Baron Global Advantage Strategy | Q4 2024

We had a great quarter to close out another good year.

Baron Global Advantage Strategy was up 11.6% during the fourth quarter, compared to the 1.0% decline for the MSCI ACWI Index (the Index), and the 2.6% gain for the MSCI ACWI Growth Index, the Strategy’s benchmarks. For the year, the Strategy was up 25.6%, outperforming the 17.5% and 24.2% returns for the benchmarks, respectively.

It was an interesting year with plenty of plot twists along the way. After staging a nice recovery in 2023, global equity indexes continued to grind higher with single-digit quarterly gains for the first nine months of 2024. Similarly to last year and for similar reasons, we barely managed to keep up. But in the most recent quarter the upward grind came to a halt, while our investments had the best showing of the year. While U.S. stocks in the Index managed to record a 2.7% gain, stocks in China were down 7.7%, Hong Kong 9.6%, Mexico 10.6%, India 11.3%, Brazil 19.4%, and Korea 19.2%. The majority of Western European countries experienced double- digit declines. Giant-cap* stocks were up 1.8%, while all other market caps were down. From this perspective, the fourth quarter has been a microcosm of what we have observed over the last two years: dramatic outperformance of domestic equities and giant-cap stocks.

U.S. companies were responsible for 87% of the Index’s returns in 2024 (78% over the last two years) and now comprise 66% of the Index. Giant caps drove 70% of the benchmark’s gains last year (63% over the last two years) despite representing only 48% of the Index, on average, in 2024. Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla, collectively referred to as the Magnificent Seven, were responsible for 45% of the Index’s return in 2024 despite representing only 19% of the benchmark on average. During the year, the Strategy was underweight the U.S. by approximately 20% (on average), underweight giant-cap stocks by 3.4%, and did not own five of the Magnificent Seven stocks. The bad news is that the investing environment remained quite unfavorable to our style and to the kinds of companies that we prefer to own. The good news is that despite these headwinds, the Strategy comfortably outperformed its primary benchmark in both 2023 and 2024.

From a quarterly performance attribution perspective, stock selection contributed the most to relative returns, while the effect of sector allocation was additive as well. Information Technology (IT) was our best sector, with 12 of our 16 holdings posted double-digit gains, with 9 rising over 20%. Shopify, Cloudflare, BILL Holdings, Snowflake, and ServiceTitan gained over 30% each during the quarter. Our performance within IT was also consistent from a sub-industry perspective as we outperformed in each sub-industry except semiconductor materials & equipment (ASML). Industrials was the second best-performing sector, where we benefited from SpaceX’s new funding round, which revalued the company 65% higher. Health Care was another standout driven by continued strength in shares of argenx. We also benefited from having negligible exposure to Materials, Consumer Staples, Utilities, Real Estate, or Energy – all sectors that declined during the quarter. This was partially offset by poor performance in Consumer Discretionary and Financials. Our international e-commerce stocks (MercadoLibre, Coupang, and PDD) were mostly responsible for weakness in Consumer Discretionary, while Indian non-bank financial company Bajaj weighed on performance in Financials.

For 2024, the Fund’s outperformance was driven by both sector allocation and stock selection. Similarly to the fourth quarter, our top three sectors were Industrials, IT, and HealthCare. Industrials was our best sector for the year, with the revaluation of SpaceX partially offset by an 84% write down in the value of GM Cruise. IT holdings added to relative gains, driven by investments in semiconductors and internet services & infrastructure stocks. (NVIDIA, Shopify, Wix, and GDS). These strong results were partially offset by weakness in IT consulting & other services, as demand for consulting services remained sluggish. IT performance was also negatively impacted by two of our systems software holdings – Snowflake and Zscaler, whose near-term revenue growth rates have yet to recover. Strength in Health Care was once again driven by argenx and the Strategy benefited from essentially having no exposure to Materials, Consumer Staples, Energy, Real Estate, or Utilities.

From a geographic perspective, all of our outperformance was attributable to our holdings in developed markets, driven entirely by stock selection. We outperformed in all but one country within the developed markets – the U.K., with IT services provider Endava being the culprit. Our emerging markets holdings contributed as well to relative results driven by stock selection, primarily related to investments in Korea (Coupang) and Poland (InPost). This was partially offset by underperformance in Argentina, which falls outside of developed and emerging markets.

