Baron Growth Fund: Latest Insights and Commentary

GDP growth is widely predicted to slow during 2025, reflecting weakening consumer demand and more cautious corporate spending. Consumer confidence has plummeted. The March 2025 inflation figure came in above the U.S. Federal Reserve’s target of 2%, as measured by the Consumer Price Index. The Fed has taken a wait-and-see approach as the effects of heightened U.S. policy uncertainty on growth, inflation, and employment play out. It left interest rates unchanged in its first meeting of the year.

Against this challenging backdrop, Baron Growth Fund declined in the first quarter. Investments within the Real Estate sector were the only material contributors to performance. Consumer Discretionary, Information Technology (IT), and Financials investments detracted the most. Second largest contributor CoStar Group, Inc. drove gains within Real Estate. Weakness within Consumer Discretionary was led by second largest detractor Vail Resorts, Inc., while top detractor Gartner, Inc. led losses within IT, and third largest detractor MSCI, Inc. led depreciation within Financials.

The second quarter may bring with it as much doubt and volatility as the first quarter, given continued elevated uncertainty around tariffs. After reaching a record high of more than $3.3 trillion in corporate profits in the fourth quarter of 2024, U.S. companies are scrambling to estimate the potential impact of the tariff war. As first quarter earnings season approaches, many observers expect businesses to offer weaker earnings guidance for the rest of the year or withdraw guidance completely.

We are closely monitoring current market conditions while staying focused on company fundamentals -- well-managed businesses with durable competitive advantages and compelling growth prospects at attractive prices -- as we believe this is the best way to generate alpha over the long term, although there are no guarantees.

CONTRIBUTORS

• Shares of specialty insurer Arch Capital Group Ltd. rebounded from weakness in the prior quarter due to favorable operating trends and the relative stability of insurance stocks in a risk-off market. In the most recent quarter, the company reported better-than-expected earnings, and returns on equity remained strong in the high-teens despite elevated catastrophe losses from Hurricane Milton. As management targets a 15% return on equity over a full cycle, they expect to exceed the target this year given firm market conditions. We continue to own the stock due to Arch’s strong management team and our expectation of significant growth in earnings and book value.
• CoStar Group, Inc. is the leading provider of information and marketing services to the commercial and residential real estate industry. Shares rose on an increase in the productivity of CoStar's sales force and signs of a start to the recovery of the commercial real estate market. Mixed results around net new sales following CoStar's significant investment in residential product Homes.com had pressured shares. We remain encouraged by growth in both traffic and brand awareness for the new product and are optimistic that the build out of a dedicated sales team as well as the potential benefits of changes in Multiple Listing Service practices will improve residential sales momentum. We also believe growth in CoStar’s non-residential business is poised to accelerate. Sales productivity has begun to improve as salespeople return to exclusively selling their core product, and we expect this to be amplified as the sales force expands by 20% or more in 2025. We believe the value of CoStar’s core non-residential business exceeds the share price, implying that investors ascribe negative value to the residential opportunity.
• Specialty insurer Kinsale Capital Group, Inc. contributed to performance due to continued growth in the company’s end market and the relative stability of insurance stocks in a risk-off market. The company reported better-than-expected earnings in the most recent quarter despite slowing premium growth. Earnings per share grew 19% and return on equity remained elevated at 30% due to strong underwriting margins and higher investment income. Excess & surplus insurance market conditions remain favorable with recent state data indicating continued double-digit growth due to share gains from the standard market. We continue to own the stock because we believe Kinsale is well managed and has a long runway for growth in an attractive segment of the insurance market.

DETRACTORS

• Shares of Gartner, Inc., a provider of syndicated research, fell on uncertainty around the impact of government spending reductions on the business. We estimate U.S. federal exposure is about 5% of Gartner’s total research contract value, with about half from the Department of Defense and intelligence organizations and half from civilian agencies. While DOGE-driven cost scrutiny is high, we believe Gartner’s services deliver significant value to users, including the potential for hard dollar savings. The private sector business appears well positioned for sustained growth, and management is adept at exercising cost controls to sustain or enhance margins and free cash flow. The company’s balance sheet is in excellent shape, and we expect management to take advantage of this drawdown with aggressive share repurchases.
• Global ski resort company Vail Resorts, Inc. detracted on investor concerns that a potential recession would result in a slowdown in visitation and spend. While we are closely monitoring economic conditions, Vail has not experienced significant declines in visitation or spend levels at its resorts. Favorable late-season ski conditions produced an uptick in destination skiers, who tend to stay longer and spend more. A base of recurring revenue from season pass sales provides visibility into earnings and cash flow. We expect to see EBITDA growth in 2025 with enough free cash flow to fund Vail's well-covered 6% dividend. A strong balance sheet and high-end customer base should provide resiliency in the event of a slowdown.
• Shares of MSCI Inc., a leading provider of investment decision support tools, detracted from performance. The company reported solid quarterly earnings and gave preliminary 2025 guidance largely in line with expectations. End market pressures persisted, but management sounded more upbeat regarding 2025 when discussing both the new sales pipeline and a normalization in cancellations after an elevated 2024. While near-term macro uncertainty remains, we retain long-term conviction, as MSCI owns strong, "all weather" franchises and remains well positioned to benefit from numerous secular tailwinds in the investment community.

