Baron Growth Fund: Latest Insights and Commentary

U.S. equities were broadly higher in the third quarter, building on gains from the prior quarter. The S&P 500 Index and NASDAQ Composite set new record highs, most recently on September 22, and the Dow Jones Industrial Average ended the quarter at an all-time high. Small caps led the market recovery, with the Russell 2000 Index finally surpassing its previous record high achieved almost four years ago on November 8, 2021. Market volatility remained muted during the quarter as the CBOE Volatility Index (VIX) continued to trade in the mid-teens, well below its long-term average of around 20. 

The preeminent driver of market strength was the increased likelihood of Federal Reserve (Fed) rate cuts, prompted by signs of weakness in the labor market and the subsequent emergence of more dovish Fed commentary. Rate cut expectations rose in early August following a much weaker-than-expected July nonfarm payrolls report and significant downward revisions to prior numbers. Dovish Fedspeak intensified as the month wore on, with Chair Powell hinting a possible interest rate cut while delivering remarks at the Fed’s annual Jackson Hole conference. Similarly, Governor Waller continued to advocate for cuts while speaking at the Economic Club of Miami. The Fed eventually resumed its rate-cutting cycle at the September meeting, lowering its policy rate by 25 basis points to a range of 4% to 4.25%, after being on hold since its previous cut last December. Robust corporate earnings, narrowing trade uncertainties, a resilient consumer, increased M&A and IPO activity, and sustained AI optimism also contributed to market gains during the quarter. 

The Magnificent Seven complex dominated market returns for a second consecutive quarter, accounting for nearly two-thirds of the S&P 500 Index’s third-quarter gains. The group appreciated 15.5% in the period, outperforming all other securities in the Index, which were up 4.6%, by a double-digit margin. Tesla (+40.0%), Alphabet (+38.1%), Apple (+24.2%), and NVIDIA (+18.1%) posted the largest gains. Meta and Amazon were essentially flat in the period, trailing the broader Index. 

Most sectors closed higher in the period, with Information Technology, Communication Services, and Consumer Discretionary being the only sectors to outperform the broader market thanks to the heavy influence of the Magnificent Seven. Consumer Staples was the only sector to decline in the period, driven by broad-based weakness across a range of sub-industries, including distillers & vintners, personal care products, food retail, tobacco, and household products. Other laggards were Real Estate, Financials, Health Care, Industrials, Energy, and Materials. From a style perspective, small caps outperformed in the third quarter, rising more than 12% and narrowing the gap with mid- and large-cap stocks this year. Performance was mixed between growth and value, with growth stocks dominating in July, losing out to value in August, and rebounding in September. Despite recent volatility, growth generally remains ahead of value year to date, with the largest differential in the mid- and large-cap segments thanks to the heavy influence of Palantir and the broader Magnificent Seven. 

Beyond the U.S., emerging market (EM) equities meaningfully outperformed in September to finish ahead of their developed market counterparts for the quarter. The rally in Chinese equities was largely responsible for EM outperformance, with gains being driven by investor optimism about AI innovation, which bolstered Chinese technology and internet companies. Targeted government initiatives, easing trade tensions with the U.S., and significant domestic capital inflows also contributed to strength in China. Taiwanese and Korean equities also performed well in the period, overshadowing weakness in India, where equity markets were pressured by underwhelming corporate earnings and concerns about recently enacted U.S. tariffs. Foreign investor flows in Indian markets turned negative in the third quarter after being meaningfully positive in May and June. Performance in developed markets was held back by weakness in continental Europe (Denmark, Germany, Norway, Switzerland, France, and Sweden). European equities were hurt by weak corporate earnings, Trump tariff headwinds, and political instability, particularly in France, where the country’s prime minister resigned after losing a crushing confidence vote in parliament.