From a stock specific perspective, we had 25 contributors against 17 detractors. NVIDIA, SpaceX, Shopify, Zomato, argenx, Coupang, Wix, MercadoLibre, and Cloudflare contributed over 100bps each to our absolute returns. Shares of NVIDIA, Zomato, Codere, GDS, and Resident Home more than doubled in price. On the other side of the ledger, Endava, Snowflake, Rivian, and Think & Learn detracted over 100bps each. Regrettably, Rivian and Think & Learn will now go under the “Permanent Loss of Capital” column as we have sold the shares of Rivian and wrote down the value of our investment in Think & Learn to essentially zero.

To better understand the Strategy’s performance, we further deconstructed it into its two components – change in multiples and change in the fundamentals. During the fourth quarter, the weighted average multiple² expanded by 4.1% though it was still down 1.5% over the full year. Since the Fund was up 11.6% in the quarter and 25.6% during 2024, the fundamentals of our holdings grew by approximately 8% in the quarter and by approximately 28% during 2024³ – implying that over 100% of our performance in 2024 was driven by growth in fundamentals as opposed to the more unpredictable and volatile change in multiple – a positive data point for the Fund’s prospective returns. The fundamentals of our businesses continue to improve after the slowdown in 2022 and 2023 with consensus revenue expectations for 2025 increasing by 1.4% during the fourth quarter and by 11.9% during 2024⁴, operating income expectations rising by 2.9% in the quarter and 12.1% over the year, and operating margin expectations increasing by 30bps in the fourth quarter and 4bps in 2024. Overall, business trends continue to improve across most economic sectors and geographies.

Space Exploration Technologies Corp. (SpaceX) is a high-profile private company founded by Elon Musk. Its primary focus is on developing and launching advanced rockets, satellites, and spacecrafts, with the ambitious long-term goal of enabling human colonization of Mars. SpaceX is generating significant value with the rapid expansion of its Starlink broadband service. The company is successfully deploying a vast constellation of Starlink satellites in Earth’s orbit, reporting substantial growth in active users, and regularly deploying new and more efficient hardware technology. Furthermore, SpaceX has established itself as a leading launch provider by offering highly reliable and cost-effective launches, leveraging the company’s reusable launch technology. SpaceX capabilities extend to strategic services such as crewed space flights. Moreover, SpaceX is making tremendous progress on its newest rocket, Starship, which is the largest, most powerful rocket ever flown. This next- generation vehicle represents a significant leap forward in reusability and space exploration capabilities. We value SpaceX using prices of recent financing transactions.

Shopify Inc. is a cloud-based software provider for multi-channel commerce. Shares rose 33.0% in the fourth quarter, finishing 2024 up 36.8% on strong financial results, including year-over-year revenue growth of 26% thanks to continued market share gains with gross merchandise value growth of 24%. Shopify reported continued success in its original online commerce segment while also expanding into offline, international, and business-to-business (B2B), which grew 27%, 30%, and 145%, respectively. Operating margins of 18% came in 240bps above expectations. While the company again guided for an accelerated pace of reinvestments into the business, which will limit short-term margin expansion, we believe this is the correct long-term strategy, as Shopify is taking advantage of its continuously improving product set and maturing go-to-market, in order to further expand its addressable market, targeting international merchants, offline and B2B retailers and going up market. We remain shareholders due to Shopify’s strong competitive positioning, innovative culture, and long runway for growth, as it still holds less than a 2% share of the global commerce market.

Cloudflare, Inc. offers enhanced security and performance for websites, apps, and software as a service. Shares increased 33.1% during the quarter and finished 2024 up 29.9% on solid quarterly results with 28% year-on-year revenue growth and 14.8% non-GAAP operating margins, which increased 210bps year-on-year. A double-digit year-on-year increase in sales productivity has started to benefit EMEA and APAC growth rates, although North American growth, where sales headcount cuts were deeper, was still softer. Large and total customer additions were robust and the remaining performance obligations were well ahead of expectations up 39%. In addition, the company announced the hiring of CJ Desai, a well- regarded executive who helped build ServiceNow into one of the best software businesses of all time, as President of Product & Engineering. We retain conviction in Cloudflare given its visionary management team, disruptive business model, and stacking S curves or markets that it can address with its platform as it helps companies modernize their networking infrastructure.

