Baron Focused Growth 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 2500 Growth Index declined 10.8%.

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 Focused Growth Fund declined in the first quarter. Information Technology (IT), Communication Services, and Real Estate holdings contributed the most. Investments within Consumer Discretionary, Financials, and Health Care detracted the most. Advances within IT were led by X.AI Holdings Corp. and Guidewire Software, Inc., the top and third largest contributors, respectively. Second largest contributor Spotify Technology, S.A. drove gains within Communication Services. Appreciation within Real Estate was attributable to CoStar Group, Inc., a provider of marketing and analytics to the real estate industry. Consumer Discretionary had a rough quarter, with all 11 holdings giving up gains, including the Fund’s top three detractors. Automated electronic broker Interactive Brokers Group, Inc. led declines within Financials, while DNA sequencing platform Illumina, Inc. drove weak performance within Health Care.

The second quarter may bring with it as much doubt and volatility as the first quarter, given continued elevated uncertainty around tariffs. After reaching a record high of more than $3.3 trillion 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 completely.

We are closely monitoring current 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.
• Spotify Technology S.A. is a leading global digital music service offering on-demand audio streaming through paid premium subscriptions and an ad-supported model. Shares were up, once again attributable to another impressive beat in gross margins and a healthy increase in operating margins. Spotify has been on a path to structurally increase gross margins, aided by its high-margin artist promotions marketplace, growing contribution from podcasts, and structural investments in advertising. Users continued to grow at a double-digit pace despite price hikes. Spotify also continued to innovate on the product side, calling 2025 the "year of accelerated execution," with priorities in improving advertising, expanding into video, developing a Super Premium tier, and taking more market share. We view Spotify as a long-term winner in music streaming with potential to reach 1 billion-plus monthly active users.
• 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%.

 

DETRACTORS

• Tesla, Inc. manufactures electric vehicles (EVs), solar products, and energy storage solutions alongside the development of advanced real-world AI technologies. Shares fell due to declining analyst expectations for auto delivery volume and margins in 2025 as a result of 1) a refresh of the Model Y, its highest volume vehicle and the world's best selling car in 2024; 2) Elon Musk’s controversial role in the Trump administration; and 3) regulatory changes that could pose potential operational challenges. Despite these headwinds, we remain confident in Tesla’s long-term growth, underpinned by secular trends in EVs and energy storage adoption, a compelling product line, its leading cost structure, and cutting-edge technology. A Model Y refresh alongside the debut of new mass-market models should boost demand. Over time, we expect the political pressure to fade, while Tesla’s AI ambitions—a robotaxi service launching this year and a fast-growing humanoid program—hold the promise of transforming its growth story.
• Shares of global hotelier Hyatt Hotels Corporation detracted as Trump's tariff policies generated heightened uncertainty around the macroeconomic environment. While the volatility during the first quarter is a concern, we believe it will be short term. Business fundamentals were strong, with solid forward bookings numbers as the business transient segment continued its post-pandemic recovery and the group business segment paced up by mid-single-digits. We expect double-digit EBITDA growth in 2025. The company has a strong balance sheet. The planned acquisition of Playa Hotels should be accretive to earnings, especially after Hyatt sells the underlying real estate properties. Once the sale is complete, over 90% of revenue will be fee-based, which should help close Hyatt's multiple discount to peers.
• Shares of Krispy Kreme, Inc. traded down following softer-than-expected quarterly earnings as a result of a cybersecurity incident that disrupted its online ordering system, a decline in U.S. retail sales, and weak international EBITDA margins due to disappointing performance in the U.K. 2025 guidance also missed expectations. We remain investors. Management is taking a conservative approach as it continues the national rollout with McDonald's, which will significantly increase Krispy Kreme's points of distribution and provide additional consumer awareness for the brand throughout the U.S.