Baron Growth Fund

24
trends are improving. This is consistent with our view that the broader U.S.
economy is strengthening, helped by lower interest rates, and evidenced by
robust auto sales, improving housing data, declining unemployment and
abundant, low cost domestic energy. Finally, we believe stocks remain
attractively valued, trading around 15.2X earnings, roughly in line with the
markets 100-year median P/E multiple.
Baron Growth Fund does not change its investment approach because
certain types of stocks are in or out of favor in the short term. We invest for
the long term in businesses with large growth opportunities, sustainable
competitive advantages and talented, visionary management. Following the
year-to-date underperformance of small cap growth businesses, we believe
Baron Growth Funds portfolio is unusually well-positioned and attractively
valued. The businesses in which Baron Growth Fund has invested have
grown significantly this year. Since the Funds shares have not, we believe
the Fund is well positioned to soon again outperform.
Over the long term, the Fund has outperformed its benchmark by 608 basis
points per year on average since its inception on December 31, 1994. It has
also outperformed the large cap S&P 500 Index by 378 basis points per year
over the same time frame. Since inception, Baron Growth Fund has earned
an average compound annual return of 13.49%. This compares to 7.41% for
the Russell 2000 Growth Index and 9.71% for the S&P 500 Index.
During the quarter, we took advantage of market volatility to add or increase
our positions in several new and existing investments that had fallen sharply
in price. Since the beginning of the year, Baron Growth Fund has invested
nearly $600 million in 11 new companies with average market caps of $1.7
billion. These included Masonite International Corp., a low-cost
manufacturer of premium residential doors and
entryways, as well as two energy services companies,
Badger Daylighting Ltd. and Atlas Energy, L.P. Badger
is a specialized provider of excavation services to the oil
and gas industry that is benefiting from significant
shale exploration throughout North America. Atlas is a
leading natural gas pipeline operator in the Midwest.
Performance listed in the above table is net of annual operating expenses.
Annual expense ratio for the Retail Shares as of September 30, 2013 was
1.30%. The performance data quoted represents past performance. Past
performance is no guarantee of future results. The investment return and
principal value of an investment will fluctuate; an investors shares, when
redeemed, may be worth more or less than their original cost. The Funds
transfer agency expenses may be reduced by expense offsets from an
unaffiliated transfer agent, without which performance would have been
lower. Current performance may be lower or higher than the performance
data quoted. For performance information current to the most recent month
end, visit www.BaronFunds.com or call 1-800-99BARON.
1
The indexes are unmanaged. The Russell 2000 Growth Index measures the performance of
small-sized U.S. companies that are classified as growth and the S&P 500 Index of 500 widely
held large cap U.S. companies. The indexes and the Fund are with dividends, which positively
impact the performance results. Russell Investment Group is the source and owner of the
trademarks, service marks and copyrights related to the Russell Indexes. Russell is a trademark
of Russell Investment Group.
2
The performance data in the table does not reflect the deduction of taxes that a shareholder
would pay on Fund distributions or redemption of Fund shares.
3
Not annualized.
Dear Baron Growth Fund Shareholder:
Performance
Baron Growth Fund declined 3.33% during the third quarter of 2014,
outperforming the Russell 2000 Growth Index, the small cap benchmark
against which we compete, which fell 6.13%. By contrast, the broader
S&P 500 Index increased by 1.13% over the same period, illustrating the
significant outperformance of large cap stocks over smaller companies during
the quarter. Large cap stocks have outperformed small cap peers throughout
2014 by more than 1200 basis points, an unusually large disparity.
We believe there are two reasons for this divergence. The first is a rotation
of interest into larger companies whose stocks lagged in 2013 and thus
appeared less expensive than faster growing, small businesses. Second, large
cap stocks represent a perceived flight to safety that, we believe, reflects
investor fear during times of instability.