MercadoLibre, Inc. is the leading e-commerce marketplace across Latin America. Shares of MercadoLibre declined 17.3% in the quarter (although finished the year up 8.0%) as the company reported weaker-than-expected operating margins, leading to a reduction in near-term earnings expectations. The margin contraction was driven by growth in the credit portfolio (with loan loss provisions accounted ahead of revenue recognition), temporary accounting changes, accruals for long-term incentive plans and investments to expand the company’s distribution network. We see these as temporary and necessary to expand MercadoLibre’s competitive advantages relative to peers, supporting its growth runway. MercadoLibre is investing in the business, which sacrifices near-term profitability but is the correct strategic decision, in our view. Apart from the margin miss, financial results were strong, with 35% year-on-year revenue growth (+103% in constant currency), 28% growth in items sold and 34% growth in total payments volume (+73% in constant currency). We retain conviction in MercadoLibre as an attractive long-term growth story tied to the secular growth of e-commerce and the penetration of financial services across Latin America.

ASML Holding N.V. is a Dutch company that designs and manufactures photolithography equipment for semiconductor manufacturing. While ASML is the leader across all types of lithography, most importantly, it is the only manufacturer of extreme ultra-violet lithography tools, which are critical for the manufacturing of leading-edge chips. Shares fell 15.6% during the fourth quarter (finishing the year down 6.6%) on reduced guidance for 2025 as well as growing investor concerns about the potential impact of U.S. government restrictions on Chinese demand and the possibility of peaking lithography intensity. Despite near-term noise, we believe that the growing demand for chips in general and AI chips in particular will continue to support long-term growth for the wafer fab equipment industry with ASML’s competitive positioning remaining unassailable. While lithography as a percentage of capital expenditure may decrease from current levels, the chip layer count requiring lithography will continue to increase, in our view, as chips continue to become more complex. As a monopoly on critical lithography tools supporting an industry with growing demand fueled by the proliferation of AI, we see strong long- term upside for ASML.

Shares of Coupang, Inc., Korea’s largest e-commerce platform, corrected 10.6% in the fourth quarter (even though they finished 2024 up 35.5%). While the company delivered solid quarterly results with 27% year-on-year revenue growth with Farfetch and other initiative losses narrowing significantly, its product commerce EBITDA margin missed expectations due to a temporarily elevated spending on technology and automation. Sluggish domestic consumption in Korea, with the e-commerce market experiencing flattish to negative growth, and political uncertainty stemming from President Yoon’s declaration of martial law and subsequent impeachment, further weighed on the stock. Despite these short-term challenges, we maintain a positive outlook on Coupang’s long-term market share expansion and margin growth trajectory, and view Coupang as one of the most competitively advantaged e-commerce businesses globally, with significant runway for both revenue and earnings growth.

The portfolio is constructed on a bottom-up basis with the quality of ideas and conviction level having the most significant roles in determining the size of each individual investment. Sector and country weights are an outcome of the stock selection process and are not meant to indicate a positive or a negative “view.”

As of December 31, 2024, the top 10 positions represented 61.2% of net assets, and the top 20 represented 85.6% (this compares to 60.2% and 87.7% at the end of 2023, respectively). We ended 2024 with 38 investments compared to 34 at the end of 2023. Our investments in the IT, Consumer Discretionary, Industrials, Financials, and Health Care sectors, as classified by GICS, represented 99.4% of net assets.

Investments in non-U.S. companies represented 53.4% of net assets, and our holdings in emerging markets and other non-developed countries (Argentina) totaled 25.3%.

Active share was 92.1% (and averaged 94.7% over the last 3 years) and its turnover was 8.3% in 2024, roughly in-line with average turnover of 7.3% and 10.9% over the last 3 and 5 years, respectively.

After a decade of a very favorable investing environment spurred by globalization and record low interest rates, the last few years have proven to be a challenge for global investors. A spike in inflation, partly caused by the COVID pandemic, triggered an unprecedented tightening cycle by the global monetary authorities which prompted a significant drawdown for equity markets worldwide in 2022. Once the tightening cycle ended, the markets stabilized and began to recover, despite increased geopolitical tensions and wars in Europe and the Middle East, the MSCI ACWI Index gained 43.6% over the last two years. While impressive on the surface, the gains were driven by a narrow group of U.S. companies with giant market capitalizations leaving most international and non-giant-cap stocks still in correction territory. The Strategy struggled for most of that period, as being in the wrong neighborhoods and not being in those few narrow stocks that drove the Index’s returns proved to be a significant headwind. As we begin 2025, deglobalization is expected to accelerate. The incoming Trump administration is vocal about using tariffs as a preferred tool to exert leverage on its trading partners. But tariffs are barriers to trade with the effect of localizing supply chains. Deglobalization will likely make it more expensive to make things, which is inflationary in nature, and the last mile in getting inflation down to the stated desired level has already proven to be harder than expected.

