our position in Trex to reallocate capital to other investment opportunities with clearer multi-year business outlooks.

Meaningfully lower exposure to biotechnology stocks, which were up more than 25% in the Index, and subpar stock selection in Communication Services and Consumer Staples also contributed to relative weakness. Liberty Live Holdings, Inc. and Primo Brands Corporation were largely responsible for relative losses in Communication Services and Consumer Staples after their share prices fell 14.2% and 25.5%, respectively, during the quarter. Liberty Live consists of Liberty Media Corporation's significant interest in Live Nation Entertainment, the world's leading live entertainment and ticketing company. The stock detracted from performance as shares traded sharply lower following Live Nation's third-quarter earnings release. During the quarter, concert segment earnings fell short of investor expectations, marking a departure from a recent string of significant earnings beats in the business. Management also lowered its outlook for ticketing in 2026 due to measures taken in response to regulatory actions around bots, as well as costs associated with the Federal Trade Commission lawsuit. Stepping back from near-term results, Live Nation continues to execute well on owned venue development and the long-term growth opportunity remains attractive. Strong demand for live entertainment and ongoing organic investment in the company’s footprint support steady double-digit earnings compounding. We continue to own the stock due to our favorable view of the Live Nation business and the attractively valued entry point provided at the Liberty holding company level.

Primo Brands is a leading seller of bottled water across both retail and home-and-office delivery channels, formed through the merger of BlueTriton and Primo Water. The stock detracted from performance following third-quarter earnings, which revealed a decline in the home-and-office delivery business due to unexpected service disruptions stemming from the execution of merger-related cost-saving efforts. These initiatives included the elimination of redundant manufacturing plants and distribution branches during the first half of 2025. As a result, the company experienced issues with 5-gallon jug availability and challenges related to the rollout of new technology systems used by drivers to manage deliveries, which negatively affected route timing and temporarily reduced on-time, in-full delivery rates. The magnitude of the disruption and associated revenue impact proved greater than expected. We believe Primo Brands will return to its normal growth trajectory in the coming quarters and that the stock will warrant a materially higher valuation once these operational issues are resolved.

Somewhat offsetting the above was strong stock selection in Information Technology (IT), where portfolio accounting and reporting software provider Clearwater Analytics Holdings, Inc. and precision power conversion and control solutions leader Advanced Energy Industries, Inc. were among the top contributors. Clearwater reported solid Q3 2025 earnings and raised 2025 guidance. Clearwater also announced that a consortium of private equity investors intends to acquire the company, which drove a sharp positive market reaction. We retain conviction and believe Clearwater has meaningful competitive advantages and the potential to compound revenue at attractive rates for several years. The company has an efficient business model that should drive 40%-plus adjusted EBITDA margins over time.

Advanced Energy’s shares contributed to performance during the quarter on better-than-expected earnings, driven by continued growth in its data center business, which is benefiting from shipments into hyperscale facilities for AI applications and a shift toward sole-source, higher-margin opportunities. AI’s rising power demands play to Advanced Energy’s strengths in power density and efficiency, and the company is one of few able to address these critical data center power challenges. Additionally, Advanced Energy is strongly positioned in semiconductor capital equipment and is benefiting from a recovery in the industrial and medical markets, supporting multi-year growth and margin expansion. The company also continues to pursue acquisitions to bolster its product offerings and presence, particularly in the fragmented industrial and medical space, which should further contribute to growth over time.

Favorable stock selection in IT was partly offset by the Fund’s materially higher exposure to this lagging sector, which was held back by declines from software and semiconductor stocks.

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

Baron Discovery Fund (the Fund) struggled during the second half of the year, relinquishing all outperformance from early in the period. The Fund rose 10.96% (Institutional Shares) for the full year, trailing the Russell 2000 Growth Index (the Index) by 205 basis points. According to MSCI Barra’s factor attribution, style and industry factors were entirely responsible for the relative shortfall during the year, overshadowing strong stock selection. The Fund encountered significant style-related headwinds, especially during the latter half of the year, with overexposure to Earnings Quality being a material drag on performance. The Earnings Quality factor suffered its worst six-month stretch of performance on record late in the year, severely hampering the Fund’s relative returns. Underexposure to the top performing Momentum factor also weighed heavily on relative results. The remaining underperformance was industry specific, with the main culprit being meaningful overexposure to Software, which was hurt by fears that AI will disrupt, commoditize, or make traditional software platforms obsolete. 

From a sector perspective, poor stock selection in Health Care and Information Technology (IT) contributed the vast majority of relative losses in the period. Performance in Health Care was hindered by sharp losses from obstructive sleep apnea treatment pioneer Inspire Medical Systems, Inc. and premier medical device outsource manufacturer Integer Holdings Corporation. Inspire’s shares were pressured by the slower-than-expected rollout of Inspire 5, the company’s next-generation implantable device. The launch was delayed due to Medicare billing software changes and the longer-than-anticipated time required to train implanting centers and upgrade them with Sleep Sync, the company’s digital platform that enables physicians to monitor usage, track adherence, and manage care remotely. Some patients also chose to defer procedures until Inspire 5 became available. Toward the end of 2025, Medicare increased facility reimbursement for Inspire procedures, driving a surge in the stock price; however, subsequent policy updates by local Medicare contractors reduced reimbursement levels, pressuring shares again. At an early January conference, management noted that it is working with Medicare to clarify appropriate facility billing codes. Long term, we believe Inspire remains well positioned to grow at a healthy rate, supported by its market leadership and the large addressable patient population.

