2020 was a year that will be hard to forget. The headlines were dominated by the pandemic and its social and economic aftermath, but there were also wildfires, violent social and racial unrest, the U.S. elections chaos and results, growing political divide, and exacerbated tensions between leading global economies, among other important things. Few positives made it to the front pages.
The extent and unpredictability of these events made the year extra challenging. But, even if we somehow knew at the beginning of the year that a deadly pandemic would strike our world, I do not think anyone could have predicted the way things unfolded after that. Many investors could likely have forecasted the economic and market volatility, although few could have guessed the severity. With the complete or near-complete shutdown of many businesses, we saw record high layoffs, the worst quarterly GDP drop in modern U.S. history, and record-high market volatility, among other dismaying developments. I think even fewer would have thought it was possible for the stock market to end the year in positive territory, and hardly anyone would have guessed the S&P 500 Index could end up as high as 18.40%.
We did not know where the market would end up either, and we did not try to guess. While we closely monitored short-term developments, our investment decisions continued to be made with a focus on the long term.
We believe our long-term view, combined with our time-tested process and expertise, resulted in the outstanding absolute and relative performance of our Funds in 2020. Those investors that remained invested in the Baron Funds were meaningfully rewarded for the active risk taken over the past 3-, 5-, and 10-year periods, as evidenced by the superior risk-adjusted returns of the majority of our Funds (see the Appendix for Sharpe ratio and information ratio data).
All of Baron's 17 mutual Funds outperformed the S&P 500 Index for the year, with 13 Funds outperforming by double digits and two Funds outperforming by triple digits. All but two of our Funds outperformed their primary benchmarks in 2020, and all Funds outperformed over the past three, five, and 10 years (or since inception for the Funds with track record less than 10 years). The table on the next page shows the performance figures by Fund and by period.
The magnitude of our recent performance stands out in the scorecard on the next page. Annual increases of 30%-50% or 100% or 150% are not something we see or expect to see every year. And when such sizeable returns happen, we certainly do not expect to see them simultaneously across all our Funds. So why did Baron generate such an outstanding record in 2020?
The Drivers of Our Returns
The remarkable returns of most of our Funds have been strongly driven by long-term investments in exceptional businesses and secular growth trends that we have identified and thoroughly researched over the years. We invest in companies we believe have significant growth potential that the market has not yet appreciated, and we often have to wait for years before our investments pay off. Sometimes the market gradually recognizes a company's merits and value creation, but most of the time the payoffs are highly nonlinear. We may see slow growth and even below-market performance for several years before a stock takes off.
In 2020, the pandemic amplified the ongoing secular changes in multiple industries (e.g., digital transformation, e-commerce, cybersecurity, etc.), which boosted the stock prices of many businesses that are or may be beneficiaries of these trends. Our Funds were well positioned and benefitted, not only because of our strategic exposure to the accelerating areas, but also because of strong stock selection. As the table below shows, in 2020, stock selection contributed positively to all of our Funds except one and was a significant driver of outperformance. Over longer periods, stock selection has been positive and significant for all Baron Funds with no exceptions.
While many of our stocks rose significantly more than the broad market, the ranges of returns and contributions to Fund performance were wide. Our most lucrative investment for the year, Tesla, Inc. (TSLA, Financial), increased significantly and drove the returns of Baron Partners Fund and Baron Focused Growth Fund, despite other excellent investments in these Funds, rising 50% – 100% for the year. For the rest of our Funds, the overall returns were driven by a variety of strongly performing holdings, as the table on the next page shows.
Furthermore, the top contributions to our performance came from a diverse group of stocks, with no or little overlap among Funds. In other words, a stock that was a top contributor for one Fund, was most likely not a top contributor for any or most of our other Funds. As the table below shows, among our 13 domestic Funds, including sector, there were 79 unique top 10 contributors to returns in 2020. 49 of them were a top 10 contributor to only one Fund and another 18 stocks were a top 10 contributor to just two Funds. Only one stock was a top 10 contributor to six of our Funds at the same time. A top 10 contributor in one Fund may have not been a top contributor in another Fund, although it may have been held by both Funds over the same period. Our analysis shows similar results for our international/global Funds and for the three-year period ended 12/31/2020.
Dissecting the data further shows that there was a good balance of company growth profiles among the top contributors to our performance. In the domestic and sector Funds, 32 out of the 79 top contributors for 2020 were disruptive growth companies and the remaining 47 were steady growers. For the international and global Funds, a little more than half of the top contributors were disruptive growth companies. The balance is similar among the top contributors to our three-year returns. We characterize as disruptive growth those companies whose businesses are growing or we expect will grow rapidly as a result of disruptive change that they are causing or from which they are benefitting. Steady Growers are typically businesses with established market positions, strong competitive advantages, and more stable fundamentals that are growing or we expect will grow at a moderate to fast pace.
Our most lucrative investments in 2020 came from a broad variety of sectors, which is also presented in the table on the prior page.
For example, out of the 79 unique top 10 contributors in 2020 in the Baron domestic Funds, including sector, 21 came from the Information Technology ("IT") sector, 19 came from Health Care, and 13 came from Consumer Discretionary. The diversity of top contributors was similarly significant over the past three years and in our international/global portfolios.
