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Baron Funds

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Baron

Baron Growth Fund For comparison purposes, we created a Baron-Adjusted Morningstar Small Growth Category that includes Baron Growth Fund with the funds in Morningstar’s Small Growth Category. Baron Growth Fund’s annualized return exceeds the surviving funds in the category by 2.74% per year over the Fund’s 22 year history.* Further, we choose not to sell stocks just because they go up, but prefer to hold them if we think their competitive advantages and growth prospects remain strong. The “hurdle rate” of return for an initial investment in Baron Growth Fund is a double in five or six years. This is since we think the stock market and economy will likely continue to double about every 12 years. After we have owned an investment for an extended period and it has been “de-risked,” we will continue to hold that investment as long as we believe its business has the potential to double in value within seven years. We think our long-term investment strategy is different than most small-cap managers or a passive strategy that sell their best investments solely for market cap reasons. Regardless of restricting the Fund’s purchases to smallcap companies, Baron Growth Fund’s performance also compares well against surviving mid-cap growth funds. The Fund ranks in the top 6% of the Morningstar Mid-Cap Growth Category.** Table II. Performance Periods of euphoria and stress “Yesterday” Clinton Years 1992-2000 12/31/99 P/E 33x Inception 12/31/1994 to 12/31/1999 Internet Bubble 10/8/1998 to 3/9/2000 “The Long and Winding Road” Bush Years 2000-2008 9/11; Iraq; Afghanistan; Housing Bubble; Financial Panic “Here Comes the Sun” Recovery and Quantitative Easing 2009-2013 Annualized Returns 12/31/1999 to 12/31/2008 12/31/2008 to 12/31/2013 “Helter Skelter” Fed tightening 12/31/2013 to 12/31/2016 “Any Time at All” Inception 12/31/1994 to 12/31/2016 Baron Growth Fund (Institutional Shares) 29.90% 67.61% 2.46% 22.39% 2.20% 12.56% Russell 2000 Growth Index 18.99% 108.38% (4.71)% 22.58% 5.05% 7.55% S&P 500 Index 28.56% 32.29% (3.60)% 17.94% 8.87% 9.55% Percentile rank in Baron-Adjusted Morningstar Small Growth Category 21 72 13 45 68 6 # of Share Classes in Baron-Adjusted Morningstar Small Growth Category 156 394 354 584 602 61 Baron-Adjusted Morningstar Small Growth Category Avg* 22.16% 117.02% (2.69)% 22.10% 3.55% 9.82% Percentile rank in Morningstar Mid-Cap Growth Category 25 79 12 29 80 6 # of Share Classes in Morningstar Mid-Cap Category 197 416 366 531 588 66 Morningstar Mid-Cap Growth Category Avg** 25.32% 120.57% (3.33)% 20.97% 3.98% 9.29% Table III. Performance Based Characteristics as of December 31, 2016 Time Interval 12/31/1994 to 12/31/1999 10/8/1998 to 3/9/2000 12/31/1999 to 12/31/2008 Time Interval 12/31/2008 to 12/31/2013 12/31/2013 to 12/31/2016 12/31/1994 to 12/31/2016 Alpha (%) 13.61 5.37 5.05 4.07 –1.30 6.91 Beta 0.77 0.62 0.58 0.79 0.66 0.68 # of Monthly Observations 60 18 108 60 36 264 * The Morningstar US Fund Small Growth Category Average is not weighted and represents the straight average of annualized returns of each of the funds in the Small Growth Category. Morningstar rankings are based on total returns and does not include sales charges. Total returns do account for management, administrative, and 12b-1 fees and other costs automatically deducted from fund assets. Morningstar moved Baron Growth Fund from the Small Growth Category effective May 31, 2011 to the Mid-Cap Growth Category. The Fund’s investment mandate has been and continues to be investing in small cap growth stocks for the long term. While the ranking information contained herein may be based on performance measurements from Morningstar, Baron created a new Morningstar Category to include Baron Growth Fund Retail and Institutional shares. We intend to continue to provide comparative performance data for the Small Growth Category because we strongly disagree with Morningstar’s reclassification of the Fund. Because of its long-term approach, the Fund could have a significant percentage of its assets invested in securities that have appreciated beyond their market capitalization at the time of the Fund’s initial investment. As