“You don’t have much of a track record with me. I need to charge you 75% interest.” Eighth grader responding to his younger sister’s request for a pre-allowance-day loan. Gary H. Stern. Former President, Federal Reserve Bank of Minneapolis. Board Director, Council for Economic Education. June 5, 2017.
On a beautiful afternoon in June, we loaned one of our conference rooms high above New York City’s Central Park to the Council for Economic Education (CEE) for a lunch meeting. The CEE is a non-profit organization that teaches financial literacy to school children from kindergarten through high school. More than five million K-12 students annually benefit from CEE programs. CEE also sponsors an annual contest among high schoolers who compete to demonstrate rigorous knowledge of economics and current events. Since I knew little about CEE, and because providing financial education to America’s youth interests me, I attended that lunch.
When Gary Stern, a CEE Board Director and former President of The Federal Reserve Bank of Minneapolis, addressed the luncheon, he relayed an anecdote of an eighth grader’s negotiations with his younger sister seeking a pre-allowance-day loan from her older brother. I laughed when Gary recounted how the student considered his sister’s “track record” determinative of the loan terms. What made the story especially funny is the serious principle underlying the eighth grader’s concern…his sister’s “track record.”
We believe “track records,” when studying businesses or individuals, encompass long-term performance and financial capacity; history of meeting obligations to employees, creditors, and shareholders; and living up to promises through good economic times and bad. Baron has never had a layoff…and continues to consistently hire through good and bad times, regardless of whether our Firm’s profit margins are under pressure or not. This is because we are trying to build an institution that will last, not to maximize our privately held Firm’s current profits.
Baron’s track record of investment performance since our founding in 1982 has, in our opinion, been exceptional. When coupled with our reputation for ethical conduct and fair dealing with employees, clients, vendors and communities, Baron Funds’ shareholders have gained confidence to invest with us…while our 145 person staff of talented, honorable, and hard-working employees continues to grow. Baron has earned more than
$23 billion in realized and unrealized profits for our investors since 1992. Baron’s assets under management were $100 million in 1992 and now approximate $25.7 billion! Since their inceptions, 98.9% of Baron mutual fund assets have outperformed their passive benchmark indexes; 96.9% of Baron mutual fund assets rank in the top 11% of their Morningstar categories; and 30.4% of Baron mutual fund assets rank in the top 1% of their peers!
When you do your own research, we think you make better decisions…
We have made many more good investment decisions than poor ones over the 35 years since Baron Capital’s founding. But, since we rely only on inferential data and opinions to create mosaics of businesses, we, like virtually all investors, have made mistakes over the years. We make a lot fewer mistakes now than 25 years ago…and recent mistakes have been less consequential. We believe this is because our process has continuously improved; our research analysts and portfolio managers have worked together longer than at most firms; and, our industry expertise, knowledge, judgment, and assessment of competitive advantage continues to improve. Finally, we remain more focused than ever on perhaps our most important principle, “we invest in people.”
…we didn’t invest with Harvey Weinstein in The Weinstein Company…
Reading about Harvey Weinstein during the last week reminded me of two high profile investments that we chose NOT to make. The Weinstein Company was one, Theranos was the other. First, The Weinstein Company. In August 2009, Harvey Weinstein and his brother Robert visited us to discuss Baron Funds making a modest investment in privately owned The Weinstein Company. This was shortly after the brothers had sold their interest in Miramax to Disney. After nearly a day and a half meeting with the Weinsteins, we were convinced that Harvey was an enormously talented producer. Further, when we questioned Harvey closely about governance issues involving the characterization of expenses as business or personal (for which he had been criticized), he promised that that would never again be an issue. When the Weinsteins left our office, we
were intrigued enough by Harvey’s ability to produce successful movies and television programs to continue our diligence. During the next two days, we spoke to several media executives who knew Harvey well. All warned us about the governance issues about which we had expressed concerns and recounted, in graphic detail, allegations that the press has been widely reporting eight years later. When I called Harvey in August 2009 following our diligence to tell him we had decided not to invest with him, he screamed at me admonishing us for wasting his time. I don’t remember whether he hung up on me or I on him, but I do remember an incredibly unpleasant conversation.
