Baron Focused Growth Fund: Latest Insights and Commentary

U.S. equity markets managed gains in a period of heightened volatility, with the CBOE Volatility Index (VIX) briefly spiking above 50 for the first time in over five years before settling back below its long-term average of 20 by quarter end as tariff policy uncertainty and war in the Middle East failed to unnerve investors. Risk-off sentiment early in the quarter centered around President Trump’s “Liberation Day” tariff announcement, which Wall Street strategists viewed as more severe than expected and likely to slow economic growth, boost inflation, and increase the odds of a recession this year. On April 2, President Trump unveiled an unprecedented global tariff regime, placing a 10% baseline tax on imports from all countries, a 34% tariff on Chinese goods, a 25% tariff on all car imports, and a 20% tariff on EU goods. In retaliation, China imposed 34% tariffs on U.S. goods and the EU announced its own countermeasures. The S&P 500 Index fell more than 12% over the next four days, nearly entering bear market territory from its all-time high on February 19, 2025 (down almost 19%). Other prominent benchmarks, such as the NASDAQ Composite Index and Russell 2000 Index, officially entered a bear market in early April, declining more than 20% from their respective all-time highs reached late last year.

After bottoming on April 8, U.S. equities rebounded due to positive trade developments. On April 9, Trump announced a 90-day pause on most reciprocal tariffs to allow for negotiations. China was the only country excluded from the pause, with Trump instead raising tariffs on China to 145%, prompting Chinese officials to increase tariffs on U.S. goods to 125%. However, U.S. and Chinese officials eventually agreed to a de-escalation of tariffs on May 12, alleviating investor concerns and contributing to additional market gains. Other market catalysts were resilient corporate earnings amid tariff-driven pressures, dovish Federal Reserve commentary following muted May inflation, AI tailwinds from NVIDIA’s strong earnings results and Middle East deals, improving consumer sentiment, and a recent ramp in M&A and IPO activity. The sudden Israel-Iran war and subsequent involvement of the U.S. via the bombing of various Iranian nuclear sites threatened to upend market momentum, but a fragile ceasefire was quickly brokered, and the market resumed its advance to close the quarter at a record high.

The Magnificent Seven complex resumed its leadership role during the quarter, accounting for nearly 60% of the S&P 500 Index’s gains. The group appreciated more than 20% in the period, outpacing the Index, which was up 10.9%. NVIDIA (+45.8%), Microsoft (+32.7%), Meta (+28.2%), and Tesla (+22.6%) posted the largest gains. Apple (-7.5%) was the only member of the group to decline and trail the broader Index.

Sector performance mirrored the influence of the Magnificent Seven, as Information Technology, Communication Services, and Consumer Discretionary were among the top performing sectors. Industrials was the only other sector to outperform the Index, helped by strong gains from aerospace & defense companies. Health Care experienced a severe reversal of fortunes during the quarter, as the sector’s 7.2% decline wiped out all year-to-date outperformance versus the broad market. After trailing the S&P 500 Index by more than 50% over the prior two calendar years, Health Care was tracking ahead of the Index this year, outperforming by 750-plus basis points through the end of April. But that all changed in May and June when the sector trailed the Index by approximately 15%. Health Care performance was hampered by multiple factors, including regulatory uncertainty, particularly around drug pricing and Medicare Advantage reimbursement rates, federal investigations involving sector heavyweight UnitedHealth, disruption at the FDA and cancellations/delays of NIH grants for academic research, concerns about tariffs on the pharmaceutical industry, and renewed investor interest in AI-driven technology companies. Energy was another notable laggard, pressured by the sharp decline in oil prices during the quarter.

From a style perspective, small caps failed to lead the way in the market recovery during the quarter, trailing mid- and large-cap stocks. Small caps remain in negative territory this year, down 1.8%, while larger-cap stocks are up about 6%, having recovered all losses from early in the year. Growth stocks outperformed for a third consecutive month to finish the quarter ahead of value by between 400 and 1,400 basis points. The largest differential was in mid and large cap, where sizeable weights in Palantir/AppLovin and Magnificent Seven factored heavily into the strong showing for these growth benchmarks. Growth is now outperforming in most size segments this year, representing a meaningful turnaround from the end of March when value was ahead by a wide margin across the board.

