Baron Focused Growth Fund: Latest Insights and Commentary

After selling off in March due to the U.S.-Iran conflict and disruptions in the Strait of Hormuz, U.S. equities rallied to new record highs during the second quarter, with most of the gains coming in April and May. Given narrow market breadth and concentrated position sizes in recent years, the gap in performance between the market cap-weighted S&P 500 Index and the equal-weighted version has reached extremes not seen since the dotcom bubble era (based on rolling three-year results). 

U.S. stocks saw a comeback after ending the prior quarter slightly down. The AI secular growth narrative was the principal driver of market returns, overshadowing uncertainty about a potential resolution to the U.S.-Iran conflict, shifting Federal Reserve rate expectations, and depressed consumer sentiment from high living costs, persistent inflation, and elevated borrowing rates. 

The S&P 500 posted one of its strongest quarterly profit prints in five years, thanks largely to the Magnificent Seven cohort, which reported blended earnings growth in excess of 60% (versus low double digits for other constituents in the Index). The other contributors were primarily Information Technology (IT) stocks—specifically companies that are perceived to be direct beneficiaries of AI capital spending and electrification and what the market has come to call “AI winners." 

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

• Space Exploration Technologies Corp. (SpaceX) develops and launches advanced rockets, satellites, and spacecraft, with the long-term goal of making humanity multi-planetary. Shares rose as the company successfully completed the largest initial public offering in history, raising more than $85 billion. The proceeds are expected to accelerate growth across massive addressable markets, such as connectivity, launch, terrestrial and space infrastructure, and AI. Fundamental momentum was further reinforced by landmark compute hosting deals totaling tens of billions of dollars annually, including agreements with market leaders Anthropic and Google. SpaceX also announced its acquisition of Cursor, a premier enterprise AI-powered coding platform. Integrating Cursor’s technology, talent, and customer base provides another strategic stepping stone into the vast opportunities within AI applications and agentic systems. Lastly, the company conducted a successful test flight of the latest version of Starship, demonstrating meaningful advancements in rapid and full reusability. We believe these developments support sustained long-term revenue and profit growth well beyond current levels.
• Shares of global hotelier Hyatt Hotels Corporation increased in the second quarter as revenue per available room accelerated and management highlighted rising franchisee interest in its brands. As a result, the company is seeing strong growth in earnings and cash flow. Hyatt continues to have a robust balance sheet and is repurchasing shares, taking advantage of the stock’s significant valuation discount to peers despite having a similar mix of fee-based business. We believe Hyatt remains an attractive investment despite recent gains.
• Global electronic brokerage firm Interactive Brokers Group, Inc. contributed to performance as the company continued to compound growth at a rare pace for its scale. Client accounts increased 34% year over year to 5.2 million, customer equity grew 40%, and margin loan balances rose 67%. Trading activity remained robust, with June daily average revenue trades increasing 53% year over year. Operating on a highly automated, low-cost platform, Interactive Brokers benefits from substantial operating leverage as volume grows, supporting industry-leading pretax margins. New opportunities, including an expanded prediction markets offering and the favorable modernization of day-trading margin rules, further extend the company's growth runway. We retain conviction in the stock, viewing Interactive Brokers as a structural share gainer with a large global addressable market that few competitors can serve at similarly low cost.

DETRACTORS

• FIGS, Inc. designs and sells scrubwear for health care professionals through a digitally native, direct-to-consumer strategy. The stock detracted from performance as shares slipped due largely to investor positioning. Even so, the company reported a very strong first quarter. Revenue came in at $159.9 million, up 28%, well ahead of the company's guidance for low-20% growth and above consensus expectations. The results were broad-based. U.S. revenue grew 24% to $131.6 million, with strength across core offerings, new product launches, and promotional periods, while international revenue accelerated 50% to $28.3 million, with double-digit growth in every region. Active customers surpassed 3 million for the first time, up 12% year over year, with both new and repeat customers contributing. We continue to have conviction in the strength of FIGS' business model and the company's ability to gain market share in the attractive global health care apparel industry.
• Shares of property and casualty (P&C) insurance software vendor Guidewire Software, Inc. declined after a handful of deals slipped from the fiscal third quarter into the fiscal fourth quarter. We believe this is purely a timing issue, with these deals having since closed in the current period. Guidewire’s InsuranceSuite platform serves as the core system of record for insurance carriers, functioning as the single source of truth for the policies an insurer writes, the claims it processes, the premiums it collects, and the payments it makes. We think the core-system opportunity alone represents nearly $20 billion of annual recurring revenue, or roughly 20 times Guidewire’s current size. In our view, AI will meaningfully expand this opportunity by enabling automation and intelligence on top of the core system of record. Guidewire is already bringing new AI-enabled capabilities to market and signing customers, and we expect adoption to accelerate over the coming year. Finally, we expect Guidewire to benefit from the same internal productivity enhancements AI is driving across enterprises, which should help it grow faster with lower costs and ultimately improve profitability.
• CoStar Group, Inc. is the leading provider of information and marketing services to the commercial and residential real estate industries. Shares fell due to multiple compression driven by rising AI fears. The market has increasingly come to view AI as an existential risk for a growing number of industries, including software, business services, information services, and video games. While there is little evidence of any fundamental impact on these sectors, investors have largely adopted a “shoot first and ask questions later” approach, leading to significant stock price declines. We continue to own CoStar due to its enviable business model, differentiated data assets, and meaningful growth opportunities in providing enhanced real estate information, analytics, and marketplace offerings. The company also maintains a substantial cash balance, which we are hopeful will be used to aggressively repurchase shares at current depressed valuation levels.

