• Awarded highest 5-star Morningstar rating for the Fund’s full 3-year performance ended December 31, 2012.
• Ranked by Morningstar in the top 4.00% of 220 real estate funds for its 3-year cumulative return of 82.91%. This represents an average annual return of 22.30%.
• The Fund’s 3-year cumulative return of 82.91% exceeded its primary benchmark, the MSCI USA IMI Real Estate Index, that gained 54.92%, and also the S&P 500 Index that gained 36.30%.
As the Fund embarks on its next chapter, we thought it would be an ideal time to check in with Jeff for an update on his outlook for real estate, the Fund, and other related topics.
What is your outlook for real estate?
We continue to be optimistic about the prospects for commercial and residential real estate. At Baron, we believe we are in the early stages of a multi-year real estate recovery fueled by rising demand, low supply, improving credit availability, and extraordinarily low interest rates. We believe the key ingredients are in place for this asset class to continue to perform well for several years.
How long do you expect the upturn for real estate to last?
Real estate cycles typically last 6 to 7 years. Commercial real estate has been mending for the last 2 to 3 years. We believe the next 3 to 4 years will be strong for commercial real estate. Following the worst housing crisis in history, the most notable development in real estate in 2012 was the onset of the rebound in the U.S. housing market. In our view, this housing rebound is a major positive game changer and the prospects for the next 4 to 5 years are promising.
What distinguishes the Baron Real Estate Fund from other real estate mutual funds?
We believe we have structured a unique and compelling real estate fund – one that is more balanced, diversified, and broader than more traditional REIT funds. In addition to our investments in REITs, the Baron Real Estate Fund invests in a broader group of real estate-related companies including hotel and leisure companies, real estate service companies, senior housing operators, infrastructure companies, data centers, homebuilders, building product and services companies, casino and gaming operators, tower operators, and real estate operating companies.
Why did you structure a diversified real estate-related fund instead of a fund dominated by REITs?
A “REIT-only” approach to real estate investing does not take advantage of numerous additional real estate categories and opportunities. Here at Baron, we believe that our more comprehensive philosophy of investing in these broader commercial and residential real estate-related categories is a more sensible strategy that can produce superior results over the long term.
What is your view on REITs and how are you currently positioned?
REITs have been strong absolute and relative performers in the last few years. REITs have benefited from the “search for yield” – REIT dividend yields of 3.5%, on average, currently exceed the 10-year treasury yield of approximately 1.8%. Additional factors that have supported REITs include increasing occupancies and rents at a time of limited new supply, improved balanced sheets that can support growth, wide ac cess to unprecedented low cost capital, accretive investment opportunities, and largely domestic income sources.
While REITs may continue to have the wind at their backs, we believe valuations have become somewhat pricey relative to many other real estate categories. As such, the Baron Real Estate Fund presently has an allocation of 14% to REITs; however, this may change from time to time, depending on our assessment of the category. Presently, 86% of the Fund is invested in other real estate categories that we believe offer more attractive valuations and growth prospects. The ability of our Fund to invest in non-REIT real estate securities is part of our competitive edge, and one of the reasons why our Fund has performed well since inception.
What areas of real estate are you most excited about?
A lot! First, the housing recovery is gaining momentum. The turnaround in the homebuilding market was the most notable development in real estate and in the broader economy in 2012. We expect this to continue in 2013 and beyond. Many of our residential-related real estate investments in senior housing operators (Brookdale Senior Living Inc., Emeritus Corp., Capital Senior Living Corp.), building product and services companies (Lowe’s Companies, Inc., CaesarStone Sdot-Yam Ltd., Owens Corning), and homebuilders (Toll Brothers, Inc.) are poised to benefit. We also remain optimistic about the long-term prospects for tower operators such as SBA Communications Corp. Why? The world is becoming wireless! We also favor the long-term outlook for leading commercial real estate service firms such as CBRE Group Inc. and Jones Lang LaSalle Inc. Finally, we are quite bullish on the prospects for hotel and leisure companies such as Hyatt Hotels Corp., Starwood Hotels & Resorts, and Wyndham Worldwide Corp.
How did you become interested in real estate?
Now, this brings a big smile to my face! My interest in real estate began as a teenager when my father introduced me to real estate. My father owned a small private retail home center firm, but transitioned into real estate development when he became concerned that he wouldn’t be able to compete with companies like Home Depot and Lowe’s. Ironically, they’re now his tenants. I became fascinated with the process and creativity associated with real estate development and consequently, I majored in real estate and finance at The Wharton School of Business.
What is Baron’s history of investing in Real Estate?
