Baron Real Estate 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

• Brookfield Corporation is a global investor in real estate, infrastructure, renewable power, private equity, and credit, with $1 trillion in assets under management. Shares contributed to performance on strong capital deployment, fundraising momentum, and improving values of real estate investments held on its balance sheet. We continue to own the company given its strong asset management platform, which offers high earnings visibility, along with its global capital deployment capabilities.
• Wynn Resorts, Limited is a global luxury resort operator with properties in Las Vegas and Macau and a new integrated resort under development in the UAE. Shares rose during the quarter due to an in-line outlook for Las Vegas, accelerating growth in Macau, and continued progress on the UAE project. Early in the quarter, the stock came under pressure due to concerns about tariffs and a potential trade war with China, as well as fears of a consumer slowdown and political risk weighing on Macau valuations. However, Macau trends improved meaningfully, with gross gaming revenue up double digits year over year through May, compared to low single-digit growth earlier in the year. In Las Vegas, management highlighted stable demand from VIP customers, ongoing investment in food and beverage, and strong group bookings extending through 2026. We remain constructive on Wynn’s long-term prospects, given its differentiated positioning in Las Vegas and the earnings potential of the new UAE development.
• Brookfield Asset Management Ltd. is a leading alternative asset manager that was spun out from Brookfield Corporation in December 2022. Shares contributed to performance on continued strong fundraising despite a volatile macroeconomic and geopolitical environment, as well as improving margins and growth in fee-related earnings. We retain conviction due to the company’s diversified asset base, sustainable cash flows, strong asset management platform, and global capital deployment capabilities.

DETRACTORS

• Churchill Downs Incorporated operates live and historical racing entertainment venues, online wagering businesses, and regional casino gaming properties in the U.S. Shares declined during the quarter following an earnings release that highlighted weakening trends in the Virginia market and lower-than-expected Kentucky Derby earnings. The company also indefinitely delayed a major Kentucky Derby expansion project and offered limited guidance on whether it would redirect the freed-up capital toward share repurchases. While the company is pursuing several growth projects with attractive long-term prospects, these initiatives will take time to ramp to full profitability, and leverage remains elevated. We believe the Virginia market and the company’s broader regional gaming portfolio are likely to remain under pressure. Given intensifying competition and an uncertain business outlook, we exited the position.
• Prologis, Inc. is the largest owner and operator of industrial warehouse real estate in the world. Shares declined during the quarter due to a slowdown in leasing demand, driven by heightened uncertainty around global tariffs and trade policies. We see this as a temporary headwind, with pent-up demand likely to be released once macroeconomic pressures ease. We believe Prologis’ multi-year growth outlook remains compelling given its scale, strategic locations, and best-in-class operations. We also view the current valuation as attractive.
• Independence Realty Trust, Inc. (IRT) owns 33,000 apartment units that cater to a more affordable income demographic. Shares declined during the quarter due to broader economic concerns, including the potential impact of tariff policies on lower-income consumers, softer-than-expected pricing power on new leases, and mixed investor reception of select strategic acquisitions. We retain conviction in IRT due to its superior management team, high-quality portfolio in select markets, and demonstrated ability to drive outsized earnings growth through its value-add program.

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 period for REITs, Baron Real Estate Fund (the Fund) appreciated 3.61% (Institutional Shares), outperforming the MSCI US REIT Index, which declined 1.46%, by 507 basis points. The Fund benefited from its unique exposure to various non-REIT categories that managed gains in the period, such as real estate operating and services companies, hotels & leisure businesses, homebuilders & land developers, and casinos & gaming operators. However, the Fund trailed the more comparable MSCI USA IMI Extended Real Estate Index (the Index) by 252 basis points.

The underperformance versus the Index was driven by active real estate category exposures, as the Fund was hurt by its underexposure to infrastructure related and hotels & leisure businesses, which were the two best performing segments in the Index, detracting around 240 basis points from relative results. The Fund’s meaningfully higher exposure to lagging real estate operating companies also proved costly. 

Stock selection was positive overall yet failed to offset the adverse allocation-related impacts noted above. The Fund’s investments in real estate operating companies, homebuilders & land developers, and real estate service companies were the standouts in the period, contributing 270-plus basis points of stock-specific gains. Strength in the real estate operating category came from Brookfield Corporation and related entity Brookfield Asset Management Ltd. Brookfield Corporation is a global investor in real estate, infrastructure, renewable power, private equity, and credit, with $1 trillion in assets under management. The company’s shares contributed to performance on strong capital deployment, fundraising momentum, and improving values of real estate investments held on its balance sheet. Brookfield Asset Management is a leading alternative asset manager that was spun out from Brookfield Corporation in December 2022. Brookfield Asset Management’s stock was bolstered by continued strong fundraising despite a volatile macroeconomic and geopolitical environment, as well as improving margins and growth in fee-related earnings.

Performance in homebuilders & land developers and real estate services was aided by high single-digit gains from luxury homebuilder Toll Brothers, Inc. and commercial real estate services and investment firm CBRE Group, Inc., respectively. Toll Brothers stock rose on better-than-feared quarterly results, despite ongoing challenges in the U.S. housing market. We believe Toll Brothers is well positioned for long-term growth, supported by its premium product offerings, extensive upgrade options, and scale advantages. CBRE’s shares were driven higher by continued strong business trends across the company's various business lines and management's view that full-year guidance remains achievable. We continue to believe that CBRE stands to benefit meaningfully from a long-term recovery in the commercial real estate industry, with profitability poised to improve as end markets stabilize.

The above-mentioned stock-specific impacts were mostly offset by poor stock selection in the building products/services, hotels & leisure, and casinos & gaming categories. Weakness in building products/services was driven by Louisiana-Pacific Corporation (LP Building Solutions), a specialty building products company focused on engineered wood siding. While the company’s financial results have continued to impress, shares fell during the quarter on broad investor concerns that weakness in the U.S. housing and home improvement markets could eventually weigh on results. We remain confident in LP Building Solutions’ multi-year growth prospects, driven by the secular shift from vinyl to engineered wood siding.

Travel company Expedia Group, Inc. was responsible for most of the losses in the hotels & leisure category after the company’s shares declined 16.0% before being sold early in the quarter. We sold Expedia and used the capital to establish a new position in Airbnb, Inc. We have been following and meeting with Airbnb since its IPO in 2020 and took advantage of the indiscriminate sell-off in April to buy a high-quality company that was on sale with a favorable risk/reward setup under a wide range of economic scenarios.

Performance in casinos & gaming was hindered by Churchill Downs Incorporated (CDI), an industry-leading racing, online wagering, and gaming entertainment company. CDI’s shares declined during the quarter following an earnings release that highlighted weakening trends in the Virginia market and lower-than-expected Kentucky Derby earnings. The company also indefinitely delayed a major Kentucky Derby expansion project and offered limited guidance on whether it would redirect the freed-up capital toward share repurchases. While the company is pursuing several growth projects with attractive long-term prospects, these initiatives will take time to ramp to full profitability, and leverage remains elevated. We believe the Virginia market and the company’s broader regional gaming portfolio are likely to remain under pressure. Given intensifying competition and an uncertain business outlook, we exited the position.