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 Focused Growth Fund (the Fund) appreciated 13.26% (Institutional Shares) in the second quarter, trailing the Russell 2500 Growth Index (the Index), which surged 24.02%. Robust stock selection, largely attributable to exceptional performance from Space Exploration Technologies Corp. (SpaceX), was not enough to overcome material headwinds from style and industry factors. Underexposure to the top performing Momentum and Beta factors was an 11.4% drag on relative performance. The Beta factor posted its best three-month performance on record in the period, accounting for about half the Fund’s overall underperformance. Momentum continued its sustained run of strong performance during the second quarter, presenting additional headwinds to relative performance. In terms of industry factors, the Fund was adversely impacted by the AI trade due to its limited exposure to “AI winners” in Semiconductors, Computers Electronics, and Semiconductor Equipment, which drove Index performance in the period. Higher exposure to industries pressured by concerns about AI-driven disruption (Diversified Financials, Media, Internet Software and IT Services, and Commercial and Professional Services) also hampered performance. Lastly, the Fund’s elevated exposure to lagging consumer-related industries (Leisure Products, Textiles, Apparel and Luxury and Hotels, Leisure and Consumer Services) was another material headwind.

From a sector perspective, investments in Information Technology (IT), Consumer Discretionary, Financials, Industrials, and Real Estate detracted the most from relative performance. A portion of the weakness in IT was due to poor stock selection in IT consulting & other services, application software, and internet services & infrastructure, where syndicated research provider Gartner, Inc., property and casualty (P&C) insurance software vendor Guidewire Software, Inc. and global commerce platform Shopify Inc. were impacted by the ongoing market rotation out of stocks perceived as “AI losers.” We believe this characterization is misplaced and that AI will ultimately be a significant tailwind for these businesses.

We continue to own Gartner given its large addressable market, significant competitive advantage, and robust free cash flow generation, which we expect management to deploy toward share repurchases at depressed valuation levels. We believe AI will be a powerful tailwind for Gartner for three key reasons. First, every company is struggling to assess AI’s risks and opportunities, and Gartner offers the most comprehensive, cost-effective service to help businesses navigate this transformation. Second, Gartner generates vast amounts of proprietary data and AI will enable the company to convert this data into deeper insights and deliver it in more intuitive, easy-to-consume formats. Lastly, AI integration will drive internal efficiencies, streamline operations, and boost Gartner's long-term operating margins.

Guidewire’s InsuranceSuite platform serves as the core system of record for insurance carriers, functioning as the single source of truth for the policies an insurer writes, the claims it processes, the premiums it collects, and the payments it makes. Insurance policies are complex, highly regulated, and stored exclusively in digital form within Guidewire, which makes the system of record particularly critical and therefore highly valuable. We believe the core system opportunity alone represents nearly $20 billion of annual recurring revenue, or roughly 20 times Guidewire’s current size. In our view, AI meaningfully expands this opportunity by enabling automation and intelligence on top of the core system of record. Guidewire is already bringing new AI enabled capabilities to market and signing customers, and we expect adoption to accelerate over the coming year. Finally, we expect Guidewire to benefit from the same internal productivity enhancements AI is driving across enterprises, helping the company support faster growth with lower costs and ultimately improving profitability.