of December 31, 2016, the Baron-Adjusted Morningstar Small Growth Category consisted of 672, 536, 393 and 61 funds (share classes) for the 1-, 5-, 10-year and Since Inception periods. The number of funds in the Category may vary depending on the date that Baron made the calculation. The Baron-Adjusted Morningstar Small Growth Category Average is not weighted and represents the straight average of annualized returns of each of the funds in the Category. Baron Growth Fund Institutional Share Class ranked in the 79 th ,67 th ,65 th and 6 th percentiles, respectively. The Category consisted of 156, 394, 354, 584, 602 and 61 funds (share classes) during the time intervals 12/31/1994–12/31/1999, 10/8/1998–3/9/2000, 12/31/1999–12/31/2008, 12/31/2008–12/31/2013, 12/31/2013– 12/31/2016 and 12/31/1994–12/31/2016, respectively. Baron Growth Fund Institutional ShareClassrankedinthe21 st ,72 nd ,13 th ,45 th ,68 th and 6 th percentiles, for the respective time intervals. ** The Morningstar US Fund Mid-Cap Growth Average is not weighted and represents the straight average of annualized returns of each of the funds in the Mid-Cap Growth Category. Morningstar rankings are based on total returns and does not include sales charges. Total returns do account for management, administrative, and 12b-1 fees and other costs automatically deducted from fund assets. The Category consisted of 197, 416, 366, 531, 588 and 66 funds (share classes) during the time intervals 12/31/1994–12/31/1999, 10/8/1998–3/9/2000, 12/31/1999–12/31/2008, 12/31/2008–12/31/2013, 12/31/2013–12/31/2016 and 12/31/1994–12/31/2016, respectively. Baron Growth Fund Institutional Share Class ranked in the 25 th ,79 th ,12 th ,29 th ,80 th and 6 th percentiles, for the respective time intervals. As of December 31, 2016, the Category consisted of 644, 504, 368 and 66 funds (share classes) for the 1-, 5-, 10-year and Since Inception periods. Morningstar ranked Baron Growth Fund Institutional Share Class in the 44 th ,52 nd ,58 th and 6 th percentiles, respectively. 24

December 31, 2016 Baron Growth Fund Table IV. Top contributors to performance for the quarter ended December 31, 2016 Year Acquired Market Cap When Acquired (billions) Quarter End Market Cap (billions) Total Return Percent Impact Primerica, Inc. 2010 $1.1 $ 3.2 30.76% 0.75% Gartner, Inc. 2007 2.3 8.3 14.26 0.68 Choice Hotels International, Inc. 1996 0.4 3.1 24.81 0.60 Arch Capital Group Ltd. 2002 0.4 10.6 8.87 0.48 Marriott Vacations Worldwide Corp. 2013 1.5 2.3 16.19 0.34 Primerica, Inc. provides term life insurance and investment products in the U.S. and Canada. The stock grew as the U.S. election results drove a sector rotation into small-cap financials and increased optimism that the pending Department of Labor fiduciary rule may be delayed or watered down. Primerica also reported financial results that beat Street expectations, with 10% sales force growth and 25% earnings per share growth. We expect strong earnings growth to persist as Primerica provides financial advice to underserved middle income households. (Josh Saltman) Shares of Gartner, Inc., a provider of syndicated IT research, contributed to performance. We believe that Gartner’s key forward-looking metrics continue to be solid. We expect to see continued acceleration due to easing comparisons, growing productivity, and sales tactics that have been finetuned to match current macro conditions. We believe that the company has significant financial flexibility and will begin to deploy capital more aggressively on share repurchases or M&A. (Neal Rosenberg) Shares of hotel franchisor Choice Hotels International, Inc. increased as investors rotated into lodging stocks, which we think will be among the biggest beneficiaries of higher inflation. The consistency of the company’s revenue and earnings throughout the lodging cycle, given its fee-based model and the strength of its dividend and share buyback program, also helped boost the share price during the quarter. (David Baron) Table V. Top detractors from performance for the quarter ended December 31, 2016 Year Acquired Market Cap When Acquired (billions) Quarter End Market Cap (billions) Total Return Percent Impact Under Armour, Inc. 2005 $1.0 $11.8 –25.31% –1.15% CoStar Group, Inc. 2004 