…we didn’t invest with Elizabeth Holmes in Theranos, either…
The second high profile investment we avoided was Theranos. One of my best friends from high school, who now lives in Palo Alto, suggested we research Theranos after he read about that company and its high profile CEO and founder, Elizabeth Holmes. In 2011, Elizabeth was the youngest female “billionaire” on Forbes’ list of 400 wealthiest Americans. Theranos’ business premise was to disrupt blood testing labs by pricking your finger at a local Walgreens’ pharmacy and using the internet to transmit markers in your blood to a remote Theranos machine for analysis. We contemplated making a $25 million investment in that privately held
$6 billion company. However, since we believed Theranos’ business opportunity was sizeable, and if Theranos were to become a publicly owned business we could make a much larger investment, we felt a significant diligence effort was justified. We studied Theranos for 10 months, visited the company in Palo Alto, had its executives visit us several times in New York, spoke to one of its clients, and tried to understand Theranos’ technology. Regardless, we could not get comfortable with numerous issues, including no FDA filings and data that didn’t seem to prove their case, and we chose not to invest. When I informed Elizabeth during her last visit to our office that we could not invest, she, like Harvey Weinstein, began to yell at me until I left our conference room. When I was writing this “Letter from Ron,” I showed Pat Patalino, our Firm’s General Counsel, an e-mail sent in June 2011 by Sunny Balwani, then Theranos’ COO, to Randy Gwirtzman, then a senior Baron analyst and now a co-manager of Baron Discovery Fund. That letter criticized Baron research and our failure to understand Theranos’ value proposition/valuation. Susan Robbins, one of our health care analysts, termed this “breathtaking chutzpah.” (“Chutzpah” is Jewish for “what incredible nerve.”)
Pat told me that soon after our decision not to invest, Sunny and Elizabeth called him on his cell phone while he was waiting for a commuter train in White Plains. “They spent the first 10 minutes scolding me for wasting their time.” They then told Pat they provided us with unprecedented access and were “particularly upset about Andrew’s skepticism and his unwillingness to accept what they were telling us at face value. It was not pleasant.”
The postscript to this story is that the Wall Street Journal and The New York Times in 2015 published a series of articles questioning whether or not Theranos’ technology worked; the FDA investigated the company and suspended Elizabeth from any involvement with Theranos for three years; Sunny resigned; and the value of Theranos’ business has fallen from more than $6 billion to $800 million! Finally, Jennifer Lawrence will star as Elizabeth Holmes in Bad Blood a movie about Theranos …which there is no way I will miss. One more thing. Andrew Peck, the “Andrew” Pat referred to above, is the portfolio manager of Baron Asset Fund; a graduate of Yale College, Stanford Business School, and Stanford Law School, with high honors from each; a senior executive at our Firm for 20 years; and one of the brightest individuals I know.
To put an exclamation point on why “we invest in people” and why “track records,” process, and people all matter, I will end this essay with the following story. Uber’s license to operate in London was revoked in September when London’s transportation regulator, citing a long list of bad behavior by Uber and its former CEO, found that company not to be “fit and proper.” Dara Khosrowshahi, the newly appointed Uber CEO, then wrote in an email to his employees, “there is a high cost to a bad reputation” and, “it’s critical that we act with integrity with everything we do, and learn how to be a better partner to every city we operate in.”
“There is such a thing as an invisible legacy. We can live longer than we are remembered.” Rabbi Ari Lorge. Central Synagogue. New York City. September 21, 2017. Rosh
Hashanah 5778.
My family and I are members of Central Synagogue’s congregation in New York City. This year on Rosh Hashanah, the holiday that celebrates the beginning of the Jewish New Year 5778, the topic of Central’s Rabbi Ari Lorge’s sermon was “An Invisible Legacy.” That subject seemed especially relevant to me, the founder of a 35-year old business that I expect to far outlive me.
