Baron Opportunity Fund: Latest Insights and Commentary

U.S. equity markets were volatile during the quarter, as positive sentiment and strong performance in January were undermined by AI-related disruption fears and geopolitical tensions. Small and mid caps generated positive returns in the first quarter while large caps declined, a margin of outperformance for small and mid caps not seen since the COVID rally in late 2020 and early 2021. 

The year began with positive momentum for U.S. stocks, supported by easing inflation, resilient economic trends, strong corporate earnings, and investor optimism about the Trump administration’s stimulative economic strategy. Market sentiment began to shift in February, with the early catalyst being widespread losses across a range of industries due to fears about AI-driven disruption. Technology and software companies experienced notable pressure as investors worried AI agents could directly replace human-led business workflows. The sell-off worsened after the U.S. and Israel attacked Iran on February 28. Investors became concerned about the potential for sustained inflation and reduced economic growth from surging oil prices and supply chain disruptions. 

Against this backdrop, the dominant market trend was the continued rotation out of the Magnificent Seven, software, and other growth-oriented stocks. The Magnificent Seven complex declined 11.3%, accounting for about 90% of the cap-weighted S&P 500 Index’s losses. Microsoft (-23.3%), Tesla (-17.3%), Meta (-13.3%), Amazon (-9.8%), and Alphabet (-8.1%) suffered the largest losses. The non-Magnificent Seven stocks in the Index were down only 0.6% for the month. 

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) is a high-profile private company founded by Elon Musk. The company's primary focus is on developing and launching advanced rockets, satellites, and spacecrafts, with the ambitious long-term goal of making life multi-planetary. SpaceX is generating significant value with the rapid expansion of its Starlink broadband service. The company is successfully deploying a vast constellation of Starlink satellites in Earth's orbit, reporting substantial growth in active users, and regularly deploying new and more efficient hardware technology. Furthermore, SpaceX has established itself as a leading launch provider by offering highly reliable and cost-effective launches, leveraging the company's reusable launch technology. SpaceX capabilities extend to strategic services such as human spaceflight missions. Moreover, SpaceX is making tremendous progress on its newest rocket, Starship, which is the largest, most powerful rocket ever flown. This next-generation vehicle represents a significant leap forward in reusability and space exploration capabilities. We value SpaceX using prices of recent financing transactions.
• Arcellx, Inc. is a biotechnology company focused on cellular therapies. In partnership with Gilead, Arcellx is developing anito-cel, a BCMA-targeted CAR-T therapy similar to Legend Biotech and Johnson & Johnson’s Carvykti. Compared to Carvykti, anito-cel appears to demonstrate similar efficacy with a more benign neurological side-effect profile. Shares rose during the quarter as Gilead announced plans to acquire Arcellx for $115 per share, plus a $5 per share contingent value right tied to cumulative revenues through year-end 2029. 
• Semiconductor equipment company Nova Ltd. contributed to performance, driven by robust demand for its metrology solutions amid a strong AI-fueled semiconductor capex cycle. Nova specializes in process control—the precise measurement and characterization of materials during chip fabrication—a capability growing increasingly critical as devices become more complex. As chipmakers push the boundaries of physics, rising defect costs make Nova’s solutions indispensable to improving yields. Nova has consistently outgrown semiconductor equipment spending, gaining share in dimensional and materials metrology through highly differentiated technology that competitors have struggled to replicate. The company is well positioned across three growth vectors: the transition to gate-all-around transistor architecture in advanced logic chips, which demands greater metrology intensity; advanced packaging proliferation driven by high-bandwidth memory adoption; and accelerating investment in DRAM. With a portfolio uniquely aligned at the intersection of the industry's most significant technological inflections, we expect Nova to deliver strong double-digit earnings growth over the next several years.

DETRACTORS

• Tesla, Inc. designs, manufactures, and sells fully electric vehicles (EVs), solar products, and energy storage solutions, while developing advanced real-world AI technologies. Following robust gains in late 2025, shares fell as investors awaited progress on robotaxis and assessed the company’s sizable investments in manufacturing and AI. Operationally, Tesla delivered strong quarterly results amid a challenging EV environment. Automotive gross margins improved sequentially and beat expectations, the energy storage business maintained robust momentum with best-in-class margins, and battery cell production ramped. The company continues to advance its AI and autonomous driving initiatives at a rapid pace. Management anticipates meaningful robotaxi expansion in 2026 and continues to finalize the Optimus Gen 3 design and build out large-scale manufacturing capacity for humanoid robots. Tesla is also releasing major Full Self-Driving (FSD) enhancements, scaling AI training compute, and deepening vertical integration in semiconductor design and production. These initiatives, while increasing near-term capital spending, underscore Tesla’s pivot toward becoming a leader in physical AI.
• Software leader Microsoft Corporation detracted from performance despite reporting slightly better-than-expected revenue, margins, and earnings per share, with cloud revenue up 24% year over year in constant currency and commercial bookings up 228%, driven by commitments from OpenAI and Anthropic. Two factors pressured shares. First, Azure growth of 38% year over year in constant currency was slightly below expectations, reflecting capacity allocation across first- and third-party applications. Management continues to emphasize that Microsoft remains capacity constrained and is optimizing usage for long-term value, prioritizing applications such as Microsoft 365 Copilot to support future adoption. Second, investors are focused on the company’s reliance on first-party models from OpenAI and Anthropic, which plan to expand into the broader enterprise software market and account for a meaningful portion of remaining performance obligations (with OpenAI representing roughly 45%). We believe Microsoft is well positioned over the medium to long term, though we see a need for continued improvement in the pace of innovation in Microsoft 365 Copilot and in advancing model capabilities.
• NVIDIA Corporation is a fabless semiconductor company specializing in compute and networking platforms for accelerated computing. The company’s dominant position in AI infrastructure, with a comprehensive portfolio spanning GPUs, systems, software, and high-performance networking solutions, continues to drive strong performance. Shares traded down during the quarter despite robust underlying fundamentals and guidance extending into next year. In our view, the market appears disconnected from the pace of AI adoption and is pricing in a significant drawdown in demand over the next two to three years. We continue to hold the stock with strong conviction, as we believe the S-curve for compute infrastructure investment required to support AI diffusion across the economy remains in its early stages. NVIDIA is well positioned to benefit disproportionately from this trend, in our view.