The third quarter was marked by a barrage of negative headlines that
contributed to investor anxiety, from war in the Middle East to tensions
between Russia and Ukraine to ISIS to Hong Kong protests to, most
recently, an Ebola panic. During these periods of inevitable volatility, we
stay focused on the fundamental prospects for our businesses. While we do
not try to predict short-term macro developments or current events, we
believe conditions remain favorable for the U.S. economy and stocks. In our
frequent meetings with management teams, we observe that business
Table I.
Performance (Retail Shares)
Annualized for periods ended September 30, 2014
Russell
Baron 2000
Growth Growth S&P 500
Fund
1,2
Index
1
Index
1
Three Months
3
(3.33)% (6.13)% 1.13%
Nine Months
3
(2.64)% (4.05)% 8.34%
One Year 5.11% 3.79% 19.73%
Three Years 20.76% 21.91% 22.99%
Five Years 15.83% 15.51% 15.70%
Ten Years 9.20% 9.03% 8.11%
Fifteen Years 9.82% 5.69% 4.87%
Since Inception (December 31, 1994) 13.49% 7.41% 9.71%
RONALD BARON Retail Shares: BGRFX
CEO AND PORTFOLIO MANAGER Institutional Shares: BGRIX
September 30, 2014
Baron Growth Fund
25
We also invested in Financial Engines, Inc. and ClubCorp Holdings, Inc.
during the quarter, two companies that we have owned in other Funds
previously and have gotten to know well. Financial Engines is a technology-
enabled service provider that offers personalized investment management
and advice to small investors in 401(k) plans, while ClubCorp is the largest
owner and consolidator of private golf and country clubs in the U.S.
Year-to-date, the Fund also added approximately $260 million to existing
holdings, while reducing positions totaling approximately $600 million in
holdings with average market caps of $5.8 billion. Those larger businesses
had been very successful investments and had been owned for several years
by the Fund.
These transactions are illustrative of our strategy. Baron Growth Fund
invests in small cap businesses under $2.5 billion in size with significant
competitive advantages and large addressable market opportunities. We
monitor their progress closely as they become mid cap stocks. We sell them
after theyve become larger, successful companies and reinvest the proceeds
in small cap growth businesses.
A good example of this strategy during the quarter was our investment in
Concur Technologies, Inc., a $7.2 billion company that was the subject of
a takeover by global software firm SAP. Baron Growth Fund has owned
Concur, a leading provider of travel and expense management software,
since 2009, when the company had a market value of roughly $1.1 billion.
We have since earned about six times our initial investment. Concur joins
CFR Pharmaceuticals SA, Windy City Investments Holdings, LLC
(Nuveen Investments), Kerzner International Holdings Ltd. and Targa
Resources Corp. as other Baron Growth Fund investments that have been
the subject of acquisitions in 2014.
We try to explain the reasons certain stocks outperformed or
underperformed during the period in the Top Contributors and Top
Detractors sections that follows. In many instances, we regard gains and
losses in the short term as random. We continue to believe all the growth
businesses in which we have invested could double in size within five years.
Importantly, we believe these investments possess stronger fundamental and
quality characteristics than the companies that comprise the benchmark.
Baron Growth Funds investments consist primarily of companies with higher
profit margins, more favorable returns on capital, and much lower earnings
volatility than the securities in the benchmark against which we compete.
We believe these characteristics should offer investors better returns over
time, although we obviously cannot guarantee that.
The Long and
Winding Road
Bush Years Here Comes
Yesterday 2000-2008 the Sun
Clinton Years 9/11; Iraq; Obama Years
1992-2000 Afghanistan; 2008-2014
Internet Bubble Housing Bubble; Recovery Any Time
12/31/99 P/E 33x Financial Panic P/E 15.2x at All
Annualized Returns
Inception Inception
12/31/94 12/31/99 to 12/31/08 to 12/31/94
to 12/31/99 12/31/08 9/30/14 to 9/30/14
Baron Growth
Fund 29.90% 2.46% 18.41% 13.49%
Russell 2000
Growth Index 18.99% 4.71% 18.51% 7.41%
S&P 500 Index 28.56% 3.60% 17.05% 9.71%
Table II.
