Baron Funds Third Quarter Quarter Report
Dozens of media and print reporters attend our conference every year. For the fourth consecutive year, CNBC's Squawk Box broadcast live from the Baron Conference from 6:00AM through 8:30AM. Squawk anchor Andrew Ross Sorkin and Ron cohosted that morning's program. Andrew and Ron interviewed executives of several companies in which Baron Funds has invested. This year that included David Rubenstein, Chairman, The Carlyle Group (CG), Tom Pritzker, Chairman, Hyatt Hotels Corp., Steve Wynn, Chairman, Wynn Resorts Ltd. (WYNN) and Kevin Plank, Chairman, Under Armour, Inc.
CNBC's visit to our annual meeting gives its 600,000 viewers a glimpse of what it is like to "walk in our shoes" as a research analyst and portfolio manager. We think these executive interviews by the Squawk anchors and Ron at our annual meetings provide Baron Funds' shareholders with good examples of what we mean when we say,"We invest in people, not just buildings."
On CNBC this year, we were joined by executives with whom Baron Funds has invested successfully and with whom we expect to make a lot more.
Kevin Plank, founder and CEO of Under Armour, Inc. (UA), spoke about his improbable success creating a business from the need to tackle a simple problem for athletes—the sweat absorbent, cotton T-shirt. Although Kevin has already revolutionized athletic apparel, he spoke about how his company is just scratching the surface in other categories, including: footwear, womens and kids.Tom Pritzker, Chairman of Hyatt Hotels Corp., a business founded by his dad, Jay, graciously made the trip from Chicago to be with us for ten minutes to discuss how he evaluates a business based on the people who run it, rather than just its business plan. Tom noted that he has rarely seen a business plan that has worked as expected. For that reason, he explained, Hyatt's best managers are the ones who can adapt to changes and handle curve balls, fitting well with our "Play Ball" baseball theme this year. Tom has clearly proven adept at identifying such talent to oversee Hyatt's growing portfolio of 500 properties. He has also surprisingly been adept at founding several other very successful multibillion dollar businesses in non-related categories by also betting on the right people to run them. He has learned well from his dad. David Rubenstein, co-CEO and co-founder of private equity firm The Carlyle Group, talked about his approach to making strategic global investments on behalf of his clients.We think Carlyle's positioning and diversification should allow his firm to continue to earn superior returns for their clients. This is especially the case since Carlyle tends to make their most profitable investments in uncertain environments. This is because in uncertain environments like the present, some businesses can be purchased at very attractive prices. One of David's other co-founders and Valley veteran at the age of only 45, even though he still looks like he's 25! This year, Rich was thrilled to be the one asking the tough questions instead of having to answer them.We thought Rich did a terrific job interviewing our managers on wide ranging topics, such as how we find businesses with sustainable competitive advantages; how we apply our Baron Investment philosophy in international markets; and how we approach stock selection in uncertain times.
The business portion of the afternoon concluded with Ron's speech which had all of the ingredients you have come to expect. As usual, Ron's talk was distinctive due to what many regard as his highly unusual sense of humor. Which, surprising to so many of his fellow Baron employees, our shareholders seemed to enjoy more than ever this year! We believe it is highly unusual for a mutual fund advisor to host such an annual conference. Our privately owned operating company, as opposed to the Baron Funds, bears the entire cost of the day. Our goal is to demonstrate to you, our shareholders, that investing for the "long term" and investing "in people, not just buildings" are not just catch phrases. They are embedded in how we think, how we study businesses and people, and how we invest. These principles are integral to our investment process. Our annual conference provides transparency into our investment process by allowing you to listen to and then question the intelligence, integrity, character and vision of the entrepreneurial executives who run businesses in which we invest on your behalf. This is so you can judge for yourselves whether the quality of our investments and our long-term approach makes sense for a portion of your family's hard-earned savings.
Of course, it wouldn't be a Baron Conference without an entertaining lunchtime interlude between our morning speakers and interaction with our Firm's portfolio managers, Linda and Ron. This year was no exception. During lunch, our shareholders were dazzled by amazing performances from iconic crooner, Harry Connick, Jr., Grammy award winner and rising rock star, Joss Stone and Tony award winner Kristin Chenoweth. As has become our custom, we had Tony nominated Kelli O'Hara grace us with her spectacular voice as she kicked off the afternoon session with "God Bless America" and Kristin Chenoweth with the baseball game standard, "Star Spangled Banner" that ended with a rousing Play Ball. Finally, to end the day, the magnificent Celine Dion, direct from her wildly successful Las Vegas show, performed her classic hits in show stopping style.
