Baron India 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

• Eternal Limited is India's leading food delivery and quick commerce platform, with roughly 55% and 40% market share in these respective categories. Shares rose during the quarter, driven by Eternal’s continued leadership in the race toward profitability in quick commerce, as well as its strong balance sheet in an increasingly competitive industry. We retain conviction, as we believe Eternal is well positioned for long-term growth in quick commerce, given its first-mover advantage, scale, and superior execution. We think Eternal will continue to benefit from structural growth in online food delivery in India, potentially doubling its revenue, while also improving profitability and growing earnings over the next three to five years.
• Shaily Engineering Plastics Limited is a leading Indian manufacturer of precision injection-molded plastic components, with diverse product offerings spanning categories such as furniture, pharmaceuticals, and toys. Shares increased during the quarter, driven by strong quarterly results and the company’s plans to significantly expand its GLP-1 pen manufacturing capability. We remain invested in Shaily, as we believe the company will benefit from global supply chain diversification away from China and growth opportunities in GLP-1 pen manufacturing.
• Centum Electronics Limited is a leading electronics system design and manufacturing services provider in India, offering solutions for mission-critical applications across defense, aerospace, industrial, and automotive industries. Shares rose on strong quarterly results. We remain invested, as we believe Centum is well positioned to benefit from the Indian government’s “Make in India” initiative, which promotes domestic manufacturing of electronic products and components through attractive tax subsidies and infrastructure support. Amid rising global geopolitical tensions, we see additional upside from India’s push to indigenize defense equipment design and production, a trend that should benefit electronic system providers like Centum. We are also encouraged by management’s commitment to restructuring its loss-making Canadian subsidiary and enhancing operational efficiency at its French subsidiary. Looking ahead, we expect Centum to deliver 18% to 20% compounded revenue growth and 25% to 30% compounded EBITDA growth over the next three to five years.

DETRACTORS

• Max Healthcare Institute Limited is a leading hospital chain in India. Shares detracted from performance during the quarter due to a slight profit miss, as the company ramped up newly added beds at its greenfield facility. We remain investors. Under the leadership of CEO and restructuring specialist Abhay Soi, management has focused on cutting costs and improving return metrics at poorly managed hospitals. These efforts have helped Max Healthcare differentiate itself among Indian hospital peers with best-in-class EBITDA margins, average revenue per occupied bed, and return on invested capital. We remain optimistic about the multi-year growth opportunity in Indian hospital services and retain conviction in Max Healthcare as a key beneficiary of ongoing industry consolidation. We expect the company to more than double EBITDA and sustain mid-teens revenue growth over the next three to five years.
• Bharti Airtel Limited is a leading telecommunications company, with operations in 18 countries across Asia and Africa. The company’s offerings include wireless services, mobile commerce, and fixed-line broadband. Shares declined during the quarter as subscriber additions came in slightly below expectations. We remain shareholders. As India’s dominant mobile operator, Bharti Airtel is benefiting from ongoing industry consolidation. In particular, competitor Vodafone Idea appears on the verge of bankruptcy amid severe pricing pressure and an unsustainable balance sheet. We retain conviction in Bharti Airtel’s outlook given its visibility into strong free cash flow generation, having moved past its peak capex intensity, and its continued transformation into a digital services provider positioned to benefit from rising mobile tariffs.
• 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.

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 challenging quarter for Indian equities, Baron India Fund (the Fund) declined 6.34% (Institutional Shares) yet outperformed the MSCI AC Asia ex Japan/India Linked Index (the Index) by 127 basis points. Solid stock selection and modest cash exposure in a down market were the main reasons why the Fund managed to hold up better than the Index in the period.

On a sector level, stock selection in Information Technology (IT), Financials, and Industrials contributed the vast majority of relative gains, with most of the strength coming from holdings in the supply chain diversification, national security, consumer finance, and power reforms themes. Performance in Information Technology (IT) was bolstered by gains from electronic manufacturing services provider Centum Electronics Limited (national security) and electronic components manufacturer Kaynes Technology India Limited (supply chain diversification). Stock selection in IT was enhanced by being underweight IT consulting & other services stocks, which were down more than 15% in the Index. We remain materially underweight IT services companies within the sector, owing to structural growth headwinds related to the advancement of AI and more recently due to the prohibitive H-1B visa fee, which will impact near-term profitability for such businesses.  Consumer finance holdings Bajaj Finance Limited, Cholamandalam Investment and Finance Company Limited, and Bajaj Finserv Limited led the way in Financials, while a handful of holdings in the supply chain diversification (Shaily Engineering Plastics Limited and Precision Wires India Limited) and power reforms (Cummins India Limited, Siemens Energy India Limited, and Kirloskar Oil Engines Limited) themes performed well in Industrials.

Somewhat offsetting the above was poor stock selection in Consumer Discretionary, where retail company Trent Limited was a material detractor. The Fund was also hurt by having limited exposure to motorcycle and automobile manufacturers, which were among the top performers in the Index. Minimal exposure to the better performing Materials sector and stock-specific weakness in Communication Services (Bharti Airtel Limited) and Health Care (Max Healthcare Institute Limited) also hampered performance. 

From an S-curve growth perspective, Phase 1 - Under the Radar / Investment Mode holdings managed gains against the difficult backdrop for Indian equities. The Fund’s Phase 2 - Disruptors / Scale Builders and Phase 3 – Compounders declined in the period yet held up better than the Index. The only group to trail the Index was Phase 4 - Mature Businesses / Market Performers, owing mostly to double-digit declines from Tata Consultancy Services Limited, Indus Towers Limited, and Reliance Industries Limited.