It is no coincidence that our top contributors came specifically from the sectors shown in the table on the prior page. Some of the strongest secular growth themes that we have identified are led by companies in these sectors. For example, the disruptive changes caused by cloud computing, artificial intelligence, and big data are mostly driven by IT companies; trends in genomics, minimally invasive surgery, and animal health are mostly driven by Health Care companies; and the secular shift to e-commerce is mostly driven by businesses in the Consumer Discretionary sector.
What's Next
Despite the already impressive performance of the top contributors to our returns, we believe that for many of them there is significant upside, and we continue to be invested. We believe that some of these companies are the prime beneficiaries of secular growth trends that are in their early days, with multifold returns yet to be made. Of course, we do not expect the stocks of these businesses to increase smoothly over time, but we believe that the long-term outcomes will eclipse any short-term fluctuations.
We also expect that a significant part of our future returns will be driven by stocks that we purchased over the past few years. The market volatility and the changing environment in 2020 presented us with a unique window of opportunity for purchasing stocks.
During the year, we added 152 new names that we still hold in our mutual funds, which is a little more than half of the total number of securities purchased over the past three years and are still held, as shown in the left chart below. Our net cost for these securities was $2.9 billion.
As the chart further shows, 278 of the 484 securities held by our mutual Funds at the end of 2020 were purchased over the past three years. Our aggregate net investment in these securities was $6.5 billion. As of 12/31/2020, our investments in these companies had grown to nearly $11 billion, which is around 26% of our net mutual Fund assets. The chart on the right below shows a breakdown of the market values of our holdings by vintage.
We expect these recent investments to multiply in value over the next few years, although there are no guarantees. Similar to the top 10 contributors to our past returns, our recent investments span across multiple sectors, with an emphasis on the IT, Health Care, and Consumer Discretionary sectors.
Our new purchases were well balanced between stable and disruptive growth businesses. Some of our more recent disruptive investments include cloud-based platforms Snowflake Inc. (SNOW, Financial) and ZoomInfo Technologies, Inc. (ZI, Financial), both of which we expect to benefit from the strong secular trends in the adoption of cloud-based computing and storage, as well as the growing demand for data insights.
In our international portfolios, a couple of new investments, one stable growth and one disruptive, were Kingsoft Corp. Ltd. (HKSe:03888), an internet service and software company, and Ozon Holdings PLC (OZON, Financial), a leading Russian internet retailer. Both businesses are benefitting from the global shift toward digitization. In 2020, COVID accelerated the penetration of digitization and how people do and transact business, which gave an additional boost to these companies.
Genomics is another long-term theme where we have been investing. As the cost of DNA sequencing has declined, new applications for DNA sequencing have emerged in cancer diagnostics and treatment, as well as in reproductive health. Examples of newly established positions in this space include disruptive growth companies Adaptive Biotechnologies Corporation (ADPT, Financial), which offers ClonoSeq for detection and monitoring of minimal residual disease in blood cancers and is developing early disease detection tests and other products based on its immune system sequencing platform; 10X Genomics, Inc. (TXG, Financial), whose technology enables life sciences researchers to conduct high throughput single-cell and spatial genomic analysis using Illumina sequencers; and Pacific Biosciences of California, Inc. (PACB, Financial), which offers a differentiated long-read sequencing platform for genetic analysis.
Some of our recent purchases are in newer companies and in early-stage trends, and we have invested via private equity, special purpose acquisition companies, and IPOs. While we have participated in such offerings, 65% of our new purchases over the past three years that are still held have been in listed companies with longer trading histories.
Our investment style has not changed, and neither has our outlook. Despite the turbulent 2020, our long-term view on the U.S. and global economies remains optimistic. We do not know, nor are we trying to guess, if 2021 will be more like 2020 or 2019. Our attention and efforts remain firmly on the long run.
Last year was an unsettling reminder to investors that the future is unpredictable, and so is the stock market. As we have often written, no one can time the market consistently and profit from that in the long run. Those investors sitting on cash at the start of 2020 perhaps thought they outsmarted the market when it fell 35% by late March. If they failed to invest then, they have likely missed out on some handsome returns. Those who sold their stocks in March, and stayed out of the market, perhaps regret their decision today. And so, our advice remains: do not try to time the market, invest for the long term, and preferably, do it with a skilled active investor.
Linda S. Martinson
President and COO
Disclosures:
Investors should consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The prospectus and summary prospectuses contain this and other information about the Funds. You may obtain them from the Funds' distributor, Baron Capital, Inc., by calling 1-800-99BARON or visiting www.BaronFunds.com. Please read them carefully before investing.
The discussion of market trends is not intended as advice to any person regarding the advisability of investing in any particular security. The views expressed in this document reflect those of the respective writer. Some of our comments are based on management expectations and are considered "forward-looking statements." Actual future results, however, may prove to be different from our expectations. Our views are a reflection of our best judgment at the time and are subject to change at any time based on market and other conditions and Baron has no obligation to update them.
