Baron Health Care 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

• Argenx SE is a biotechnology company best known for developing Vyvgart, the leading FcRn inhibitor for the treatment of autoimmune conditions. Shares rose after second-quarter Vyvgart sales meaningfully exceeded investor expectations, rebounding from prior weakness linked to seasonal factors (such as insurance reverification) and higher Medicare Part D utilization and associated discounts. Our conversations with management and neurologists continue to reinforce Vyvgart’s value as an important treatment option with strong long-term growth potential. The drug continues to launch well in generalized myasthenia gravis, and its launch in chronic inflammatory demyelinating polyneuropathy is off to a strong start. Over time, we expect Vyvgart to demonstrate efficacy across an expanding range of autoantibody-driven autoimmune conditions, and we are encouraged by argenx’s progress with its next pipeline candidate, ARGX-119, in neuromuscular diseases.
• Insmed Incorporated is a biotechnology company developing therapies for serious pulmonary diseases, with three lead drug candidates that collectively have the potential to generate more than $8 billion in peak sales. Shares rose during the quarter following the U.S. approval of Brinsupri for non-cystic fibrosis bronchiectasis, a condition affecting an estimated 500,000 patients in the U.S. that is often misdiagnosed as asthma or chronic obstructive pulmonary disease, representing a $5 billion-plus opportunity given the lack of approved treatments. We are also optimistic about treprostinil palmitil inhalation powder (TPIP), a once-daily prostanoid in development for pulmonary arterial hypertension (PAH) and pulmonary hypertension associated with interstitial lung disease. Unlike existing inhaled prostanoids—currently a $2 billion–plus market requiring four daily doses—TPIP can be administered once a day at higher doses, offering the potential for improved efficacy with fewer side effects.
• RadNet, Inc. is the largest operator of outpatient diagnostic imaging services and related solutions in the U.S. Shares rose on quarterly results that exceeded expectations, reflecting strong volume trends and raised 2025 guidance. Revenue grew 8.4% and EBITDA rose 12.3%, beating consensus by 2% and 6%, respectively, supported by total imaging volume growth of 4.9%. Same-store advanced imaging growth accelerated 300 basis points sequentially to 6.6%, while routine imaging increased 1.9%. Adjusted EBITDA margin reached 16.4%. Higher-revenue advanced procedures (CT, PET/CT, MRI) now represent 27.5% of total screenings. The Digital Health segment also outperformed, with revenue up roughly 31% and adjusted EBITDA up 4.1%. Management cited positives such as an expected 3.3% Medicare rate hike in 2026, expanded MRI and ultrasound capacity through AI-enabled software upgrades, a strong de novo pipeline (11 new sites in both 2025 and 2026), and potential cost savings from improved call center efficiency. We retain long-term conviction in RadNet given the aging U.S. population, the shift towards lower-cost outpatient settings, and the company’s operational scale and AI capabilities.

DETRACTORS

• Intuitive Surgical, Inc. manufactures the da Vinci Surgical System, a robotic surgical system used for minimally invasive surgical procedures. The stock detracted from performance amid investor concerns about financial pressure on hospital customers following Medicaid cuts included in the One Big Beautiful Bill Act. Additional concerns emerged regarding the potential use of third-party reprocessed instruments with Intuitive’s robotic systems. We believe hospitals are likely to be cautious about adopting reprocessed instruments given potential quality, reliability, and liability risks. Looking ahead, we see a long runway for growth as adoption of Intuitive’s robotic systems continues to expand across a growing range of surgical procedures.
• Eli Lilly and Company is a global pharmaceutical company currently best known for its GLP-1 treatments for diabetes and obesity. Shares declined after Phase 3 data for Lilly’s oral orforglipron in obesity fell short of elevated investor expectations. Investors had anticipated roughly 13% to 14% placebo-adjusted weight loss, while the trial showed 11.5%. The stock was also pressured by broader regulatory uncertainty related to potential sector tariffs and drug pricing risks. We view these risks as manageable and believe Lilly is among the least exposed pharmaceutical companies to both. We continue to believe orforglipron will be an important treatment option, as physicians and patients are likely to value the convenience of a daily oral therapy. Long term, we expect the GLP-1 drug class to become the standard of care for diabetes and obesity, ultimately representing a $150 billion-plus market, and believe Lilly possesses the leading portfolio in this category. In our view, GLP-1 adoption remains in the early stages, and continued uptake should drive a near doubling of Lilly’s total revenues by 2030.
• Boston Scientific Corporation is a global manufacturer of medical devices used in a broad range of interventional medical specialties. While the company continues to execute well, particularly with its Watchman device and pulsed field ablation (PFA) offerings, shares fell during the quarter amid rising competition in the attractive PFA space for treating arrhythmia. Medtronic has launched its Affera system, Johnson & Johnson markets Varipulse, and Abbott offers its Volt system—all large-scale rivals with significant sales forces and established electrophysiology footprints. Despite this competitive backdrop, we believe Boston Scientific remains a strong compounder. Coupled with cost discipline and more than 50 basis points of annual operating margin expansion, we think the company’s double-digit earnings per share growth profile makes it a compelling name within the large-cap medical device universe.

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 Health Care Fund (the Fund) appreciated 5.39% (Institutional Shares) in the third quarter, performing similarly to the Russell 3000 Health Care Index (the Index), which rose 5.05%. The Fund failed to distance itself from the Index because solid stock selection was mostly offset by adverse impacts from active sub-industry weights and cash exposure in an up market.