Also, as has been our tradition, our shareholders departed with "party favor" gifts of chocolate chip cookies and a Baron Funds 2012 "Play Ball" Conference T-shirt (an Under Armour limited edition for Baron Capital's 30th anniversary) "autographed" by the day's performers.
The content in our September 30, 2012 shareholder letters that follow is different than you find in our other quarterly letters. Instead of our usual "Letter from Ron" and "Letter from Linda," we have included Ron's conference speech and a version of Linda's conference speech, respectively. We chose "Play Ball", not only because Linda is a huge Yankees fan, but also because it describes our commitment to investing for the long term. We believe that "Playing Ball" and "Getting in the Game" is the only way to win on the field of investing, and, hopefully, after you read our letters, you will see why.
All our employees had a hand in making this conference, which has become a very complicated event to produce, a success. We thank them for that. The 2012 Baron Conference celebrated our management company's 30th year in business and marked the 25th year since the founding of Baron Funds. It will probably not be surprising to you that we are already hard at work on the 2013 Baron Investment Conference, our 22nd meeting. Thank you for joining us as fellow shareholders in Baron Funds.We look forward to seeing you at the Metropolitan Opera House in New York for the 22nd Annual Baron Investment Conference next fall.
Michael Baron, Vice President and Analyst
MatthewWeiss, Vice President and Analyst
NOTE FROM RON
I hope you enjoy my speech, Linda's speech and the letters written by Baron Funds' portfolio managers. Linda chose our baseball oriented theme, "Play Ball," this year. We think you will find her discussion about why and how baseball strategy can be analogized to investment strategy both entertaining and interesting.
If you'd like to watch a replay of our investment conference, including CEO presentations, the Portfolio Manager panel and Linda's or my speech, you can do so by visiting our website at: www.baronfunds.com.
If you're a shareholder and were unable to attend our meeting this year, please let us know and we'll send you a Baron Funds 2012 conference T-shirt with printed "autographs" of this year's Baron Conference entertainers. There is no charge, of course, as long as the T-shirts last. If you send us a picture of you or your family members wearing our T-shirt (PG only, please), with your permission, we'll display it at our next conference and on our website. We'd also love to hear about any unusual Baron Tshirt sightings around the globe.
To get your free T-shirt or upload a photo, go to www.baronfunds.com/photos or call 1-800-99- BARON.
Please know as well that since demand to attend our annual meeting has begun to exceed our seating capacity in the Lincoln Center venue where we hold this event, we had to limit attendance this year for the first time.We are sorry we had to disappoint some of our long term and loyal shareholders by not being able to provide tickets to attend.We have tried to be fair in changing the requirements to attend this year. If you were unable to attend, you can watch a replay of our meeting at www.BaronFunds.com…all but the performances by our entertainers whose contracts expressly prohibit this to occur. Thank you for understanding.
CEO and Chief Investment Officer
RON'S 2012 CONFERENCE SPEECH. "PLAY BALL."
SLIDE: Baseball player swinging a bat.
My grand-parents were born in Poland and Russia, my parents in Brooklyn. I had been a Brooklyn Dodgers' fan since birth. In 1951, when I was eight, my family was the first on our block to buy a television. Our Emerson TV had a 19 inch, black and white screen. I watched Dodgers' night games from the top steps outside my bedroom before I went to sleep. Soon after my dad bought that TV, my grandmother took me to a game at Ebbets Field as a birthday present.We walked to the stadium while I held her hand and proudly wore my Dodgers baseball jacket. After we entered the park, I peered through a grimy portal to the sunlit field below. Directly in front of us, "Pee Wee" Reese, Gil Hodges and Jackie Robinson were playing catch. It was better than anything I could have imagined from watching TV. I remembered that experience when we chose "Play Ball" as our 2012 conference theme. What could be more appropriate, I thought, than to use Ebbets Field, "The Greatest Ballpark Ever," as a metaphor for America?
My talk today will focus on three topics.
I. The Playing Field.
The current investment environment.
II. Spring training.
The Preparation; and
III. Play Ball.
Why we think you should get in the game.
I. THE PLAYING FIELD. In a little more than three weeks, we will either reelect President Obama or give Governor Romney a chance to see if he can do any better… unless we decide to go with none of the above.
SLIDE: Clint Eastwood talking to an empty chair at the Republican National Convention. We are now being asked if we are better off than four years ago?