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 Opportunity Fund (the Fund) declined 8.88% (Institutional Shares) in the first quarter, modestly outperforming the Russell 3000 Growth Index (the Index), which declined 9.54%. The Fund managed to beat the Index amid challenging market conditions because strong stock selection helped overcome headwinds from industry and style factors. According to MSCI’s Barra factor attribution, the Fund’s underexposure to AI beneficiaries in Computer Electronics, Semiconductor Equipment, and Electrical Equipment weighed heavily on performance. These industries were up nearly 30% on average in the period, accounting for about half of the industry-specific weakness. Additionally, overexposure to Internet Software and IT Services proved costly as the industry faced significant selling pressure due to investor fears that AI will disrupt their businesses. In terms of styles, the Fund’s underexposure to various value-oriented (Dividend Yield and Earnings Yield) factors and overexposure to Growth hampered performance given the meaningful rotation into value stocks during the period. The Fund’s underexposure to the Momentum factor, which continued to perform well to begin 2026, also weighed on performance.

From a sector perspective, strong stock selection in Industrials coupled with higher exposure to this better performing sector accounted for most of the relative outperformance in the period. Strength in Industrials was driven by the Fund’s sizable position in Space Exploration Technologies Corp. (SpaceX), a high-profile private company founded by Elon Musk. The company's primary focus is on developing and launching advanced rockets, satellites, and spacecrafts, with the ambitious long-term goal of making life multi-planetary. SpaceX is generating significant value with the rapid expansion of its Starlink broadband service. The company is successfully deploying a vast constellation of Starlink satellites in Earth's orbit, reporting substantial growth in active users, and regularly deploying new and more efficient hardware technology. Furthermore, SpaceX has established itself as a leading launch provider by offering highly reliable and cost-effective launches, leveraging the company's reusable launch technology. SpaceX capabilities extend to strategic services such as human spaceflight missions. Moreover, SpaceX is making tremendous progress on its newest rocket, Starship, which is the largest, most powerful rocket ever flown. This next-generation vehicle represents a significant leap forward in reusability and space exploration capabilities. We value SpaceX using prices of recent financing transactions.

Solid stock selection in Information Technology (IT) also added value, with the standouts being semiconductor companies Taiwan Semiconductor Manufacturing Company Limited (TSMC) and Monolithic Power Systems Inc. (MPS). TSMC’s stock performed well after reporting better-than-expected revenue growth due to surging demand for AI chips. TSMC dominates the advanced semiconductor foundry market, controlling over 90% share of cutting-edge sub-7 nanometer (nm) nodes that power AI servers, flagship smartphones, and autonomous vehicles. The company benefits from a virtuous cycle in which its massive scale and profitability generate the capital necessary to fund industry-leading R&D and capex, in turn widening its technological moat and reinforcing its pricing power. As the ultimate "picks and shovels" provider of the AI era, TSMC remains insulated from the competitive dynamics of the AI chip design ecosystem. Whether hyperscalers develop custom accelerators or deploy merchant graphics processing units from companies like NVIDIA and AMD, nearly all advanced AI accelerators are manufactured exclusively at TSMC’s 3nm and 5nm nodes. We believe TSMC will deliver 20% earnings growth over the next several years, supported by secular AI-driven demand for leading-edge manufacturing capacity.

MPS designs chips that deliver precise, safe, and efficient power to processors, memory, and sensors in electronic systems. With deep system-level expertise and highly integrated solutions, MPS has established a strong leadership position in power management. The company’s shares rose in response to raised full-year guidance and expectations for further upward revisions. MPS is poised to benefit from two major secular trends: AI-driven data center redesigns and automotive electrification. AI is fueling exponential growth in data center power needs, forcing a fundamental rethink in how power is distributed. While server shipments are experiencing unprecedented growth, power content per system is also rising, creating a durable multi-year tailwind. At the same time, vehicles are shifting to centralized computing and higher-voltage architectures, significantly increasing the need for advanced power management content per vehicle. MPS’ leadership positions it to directly benefit from both the AI infrastructure buildout and long-term automotive electrification.