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 Growth Fund (the Fund) generated strong outperformance in worsening market conditions to recoup most of last year’s underperformance. The Fund declined 4.25% (Institutional Shares) in the first quarter, meaningfully outperforming the Russell 2000 Growth Index by 687 basis points. Relative strength was driven by a combination of stock selection and style-related tailwinds, particularly lower exposure to the worst performing Beta factor and overexposure to the top performing Size factor (larger caps).

From a sector perspective, strong stock selection in Financials, Information Technology (IT), Consumer Discretionary, and Real Estate was responsible for most of the outperformance in the period. The Fund’s higher exposure to the better performing Financials and Real Estate sectors added another 300-plus basis points of relative gains. Insurers Arch Capital Group Ltd., Kinsale Capital Group, Inc., and Primerica, Inc. led the way in Financials, benefiting from financial results that beat Street expectations and the relative stability of insurance stocks in a risk-off market.

Favorable stock selection in IT was attributable to property and casualty (P&C) insurance software vendor Guidewire Software, Inc., whose stock was up double digits for the quarter. After a multi-year period, we believe Guidewire's cloud transition is substantially over, and cloud will be the sole path forward, with annual recurring revenue (ARR) benefiting from new customer wins and migrations of the existing customer base to InsuranceSuite Cloud. We also expect the company to shift R&D resources to product development from infrastructure investment, which will help to drive cross-sales into its sticky installed base and potentially accelerate ARR over time. Additionally, we are also encouraged by Guidewire’s subscription gross margin expansion, which improved by more than 1,000 basis points in its most recently reported quarter.
Performance in Consumer Discretionary was bolstered by hotel franchisor Choice Hotels International, Inc. and corporate daycare provider Bright Horizons Family Solutions, Inc. Choice Hotels’ stock outperformed despite macroeconomic uncertainty surrounding Trump’s tariff policy and potentially slower unit growth due to financing issues. While volatility is a concern, we believe it will be temporary. We expect mid-single-digit gains in EBITDA in 2025 generated by growth in revenue, units, and revenue per available room, with the resulting cash flow deployed to pay out the company's well-covered dividend, buy back shares, and invest in the business. Choice Hotels benefits from a strong balance sheet and its 2022 acquisition of Radisson continues to generate additional revenue and cost synergies. The business is 100% fee-based, which should provide some resiliency should we enter a slowdown. Bright Horizons’ shares increased after reporting above-consensus guidance for fiscal year 2025. The company’s high-growth, high-margin Back Up Care segment has transformed the business and greatly enhanced growth prospects, with its $170 million in 2024 operating income alone exceeding the peak pre-pandemic income generated by Full Services. The Full Services segment continued its recovery, with enrollment growth more in line with pre-pandemic levels.

Strength in Real Estate came from real estate data and marketing platform CoStar Group, Inc. and specialty gaming REIT Gaming and Leisure Properties, Inc., whose share prices rose 10.7% and 7.3%, respectively, in the period. CoStar‘s shares rose on an increase in the productivity of the company’s sales force and signs of a start to the recovery of the commercial real estate market. Mixed results around net new sales following CoStar's significant investment in residential product Homes.com had pressured shares. We remain encouraged by growth in both traffic and brand awareness for the new product and are optimistic that the build out of a dedicated sales team as well as the potential benefits of changes in Multiple Listing Service practices will improve residential sales momentum. We also believe growth in CoStar’s non-residential business is poised to accelerate. Sales productivity has begun to improve as salespeople return to exclusively selling their core product, and we expect this to be amplified as the sales force expands by 20% or more in 2025. Gaming and Leisure’s stock was lifted by a market rotation into defensive, dividend-yielding companies. The company generates consistently strong cash flow that is used to pay out its well-covered 6% dividend. With its solid balance sheet, the company is well positioned to pursue accretive acquisitions. Should global economic uncertainty persist, Gaming and Leisure’s stock should continue to perform well.

Partially offsetting the gains above were adverse impacts associated with the Fund’s limited exposure to the better performing Health Care and Consumer Staples sectors.