Four years ago the Baron conference took place on Friday, October 24, 2008, 39 days after Lehman Brothers' bankruptcy sent financial markets reeling. Stocks had already fallen more than 40% during the last year. Many feared an imminent Crash and a second Great Depression. Bank credit, our economy's lifeblood, was virtually unavailable. Stores were empty. Commercial activity had almost stopped. Home prices were falling. Businesses were cutting capital spending and firing employees. America was losing 750,000 jobs a month. On the morning of our 2008 conference, markets couldn't even open! The New York Stock Exchange was "limit down."
VIDEO: Ron Baron October 24, 2008 CNBC appearance.
Today, the Dow Jones is 5,000 points higher! Banks hold $1.6 trillion excess reserves. Loans at rates that have never been as low are readily available. Corporations hold $2 trillion in cash. Investors who feared the worst and sought the "safety" of fixed income missed this 60% stock market rebound.
While many of us are better off than four years ago, 18 million Americans who can't find jobs are not. America has no shortage of problems. Budget deficits; unaffordable entitlements; a tax system that needs to be reformed; a "fiscal cliff;" an economy growing too slowly to reduce unemployment; a Congress that can't legislate; the European debt crisis; and, most important of all, a nuclear Iran.
SLIDE: "Since 1776, it's never paid to bet against America." – Warren Buffett
Regardless, we continue to feel, as we have for four years, that prospects for stocks in America are bright. But, after telling you about all these problems, you must be thinking, "How can he possibly be optimistic?!"
Reasons to be optimistic:
A. Stocks are cheap
Stocks are cheap. Businesses are well capitalized and very profitable; yet, their stocks are being valued for 13.8X earnings vs. a more normal 15.5X for the past 200 years!
B. Federal Reserve's reflationary activity Federal Reserve Chairman Ben Bernanke intends to keep interest rates low, create inflation and devalue the dollar. Inflation increases pricing power and drives higher return on investment and faster earnings growth. A devalued dollar will increase demand for our nation's products and should encourage businesses to invest to create jobs.We think the Federal Reserve will be successful.
Stocks, real estate, businesses, art and gold are all hedges against a devalued dollar. Stocks historically have provided the best returns. In no instance has any nation's currency maintained its purchasing power through the years – that includes the dollar.
Nations default. Their currencies are devalued or their currencies die. Ancient Romans and Greeks removed precious metals from their coins to make them worth less. Modern societies "print" money.
The average salary in America in 1940 was $2,000. My parents bought their first home in 1948 for $5,000. During my last year in college in 1965, tuition, room and board were $3,500! That's what I mean by a devalued dollar.
In the 1920's, the Weimar Republic tried to reduce its World War I reparations with inflation. Its annual deficit was 180% of GDP! America's is now 9%. Germany "printed" too much and caused hyperinflation.
SLIDE: Photograph of a man holding a wheelbarrow of cash: "We're gonna need a bigger wheelbarrow." When governments are in debt and do not print enough, they create deflation. Japan has had no growth for more than two "lost decades" for that reason.
SLIDE: Chart of Japan's Nikkei Index – 1970–2007.
Spain today can't "print" and is in the midst of an economic Depression with deflation and 25% unemployment.
SLIDE: Photograph of the Spanish Financial
Crisis Riots – March 2012.
Successful reflations boost economic growth. It took three years in the 1930s for America to learn to reflate. It took Chairman Bernanke six months. Bernanke seems to have engineered the most successful reflation in history. While many consider leadership in the world problematic, two leaders who do what they think is right rather than what is politically expedient are Federal Reserve Chairman Bernanke and the European Central Bank's ("ECB") President Mario Draghi.
In other times they might have been considered peers of Roosevelt and Churchill. To keep with our baseball theme, we hope they'll be thought of like Sandy Koufax and Jackie Robinson.
SLIDE: Photograph of Federal Reserve Chairman Bernanke and ECB President Mario Draghi appearing as players on baseball cards.
History will judge if Bernanke and Draghi's policies were right. We hope so.
II. SPRING TRAINING.
It's about people, preparation and performance. We think becoming a championship team, an innovative business or a top performing investment manager is about assembling talent, molding them into a team and teaching them a consistent process.
SLIDE: "Don't worry about your individual numbers. Worry about the team. If the team is successful, each of you will be successful." – Branch Rickey.
Businesses have the best opportunities to hire talented individuals when others are not hiring. In 2006, our firm consisted of 60 individuals, 20 of whom were analysts and portfolio managers. We have consistently grown our firm over the past six years.We now consist of 115 individuals including 27 analysts and portfolio managers. We want our analysts and managers to "go deep" to understand what makes a business tick.