Favorable stock selection in IT was enhanced by having limited exposure to Index heavyweight Microsoft Corporation, whose share price collapsed 23% in the period. Two factors Microsoft’s pressured shares. First, Azure growth of 38% year over year in constant currency was slightly below expectations, reflecting capacity allocation across first- and third-party applications. Management continues to emphasize that Microsoft remains capacity constrained and is optimizing usage for long-term value, prioritizing applications such as Microsoft 365 Copilot to support future adoption. Second, investors are focused on the company’s reliance on first-party models from OpenAI and Anthropic, which plan to expand into the broader enterprise software market and account for a meaningful portion of remaining performance obligations (with OpenAI representing roughly 45%). Given the need for improvement in the pace of innovation in Microsoft 365 Copilot and in advancing model capabilities, we exited our position.

Partially offsetting the above was disappointing stock selection in Communication Services, Consumer Discretionary, and Real Estate, which detracted approximately 190 basis points. Global digital music service platform Spotify Technology S.A. was partly responsible for the relative shortfall in Communication Services after the company’s shares fell amid AI disruption fears and a broader selloff in higher-valuation technology names. In our view, the company’s fundamentals remain intact. Despite recent price hikes, user growth has continued at a double-digit year-over-year pace, with engagement remaining high. The company also reaffirmed its plan to structurally increase gross margins on an annual basis, aided by its high-margin artist promotions marketplace, growing contribution from podcasts and audiobooks, and ongoing investments in advertising. Spotify continues to innovate across its platform, improving advertising, expanding into video, developing a Super Premium tier, and taking more market share. We believe AI is a net positive for Spotify, with risks limited by the company’s freemium model and by the incentives labels and artists have to continue working with existing distributors. We still view Spotify as a long-term winner in music streaming with potential to reach 1 billion-plus monthly active users.

Lower exposure to Index heavyweight Alphabet Inc. also contributed to relative weakness in Communication Services given the company’s shares performed slightly better than the sector and overall Index.

Weakness in Consumer Discretionary was broad based, led by sharp losses from electric vehicle (EV) manufacturer Tesla, Inc. and digital sports betting and gaming operator DraftKings Inc. Following robust gains in late 2025, Tesla’s shares fell as investors awaited progress on robotaxis and assessed the company’s sizable investments in manufacturing and AI. Operationally, Tesla delivered strong quarterly results amid a challenging EV environment. Automotive gross margins improved sequentially and beat expectations, the energy storage business maintained robust momentum with best-in-class margins, and battery cell production ramped. The company continues to advance its AI and autonomous driving initiatives at a rapid pace. Management anticipates meaningful robotaxi expansion in 2026 and continues to finalize the Optimus Gen 3 design and build out large-scale manufacturing capacity for humanoid robots. Tesla is also releasing major Full Self-Driving enhancements, scaling AI training compute, and deepening vertical integration in semiconductor design and production. These initiatives, while increasing near-term capital spending, underscore Tesla’s pivot toward becoming a leader in physical AI.

DraftKings stock declined as investors grappled with a guidance range that implied a slowdown in betting activity, elevated investment in prediction markets, and lingering debate around the sustainability of structural hold (the percentage of wagers retained as revenue). These headline concerns obscure what we believe are strong fundamentals in the core sports betting customer cohorts. Management built fiscal 2026 guidance on flat actual hold, even though hold has expanded every year in the industry's history. Parlay mix, the primary mechanical driver of hold, increased 500 basis points during NFL season and 200 basis points year to date. The $800 million EBITDA midpoint also embeds a $200 million headwind from prediction markets investment, which currently carries no associated revenue. Excluding that impact, implied core business EBITDA exceeds $1 billion. We believe the stock is trading at attractive multiples relative to the company’s long-term earnings potential and think the total addressable market for prediction markets, while nascent, has the potential to accelerate growth.

Performance in Real Estate was hindered by real estate data and marketing platform CoStar Group, Inc., whose shares were down 40% to start the year. Shares fell due to multiple compression driven by rising AI fears. The market has come to view AI as an existential risk for a growing number of industries—including software, business services, information services, and video games—despite no evidence of any fundamental impact to these sectors. This “shoot first and ask questions later” dynamic has resulted in meaningful share price declines. We continue to own CoStar given its differentiated data assets and significant growth opportunities in providing enhanced real estate information, analytics, and marketplace offerings. CoStar boasts an enviable business model with high levels of recurring revenue and meaningful cash flow generation potential. While near-term cash flow is obscured by elevated investment in Homes.com, we expect spending to moderate and cash flow to improve over the next several years. The company also maintains a substantial cash balance, which we are hopeful will be used to aggressively repurchase shares at current depressed valuation levels.

Minimal exposure to the better performing Consumer Staples sector was another material drag on relative performance.