Baron Emerging Markets Fund: Latest Insights and Commentary

U.S. equities were broadly higher in the third quarter, building on gains from the prior quarter. The S&P 500 Index and NASDAQ Composite set new record highs, most recently on September 22, and the Dow Jones Industrial Average ended the quarter at an all-time high. Small caps led the market recovery, with the Russell 2000 Index finally surpassing its previous record high achieved almost four years ago on November 8, 2021. Market volatility remained muted during the quarter as the CBOE Volatility Index (VIX) continued to trade in the mid-teens, well below its long-term average of around 20. 

The preeminent driver of market strength was the increased likelihood of Federal Reserve (Fed) rate cuts, prompted by signs of weakness in the labor market and the subsequent emergence of more dovish Fed commentary. Rate cut expectations rose in early August following a much weaker-than-expected July nonfarm payrolls report and significant downward revisions to prior numbers. Dovish Fedspeak intensified as the month wore on, with Chair Powell hinting a possible interest rate cut while delivering remarks at the Fed’s annual Jackson Hole conference. Similarly, Governor Waller continued to advocate for cuts while speaking at the Economic Club of Miami. The Fed eventually resumed its rate-cutting cycle at the September meeting, lowering its policy rate by 25 basis points to a range of 4% to 4.25%, after being on hold since its previous cut last December. Robust corporate earnings, narrowing trade uncertainties, a resilient consumer, increased M&A and IPO activity, and sustained AI optimism also contributed to market gains during the quarter. 

The Magnificent Seven complex dominated market returns for a second consecutive quarter, accounting for nearly two-thirds of the S&P 500 Index’s third-quarter gains. The group appreciated 15.5% in the period, outperforming all other securities in the Index, which were up 4.6%, by a double-digit margin. Tesla (+40.0%), Alphabet (+38.1%), Apple (+24.2%), and NVIDIA (+18.1%) posted the largest gains. Meta and Amazon were essentially flat in the period, trailing the broader Index. 

Most sectors closed higher in the period, with Information Technology, Communication Services, and Consumer Discretionary being the only sectors to outperform the broader market thanks to the heavy influence of the Magnificent Seven. Consumer Staples was the only sector to decline in the period, driven by broad-based weakness across a range of sub-industries, including distillers & vintners, personal care products, food retail, tobacco, and household products. Other laggards were Real Estate, Financials, Health Care, Industrials, Energy, and Materials. From a style perspective, small caps outperformed in the third quarter, rising more than 12% and narrowing the gap with mid- and large-cap stocks this year. Performance was mixed between growth and value, with growth stocks dominating in July, losing out to value in August, and rebounding in September. Despite recent volatility, growth generally remains ahead of value year to date, with the largest differential in the mid- and large-cap segments thanks to the heavy influence of Palantir and the broader Magnificent Seven. 

Beyond the U.S., emerging market (EM) equities meaningfully outperformed in September to finish ahead of their developed market counterparts for the quarter. The rally in Chinese equities was largely responsible for EM outperformance, with gains being driven by investor optimism about AI innovation, which bolstered Chinese technology and internet companies. Targeted government initiatives, easing trade tensions with the U.S., and significant domestic capital inflows also contributed to strength in China. Taiwanese and Korean equities also performed well in the period, overshadowing weakness in India, where equity markets were pressured by underwhelming corporate earnings and concerns about recently enacted U.S. tariffs. Foreign investor flows in Indian markets turned negative in the third quarter after being meaningfully positive in May and June. Performance in developed markets was held back by weakness in continental Europe (Denmark, Germany, Norway, Switzerland, France, and Sweden). European equities were hurt by weak corporate earnings, Trump tariff headwinds, and political instability, particularly in France, where the country’s prime minister resigned after losing a crushing confidence vote in parliament.

CONTRIBUTORS

• Semiconductor giant Taiwan Semiconductor Manufacturing Company Limited (TSMC) contributed to performance during the quarter, driven by robust demand for AI chips. We retain conviction that TSMC’s technological leadership, pricing power, and exposure to secular growth markets—including AI and high-performance computing, automotive, 5G, and Internet of Things—will allow the company to sustain strong double-digit earnings growth over the next several years.
• Alibaba Group Holding Limited is the largest retailer and e-commerce company in China. Alibaba operates shopping platforms Taobao and Tmall, and has businesses spanning logistics, local services, digital media, and cloud computing. Shares rose during the quarter due to an acceleration in cloud revenue, driven by AI and positive momentum in quick commerce. Alibaba is ramping capital expenditures over the next three years, committing more than $53 billion to build out its cloud infrastructure layer and add AI capabilities to existing applications, such as consumer search. Within the company’s commerce business, quick commerce is showing strong early traction, and management is focused on substantially improving unit economics. We retain conviction that Alibaba is well positioned to benefit from China's ongoing growth in e-commerce and cloud, although competitive concerns remain.
• Tencent Holdings Limited operates China’s leading social network and messaging platforms (WeChat and QQ), its largest online gaming business, and one of the country’s dominant online entertainment and media ecosystems. Shares rose during the quarter as core gaming growth reaccelerated, profitability exceeded expectations, and the company reaffirmed its commitment to increased AI investment. Tencent noted that AI is already improving its core advertising technology through better targeting, content ranking, and new forms of engagement such as AI-powered search. We remain confident in the company’s ability to compound earnings over time, supported by its diversified growth structure, massive scale, and operational efficiency. Longer term, we also believe Tencent could be a leading beneficiary of generative AI in China, given its ability to enhance existing products and enter adjacent markets through its extensive platform ecosystem. We continue to monitor the regulatory environment.

