Baron Partners Fund®: A High-Conviction, Differentiated Investment Approach

Baron Partners Fund is a concentrated portfolio of the highest conviction ideas of Baron Capital’s Founder and CEO Ron Baron. The Fund is designed to maximize the advantages we have gained from four decades of refining and applying our proprietary, research-intensive, fundamental investment process aimed at finding and investing in the most promising growth businesses for the long term.

This approach may seem old fashioned in a time seemingly dominated by algorithms and high-speed trading, but we make no excuses. In fact, now more than ever, we believe this investment approach is still the best way to create alpha. While other investors chase the latest unicorn or buy and sell based on short-term macro trends—which we contend are virtually impossible to predict—we remain true to our repeatable, time-tested process.

For Baron Partners Fund, portfolio managers Ron Baron and Michael Baron focus on businesses that we believe could double in value within five years. To accomplish this ambitious goal, we manage a focused portfolio of about 20 to 30, competitively advantaged, well-run growth businesses at attractive prices, with the top 10 positions representing a significant portion of net assets. The Fund’s all-cap mandate and ability to invest in private companies provide the flexibility to invest in what we think are the best ideas regardless of market cap or other constraints. While we tend to initiate positions in small- and mid-cap companies as these are the asset classes where we most frequently find the most promising growth opportunities, we will hold these positions as long as our investment premise remains intact.

The Fund uses leverage to enhance returns, but not in the typical way. We do not lever the entire portfolio pro-rata to enhance market exposure, since we do not make bets on short-term market moves, which we believe are almost impossible to predict. Rather, we draw on a credit line to add to or buy positions in specific companies in which we have our highest conviction to increase our exposure to these names. This use of leverage reflects our stock-specific, bottom up, fundamental approach to investing.

We look at 2020 as a testament to our active, long-term approach to investing. If one had to guess how the market would react to a global pandemic with segments of the economy shuttered for extended periods of time topped off by a highly polarized election, few would guess the market would reach record highs. Yet it did, and the patient investor was rewarded for staying calm during the storm.

A Time-Tested, Repeatable Investment Approach

We believe the Fund’s strong performance is the result of our consistent, repeatable, and time-tested investment approach that is differentiated by the following characteristics:

• High-conviction portfolio with limited holdings
• Long-term perspective with low turnover
• Multi-faceted management of risk

High-conviction portfolio with limited holdings

We take a bottom-up investment approach to identify what we believe are competitively differentiated businesses that can grow independently of their sector economy and macroeconomy. To build and manage our portfolio, we use our extensive research capacity and industry expertise—currently comprised of 44 investment professionals—to source these investment opportunities. Because Baron Partners Fund invests only in our highest-conviction opportunities, it holds a limited number of names. As of September 30, 2024, the Fund held 21 stocks, compared with a category average of over 100 stocks. The top 10 holdings comprised 88.6% of total investments. We have always maintained high active share; our current active share is 94.8%.

This high-conviction, long-term approach, combined with our deep bench of research analysts, means we can do the necessary due diligence to acquire the in-depth knowledge, including regularly engaging company management teams and visiting key facilities, to gain the confidence we need to invest and stay invested. This is our competitive advantage.

Long-term perspective with low turnover

Warren Buffett, who has a talent for words almost as impressive as his talent for investing, once said, “Someone is sitting in the shade today because someone planted a tree a long time ago.” We agree.

Consistent with our longstanding Baron Capital investment philosophy, Baron Partners Fund is managed with a long-term perspective. We believe this time-arbitrage approach gives us an edge. Most managers are focused on the short term, basing trading decisions on factors that may have little to do with business fundamentals, such as a quarterly earnings beat or miss or overall market volatility.

We believe our long-term perspective affords us less competition while allowing us to take advantage of the shortsightedness of the market. We leverage our extensive research capabilities to conduct a deep dive into the fundamentals of every company in which we are considering an investment. Our research allows us to develop an informed and thorough understanding of the longer-term secular advantages of these companies. Ultimately, we are more interested in the duration of a company’s growth opportunity, rather than being overly focused on its timing. We like to invest early, before a company is on the market’s radar, because we believe it’s impossible to pinpoint exactly when the market will take notice and start trading the stock up to properly reflect its growth opportunity. We believe this is a key part of the engine that drives positive performance for us.

The Fund’s low three-year average turnover of 5.00% is an outgrowth of our investment process rather than a goal in and of itself. If we find and invest in the right companies, we believe that it makes little sense to replace these companies with new and relatively untested ones. We would rather remain invested throughout the duration of our highest-conviction companies’ growth trajectories. We also believe this is a more tax efficient approach to managing a portfolio, and one that is often attractive to management teams that are aware of our reputation as long-term holders of stock.

Our primary goal is capital appreciation, and we strongly believe we should stay involved as our companies grow and flourish as long as our investment thesis holds true.

Multi-faceted management of risk

We seek to offset the volatility inherent in a concentrated, leveraged portfolio in two key ways:

• Extensive due diligence on our holdings throughout the time we are invested
• Diversifying our holdings across non-correlated categories

Extensive due diligence

We believe the best risk management starts with knowing the companies in which we invest. The extensive research we conduct for months and sometimes years prior to initiating a position in a company is just the beginning. Throughout the life of all our investments, we continue to conduct due diligence and interact with management to keep apprised of the company’s growth story as it develops. We visit with and speak to our companies’ management teams multiple times per year. Our sustained level of interaction with management helps sharpen our model inputs and assumptions. As portfolio managers of the Fund, Ron and Michael are involved in research on each name and are supported by Baron Capital analysts who are industry experts.