CONTRIBUTORS

• Veterinary diagnostics leader IDEXX Laboratories, Inc. contributed to performance after reporting better-than-expected financial results. Foot traffic to veterinary clinics in the U.S. remains under pressure, which has continued to hamper aggregate revenue growth. Even so, IDEXX’s excellent execution has enabled the company to maintain strong performance. We believe IDEXX’s competitive trends are outstanding, and we expect new proprietary innovations and field sales force expansion to be meaningful contributors to growth this year. We see increasing evidence that long-term secular trends around pet ownership and pet care spending have structurally accelerated, which should support IDEXX’s long-term growth rate.
• Red Rock Resorts, Inc. is a casino owner and operator focused on the Las Vegas Locals market. Shares rose during the quarter as investors reacted positively to incremental visitation from new customers and accelerating spend-per-visit trends, despite concerns about a market slowdown. The company continues to report strong visitation and robust slot and table game play, along with improving activity from uncarded and non-rewards customers. Red Rock is regaining business at its flagship resort following some initial cannibalization from the opening of its Durango property, with management expecting a full recovery next year and trends already improving faster than anticipated. The new property is generating robust returns, and performance across the company’s six core casinos has strengthened as the Las Vegas Locals market absorbs Durango and returns to its historical low-single-digit growth rate. Given the strength of the market, management continues to ramp up capital investment, which we believe should support ongoing revenue and EBITDA growth over the next several years.
• FIGS, Inc. designs and sells scrubwear for health care professionals using a digitally native, direct-to-consumer strategy. Shares rose after the company reported better-than-expected quarterly results and raised its revenue and profitability guidance for the remainder of the year. Despite intentionally reducing promotional activity, FIGS achieved nearly 6% revenue growth during the second quarter and delivered stronger-than-expected margin improvement driven by efficiency gains at its new fulfillment center. After several years of industry pressure, the company is experiencing more normalized purchasing and replenishment patterns, supported by product and marketing initiatives that continue to resonate with customers. Looking ahead, we retain conviction in FIGS’ ability to gain share given its high-quality, needs-based products and exposure to the fast-growing U.S. health care industry. We expect continued growth fueled by the company’s efforts to expand its retail footprint, increase business-to-business revenue, and grow internationally.

DETRACTORS

• Gartner, Inc., a provider of syndicated research, detracted from performance following disappointing quarterly earnings. Contract value growth, a leading indicator of future revenue, decelerated by approximately 2%. We attribute most of the slowdown to ongoing cost cutting in the U.S. public sector, which represents about 5% of revenue, as well as more challenging business conditions in industries dependent on public-sector funding. In addition, companies with meaningful exposure to tariffs appear to be reducing costs, resulting in longer sales cycles and slightly higher client attrition. While the market expressed concern about the impact of AI on Gartner’s insights business, we see no evidence that this is negatively impacting its value proposition. The company continues to benefit from a vast and expanding set of proprietary data generated through hundreds of thousands of interactions with buyers, sellers, and technology consumers. Gartner bought back approximately $800 million worth of stock in July and August and authorized an additional $1 billion in September, and we expect the company to continue repurchasing shares aggressively to capitalize on the discounted valuation.
• FactSet Research Systems Inc. is a leading provider of investment management tools. Shares fell during the quarter due to a combination of industry-wide concerns about AI, uncertainty surrounding the ongoing CEO transition (which prompted a more conservative preliminary fiscal 2026 outlook), and cautious commentary from several financial data and software peers. The company nevertheless reported solid fiscal fourth-quarter 2025 earnings results, its best quarter ever for new sales, and discussed at length how AI is benefiting the business. We retain long-term conviction in FactSet given its large addressable market, strong execution across both new product development and financial results, and robust free cash flow generation.
• Morningstar, Inc. is a leading data provider to the investment community. Despite solid second-quarter results, shares declined on slowing organic growth in PitchBook, the company’s private markets data and research platform. The broader financial information services sector also underperformed during the quarter, partly due to factor rotation as investors shifted from high-quality, defensive names to higher-growth stocks. Additionally, investor concerns have emerged that AI and large language models could disrupt the industry. However, we believe Morningstar’s long track record of managed investment data, along with proprietary insights from PitchBook, will remain highly valuable to clients, regardless of how that data is accessed. We expect PitchBook’s growth to reaccelerate over time, particularly as capital markets activity improves. We remain investors in the stock.

When reviewing performance attribution on our portfolio, please be aware that we construct the portfolio from the bottom up, one stock at a time. Each stock is included in the portfolio if it meets our rigorous investment criteria. To help manage risk, we are aware of our sector and security weights, but we do not include a holding to achieve a target sector allocation or to approximate an index. Our exposure to any given sector is purely a result of our stock selection process.

Baron Growth Fund (the Fund) underperformed for a second consecutive quarter as the market recovery continued to gain steam. The Fund declined 8.69% in the third quarter, meaningfully trailing the Russell 2000 Growth Index’s gain of 12.19%. Nearly half of the relative losses stemmed from style-related headwinds, as the Fund was punished for being overexposed to the Earnings Quality factor, which suffered its worst three-month performance on record. We believe this is indicative of the low-quality nature of the market rally during the quarter, which was challenging given the Fund’s higher quality profile. Underexposure to the strong performing Momentum, Beta, and Residual Volatility factors also contributed to the relative shortfall in the period. The remaining underperformance came from stock-specific issues and active industry exposures.