SLIDE: "The most important thing is to never stop questioning." – Albert Einstein.
Baseball players need spring training, practice and a lot of games to grow from rookies into stars. It's about muscle memory. It takes a while before they get to first base.
VIDEO: Stephen Colbert discussing "getting to first base" on The Colbert Report.
Analysts also need a lot of experience and training to become great investors. It's about perspective. Social scientist Malcolm Gladwell's premise that expertise and skill are achieved after 10,000 hours of intense work makes sense. That's at least five years.
That was how Ted Williams became "the greatest hitter who ever lived."
SLIDE: "All I want out of life, is when I walk down the street folks will say, 'There goes the greatest hitter that ever lived.'." – Ted Williams.
By studying hitting and swinging a bat at least three hours a day every day, year after year for his entire career.
The Beatles became the "greatest band in the entire world" by performing 1200 live performances over four years in Hamburg, Germany strip clubs! They often played for eight hours a day seven days a week from early evening till well after midnight.
SOUND: The Beatles – "I Want to Hold Your Hand."
By the way...that was in German.
When The Beatles returned to England in 1964, they had become a band that sounded like no one else. Talk about "A Hard Day's Night". Similarly, we give our talented and hardworking analysts and portfolio managers a framework in which to study businesses and people. They spend their days year after year watching which companies and managers become the successful and which fail. This helps our analysts gain perspective and become even more talented investors. The longer they work together, the more successful they will be as a team, just like the Beatles were as a band.
Over the course of a year, our research staff meets with approximately 1,000 companies.We host three to four management teams in our office every day.
SLIDE: Photograph of Steve Martin and John Candy appearing in the movie poster for "Planes, Trains and Automobiles."
Our research team also continuously visits companies and tours plants, facilities, distribution centers, stores, hotels and casinos to "cover all the bases."
What is the "tipping point" that makes us decide to invest? My friend, Buzzy Krongard, calls this the Epistemology of an investment.
SLIDE: "The branch of philosophy concerned with the nature and scope of knowledge." – Epistemology.
The analogy to baseball is, what makes a batter swing at a pitch?
SLIDE: Photograph of Babe Ruth hitting a home run.
Unlike batters who have only an instant to estimate location, speed, and type of pitch, we take time to understand businesses' growth opportunities and competitive advantages. That's what gets us interested. But it's our assessment of management that is the "tipping point" that determines whether or not we invest. When growth opportunities, competitive advantages and great managements come together, they become RBIs. Ron Baron Investments. SLIDE: RBI. "Ron Baron Investments." You heard from several today.The Carlyle Group, United Natural Foods, Vail Resorts, Verisk Analytics and Under Armour. We're identifying RBIs every day to help us win.
American Campus Communities: There are five million obsolete college campus housing units that need to be replaced and renovated. Colleges can't afford to do this. That's the growth opportunity. American Campus is the largest provider of such housing with nearly 70,000 units. It builds and owns housing on college campuses with 80 year land leases that prevent others from competing against them. SLIDE: "Animal House" movie poster.
Vail Resorts: Summer recreation activities and a regentrified town offer Vail, the best ski mountain in America, maybe the world, growth opportunities. No one is building another ski mountain. That's the competitive barrier.
SLIDE: Photograph of Vail Mountain.
ITC Holdings: There are hundreds of billions that need to be spent to upgrade our electric grid. Independent transmission businesses have been granted favorable regulated rates of return and capital structures to incent investment. That's the opportunity. ITC is the only independent electricity transmission business. It is a difficult and lengthy process to obtain regulatory approvals to do this. That's the barrier.
SLIDE: Photograph of Electric Grids.
Hyatt Hotels Corporation (H): We've invested with Tom Pritzker and his dad, Jay, since the 1970s. Tom is now creating competitive advantage for Hyatt in Asia by building five star hotels influenced by his dad's love of iconic architecture.
Tom recently mentioned that he had never seen a business plan that worked as expected. "It seems so simple in retrospect," he remarked. "All you need to do is invest in people who are flexible enough to adapt to changing circumstances." Sounds like guys who can consistently hit a curveball to me.
SLIDE: Photograph of Tom Pritzker, Chairman of Hyatt Hotels.
III. PLAY BALL.
Consumers spend lots of time researching how much to spend on a TV, a car, a vacation and a refrigerator. Not nearly as much on investments they will need to finance their retirement. They often don't even open their monthly financial statements. They are not in the game.We think that is a bad choice.
