Ron Baron's Baron Funds 3rd-Quarter Letter

Discussion of markets and performance

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Nov 11, 2022
Summary
  • Due to our optimistic mindset, we have always believed that any recessions or declines in the value of our growth business holdings would not be long lasting.
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“Welcome Back... Welcome Back...Welcome Back.” “Welcome Back” John Sebastian. 1976. Celebrating the Fortieth Anniversary (“XL”) of Baron Capital. November 4, 2022.

After a three-year pandemic-induced hiatus, Baron Capital will hold the 29th Annual Baron Investment Conference on November 4, 2022. Our annual meeting will again take place principally at the Metropolitan Opera House, Lincoln Center, New York City. We will also use three other venues on the Lincoln Center campus that day, Alice Tully Hall, David Geffen Hall, and David Koch Theatre, for lunchtime entertainment and morning Baron portfolio manager/analyst panels.

The Baron 2022 “Anything is Possible” themed conference will celebrate the 40th Anniversary of Baron Capital’s founding on March 16, 1982. The XL on our 2022 Baron t-shirts is intended to represent the Roman numeral 40. It is not necessarily the size of the t-shirt in your gift bags. Only 60 years to go...to reach our business’ first century milestone. Baron Capital is a privately owned, family business that manages Baron mutual funds, offshore funds, and
partnerships...and separate accounts. We manage the growth equity assets in other Baron accounts similarly to how we manage our mutual funds.

We think the theme of the 2022 Baron Investment Conference, “Anything is Possible,” is appropriate for several reasons. First, the theme of the 2019 Baron pre-COVID conference, our last conference was “What’s Next?” Could any theme have been more prescient in the fall of 2019? Sure makes “Anything is Possible” relevant this year. Either looking backwards... or looking forwards considering the present entropic, disorderly, and chaotic state of our world.

Second, we think the significant appreciation of Tesla, Inc. (TLSA) and privately owned Space Exploration Technologies Corp. (“SpaceX”) since our initial investments also suggests that “Anything is Possible.” Tesla and SpaceX have grown so dramatically in the past three years that Tesla has become Baron’s largest investment and SpaceX the sixth largest in our portfolios. Were it not for Elon Musk’s Tesla, it is unlikely electric cars and autonomous cars would have become a reality for decades! Were it not for Elon Musk’s SpaceX and the low-cost path to space for its Starlink LEO satellites provided by SpaceX’s reusable rockets, the same could be said for broadband internet satellite communication for the entire planet!

Elon’s mammoth, reusable Starship makes it likely that humanity could reach Mars in our lifetimes. SpaceX’s Starship is the largest rocket ever built on Planet Earth. We believe that, in 500 years, Elon will be remembered similarly to the way the 16th century engineer/inventor Leonardo di Vinci is today.

We expect additional, substantial appreciation for Tesla and SpaceX. Of course, we cannot assure you that will be the case. Most analysts and commentators were skeptical when we invested in Tesla from 2014-2016 ...and when we began to invest in SpaceX five years ago. We continue to own about 70% of our peak Tesla investment and 100% of our investment in SpaceX. Tesla has increased about 22 times and SpaceX has more than quadrupled from our initial cost. The two now represent in aggregate about 15.7% of our Firm’s assets under management. This high asset percentage is due almost entirely to appreciation and not to additional purchases. Yet, we still believe that Tesla and SpaceX are at the very early stages of their growth. We expect Tesla’s and SpaceX’s share prices over time to reflect their favorable prospects.

There is a third reason for our “Anything is Possible” theme. Forty years ago, it was not exactly a “slam dunk” that our family-owned management company, founded with three individuals and $100,000 book value, would grow to 185 employees...from $10 million assets under management to $37.8 billion as of October 31, 2022, including $35.4
billion in realized and unrealized gains...achieve top ranked performance since inception for its mutual funds...on average several hundred basis points per year above benchmarks.... and grow our book value to substantially more than $100,000!

Our long-term investment strategies, extensive due diligence, and research by our tenured and talented, consistently growing 43-person team of analysts and portfolio managers...including me...are the principal reasons for our success. That is what has permitted us to continue to hold almost the entire investments we have made in Tesla and SpaceX. We believe both companies are extraordinarily well managed and competitively advantaged. Our conviction has been to the good fortune of our investors. My family and Baron Capital are the largest investors in Baron Funds and also have the largest investment portfolios managed by Baron. My family entities represent approximately 6.8% of our assets under management.