0.7 6.1 –12.95 –0.52 Benefitfocus, Inc. 2013 1.3 0.9 –25.60 –0.45 Inovalon Holdings, Inc. 2015 4.4 1.5 –33.54 –0.41 Caesarstone Ltd. 2012 0.4 1.0 –24.03 –0.36 Portfolio Structure and Investment Strategy Due to Baron Growth Fund’s low turnover, the Fund holds a significant percentage of its assets in securities that have appreciated beyond their market capitalizations at the time of the Fund’s initial investment. The Fund’s three-year average turnover is 7.85%, which means we hold investments on average for over 12.5 years. Because those companies are penalizing their current earnings by growth expenditures, Baron Growth Fund had opportunities to invest in those businesses at unusually attractive prices. We believe this strategy is the reason the Fund has so significantly outperformed both its peers and its benchmark indices over the long term. Baron Growth Fund’s strategy of investing for the long term in what we believe are competitively advantaged businesses with exceptional management is very different than most other small cap growth funds. Many of those funds invest top down in industries that in their assessments are likely to benefit in the near term from what they believe are economic trends created by political developments like Brexit and the U.S. presidential election, tax, regulatory and budget policies, international conflicts, interest rates, commodity prices, currency fluctuations, and cyclical demand for products and services. Those funds “turn over” their portfolios every 16 months, on average. As a result, over the long term, in our opinion, they are likely to achieve “average” returns, at best. We believe, few, if any, investors are able to consistently predict what we regard as unpredictable events. Further, even if they could predict the outcome of those events, we think it is unlikely they would be able to predict their impact on stocks and markets. For new investments, we exclusively purchase small capitalization companies that we think can double in size in a five- or six-year period. Ideally, these new investments generate strong price appreciation during the early phase of our investment, such as the ones highlighted in Table VI below. However, the performance of newer investments is more often significantly below our long-term expectations. This is generally because these businesses are investing in themselves in order to capture significant long-term market opportunities. Recent portfolio examples include Benefitfocus, Inc., which is investing to add new products and expand its ecosystem; AO World plc, which is investing to expand into Europe from its base in the U.K.; Nord Anglia Education Inc., which is investing to expand its presence in mainland China; Littelfuse, Inc., which is investing to grow its sensor business that will benefit from the electrification of cars; and Glaukos Corporation, which is investing to expand its product portfolio, grow its market coverage, and prove its efficacy in non-cataract surgeries. While all these investments penalize short-term results, and often negatively impact stocks’ short-term performance, we encourage this because it paves the way for sustained growth and profitability over the long term. We regard these investments as “seed corn,” because we believe these companies have the potential to grow significantly. If these investment programs are successful, the results eventually show up in the financial statements as faster-than-expected revenue growth, greater profitability, and higher cash flow. Table VI. Top performing stocks owned less than five years Year of First Purchase Cumulative Total Return Since First Date of Purchase Pinnacle Entertainment, Inc. 2013 238.5% Caesarstone Ltd. 2012 163.0 West Pharmaceutical Services, Inc. 2013 159.7 Bright Horizons Family Solutions, Inc. 2013 147.2 Marriott Vacations Worldwide Corp. 2013 108.2 Baron Growth Fund owns stock in 28 businesses in which the Fund has been a shareholder for less than five years. These investments represent approximately 26.6% of Baron Growth Fund’s portfolio. They have on average earned an annualized rate of return that approximates 10.5%. This compares to 9.0% for the Russell 2000 Growth Index over the same periods. 25

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