Baron Asset Fund: Latest Insights and Commentary

U.S. stocks struggled during the first quarter of 2025 as the shock of Trump’s tariff war erased any optimism that the U.S. stock market or economy would continue to flourish under the new administration, replaced by heightened concerns of a possible recession. The mass layoffs of federal workers added to the confusion. The Magnificent Seven, which had led the market on AI-driven enthusiasm, were even harder hit by tariff uncertainties, as their relatively high valuations made them more exposed to a slowdown. In addition, the January launch of Chinese AI app DeepSeek as a less expensive alternative to U.S.-based AI models had investors questioning whether the massive investments in AI would ultimately produce the expected outsized returns. The Russell Midcap Growth Index declined 7.1%.

GDP growth is widely predicted to slow during 2025, reflecting weakening consumer demand and more cautious corporate spending. Consumer confidence has plummeted. The March 2025 inflation figure came in above the U.S. Federal Reserve’s target of 2%, as measured by the Consumer Price Index. The Fed has taken a wait-and-see approach as the effects of heightened U.S. policy uncertainty on growth, inflation, and employment play out. It left interest rates unchanged in its first meeting of the year.

Against this challenging backdrop, Baron Asset Fund declined in the first quarter. Holdings within Information Technology (IT), Real Estate, and Financials contributed. Consumer Discretionary, Health Care, and Industrials investments were the top detractors. Top contributor X.AI Holdings Corp. led positive results within IT. Gains within Real Estate were driven by CoStar Group, Inc. This provider of marketing and data analytics to the real estate industry contributed on increased productivity of its sales force and signs of the start of a recovery in commercial real estate. Arch Capital Group, Ltd. led appreciation within Financials due to favorable operating trends and the relative stability of insurance stocks in a risk-off market. With all nine holdings losing ground, Consumer Discretionary had a weak quarter. Declines within Health Care were led by third largest detractor West Pharmaceuticals, Inc. Detractors outweighed contributors within Industrials, led by Dayforce, Inc., a provider of payroll software.

The second quarter may bring with it as much doubt and volatility as the first, given continued elevated uncertainty around tariffs. After reaching a record high in corporate profits in the fourth quarter of 2024, U.S. companies are scrambling to estimate the potential impact of the tariff war. As first quarter earnings season approaches, many observers expect businesses to offer weaker earnings guidance for the rest of the year or withdraw guidance altogether.

We are closely monitoring market conditions while staying focused on company fundamentals -- well-managed businesses with durable competitive advantages and compelling growth prospects at attractive prices -- as we believe this is the best way to generate alpha over the long term, although there are no guarantees.

CONTRIBUTORS

• X.AI Holdings Corp. is developing an AI model "to understand the true nature of the universe." In a short period since its inception, xAI launched its AI model and product, including the third version of the model, Grok 3, which demonstrated top scores in evaluation tests, ahead of other industry-leading AI models. The company also opened the Colossus data center, operating more than 100,000 Graphical Processing Units and considered at the time to be the largest coherent training center in the world. Grok 3 was the first model trained on xAI's Colossus, leveraging more than 10 times the compute used to train Grok 2. Most recently, xAI acquired X, formerly Twitter. The acquisition is expected to improve alignment of corporate objectives, enhance resource allocation, and integrate data, compute, and products. In addition, it provides xAI access to X’s vast, real-time, multimodal data generated by 600 million users worldwide. We value the stock based on recent share transactions, including the recently announced merger.
• Shares of property & casualty (P&C) insurance software vendor Guidewire Software, Inc. contributed to performance in the quarter. After a multi-year period, we believe Guidewire's cloud transition is substantially over, and cloud will be the sole path forward, with annual recurring revenue (ARR) benefiting from new customer wins and migrations of the existing customer base to InsuranceSuite Cloud. We also expect the company to shift R&D resources to product development from infrastructure investment, which will help drive cross-sales into its sticky installed base and potentially accelerate ARR over time. We are also encouraged by Guidewire’s subscription-based gross margin expansion, which improved by more than 1,000 basis points in its most recently reported quarter. We believe Guidewire will be the critical software vendor for the global P&C insurance industry, capturing 30% to 50% of its $15 billion to $30 billion total addressable market and generating margins above 40%.
• Shares of Verisk Analytics, Inc., a leading data and analytics vendor, contributed to performance. The company reported solid quarterly results, including particularly strong organic revenue growth. CEO Lee Shavel also sounded upbeat on Verisk’s growth potential in 2025. Verisk benefited as well from the investor rotation into more defensive stocks driven by tariff-related uncertainty. We maintain conviction in the competitive positioning, long-term growth, margin expansion, and capital deployment prospects for the business.

 

DETRACTORS

• Shares of Gartner, Inc., a provider of syndicated research, fell on uncertainty around the impact of government spending reductions on the business. We estimate U.S. federal exposure is about 5% of Gartner’s total research contract value, with about half from the Department of Defense and intelligence organizations and half from civilian agencies. While DOGE-driven cost scrutiny is high, we believe Gartner’s services deliver significant value to users, including the potential for hard dollar savings. The private sector business appears well positioned for sustained growth, and management is adept at exercising cost controls to sustain or enhance margins and free cash flow. The company’s balance sheet is in excellent shape, and we expect management to take advantage of this drawdown with aggressive share repurchases.
• The Trade Desk is the leading internet advertising demand-side platform, enabling agencies to efficiently purchase digital advertising across PC, mobile, and online video channels. Shares fell on an earnings miss for the first time in 33 quarters. Since the most recent earnings report, we have done substantial research to test our investment thesis. We believe the miss was due largely to a reorganization in December and delays in its Kokai platform rollout, both of which we believe have since improved. While we monitor the competitive landscape as Amazon enters the market more meaningfully, we believe The Trade Desk still represents the best option for biddable Connected TV (CTV) inventory. It gained share against the incumbent Google in the last five years, even when Google charged low/no fees, and major companies like Netflix, Disney, and Spotify have opened their ad inventory to The Trade Desk. Its market remains large and underpenetrated, as the shift to CTV advertising is still in early stages. We believe The Trade Desk can grow its top line by high-teens to 20% year-over-year for years to come.
• West Pharmaceutical Services, Inc. is a leading manufacturer of drug packaging components and delivery systems for injectable drugs. Although management expects the core business to perform well in 2025, shares fell on setbacks in two other areas of the business. First, West declined to renew two contracts in its contract manufacturing business due to unfavorable economics. We would note that, compared to the core business, the contract manufacturing business is low margin and low value. Second, some high-margin 2024 revenue with a large customer for West's Smart Dose On-Body Delivery System will not repeat in 2025. As a result, 2025 earnings guidance was materially below investor expectations. While we are disappointed with the re-set, we think earnings can grow at a mid-teens rate from this new level.