Top contributors to performance for the quarter ended September 30, 2014
Market
Cap Quarter
When End Market
Year Acquired Cap Total Percent
Acquired (billions) (billions) Return Impact
Under Armour, Inc. 2005 $1.0 $14.7 16.21% 0.50%
Community Health
Systems, Inc. 2004 2.4 6.3 20.71 0.38
Concur
Technologies, Inc. 2009 1.1 7.2 35.87 0.34
Vail Resorts, Inc. 1997 0.2 3.1 12.41 0.23
The Middleby Corp. 2011 1.6 5.0 6.54 0.19
Shares of athletic apparel company Under Armour, Inc. increased in the
third quarter. Under Armour continues to have brand momentum. Sales are
growing faster than 30% in nearly all categories, and sales of higher priced
merchandise and postponed inventory liquidations have boosted gross
margins. Operating expenses rose as the company invested for future
growth in womens apparel, footwear, international, and direct-to-
consumer selling. The company has diversified from a single
product/category into a global sports brand. (Michael Baron)
Community Health Systems, Inc. is one of the largest hospital operators
in the U.S., with a focus on small and mid-sized markets in 29 states. Shares
rose on strong second quarter results, driven by higher utilization and an
improved payor mix stemming from health care reform and the improving
economy. Managements volume initiatives are taking hold. More states
with large Community footprints are pursuing Medicaid expansion. Finally,
the integration with HMA is going well, and we think synergies will
ultimately exceed initial guidance. (Susan Robbins)
Shares of Concur Technologies, Inc. increased in the third quarter. Concur
is a leading provider of travel booking and expense management software.
On September 18, SAP SE announced an agreement to acquire Concur for
$129 per share, a 28% premium to the closing price on September 2, the
day before Bloomberg reported that Concur was exploring a sale. The $8.3
billion acquisition implied a valuation of roughly 9.7 times Concurs
estimated fiscal year 2015 revenue and confirmed our view that Concur
was a valuable strategic asset. (Neal Kaufman)
Table III.
Top detractors from performance for the quarter ended September 30, 2014
Quarter
Market End Market
Cap Cap or
When Market Cap
Year Acquired When Sold Total Percent
Acquired (billions) (billions) Return Impact
Colfax Corp. 2011 $1.0 $7.0 -23.57% -0.51%
Financial Engines, Inc. 2010 0.7 1.8 -24.23 -0.29
Benefitfocus, Inc. 2013 1.3 0.7 -41.72 -0.29
CARBO Ceramics, Inc. 2009 1.5 1.6 -55.71 -0.29
Generac Holdings, Inc. 2010 0.9 2.8 -16.82 -0.27
Shares of industrial machinery company Colfax Corp. fell in the wake of
weaker-than-expected second quarter results. Strong margins in welding
were offset by operational missteps in the legacy fluid handling business
26
Baron Growth Fund
combined with a weak macro environment. Colfax recently announced a
new president for the fluid handling business, and we expect this business
to get back on track soon. We believe that Colfax will continue to use its
proven business strategy to improve operations at acquired companies,
generating substantial shareholder value over time. (Rebecca Ellin)
Shares of Financial Engines, Inc., a service provider to defined contribution
plans and individual investors, fell in the third quarter. While the company
continues to penetrate the market, investors have become concerned about
profitability and competition. Gross profit yield continues to gradually
decline as plan providers use their gatekeeper positions to receive a higher
share incremental economics. Investors are also concerned that cheaper
target date funds could take market share. We retain conviction about the
companys unique product and significant market opportunity. (Michael
Baron)
Shares of Benefitfocus, Inc. fell in the third quarter, partly due to a
secondary offering in July that increased the public float by more than 30%.