Beyond the U.S., developed and emerging market (EM) equities were up double digits for the quarter, benefiting from the significant allocation shift away from U.S. equities early in the period. Despite modest underperformance in June, developed Europe was a standout for the quarter, bolstered by sharp gains in the Netherlands, Spain, Ireland, Germany, Italy, Finland, and Sweden. Securities in Israel, Hong Kong, Australia, and Canada also contributed to strength in developed markets. EM equities were lifted from semiconductor-related strength in Taiwan and Korea (SK hynix). Solid gains in Mexico and Brazil also contributed to EM outperformance, as investors were relieved about the relatively less punitive tariff approach announced by the U.S. administration. 

CONTRIBUTORS

• Spotify Technology S.A. is a leading global digital music service, offering on-demand audio streaming through paid premium subscriptions and an ad-supported model. Shares of Spotify were up, largely due to solid underlying results and the company's durability amid an unpredictable macroeconomic environment. Spotify has been on a path to structurally increase gross margins, aided by its high-margin artist promotions marketplace, growing contribution from podcasts, and structural investments in advertising. Users continued to grow at a double-digit pace despite recent price hikes. Spotify remains a sticky subscription product with relative resilience in times of consumer uncertainty. Spotify also continued to innovate on the product side, calling 2025 the "year of accelerated execution," with priorities in improving advertising, expanding into video, developing a Super Premium tier, and taking more market share. We continue to view Spotify as a long-term winner in music streaming with potential to reach 1 billion-plus monthly active users.
• Tesla, Inc. designs, manufactures, and sells electric vehicles (EVs), solar products, and energy storage solutions, while also developing advanced real-world AI technologies. Despite ongoing macroeconomic challenges and regulatory complexities, shares climbed after Tesla completed a limited commercial rollout of its highly anticipated robotaxi business in Austin—following more than a decade of development and billions of dollars in investment. This milestone signals a potentially transformative shift in the automotive industry and opens up a sizable new market beyond the company’s core operations. Investor sentiment also improved after Elon Musk stepped back from government-related engagements, boosting confidence in Tesla’s near-term execution. Tesla introduced a refreshed Model Y globally, featuring design and performance upgrades, and outlined plans to unveil new mass-market models starting next quarter. Meanwhile, the company is progressing toward scaling production of its humanoid robot, adding another dimension to its long-term growth story.
• Leading online brokerage house Interactive Brokers Group, Inc. contributed to performance, driven by strong quarterly results and a rebound in equity markets. The quarter began with considerable turbulence following Liberation Day in early April, when President Trump announced sweeping tariffs on most U.S. trading partners. This initially triggered recession fears and led to a selloff in capital markets stocks, including retail brokers and alternative asset managers. However, as the quarter progressed, many of these tariffs were either paused or rolled back as the Trump administration pursued trade deals. Markets rebounded sharply in May and June, with the S&P 500 and NASDAQ Composite both ending the quarter at record highs. This recovery supported robust business momentum at Interactive Brokers, with continued growth in client accounts and assets under management, elevated trading volumes, and a rebound in margin balances. We continue to own the stock due to its long-term earnings potential and its consistent 30%-plus account growth rate.

DETRACTORS

• Specialty insurer Arch Capital Group Ltd. gave back some of its gains from earlier in the year, following slower growth and broader weakness across insurance stocks during the second quarter. In the first quarter, premium growth came in below forecasts and slowed relative to the prior quarter due to rising competition and lower pricing in certain business lines. Even so, earnings beat expectations due to stronger underwriting margins and lower tax rates. We continue to own the stock due to Arch’s strong management team and our expectation of significant growth in earnings and book value over time.
• Global ski resort company Vail Resorts, Inc. detracted from performance on investor concerns about slowing visitation levels and the potential impact on early season pass sales for the upcoming ski season. The return of former CEO Rob Katz added uncertainty about the company’s future strategic direction, further pressuring shares. We remain investors. Vail continues to deliver consistent revenue and earnings, with roughly a third of revenue already secured in advance of the season, providing strong financial visibility and enabling more effective operational and strategic planning. We view Katz’s return positively and expect his emphasis on guest experience, pricing, and targeted acquisitions to reignite growth. Combined with a well-covered mid-single-digit dividend yield and a strong balance sheet that supports strategic growth through M&A, reinvestment in the portfolio, and share repurchases, we see an attractive long-term opportunity and the potential for multiple expansion from multi-year lows.
• Choice Hotels International, Inc. is a global franchisor of economy and midscale hotels across a portfolio of well-known brands. Shares fell during the quarter as investors focused on slowing revenue-per-available-room (RevPAR) growth. However, management has steadily reduced Choice’s exposure to RevPAR fluctuations by expanding higher-margin, non-RevPAR fee income as it leverages the company’s 70-million-member loyalty database to secure additional partnerships with credit card companies, timeshare operators, and casinos. Choice is also adding higher-revenue units at a low single-digit rate, with a focus on larger room sizes, premium royalty rates, and RevPAR levels that exceed the current portfolio. We expect revenue growth to accelerate as a robust pipeline of new projects come online and Choice captures synergies from its Radisson Americas acquisition by increasing traffic to those properties and narrowing the royalty-rate gap between Radisson and legacy Choice brands. With a strong balance sheet, Choice is well positioned to return capital to shareholders through dividends and share repurchases.