Rabbi David Wolpe of Sinai Temple says people often make bad choices because they "don't believe in the future. They only believe in the present."
SLIDE: "You gotta believe!" – Tug McGraw. This is consistent with Warren Buffett's thoughts about the futility of "trading the news."
SLIDE: "My favorite holding period is forever." – Warren Buffett
Stocks have returned 7% per year over the past 60 years. However, because individual investors often buy and sell based upon news and emotions, they have earned only 3.8% per year.
A long term perspective allows you to see America as "The Best Ballpark Ever," a "Field of Dreams."
When you choose to invest in America we think it's important that you understand the competitive advantages of our nation. They include the ingenuity and creativity of its hardworking entrepreneurs, many of whom are immigrants, who have come here in search of freedom from tyranny, religious persecution and a better life for themselves and their children.
Living standards in our country in the last century have experienced a 10 fold increase.
SLIDE: "Standard of Living? It's about painkillers. If you want to have some fun, try getting a tooth pulled in 1900." – Stephen Colbert.
We expect living standards in America during the next century to improve as dramatically as they have in the last hundred years offering great investment opportunity. But, for the first time, the majority of Americans do not believe their children and grandchildren will have a higher standard of living than theirs'.
SLIDE: 52% of people surveyed for a poll feel that the standard of living for their children will be the same or worse when they reach the their age.
We strongly disagree.We understand why individuals who have witnessed improbable "black swan" events are afraid for their future. We understand why electronic trading mishaps and flash crashes have made them think markets are rigged. We have invested in our business to study and value businesses and management teams just like you have studied to be a teacher, engineer, dentist, lawyer or doctor. We believe our expertise allows us to take advantage of investment opportunities that will improve our living standards; make our country stronger; and produce economic growth and jobs.
America has low cost, shale gas and oil energy reserves that could last 200 years. The price of domestic gas is $3.50 per Mcf. This is equivalent to $20 per barrel of oil. The current price for a barrel of oil is $90! This is a transformative development. Our country will soon be less dependent upon unfriendly nations to supply our energy. Plentiful energy at stable or lower prices will let us create more high paying jobs.
Businesses that can reduce healthcare costs and improve outcomes offer opportunities. Minimally invasive surgeries, information technology, less expensive drugs and genetic analysis tools that can improve outcomes offer opportunities.We are on the verge of personalized medicine. Medicines just for you will turn on and off genes that express proteins that will make you healthier. Life expectancy in 1900 was 40! It is now 78. In the next century, Nobel Prize winning scientists think it will increase another 30 years.
SLIDE: Digital Opportunity.
There may be inflation everywhere else. It is not in technology. The Apollo 10 guidance computer got its human crew of astronauts to the moon and back. It cost $150,000 in 1969. An iPhone 4 is 2,000 times as powerful and cost $500!
The democratization of the Internet allows businesses to operate more efficiently and provide services to consumers that amaze and delight and are nearly unimaginable, except by Steven Spielberg I guess. These opportunities are not unique to America, we are finding them worldwide. That is why we started the Baron International Growth Fund, the Baron Emerging Markets Fund and the Baron Global Advantage Fund.
SLIDE: Baseball player swinging a bat. Finally, why do we think you should get in the game?
After the most difficult 13 year period in the history of our nation's financial markets, we think investment returns in stocks will soon revert to the 7% annual returns they have achieved over the past 100 years. If you want to achieve "market returns" of 7% per year, we think you should invest in low cost index funds for the long term.
If you want to do better than the market, we think you should invest with active managers who have accomplished that goal. Baron Funds has beaten the market by approximately 400 basis points per year on average for 25 years.* We have done this with less volatility using our common sense, research focused approach. If you are able to beat an index fund over 15 years by 360 basis points per year, you will have more than twice as much money as if you had invested in an index.
O.K. This is the bottom of the ninth! 2012 is the 30th year since we founded our business in March 1982. It seems like a blink. Few businesses survive 30 years. I believe the social utility of Baron Capital has enabled us to not just survive but to become a growing institution that will far outlive me.
A friend who is also a money manager and I were recently discussing our respective businesses. I told him how interesting and enjoyable it was for me to work with a group of really smart, nice, hardworking, funny individuals, many of whom you've met today and have among the most interesting executives and entrepreneurs in our country visit us daily to tell us about their businesses and their opportunities and problems.
He told me he thought being a money manager would be a terrific business if "it weren't for the clients." I told him I thought it was a great business because of our clients!
SLIDE: "This country is insanely great." – Steve Jobs.
Thank you for investing with us.