Benefitfocus is the leading provider of cloud-based benefits software,
offering an integrated suite of solutions to help customers more efficiently
shop, enroll, manage, and exchange benefits information. We think
Benefitfocus serves an addressable market more than 100 times larger than
its current business, which should allow it to compound revenue at more
than 30% annually. (Neal Rosenberg)
RECENT PURCHASES
Table IV.
Top net purchases for the quarter ended September 30, 2014
Market Quarter
Cap End
When Market Amount
Year Acquired Cap Purchased
Acquired (billions) (billions) (millions)
Masonite International Corp. 2014 $1.7 $1.6 $8.3
Badger Daylighting Ltd. 2014 1.3 0.9 7.5
Financial Engines, Inc. 2010 0.7 1.8 6.5
Atlas Energy, L.P. 2014 2.2 2.3 5.8
ClubCorp Holdings, Inc. 2013 1.1 1.3 4.4
During the third quarter, we increased our investment in Masonite
International Corp. Masonite is a leading, vertically-integrated manufacturer
of interior and exterior doors. In 2013, Masonite sold 32 million doors to over
7,000 customers in 80 countries. Sales are split 58% U.S., 16% Canada, and
26% rest of the world. Masonite has dominant market positions in its product
categories, particularly in North America, and is poised to benefit from an
improvement in residential and non-residential construction activity off of
depressed levels. Additionally, the door industry has consolidated recently for
certain product categories, improving Masonites ability to raise prices, even
though capacity is underutilized. The management team is impressive and has
inculcated a culture of operational discipline and innovation. We believe that
EBITDA can triple as construction levels normalize and pricing firms. Accretive
automation investments and acquisitions should be additive to growth.
(David Kirshenbaum)
We increased our position in Badger Daylighting Ltd., a provider of
custom-made trucks that use pressurized water and powerful vacuums to
excavate in areas with buried pipes and cables. These hydrovac trucks are
much safer than mechanical equipment and more efficient than manual
digging. Hydrovac truck demand is growing rapidly as oil & gas companies
use them to build new wells and pipelines and as utilities increasingly use
them to maintain underground infrastructure. Badger is meeting this
demand by building more trucks and adding more service locations across
the U.S. and Canada. With over 900 trucks and 110 locations, Badger is by
far the largest provider of hydrovacs in North America. The company enjoys
a cost advantage relative to peers by manufacturing its own trucks and
maximizing utilization across its large geographic footprint. Given the
strong tailwinds of capital investment by the energy and utility industries,
along with increasing safety pressures around accessing and maintaining
existing infrastructure, demand for Badgers services should continue
growing nicely. (Josh Saltman)
The share price of Financial Engines, Inc., a service provider to defined
contribution plans and individual investors, has declined by approximately
50% year-to-date. Although we thought its valuation was justified by its
growth prospects, lower profit yield in 2014 and investor rotation away
from less established businesses led to the drop in share value. We took
advantage of its attractive stock price to add to the Funds investment and
believe its long-term investment premise still holds. Financial Engines is the
dominant player in a $5 trillion market, with roughly $900 billion in plan
assets under contract and $100 billion in assets under management.
Significant potential exists to add to these amounts through increased sales
to plan sponsors and improved marketing to plan participants and
broadening product offerings. Additionally, we believe the company should
eventually be able to use its expertise to service the IRA and defined benefit
market, each of which represents an additional $5 trillion in assets. We
believe that Financial Engines essential advice offering and plan
connectivity advantage will result in significant client growth and a highly
profitable recurring revenue stream. (Michael Baron)
PORTFOLIO STRUCTURE AND STRATEGY
Baron Growth Fund owns 98 stocks. Its top 10 holdings comprise
approximately 27% of the Fund. We believe this diversified Fund offers
investors potentially better than market returns with less volatility than the
market. The Funds beta, or sensitivity to market movements, is 0.77. Our
strategy to accomplish this is to invest for the long term in a diversified
portfolio of appropriately capitalized, well-managed, growing small cap
businesses at attractive prices. The Funds average portfolio turnover for the
past three years is 12%. This means the Fund has an average holding period
for its investments of over eight years. This contrasts sharply with the
average small cap mutual fund which typically turns over its portfolio
every eight months. We invest in companies with market capitalizations of
$2.5 billion or less at the time of purchase that we believe have the
potential to double in size within four to five years. We believe that a
portfolio of investments, diversified among several industries, all of which
are dependent upon different, non-correlated fundamentals, will likely
reduce portfolio volatility. In addition, many of the companies in which the
Fund invests have significant recurring revenue, which makes their earnings
September 30, 2014
Baron Growth Fund
27
Investors should consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The prospectus and summary
prospectus contains this and other information about the Funds. You may obtain them from its distributor, Baron Capital, Inc., by calling 1-800-99BARON or
visiting www.BaronFunds.com. Please read them carefully before investing.