Even so, we are optimistic about what is to come.

We are not talking about further interest rate cuts, deregulation, improved efficiency and productivity, increased M&A activity, and a more benign geopolitical background – things that are reasonably likely to happen that could provide a nice tailwind for the market and our stocks. No one gifted us a crystal ball this holiday season and even if we had one, we would not know how to use it. We do not know what is priced in or how the market would react to the events in the short term as they unfold.

We are in the early stages of one of the biggest disruptive changes we have witnessed in our careers and perhaps in all human history. Invoking pattern recognition once again, this reminds us of the early 90’s with the internet. Jeff Bezos, whose company was arguably at the epicenter of that transformation, recently remarked that “This is most like electricity. There was electricity, then compute, and now AI. These horizontal layers, they go everywhere. I guarantee there is not a single application that you can think of, that is not going to be made better by AI⁵.” Elon Musk, no stranger to disruptive change himself, recently said that “Probability that AI exceeds the intelligence of all humans combined by 2030 is about 100%.”⁶ Tobi Lutke, the CEO and Founder of Shopify said in a recent podcast that even if AI development completely stopped today “there’s probably $10 trillion of value for industry that can be pulled out of just that over the next ten years.”⁷ Jensen Huang, NVIDIA’s Co-Founder and CEO, commented during his 2025 CES keynote⁸ that “AI agents will drive a multi-trillion dollar industry and transform how people work.”

We believe that AI model intelligence, or how capable these models are, is improving rapidly. Scaling laws suggest that as models get bigger and are trained on more data, they become smarter. However, we now have additional ways to enhance model intelligence beyond just increasing model and data size during pre-training. Even if scaling laws slow down (which has not happened yet), we now have more vectors to progress:

• Multiple modalities: Training models on text, images, videos, and audio.
• Synthetic data: Using AI-generated and simulated data to improve training and fine-tuning.
• Post-training techniques: For example, Reinforcement Learning (RL) methods like Proximal Policy Optimization (PPO), RLHF (RL with Human Feedback) or RLAIF (RL with AI Feedback).
• Inference-time scaling: Models that are capable of thinking through multiple steps (or chain of thought) before answering, like OpenAI’s new reasoning models (o1 and o3). These models have shown great improvement in advanced benchmarks, with frontier math scores rising from 2% (o1) to 25% (o3), and general intelligence scores improving from 25-30% to 75-88%⁹.

In robotics, we are also seeing promising progress even though it is still early – with Waymo reaching an incredible 22% market share in San Francisco, same as Lyft¹⁰ and Tesla showing Optimus robots in the wild at its “We Robot” event.

We own a portfolio of great businesses that should benefit from these disruptive changes over time – from NVIDIA at the epicenter of the AI paradigm shift, to the e-commerce platforms such as Shopify that can utilize AI to help its merchants run their businesses better, to infrastructure software platforms like Datadog or Cloudflare, that use AI on their proprietary data to dramatically improve their offerings for customers. 

After the weighted average multiple of the Strategy¹¹ declined by 57% in 2022, and recovered 16% in 2023, it declined again in 2024, by 1.5%. Overall, in the last two years, while the multiple recovered approximately 14%, the Strategy gained significantly more, suggesting that approximately three quarters of the recovery has been driven by growth in fundamentals rather than multiple expansion. We expect that to continue to be the case over the long term, and the longer the time horizon, the more important growth in fundamentals will be to the performance of the Strategy.

Every day we live and invest in an uncertain world. Well-known conditions and widely anticipated events, such as Federal Reserve rate changes, ongoing trade disputes, government shutdowns, and the unpredictable behavior of important politicians the world over, are shrugged off by the financial markets one day and seem to drive them up or down the next. We often find it difficult to know why market participants do what they do over the short term. The constant challenges we face are real and serious, with clearly uncertain outcomes. History would suggest that most will prove passing or manageable. The business of capital allocation (or investing) is the business of taking risk, managing the uncertainty, and taking advantage of the long-term opportunities that those risks and uncertainties create.

We are optimistic about the long-term prospects of the companies in which we are invested and continue to search for new ideas and investment opportunities while remaining patient and investing only when we believe the target companies are trading at attractive prices relative to their intrinsic values.