Shopify’s share price decline was driven by multiple compression rather than any deterioration in the underlying business or fundamental outlook. The company continued to post healthy growth in gross merchandise volume and revenue. Instead, the pressure reflected investor concerns about the company's long-term positioning in a future state of e-commerce that may rely more heavily on AI-driven applications than traditional websites. We view those concerns as misplaced and increasingly see Shopify as an AI winner. Two decades of proprietary data across millions of merchants provide Shopify with a strong foundation for AI tools that improve merchant outcomes. Recent product releases also embed the platform more deeply within the emerging agentic commerce ecosystem while creating new monetization opportunities. We continue to believe that Shopify is the category-defining platform for modern commerce, benefiting from durable secular growth in digital retail, an expanding suite of merchant solutions, improving free cash flow, and a widening competitive moat.

Disappointing stock selection in IT was exacerbated by not owning semiconductor stocks, which were up more than 120% in the Index, contributed about 40% of the losses in the sector.

Within Consumer Discretionary, meaningfully higher exposure to this lagging sector coupled with poor performance health care apparel company FIGS, Inc. hampered relative results. Following strong performance to begin the year, FIGS stock declined significantly in the second quarter, primarily driven by investor positioning. FIGS reported a very strong first quarter, with revenue of $159.9 million, up 28%, well ahead of management's low-20% growth guidance and consensus expectations. Results were impressive across the board. The U.S. grew 24% to $131.6 million, with strength across core demand, new product launches, and promotional activity, while the international segment accelerated to 50% growth, reaching $28.3 million with double-digit growth in every region. Active customers surpassed 3 million for the first time, up 12% year-over-year, with both new and repeat cohorts contributing. We retain conviction in FIGS' long-term growth potential as it gains share in the attractive global healthcare apparel market. 

Weakness in Financials was largely driven by financial exchange & data companies MSCI Inc., Morningstar, Inc., and FactSet Research Systems Inc., whose share prices underperformed due to ongoing concerns that generative AI could disrupt their businesses. We maintain long-term conviction because all three companies have strong, "all weather" franchises underpinned by proprietary data assets and we believe they remain well positioned to benefit from numerous secular tailwinds in the investment community. 

Performance in Industrials was hindered by Verisk Analytics, Inc., a leading data and analytics provider. While the company reported better-than-expected first-quarter 2026 earnings, the stock was pressured by a broader factor-driven selloff across information services companies amid industry-wide concerns about AI, as well as a softer P&C insurance pricing backdrop. We maintain conviction in the company's competitive position, long-term growth prospects, margin expansion opportunities, and disciplined capital deployment. We believe that AI will be a tailwind for Verisk for multiple reasons. First, Verisk possesses proprietary data assets and a trusted, indispensable role in a heavily regulated industry. Second, Verisk’s ability to sign large insurance carriers to multi-year contract renewals with solid annual pricing uplifts reflects the cruciality of the company’s data. Finally, the company is experiencing robust client interest and expanding sales pipelines, marked by faster trial cycles and an increasing number of proof-of-concepts for their AI solutions. Finally, Verisk recently won a competitive RFP to help a global insurance firm launch a digital underwriting platform, demonstrating the strength of the company’s offerings.

Real estate information and marketing services platform CoStar Group, Inc. hampered performance in the Real Estate sector. Like other software and services peers in the Fund, CoStar's shares remained under pressure due to multiple compression driven by rising AI fears. We continue to own CoStar due to its enviable business model, differentiated data assets, and meaningful growth opportunities in providing enhanced real estate information, analytics, and marketplace offerings. The company also maintains a substantial cash balance, which we are hopeful will be used to aggressively repurchase shares at current depressed valuation levels. 

Somewhat offsetting the above was strong stock selection in Communication Services, where performance was bolstered by the Fund's large position in Space Exploration Technologies Corp. (SpaceX). The company completed the largest initial public offering in history during the quarter, raising more than $85 billion. The proceeds are expected to accelerate growth across massive addressable markets, such as connectivity, launch, terrestrial and space infrastructure, and AI. Fundamental momentum was further reinforced by landmark compute hosting deals totaling tens of billions of dollars annually, including agreements with market leaders Anthropic and Google. SpaceX also announced its acquisition of Cursor, a premier enterprise AI-powered coding platform. Integrating Cursor’s technology, talent, and customer base provides another strategic steppingstone into the vast opportunities within AI applications and agentic systems. Lastly, the company conducted a successful test flight of the latest version of Starship, demonstrating meaningful advancements in rapid and full reusability. We believe these developments support sustained long-term revenue and profit growth well beyond current levels.

Lack of or lower exposure to the lagging Health Care, Energy, Materials, Consumer Staples, and Utilities sectors contributed another 250-plus basis points of relative gains.