Baron has a long history of investing in real estate. Since our first fund started in 1987, Baron Funds has invested billions of dollars in real estate securities. In fact, since 1992, one of Baron Funds’ largest holdings and a strong performer has been Alexander’s, Inc., a NY-centric commercial real estate company. We began purchasing Alexander’s, Inc., in 1992 at $18 per share. Over the years we have continued to purchase it for many of the portfolios we manage. In 2012, the stock reached more than $450 per share, up more than 25 fold since that first purchase, and the company paid a $122 per share special one-time capital gain dividend in December 2012. Today, Baron’s various Funds collectively remain one of the largest shareholders of the company.
Our decision to invest in Alexander’s illustrates our approach to real estate, and more broadly, the Baron philosophy of investing. We assiduously seek to identify high-quality companies with excellent management teams, strong growth prospects, leading competitive positions, liquid balance sheets and attractive valuations. Those companies that meet our criteria, we buy and own for the long term. We believe the companies with these characteristics will be the long-term winners.
Do you have any concluding thoughts on the 3-year anniversary of the Fund?
We are pleased that we have been able to capitalize on Baron’s long history of investing in real estate by creating a diversified real estate fund that we believe is a sensible approach to investing in real estate. We are already hard at work in 2013, and energized to continue to produce strong results for our shareholders.
The Fund may not achieve its objectives. Baron Real Estate Fund is non-diversified, which means the volatility of the Fund’s returns may increase and exposure the Fund to greater risk of loss in any given period. In addition to general market conditions, the value of the Fund will be affected by the strength of the real estate markets as well as by the interest rate fluctuations, credit risk, environmental issues and economic conditions. The Fund invests in companies of all sizes, including small and medium sized companies whose securities may be thinly traded and more difficult to sell during market downturns.
Performance data quoted represents past performance. Past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate; an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted above. For performance information current to the most recent month end, visit www. BaronFunds.com or call 1-800-99BARON. The Adviser has reimbursed certain fund expenses for the Fund and the Fund’s transfer agency expenses may be reduced by expense offsets from an unaffiliated transfer agent, without which performance would have been lower. The expenses of the Fund are 2.14% total and 1.10% net (net of Adviser’s fee waivers).
* Performance information cited is based on the Institutional share class. The Institutional share class was ranked #1 by Morningstar and Lipper, and the Retail share class was ranked #2 by Morningstar and Lipper. Morningstar’s and Lipper rankings are based on total returns for the 1 year ended 12/31/2012. Its Morningstar 3 year star rating is based on risk adjusted returns with 220 funds in the category for the period ended 12/31/2012.
For each fund with at least a three-year history, Morningstar calculates a Morningstar Rating based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. (Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages.)
The MSCI USA IMI Extended Real Estate Index Net is a custom index calculated by MSCI for, and as requested by, BAMCO, Inc. The index includes real estate and real estate-related GICS classification securities. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed or produced by MSCI. The S&P 500 Index measures the performance of 500 widely held large-cap U.S. companies. The indexes and the Fund include reinvestment of interest, capital gains and dividends, which positively impact the performance results.
The Morningstar Real Estate Average is not weighted and represents the straight average of annualized returns of each of the funds in the Real Estate category. The Fund has been included in the category since December 31, 2010. As of 12/31/2012, the category consisted of 263, 220, and 220 funds for the 1-year, 3 year and since inception periods.
© 2013 Morningstar, Inc. All Rights Reserved. The Morningstar information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.
Baron Growth Fund and Small Cap Fund invest primarily in small-cap securities, Baron Asset Fund in mid-cap securities, Baron Focused Growth Fund and International Growth Fund in both. Small and mid-cap securities may be thinly traded and more difficult to sell during market downturns. Baron Opportunity Fund emphasizes mid-sized companies that we believe will benefit from innovations and advances in technology, which present the risk of rapid change and product obsolescence and their successes may be difficult to predict for the long term. Baron Partners Fund, Focused Growth Fund, Baron Real Estate Fund and Baron Energy and Resources Fund are non-diversified and Baron Partners Fund uses leverage, which increase volatility of the Funds’ returns and expose the Funds to greater loss in any given period. In addition, the value of Baron Real Estate Fund is affected by the strength of the real estate markets. Baron Fifth Avenue Growth Fund invests primarily in large-cap securities, which like all equities are subject to price fluctuations in the stock market. Baron International Growth Fund, Baron Emerging Markets Fund and Baron Global Advantage Fund invests primarily in non-U.S. securities, which involve additional risks to those inherent in U.S. investments, including exchange-rate fluctuations, political or economic instability, the imposition of exchange controls, expropriation, limited disclosure and illiquid markets. These risks are heightened for the Baron Emerging Markets Fund. Baron Energy and Resources Fund invests in energy companies, which can be affected by fluctuations in energy prices and supply and demand of energy fuels, and in resources industries, which can be affected by international political and economic developments, the success of exploration projects, and meteorological events.