On a sector level, the Fund’s Financials investments were responsible for nearly half of the underperformance in the period, owing to a combination of poor stock selection and significantly higher exposure to this lagging sector. Financial exchanges & data holdings FactSet Research Systems Inc., Morningstar, Inc., and MSCI Inc. were material detractors, hurt by combination of industry-wide AI concerns, cautious commentary from several financial data and software peers, and factor rotation as investors shifted from high-quality, defensive names to higher-growth stocks. We remain investors in these high-quality businesses that have been big winners for the Fund over the long term.

Specialty insurers Kinsale Capital Group, Inc. and Arch Capital Group Ltd. also contributed to relative weakness in the sector owing to concerns about moderating growth and a cyclical slowdown in the broader insurance industry. Nevertheless, Kinsale reported quarterly earnings that exceeded Street expectations, with 14% premium growth outside of large property policies, which face the most competition. Recent data from several state insurance commissioners also presages faster premium growth for the company in the third quarter. We remain investors because we believe Kinsale is well managed and has a long runway for growth in an attractive segment of the insurance market. Similarly, Arch reported results that exceeded Street expectations, as underwriting margins remained strong despite increasingly competitive market conditions. Return on equity of 18% was above management’s long-term target, driving 12% growth in book value per share, or 22% growth when adjusted for the recent special dividend. We continue to own the stock due to Arch’s strong management team and our expectation of continued growth in earnings and book value over time.

Adverse stock selection in Information Technology was another material headwind, with most of the weakness coming from the Fund’s sizable position in syndicated research provider Gartner, Inc. Gartner’s shares declined in response to disappointing quarterly earnings. Contract value growth, a leading indicator of future revenue, decelerated by approximately 2%. We attribute most of the slowdown to ongoing cost cutting in the U.S. public sector, which represents about 5% of revenue, as well as more challenging business conditions in industries dependent on public-sector funding. In addition, companies with meaningful exposure to tariffs appear to be reducing costs, resulting in longer sales cycles and slightly higher client attrition. While the market expressed concern about the impact of AI on Gartner’s insights business, we see no evidence that this is negatively impacting its value proposition. The company continues to benefit from a vast and expanding set of proprietary data generated through hundreds of thousands of interactions with buyers, sellers, and technology consumers. Gartner bought back approximately $800 million worth of stock in July and August and authorized an additional $1 billion in September, and we expect the company to continue repurchasing shares aggressively to capitalize on the discounted valuation.

Lack of exposure to the strong performing Industrials sector coupled with disappointing stock selection in Consumer Discretionary and Communication Services were the remaining drivers of underperformance in the period. Weakness in Consumer Discretionary came from hotel franchisor Choice Hotels International, Inc. and global ski resort operator Vail Resorts, Inc. Choice shares fell during the quarter amid investor concerns over continued revenue per available room (RevPAR) weakness at the company’s lower-end economy and midscale brands. While the slowdown in RevPAR is disappointing and bears monitoring, Choice continues to grow its more revenue-intensive units at a strong pace, helping offset the softness. The company is also increasing royalty rates, particularly across its Radisson brands, further supporting revenue and margin expansion. Choice generates strong cash flow and maintains a solid balance sheet, providing flexibility to pursue acquisitions, reinvest in the business, and repurchase shares. We believe the stock’s valuation continues to reflect a significant discount to intrinsic value, and management’s disciplined capital allocation and commitment to returning capital to shareholders position the company for upside as growth reaccelerates following the recent economic slowdown.

Global ski resort company Vail Resorts, Inc. detracted from performance amid investor concerns about slowing visitation levels, driven by a lack of growth in season pass sales. In response, the company is refining its marketing strategy and investing in new media channels, including social media and influencer partnerships, to attract new skiers and accelerate pass sales. Vail also plans to narrow the pricing gap between lift tickets and season passes to encourage more non-pass holders to join its ecosystem, which should drive stronger pass growth next year. Consumer sentiment toward Vail’s pass products is improving, and management continues to enhance the value of the portfolio. The company maintains strong margins and cash flow, which support both share repurchases and a 6% dividend yield. We believe the stock’s significant discount to its historical valuation should narrow as growth reaccelerates in the coming years.

Performance in Communication Services was hindered by Iridium Communications Inc., a mobile voice and data communications services vendor offering global coverage via satellite. The company’s shares declined following a weaker-than-expected quarterly report that highlighted a continued slowdown in revenue growth and a rare downward revision to full-year guidance. Compounding these challenges, SpaceX announced in early September a $19 billion acquisition of S-band spectrum, which in some respects resembles Iridium’s L-band spectrum. This development could allow SpaceX to expand its direct-to-device offerings, potentially intensifying competition within Iridium’s key operating verticals. We exited our position during the quarter amid weakening investor sentiment and rising skepticism about Iridium’s ability to meet its long-term growth objectives in a shifting competitive landscape.