Strong stock selection in biotechnology contributed the vast majority of relative gains in the period, with the main drivers being argenx SE and Insmed Incorporated. Argenx is best known for developing Vyvgart, the leading FcRn inhibitor for the treatment of autoimmune conditions. The company’s shares rose after second-quarter Vyvgart sales meaningfully exceeded investor expectations, rebounding from prior weakness linked to seasonal factors (such as insurance reverification) and higher Medicare Part D utilization and associated discounts. Insmed has three lead pulmonology drugs that could collectively generate over $8 billion of peak sales. One of the three drugs, Brinsupri for non-cystic fibrosis bronchiectasis, represents a $5-plus billion opportunity. The company’s shares rose sharply after Brinsupri was approved in August. Other notable contributors in the sub-industry were Arcellx, Inc. (developing cell therapy for multiple myeloma), Ionis Pharmaceuticals, Inc. (developing RNA-targeted therapeutics), Cidara Therapeutics, Inc. (developing a long-acting anti-viral to prevent influenza), and Xenon Pharmaceuticals Inc. (developing novel medicines to treat epilepsy, depression, and pain).

Investments in health care services and health care technology also added value, with outpatient diagnostic imaging centers operator RadNet, Inc. and AI-driven coronary artery disease management platform Heartflow, Inc. leading the way in these sub-industries. RadNet’s shares rose on quarterly results that exceeded expectations, reflecting strong volume trends and raised 2025 guidance. We retain long-term conviction in RadNet given the aging U.S. population, the shift towards lower-cost outpatient settings, the growth of advanced imaging procedures, and the benefits that AI and new technologies are having on the company’s operations.

Heartflow’s shares performed exceptionally well after the company’s August IPO was well received by investors. The company’s solution provides a minimally invasive way to catch blockages in the heart vessels, reducing both false negatives and false positives relative to the standard of care today. The company has a strong competitive moat, with a repository of 110 million images supplemented by human-aided training that has taken over 10 years to build. We like the asset-light nature of the business, along with the margin expansion opportunity as the AI algorithm improves with scale and data, enabling Heartflow to reduce the number of employee hours involved in real-time workflows. Heartflow has over 600 peer-reviewed publications, its solution has been approved by the FDA, and its core product has 99% insurance coverage. We remain excited about Heartflow’s prospects given the company is in the early innings of its growth ramp. 

Partially offsetting the above was poor stock selection in health care equipment coupled with higher exposure to this lagging sub-industry, which was a 160 basis point drag on performance. Weakness in health care equipment was broad based, led by declines from Masimo Corporation and Boston Scientific Corporation. Masimo is a medical device company that manufactures and sells a range of non-invasive patient monitoring technologies, best known for its pulse oximeters that measure blood oxygen levels. Shares fell after the company reported quarterly results that raised concerns about a steep decline in incremental contract value. However, this metric is inherently uneven, as it depends on deal timing and when contracts come up for bid. By contrast, unrecognized contract revenue (the backlog) remains strong. We believe stable compounding in Masimo’s core health care business, together with cost rationalization and disciplined spending, should allow the company to achieve its goal of more than doubling earnings per share within five years. 

Boston Scientific is a global manufacturer of medical devices used in a broad range of interventional medical specialties. While the company continues to execute well, particularly with its Watchman device and pulsed field ablation (PFA) offerings, shares fell during the quarter amid rising competition in the attractive PFA space for treating arrhythmia. Medtronic has launched its Affera system, Johnson & Johnson markets Varipulse, and Abbott offers its Volt system—all large-scale rivals with significant sales forces and established electrophysiology footprints. Despite this competitive backdrop, we believe Boston Scientific remains a strong compounder. Coupled with cost discipline and more than 50 basis points of annual operating margin expansion, we think the company’s double-digit earnings per share growth profile makes it a compelling name within the large-cap medical device universe.

Apart from cash, disappointing stock selection in life sciences tools & services and pharmaceuticals also weighed heavily on performance. Performance in life sciences tools & services was hindered by Waters Corporation, a leader in providing quality control instruments and consumables for biopharmaceutical drug manufacturing. Shares fell after Waters announced the acquisition of Becton, Dickinson’s biosciences and diagnostics assets, a move that we thought would dilute the company’s growth rate and margins. Management’s rationale for the transaction was that they believed they could turn around an underperforming business. In our view, this fundamentally changed our original investment thesis, and we exited our position in favor of other opportunities.

Within pharmaceuticals, the Fund’s large position in Eli Lilly and Company accounted for a portion of the stock-specific weakness in the sub-industry. Lilly’s stock price fell modestly after Phase 3 data for the company’s oral drug orforglipron in obesity fell short of elevated investor expectations. Investors had anticipated roughly 13% to 14% placebo-adjusted weight loss, while the trial showed 11.5%. The stock was also pressured by broader regulatory uncertainty related to potential sector tariffs and drug pricing risks. Lilly remains the largest position in the Fund, and we continue to be excited about the company’s long-term prospects. Poor stock selection in pharmaceuticals was exacerbated by not owning Index heavyweight Johnson & Johnson, whose share price rose 22.3% in the period, detracting 116 basis points from relative results. We did not think Johnson & Johnson would meet our growth hurdle of achieving at least double-digit earnings growth over the long term, but clearly other investors saw something we missed. We have been evaluating whether this move in the stock reflected a short-term recovery from a discounted valuation or a change in the long-term growth outlook versus our prior expectations.