Rabbi Lorge began his sermon by discussing two years he spent as a rabbinical student researching a thesis on the life of Rabbi Louis Grossmann. Grossmann was a senior rabbi at one of the most prestigious synagogues in America more than 100 years ago. When Rabbi Lorge uncovered Grossmann’s “rich and vibrant legacy,” he wondered how that rabbi’s name had been lost not just to history but to his own family? How could the memory of such a leader, the teacher of a generation of rabbis during an important period of Jewish history that encompassed “mass immigration of Eastern European Jews to America and the Balfour Declaration” just disappear? Even Rabbi Grossmann’s family, his descendants just four generations later, knew little about him. When it goes beyond parents and grandparents, Rabbi Lorge explained, “our ancestors become two-dimensional at best.” This conformed to the Russian proverb that “you live as long as you are remembered.”
Rabbi Lorge observed that even the memories of Presidents, famous athletes, and celebrities fade in a remarkably short period. He pointed out that Alexander Hamilton, the individual most responsible for the drafting and adoption of America’s Constitution 236 years ago and who invented our financial system, had been mostly forgotten. Until, that is, the Broadway smash hit, Hamilton, celebrated him and revived his legacy…at least for a short period. We did our part by honoring the first Treasury Secretary, an immigrant, by using a Hamilton inspired theme, “Exceptional Takes Time,” for the 25th annual Baron Investment Conference last year!
But, back to my story. When I thought about what Rabbi Lorge was really saying, both while I listened to him speak and, when I read the text of his remarks afterwards, it made me think about the relevance of his comments to my life and to our “family business,” Baron Capital. I think about my legacy as the people with whom I work every day (including my two sons, David and Michael, who are both senior analysts and assistant portfolio managers at Baron Capital) and the founding and growth of our financially strong business with an outstanding reputation that has impacted many lives. My “invisible legacy,” when memories of me fade, is not a monument. It is our Firm’s values, research principles and the idea that “we invest in people”–individuals with whom we work and who manage the businesses in which we invest.
Our Firm has been built with the intention to create and maintain an exceptional reputation and a workplace to attract the most talented individuals. They work with us in large part because they are proud of our business and what they do; are committed to conduct themselves ethically; and work on behalf of our clients to strive to produce significantly better returns than those clients could achieve by investing in passive indexes. Our employees are taught to think about everything for the long term; that there are no shortcuts to success; and, to create goals for themselves and our business in which our employees and customers both believe. I never intend to retire since my office is one of my favorite places in the world…which I hope will be the case for many more years.
Baron Investment Conference 2017. November 10, 2017. Metropolitan Opera House, Lincoln Center. New York City.
We hope you will be able to attend our 26th Annual Investment Conference on November 10th.
It is unusual for investment firms to invite their shareholders and clients to meet and question the chief executives of businesses in which their savings have been invested and to meet and question the investment firm’s managers and analysts about those investments. At Baron Capital we believe in providing our shareholders with unique insight and access to the entrepreneurs and businesses that are disrupting and improving our world to see first hand the opportunities we see.
One lucky Baron Funds’ shareholder attendee this year will have a chance to win an “electrifying” and “disruptive” prize. For those of you who can’t attend, you will be able to watch a live webcast on the Baron Funds’ website (except for the entertainment, which we are contractually prevented from streaming). You can also get a sense of our meeting by watching CNBC’s Squawk Box that morning from 6 a.m. to 8:30 a.m. EST when I will appear with several of our speakers, executives…and Squawk Box anchors Becky, Joe and Andrew.
We hope when you attend our annual conferences or watch us on CNBC or visit our website, you will gain a better understanding of the businesses in which we invest, the character and talent of their executives, as well as of the people who work at our Firm. Thank you for joining us as fellow shareholders in Baron Funds. We will continue to work hard to justify your confidence in us. See you in November.
Respectfully,
Ronald Baron
CEO and Chief Investment Officer October 19, 2017