One more thing. Another important reason we are able to continue to hold such large investments in Tesla and SpaceX is that 84.3% of our assets are NOT invested in Tesla and SpaceX. Rather, they are invested in other exceptionally attractive growth companies, many of which have also achieved enormous growth over the long term. This includes financial businesses MSCI, Inc. (

MSCI, Financial), FactSet Research Systems, Inc. (FDS, Financial), Arch Capital Group Ltd. (ACGL, Financial), The Charles Schwab Corp. (SCHW, Financial), and Kinsale Capital Group, Inc. (KNSL, Financial); real estate/resort businesses like Vail Resorts, Inc. (MTN, Financial), Hyatt Hotels Corp. (H, Financial), and Choice Hotels International, Inc. (CHH, Financial); health care businesses like IDEXX Laboratories, Inc. (IDXX, Financial), and Mettler-Toledo International, Inc. (MTD, Financial); and services businesses like CoStar Group, Inc. (CSGP, Financial), Gartner, Inc. (IT, Financial), ANSYS, Inc. (ANSS, Financial), and Iridium Communications Inc. (IRDM, Financial). Those businesses are affected by different economic, social, environmental, and political factors than Tesla and SpaceX.

Although in aggregate Baron owns shares in 509 businesses, about 62% of our Firm’s AUM is invested in our top 40 holdings. That is due to the unusually strong performance of those businesses since we purchased shares...and to what we believe are the continuing favorable prospects for those businesses. We regard our portfolios as well diversified and “all-weather,” although not in the traditional fixed income/ equity sense. Our growth equity portfolios have been uniquely constructed to significantly outperform over the long term. Accordingly, our long-term investment strategy has enabled us to NOT SELL these companies as well as Tesla and SpaceX after they have achieved substantial appreciation. Although some may regard this strategy as riskier than investing in passive, conventionally diversified portfolios, we believe, as poet Robert Frost wrote all those years ago, they have “promises to keep and miles and miles to go before they sleep.” Not exactly what Robert Frost wrote, but close.

“How does

Ron Baron (Trades, Portfolio), trained as a lawyer and stock analyst, create such attractive returns (and a loyal following)? Ron’s technique is patterned after Warren Buffett (Trades, Portfolio)’s-find businesses with strong franchises and solid management and hold more or less forever. His technique is a bit more complicated, or everyone would be doing what he does. He does an extraordinary amount of research on the companies in which he invests.” David Rubenstein. “How To Invest.” Masters on the Craft. David M. Rubenstein. 2022

In his book, David described his first meeting with me when Carlyle was preparing to go public. “I met Ron on our roadshow. I was surprised the head of an organization was doing the detailed due diligence; he took copious notes and asked quite informed questions.” What do we believe is Baron Capital’s competitive advantage that has allowed our business to thrive during its first 40 years? Me leading by example as a researcher with unquenchable curiosity is one reason. Being optimistic despite unrelenting negative short-term news cycles for nearly the entire 40-year period from our founding is also part of the answer. Optimistic about our country and economy despite wars...pandemics...financial panics...market crashes...inflation...natural disasters...violence in our streets and schools...recessions...and, threats to our democracy. And, we were right! The market has increased nearly 37-fold since 1982 when the Dow Jones Industrial Average was below 800...and we have done even better.

For example, since their respective inceptions as mutual funds, 15 funds, representing 98.6% of Baron Funds’ AUM, have outperformed their respective benchmarks and 12 Funds, representing 84.5% of Baron Funds’ AUM, rank in the top 15% of their respective Morningstar categories.1 For the 19 plus years since Baron Partners Fund converted into a mutual fund in 2003, it is ranked number one among all U.S. equity funds (4,132 share classes) through September 30, 2022.* When you add the results it achieved as a partnership from its inception in 1992 through the present, its performance is better than that of any U.S. equity mutual fund! On average, our funds have outperformed their benchmark indices by several hundred basis points per year.

We attribute our favorable results on both an absolute and relative basis to our exceptional people... and to our long-term oriented process of investing in people who work at Baron and people who work at the competitively advantaged growth companies in which we invest for our clients. We have also learned from Charles Schwab, Goldman Sachs, JP Morgan, Jefferies, Blackstone, Blackrock, and other successful financial businesses to put our clients’ interests before our own. We have gone a step further and have consistently put our employees’ interests ahead of the profitability of our business. We have consistently expanded...in good times and not so good times...and have not once had a Firm layoff due to diminished profits.