DETRACTORS

• InPost S.A., Poland’s leading logistics operator with a rapidly expanding pan-European presence, detracted from performance during the quarter. Allegro, Poland’s top e-commerce platform and InPost’s largest customer—contributing around 15% of group revenue—has begun exploring alternative logistics solutions and partnering with multiple providers. This has raised concerns about potential volume pressure in Poland and further market share erosion once the current Allegro–InPost contract expires in 2027. Despite worst-case fears, we believe a full exit by Allegro is unlikely. InPost controls roughly 70% of parcel lockers and 90% of out-of-home delivery volumes in Poland, making a complete transition away from its network highly disruptive to service quality. We remain positive on InPost’s market leadership, expanding international footprint, and growing client diversification.
• Trent Limited is a leading retailer in India that sells private-label apparel direct-to-consumer through its proprietary network. Shares declined on lower-than-expected quarterly sales, with retail activity partly affected by above-normal rainfall. We remain invested as we believe the company can sustain over 25% revenue growth in the near to medium term, driven by same-store-sales growth and outlet expansion. In addition, we expect operating leverage and a growing share of franchisee-operated stores to support stronger profitability and return on capital, driving 30%-plus compound annual EBITDA growth over the next three to five years.
• Indus Towers Limited is a leading telecommunications tower company in India, holding roughly 60% share in the country’s duopolistic tower market. Shares declined during the quarter amid ongoing concerns about key customer Vodafone Idea’s ability to raise funding and repay debt, which could weigh on Indus’ 5G rollout and growth prospects. We initially invested in the company based on our belief that Vodafone Idea’s resumption of monthly payments would support a multiple re-rating for Indus. With that thesis now realized and the upside potential largely captured, we exited our position during the quarter.

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.

In a period of continued strong gains for emerging market equities, Baron Emerging Markets Fund (the Fund) appreciated 10.89% (Institutional Shares), performing similarly to the MSCI Emerging Markets Index (the Index), which rose 10.64%. The Fund failed to separate itself from the Index because solid stock selection was largely offset by adverse impacts from active country weights.

On a country level, strong stock selection in China, Taiwan, and Mexico contributed 350-plus basis points of relative gains, overshadowing stock-specific weakness in Poland and Korea (-96 basis points combined). Stock selection in India was also favorable but was undone by the Fund’s significantly higher exposure to this lagging country, which detracted approximately 215 basis points from relative results. Indian equities were pressured by underwhelming corporate earnings and concerns about the impact of new U.S. trade and visa policy announcements, which contributed to escalating foreign investor outflows. Unique exposure to Argentina, where MercadoLibre, Inc. was down double digits, and lower exposure to better performing South Africa equities also proved costly.

From a sector or theme perspective, stock selection in Industrials and Information Technology (IT) added the most value, with most of the strength coming from holdings in the China value-added, sustainability/ESG, and semiconductors/AI themes. Performance in Industrials was bolstered by sharp gains from Chinese battery manufacturer Contemporary Amperex Technology Co., Limited (sustainability/ESG) and China value-added holdings Zhejiang Sanhua Intelligent Controls Co., Ltd. and Jiangsu Hengli Hydraulic Co., Ltd. Taiwanese power and thermal management solutions provider Delta Electronics, Inc. (semiconductors/AI) and Chinese autonomous driving technology company Pony AI Inc. (China value-added) were responsible for most of the stock-specific gains in IT after their share prices rose 98.8% and 68.6%, respectively, in the period. 

Mostly offsetting the above was disappointing stock selection in Consumer Discretionary, Communication Services, Health Care, and Consumer Staples, where holdings in the EM consumer and digitization themes accounted for most of the relative losses. Weakness in Consumer Discretionary came from Indian retail company Trent Limited (EM consumer), Latin American e-commerce marketplace MercadoLibre (digitization), and Indian food delivery platform Swiggy Limited (digitization). Indian digitization companies Bharti Airtel Limited, Indus Towers Limited, and Tata Communications Limited were the largest detractors in the Communication Services, while Indian hospital chain Max Healthcare Institute Limited (best-in-class/high-quality growth) weighed heavily on performance in Health Care. Most of the losses in Consumer Staples were attributable to declines from EM consumer holdings China Mengniu Dairy Company Limited, Dino Polska S.A., and Godrej Consumer Products Limited.