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) increased 12.78% (Institutional Shares) in the second quarter, outperforming the Russell 2500 Growth Index by 147 basis points due to solid stock selection. 

Health Care investments accounted for the bulk of the relative gains in the period, owing partly to strong performance from veterinary diagnostics leader IDEXX Laboratories, Inc., whose shares rose 28% after reporting better-than-expected financial results. Foot traffic to veterinary clinics in the U.S. remains under pressure, which has continued to hamper aggregate revenue growth. Despite macroeconomic challenges, IDEXX’s excellent execution has enabled the company to maintain strong performance. We believe competitive trends are outstanding, and we expect new proprietary innovations and field sales force expansion to be meaningful contributors to growth in 2025. We see increasing evidence that long-term secular trends around pet ownership and pet care spending have structurally accelerated, which should help support IDEXX’s long-term growth rate. Lack of exposure to lagging biotechnology and pharmaceutical stocks contributed another 135-plus basis points of relative gains.

Favorable stock selection in Communication Services and Consumer Discretionary also added value in the quarter. Strength in Communication Services came from global digital music service provider Spotify Technology S.A. Shares of Spotify were up largely due to solid underlying results and the company's durability amid an unpredictable macroeconomic environment. Spotify has been on a path to structurally increase gross margins, aided by its high-margin artist promotions marketplace, growing contribution from podcasts, and structural investments in advertising. Users continued to grow at a double-digit pace despite recent price hikes. Spotify remains a sticky subscription product with relative resilience in times of consumer uncertainty. Spotify also continued to innovate on the product side, calling 2025 the "year of accelerated execution," with priorities in improving advertising, expanding into video, developing a Super Premium tier, and taking more market share. 

Performance in Consumer Discretionary was bolstered by electric vehicle manufacturer Tesla, Inc. Despite ongoing macroeconomic challenges and regulatory complexities, Tesla’s shares climbed after the company completed a limited commercial rollout of its highly anticipated robotaxi business in Austin—following more than a decade of development and billions of dollars in investment. This milestone signals a potentially transformative shift in the automotive industry and opens up a sizable new market beyond the company’s core operations. Investor sentiment also improved after Elon Musk stepped back from government-related engagements, boosting confidence in Tesla’s near-term execution. Tesla introduced a refreshed Model Y globally, featuring design and performance upgrades, and outlined plans to unveil new mass-market models starting next quarter. Meanwhile, the company is progressing toward scaling production of its humanoid robot, adding another dimension to its long-term growth story. Casino operator Red Rock Resorts, Inc., premium performance sports brand On Holding AG, and healthcare apparel company FIGS, Inc. also performed well in the sector. 

Somewhat offsetting the gains above was disappointing stock selection in Industrials and Financials. Weakness in Industrials came from the Fund’s sizable positions in private rocket and spacecraft manufacturer Space Exploration Technologies Corp. (SpaceX) and data and analytics vendor Verisk Analytics, Inc. SpaceX shares were unchanged for the quarter, hampering performance in a rising market. We value SpaceX using prices of recent financing transactions. Verisk’s stock lagged alongside other defensive stocks during the quarter. There was no materially negative company specific news in the period. Verisk reported solid Q1 2025 earnings and CEO Lee Shavel sounded upbeat about the company’s growth potential. We maintain conviction in the competitive positioning, long-term growth, margin expansion, and capital deployment prospects for the business. Lower exposure to this strong performing sector also hampered relative results. 

Adverse stock selection in Financials came largely from Arch Capital Group Ltd., whose shares fell after the company reported premium growth below expectations and slowed from the prior quarter due to lower pricing in certain business segments. We maintain conviction as we believe both companies are well managed and have significant growth potential. Financial data providers MSCI Inc. and FactSet Research Systems Inc. also weighed on performance in the sector.