Of course, due to our optimistic mindset, we have always believed that any recessions or declines in the value of our growth business holdings would not be long lasting. There is only one year since our inception in 1982 when we did not increase our employee head count. That was last year when we fell from 167 employees to 165 employees. We were told that this was due to our policy to have employees in the office five days a week like Jon Gray’s policy at Blackstone among others. We believed him when he told us, “The Yankees play in Yankee Stadium.” Unfortunately, we are not the Yankees...and we’re not Blackstone, either. Yet.

Last year, we had eight open positions for which we did not receive quality résumés. In 2022, when we began a hybrid in-office and work from home policy for several employee groups, we were flooded with quality résumés. We have since increased the number of investment professionals from 38 to 43 and our overall staff from 165 to 185. Since we are out of space, we are also in the process of expanding our physical office footprint by 50%. We currently occupy the 48th and 49th floors in the General Motors building where we have been tenants for about 30 years. Since we signed our first lease in that building for half the 26th floor, we have consistently expanded our long-term leased space. We are building out the 47th floor to include great technology...lots of glass...cool open stairways...a 60-seat auditorium with stadium seating...and, of course, more fish...and more Jerusalem stone. We expect to occupy the 47th floor before February 28, 2023. The 47th floor, by the way, was previously occupied by my friend

Carl Icahn (Trades, Portfolio). Carl left New York for warmer and what he feels are more hospitable climes three years ago. We expect 47 to have good karma.

So, that’s our secret. Work hard. Hire exceptional people. Train our analyst/managers and keep them working together as a team...for a long time. In fact, think long term about everything. Live by your word. Jay Pritzker, Hyatt’s founder and current CEO Tom Pritzker’s dad, considered himself a handshake guy. We think of him as a role model and try to conduct ourselves the way he would have. Oh, one more thing. Guard your reputation like

Warren Buffett (Trades, Portfolio) would. Zealously. Treat others the way you want to be treated.

Make sure your balance sheet is as close to impregnable as possible.

Respectfully,

Ronald Baron

CEO

November 4, 2022

1 Excess returns and rankings were calculated using the Retail Share Class of our U.S. mutual funds with at least one year of history. The Retail Share Class is the highest cost and oldest share class. AUM reflects assets in all share classes of our U.S. mutual funds. Since Baron WealthBuilder Fund is a fund of funds investing exclusively in other Baron Funds, its AUM is not included in the above calculations.

* This is a hypothetical ranking created by Baron Capital using Morningstar extended performance data and is as of 9/30/2022. There were 4,132 share classes in these nine Morningstar Categories for the period from 4/30/2003 to 9/30/2022.

Note, the peer group used for this analysis includes all U.S. equity share classes in Morningstar Direct domiciled in the U.S., including obsolete funds, index funds, and ETFs. The individual Morningstar Categories used for this analysis are the Morningstar Large Blend, Large Growth, Large Value, Mid-Cap Blend, Mid-Cap Growth, Mid-Cap Value, Small Blend, Small Growth, and Small Value Categories.

The Morningstar Large Growth Category consisted of 1,252, 1,060, and 790 share classes for the 1-, 5-, and 10-year periods. Morningstar ranked Baron Partners Fund (Institutional Shares) in the 3rd, 1st, 1st, and 1st percentiles for the 1-, 5-, 10-year, and since conversion periods, respectively. The Fund converted into a mutual Fund on 4/30/2003, and the category consisted of 787 share classes. Morningstar calculates the Morningstar Large Growth Category Average performance and rankings using its Fractional Weighting methodology. Morningstar rankings are based on total returns and do not include sales charges. Total returns do account for management, administrative, and 12b-1 fees and other costs automatically deducted from fund assets.

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 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. The Adviser reimburses certain Baron Fund expenses pursuant to a contract expiring on August 29, 2033, unless renewed for another 11-year term 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. Current performance may be lower or higher than the performance data quoted. For performance information current to the most recent month end, visit www.BaronFunds.com or call 1-800-99BARON.

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I/we have no positions in any stocks mentioned, and have no plans to buy any new positions in the stocks mentioned within the next 72 hours. Click for the complete disclosure
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