The Adviser believes that there is more potential for capital appreciation in smaller companies, but there also may be more risk. Specific risks associated with
investing in smaller companies include that the securities may be thinly traded and they may be more difficult to sell during market downturns. The Fund
may not achieve its objectives. Portfolio holdings are subject to change. Current and future portfolio holdings are subject to risk.
The discussions of the companies herein are not intended as advice to any person regarding the advisability of investing in any particular security. The views expressed in this report reflect those of the
respective portfolio managers only through the end of the period stated in this report. The portfolio managers views are not intended as recommendations or investment advice to any person reading
this report and are subject to change at any time based on market and other conditions and Baron has no obligation to update them.
This report does not constitute an offer to sell or a solicitation of any offer to buy securities of Baron Growth Fund by anyone in any jurisdiction where it would be unlawful under the laws of that
jurisdiction to make such offer or solicitation.
Beta: measures a funds sensitivity to market movements. The beta of the market (Russell 2000 Growth Index) is 1.00 by definition.
P/E: the price earnings ratio is a valuation ratio of a companys current stock price to its actual earnings per share.
less volatile than the Russell 2000 Growth Index. We find all these
businesses through our dedicated research effort. Our holdings are well-
managed businesses with significant barriers to competitive threats. These
barriers provide our companies with pricing power. Most of our companies
produce significant cash flows, which are often reinvested in their
businesses to increase their revenues and margins over the long term. We
believe the Fund has an opportunity to meet its objectives, although there
is no guarantee that it will do so.
Table V.
Top 10 holdings as of September 30, 2014
Market Quarter
Cap End
When Market Percent
Year Acquired Cap Amount of Net
Acquired (billions) (billions) (millions) Assets
Under Armour, Inc. 2005 $1.0 $14.7 $272.9 3.5%
ITC Holdings Corp. 2005 0.8 5.5 237.8 3.1
The Middleby Corp. 2011 1.6 5.0 224.7 2.9
Arch Capital Group Ltd. 2002 0.4 7.4 216.1 2.8
Gartner, Inc. 2007 2.3 6.5 207.6 2.7
FactSet Research
Systems, Inc. 2006 2.5 5.1 194.4 2.5
Genesee &
Wyoming, Inc. 2004 0.5 5.1 190.6 2.5
Dicks Sporting
Goods, Inc. 2004 1.4 5.3 179.9 2.3
Vail Resorts, Inc. 1997 0.2 3.1 179.1 2.3
Community Health
Systems, Inc. 2004 2.4 6.3 178.1 2.3
Thank you for investing in Baron Growth Fund.
Thank you for joining us as fellow shareholders in Baron Growth Fund. We
believe the growth prospects for the businesses in which Baron Growth
Fund has invested continue to be favorable.
We continue to work hard to justify your confidence and trust in our
stewardship of your familys hard-earned savings. We will also continue to
provide you with information that I would like to have if our roles were
reversed. This is so you will be able to make an informed judgment about
whether Baron Growth Fund remains an appropriate and attractive
investment for your family.
Respectfully,
Ronald Baron
CEO and Portfolio Manager
October 20, 2014
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