1 As of September 30, 2011 for Baron Asset, Baron Growth, Baron Small Cap, Baron Opportunity and Baron Fifth Avenue Growth Funds. For Baron Fifth Avenue Growth Fund, the total expense ratio was 1.59% Retail share class and 1.31% Institutional share class, but the net annual expense ratio is 1.30% Retail and 1.05% Institutional (net of the Adviser’s fee waivers).
2 As of December 31, 2011 for Baron Partners, Baron Focused Growth, Baron International Growth, Baron Real Estate and Baron Emerging Markets Funds. Total expense ratio shown for Baron Partners Fund was comprised of operating expenses of 1.35% and interest expense of 0.36% for the Retail share class and 1.09% and 0.36% respectively for the Institutional share class. For Baron Focused Growth Fund, the total expense ratio was 1.48%, but the net annual expense ratio was 1.35% for the Retail share class and 1.18% and 1.10% respectively for the Institutional share class (net of the Adviser’s fee waivers). For Baron International Growth Fund, the total expense ratio was 1.73%, but the net annual expense ratio was 1.50% for the Retail share class and 1.38% and 1.25% respectively for the Institutional share class (net of the Adviser’s fee waivers). For Baron Real Estate Fund, the total expense ratio was 2.33% but the net annual expense ratio was 1.35% for the Retail share class and 2.14% and 1.10% respectively for the Institutional share class (net of the Adviser’s fee waivers). For Baron Emerging Markets Fund, the total expense ratio was 4.49%, but the net annual expense ratio was 1.50% for the Retail share class and 3.83% and 1.25% respectively for the Institutional share class (net of the Adviser’s fee waivers). For Baron Energy and Resources Fund, the estimated total expense ratio is 4.25%, but the net annual expense ratio is 1.35% for the Retail share class and 4.00% and 1.10% respectively for the Institutional share class (net of the Adviser's fee waivers). For Baron Global Advantage Fund, the estimated annual operating expense is 4.50% (*not annualized), but the net annual expense ratio Is 1.50% for the Retail share class and 4.25% (*not annualized), and 1.25% respectively for the Institutional share class (net of the Adviser's fee waivers).
3 Reflects the actual fees and expenses that were charged when the Funds were partnerships. The predecessor partnerships charged a 20% performance fee (Baron Partners Fund) or a 15% performance fee (Baron Focused Growth Fund) after reaching a certain performance benchmark. If the annual returns for the Funds did not reflect the performance fee for the years the predecessor partnerships charged a performance fee, returns would be higher. The Funds’ shareholders are not charged a performance fee. The predecessor partnerships’ performance is only for periods before the Funds’ registration statements were effective (4/30/03 for BPF and 6/30/08 for BFGF). During those periods, the predecessor partnerships were not registered under the Investment Company Act of 1940 and were not subject to its requirements or the requirements of the Internal Revenue Code relating to registered investment companies, which, if they were, might have adversely affected their performance.
Portfolio holdings as a percentage of net assets as of 12/ 31/2012 for securities mentioned and top ten holdings: Brookdale Senior Living, Inc. - 6.0%; CaesarStone Sdot-Yam Ltd. - 2.8%; Capital Senior Living Corp. -5.2%; CBRE Group, Inc. - 4.0%: Emeritus Corp. - 3.6%; Hyatt Hotels Corp. - 5.1%; Jones Lang LaSalle, Inc. - 2.1%; Lowe's Companies, Inc. - 2.2%; Owens Corning - 1.7%; SBA Communications Corp. - 2.4%; Starwood Hotels & Resorts Worldwide, Inc. - 3.1%; Toll Brothers, Inc. - 0.5%; Wyndham Worldwide Corp. - 2.9%
Net Realized and Unrealized gains (in $mm) as of 12/31/2012 of Alexander’s Inc. in our Funds: For Baron Asset Fund $97.6, Baron Focused Growth Fund ($0.8), Baron Growth Fund $38.3, Baron Partners Fund $2.2, Baron Real Estate Fund$0.0, and Baron Small Cap Fund $0.0.
Investors should consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The Baron Funds’ prospectuses contain this and other information about the Funds. Please read it carefully before investing. You can obtain one from its distributor, Baron Capital, Inc., by calling 1-800-99BARON or visiting www.BaronFunds.com.