Integer’s stock fell sharply after the company lowered its 2025 guidance during third-quarter earnings and provided preliminary 2026 and 2027 outlooks that fell well below expectations. Management attributed the shortfall primarily to three new product launches that meaningfully underperformed expectations, resulting in limited near-term reorder activity. While Integer now expects minimal growth contribution from these products, management continues to target a return to 7% to 8% organic growth beginning in 2027 as newer programs ramp. Although shares appeared undervalued relative to the longer-term growth outlook, we found it difficult to underwrite the undisclosed new products and the expected growth reacceleration. As a result, we exited the position.

Disappointing stock selection in Health Care was exacerbated by having limited exposure to biotechnology and pharmaceutical stocks, which were up 39.3% and 55.6%, respectively, in the Index. Lower exposure to these sub-industries accounted for most of the relative losses in the sector.

Stock-specific weakness in IT was a 170-plus basis point drag on performance, as declines from several of the Fund’s software holdings proved costly owing partly to broader uncertainty around the impact of AI on the software space. Restaurant foodservice technology provider PAR Technology Corporation was the largest detractor after the company lowered annual recurring revenue growth guidance to 15% from 20%, reflecting weak conditions among restaurant customers and the intentional delay of certain new rollouts to prioritize winning late-stage opportunities with large potential customers. Management also indicated that 15% should represent the company’s core growth rate going forward, below prior targets. Despite the slower start to the year and a more modest outlook, management remains confident in its ability to deliver on updated targets and sees potential for near-term upside due to a strong pipeline of contracted and prospective customers, including an ongoing rollout with Burger King. We think PAR is well positioned to win at least one of its three late-stage “mega deals,” one of which would be significantly larger than any contract the company has signed to date. With a more compelling near-term valuation, we believe the stock is well positioned to meaningfully outperform over time, driven by durable growth, improving profitability, and strong customer momentum. That being said, we sold the position given the macroeconomic headwinds the company is facing. Other material detractors in software were AI-powered DevSecOps platform GitLab Inc., cloud-based cybersecurity leader SentinelOne, Inc., observability software platform Dynatrace, Inc., digital banking solutions provider Alkami Technology Inc., and professional services software provider Intapp, Inc. 

Limited exposure to the top performing Materials sector and disappointing stock selection in Consumer Discretionary (Floor & Decor Holdings, Inc., RH, Birkenstock Holding plc, and DraftKings Inc.), Real Estate (Independence Realty Trust, Inc. and The Macerich Company), and Consumer Staples (Primo Brands Corporation) also hampered performance.

Somewhat offsetting the above was solid stock selection in Industrials and Communication Services along with lower exposure to the lagging Financials sector, which added nearly 700 basis points of relative gains. Strength in Industrials was driven by the Fund’s aerospace & defense holdings, namely Kratos Defense & Security Solutions, Inc., Karman Holdings Inc., and Mercury Systems, Inc., whose shares were bolstered by strong earnings releases amid heightened defense spending. Environmental services company Montrose Environmental Group, Inc. also performed well in the sector after reporting strong growth and raising full-year guidance, driven by both organic expansion and increased emergency response revenue. The results boosted investor confidence in Montrose’s long-term outlook for 7% to 9% organic growth, supported by rising client demand for services that help manage environmental risks, and eased concerns that the business could face pressure in the current political environment. In addition, the company completed the redemption of its preferred convertible instrument in early July, enhancing balance sheet transparency. 

Performance in Communication Services was aided by forum-based social network Reddit, Inc. and live entertainment company Liberty Live Holdings, Inc. Reddit’s stock performed well before being sold in mid-February. The company reported premium growth and user engagement on the platform was robust, driven by improved content discoverability and international expansion. Advertisers have found Reddit compelling given its unique user communities and strong return on investment based on contextual targeting and inexpensive pricing. The rollout of products has been steady, helping onboard advertisers and ramping their spend, and new areas such as search advertising appear promising. Revenue from data licensing for AI model training also remains margin accretive. The business model has been quite profitable and the roadmap ahead does not require much additional investment. However, after a substantial run up (rising nearly 500% since initial purchase), the stock exceeded our long-term price target and we sold our position.

Liberty Live consists of Liberty Media Corporation's interest in Live Nation Entertainment, the world's largest live entertainment company. Shares increased following better-than-expected margin growth in the concert segment, an increase in long-term adjusted operating income targets based on robust demand performance indicators, and strong earnings results that showed healthy growth across all segments. We believe the combination of strong category demand, expanding global artist supply, owned venue development, and margin expansion provides a solid backdrop for long-term adjusted operating income (AOI) growth. Concert segment margins continue to expand consistently, driven by scale, operational efficiencies, and the shift toward owned and operated venues. We also believe the historically loss-leading promotion segment is becoming a fundamentally stronger business. Additionally, management is investing in promotion talent internationally to support the company’s expanding footprint. Overall, we remain optimistic about Liberty Live’s ability to deliver double-digit AOI growth over the long term.