As with all Baron Funds, we take a stock-specific approach. We focus on businesses with:

• Long-term, secular growth opportunities
• Strong, durable competitive advantages
• Attractive business model
• Exceptional management
• Attractive valuation

Long-term, secular growth opportunities

We seek companies that we believe are well positioned to benefit from secular growth opportunities with large, addressable markets. We find these opportunities across a range of sectors and sub-industries.

Strong, durable competitive advantages

A durable competitive advantage is another key attribute of the companies we own. We look for businesses that are establishing their competitive advantages, as a fully realized competitive advantage is more likely to be reflected in the stock price.

Attractive business model

We prefer companies with pricing power that is tied to the utility of their product or service rather than a monopolistic hold on the market. For example, with subscription-based business models, companies are able to leverage the continual improvement and expansion of the services they provide to raise prices on a regular basis. Long-term contracts with high retention rates—another characteristic of many of our subscription-based businesses— provide stability, durability, and transparency, as does recurring or reoccurring revenue.

We like companies with high or expanding margins that are reinvesting their profits in future growth. Many of our holdings are asset light, low capital-intensive businesses because once they have built their core assets—database, platform, etc.—as they scale, margins can expand significantly. We also like strong and visible free cash flow, because we consider it a more accurate measure of a company’s financial situation than earnings per share. Finally, we look for a capital structure appropriate to the industry in which the company operates. We are comfortable with leverage if it is an established business with recurring and predictable free cash flow and sensible debt levels. We believe such balance-sheet optimization is a way to maximize shareholder returns.

¹Portfolio holdings are subject to change. Current and future portfolio holdings are subject to risk.

Exceptional management

Baron Capital’s long-held motto, “we invest in people,” reflects our belief that experienced, visionary management is at the heart of a company’s success. To find these talented people, Ron and Michael tap their decades of experience as investment professionals, over the course of which they have met with and interviewed thousands of executives about their companies. We look for a personal financial stake in the company’s success.

Attractive valuation

We project the long-term intrinsic value of every stock we own using both quantitative and qualitative analysis. Our projection is based on key revenue growth drivers, profitability, cost structure, and capital structure – as well as more qualitative factors, such as the total addressable market, durability of the competitive advantage, and strength of the management team. We will initiate a position only if we believe the stock can double in size in a five-year period. We will remain invested as long as the stock’s valuation is supported by our projection of intrinsic value.

Diversifying our holdings across categories*

The second way we seek to mitigate risk is by diversifying the portfolio across four categories, each of which tends to behave differently in different economic environments. These four categories are:

• Disruptive Growth (50% to 60% of weighted assets)
• Core Growth (about 20% of weighted assets)
• Real/Irreplaceable Assets (about 15% of weighted assets)
• Financials (about 20% of weighted assets)

* Percentages add up to greater than 100% due to leverage.

Electric car manufacturer Tesla, Inc., the Fund's largest holding, is a well-known name among our Disruptive Growth holdings, which are typically very fast-growing companies. Despite near-term challenges, we expect Tesla to continue to grow its automotive business over the long term through international production capacity and product expansion, including pickup and semi-truck lineups. We believe that Tesla’s vertical integration, technology innovation, brand, profitability, and growing supplier support offer unique and durable growth opportunities that are hard to replicate. In addition, Tesla’s energy and software expertise is broadening the industrial opportunity to large and profitable revenue avenues that were locked in the legacy vehicle architecture such as autonomous, insurance, and other AI use cases.

Space Exploration Technologies Corp. (SpaceX), another Disruptive Growth company, designs, manufactures, and launches rockets, satellites, and spacecrafts. SpaceX disrupted the space launch market with its reusable orbital launch systems and is rapidly expanding its satellite-enabled global internet broadband service. The company's ultimate goal is to enable humanity to be multi-planetary.

With its highly differentiated reusable rocket technology, SpaceX has increased the availability and reduced the cost of launch from Earth to space. SpaceX's newest rocket, Starship, is the largest rocket ever built at 394 feet tall --the size of a 40-story building --and should help drive SpaceX's costs lower. We believe SpaceX will become the “railroad to space,” making it even more competitive in a growing number of activities such as Moon and Mars missions. Its launch cost advantages should allow the company to deploy its satellite constellation more efficiently than competitors.

However, we believe investments in Disruptive Growth companies can only be successfully made if there are other more stable holdings in the portfolio to minimize volatility. Core Growth businesses like veterinary diagnostics company IDEXX Laboratories, Inc. and CoStar Group, Inc., a data and marketing analytics provider to the commercial real estate industry, have steadier growth prospects and continually return excess free cash flow to shareholders. Real/Irreplaceable Assets businesses have tangible properties that are less subject to competition. Companies like global hotelier Hyatt Hotels Corporation and ski resort owner/operator Vail Resorts, Inc. invest in their properties to offer a superior service vs. their competitors, which also increases asset values. Financial businesses’ returns are generally more correlated with the economy and interest rates (factors that we feel are unpredictable in the short run). However, the Fund’s Financials holdings tend to be “capital-light” businesses that are gaining market share (brokerage The Charles Schwab Corporation), offering deeper product sets (data and analytics provider to the financial industry FactSet Research Systems Inc.) and are selectively increasing price (specialty insurer Arch Capital Group Ltd.).

Conclusion

Throughout its long history, the Fund has remained steadfast in its commitment to long-term investments in competitively advantaged businesses with large growth opportunities that are taking share and are managed by people we believe to be exceptional executives. Although there are no guarantees, we believe a time-tested reputable approach will generate alpha over the long term.