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1 year ago

Baron Funds

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Baron

Baron Opportunity Fund the J.P. Morgan Healthcare Conference in January, Illumina announced an exciting new high-throughput sequencing platform, called NovaSeq, which has the potential in future years to deliver the world’s first $100 full human genome. We continue to believe Illumina has a long runway for growth driven by increasing adoption of DNA sequencing in clinical markets such as cancer screening, diagnosis, and treatment. (Neal Kaufman) Portfolio Structure The Fund invests in high-growth, innovative businesses across all market capitalizations. As of the end of the fourth quarter, the largest market cap holding in the Fund was $538.6 billion and the smallest was $884 million. The median market cap of the Fund was $12.6 billion. The Fund had $194.1 million of assets under management. The Fund had investments in 39 companies and 40 securities (two Alphabet Inc. share classes). The Fund’s top 10 positions accounted for 48.4% of the portfolio. Table IV. Top 10 holdings as of December 31, 2016 Quarter End Market Cap (billions) Quarter End Investment Value (millions) Percent of Net Assets Amazon.com, Inc. $356.3 $14.8 7.6% CoStar Group, Inc. 6.1 11.9 6.1 Alphabet Inc. 538.6 11.6 5.9 Gartner, Inc. 8.3 10.9 5.6 Guidewire Software, Inc. 3.6 10.5 5.4 Tesla Motors, Inc. 34.4 8.5 4.4 Acxiom Corporation 2.1 7.7 4.0 Netflix, Inc. 53.1 6.4 3.3 Benefitfocus, Inc. 0.9 6.0 3.1 Visa, Inc. 181.5 5.8 3.0 Recent Activity Table V. Top net purchases for the quarter ended December 31, 2016 Quarter End Market Cap (billions) Amount Purchased (millions) Intuitive Surgical, Inc. $24.6 $3.2 Edwards Lifesciences Corp. 20.0 2.6 Splunk, Inc. 6.9 1.8 Ultragenyx Pharmaceutical Inc. 2.9 1.4 CoStar Group, Inc. 6.1 1.1 We re-invested in two of the leading minimally-invasive surgery businesses, Intuitive Surgical, Inc. and Edwards Lifesciences Corp. Candidly, we missed both stocks’ initial moves last year, but conducted fresh analyses of each, and established our buy points. We acted when both stocks pulled back in the quarter. Intuitive Surgical manufactures and markets the da Vinci Surgical System, a robotic surgical system consisting of a surgeon’s console, a patient-side cart, a high performance vision system and proprietary “wristed” instruments and surgical accessories. The da Vinci system seamlessly translates the surgeon’s natural hand movements on instrument controls at the console into corresponding micro-movements of instruments inserted into the patient through small puncture incisions or ports. The da Vinci provides the surgeon with the intuitive control, range of motion, fine tissue manipulation capability and 3-D vision characteristics of open surgery, while simultaneously allowing the surgeon to work through the small ports of minimally-invasive surgery. Patients treated with the da Vinci system benefit from improved clinical results, smaller incisions, fewer complications, less blood loss, less nerve damage, reduced pain and faster recovery compared with open surgery. The company is targeting four million annual surgical procedures worldwide and, we believe, this target is likely to increase over time. In 2016, roughly 750,000 procedures were performed using Intuitive’s robotic systems, implying substantial runway for growth. Edwards is the world’s leading manufacturer of tissue heart valves and repair products, which are used to replace or repair a patient’s diseased or defective heart valve. Edwards has leveraged the knowledge and experience from its surgical tissue heart valve business to develop transcatheter heart valve replacement technologies, designed to treat heart valve disease using catheter-based approaches as opposed to open surgery. Transcatheter aortic valve replacement (TAVR) is an innovative procedure in which a valve is inserted through a catheter and implanted within the diseased aortic valve. The procedure is significantly less invasive than surgery, takes about 90 minutes and recovery can be as short as a few days. TAVR is transforming the market because it provides a new, less invasive treatment option for patients ineligible for surgery or at high surgical risk. Edwards believes there are about 650,000 aortic stenosis patients addressable with TAVR–over twice their prior view of the addressable market–only a fraction of which are being treated with TAVR today. Edwards is also investing in transcatheter valve technologies to treat patients with mitral and tricuspid diseases–which present large, untapped addressable markets (2.5 million for mitral and 1.5 million for tricuspid)–and have the potential to open up significant new growth opportunities for the company. We purchased Splunk, Inc. as the stock came back in from its mid-summer high when many software and internet stocks sold off after Election Day. Splunk is one of the leading “big data” businesses, providing a real-time operational intelligence software platform that enables its customers to search, monitor, analyze, and visualize machine-generated data coming from websites, applications, servers, networks, sensors, and mobile devices. Its software transforms machine generated data into valuable insights in areas such as security and fraud, IT operations, log management, business analytics, and application delivery. Splunk’s growth is being propelled by the explosion of “big data”–data volumes are growing at roughly a 50% rate (with machine-generated data growing closer to 80%) and this data can now be captured, stored, and analyzed to extract actionable business intelligence. Growth in the frequency and severity of cybersecurity breaches are accelerating demand for security monitoring software, which represents around 40% of Splunk’s bookings, as many customers have made Splunk the “nerve center” of their security operations. The emerging Internet of Things should dramatically accelerate the growth and analysis of machine data. Splunk is undergoing a transition from a perpetual software license model– where the software is paid for upfront and loaded behind a customer’s firewall–to cloud-delivered and ratable pricing models. This has caused a lot of confusion for Wall Street, and has led to what we believe is Splunk’s attractive valuation in light of its free cash flow generation and long-term growth opportunity. 36

December 31, 2016 Baron Opportunity Fund Ultragenyx Pharmaceutical Inc. is a developer of drugs for rare diseases whose patients number in the hundreds to thousands and tend to have no available treatments with dire associated outcomes. Ultragenyx currently has four drugs in clinical development targeted at treating six rare disease disorders. Lead program KRN23 for bone-related disorders could be on the market as soon as this year, with its next product, triheptanoin for metabolic disorders, generating pivotal data throughout 2017. Led by Emil Kakkis, the former chief medical officer of Biomarin, a $15 billion rare disease pioneer, we expect continued execution and excellence from Ultragenyx as it helps discover, develop, and commercialize therapies for these orphan disorders. CoStar Group, Inc. has been one of the Fund’s longest investments. As we described earlier, the stock fell when CoStar’s management announced an incremental $20 million investment to target a $200 million, high-margin incremental and recurring revenue opportunity. CoStar’s stock reached a high of just under $225 this summer but fell to a low of $180 after this announcement. We thought the market significantly overreacted and decided to “max out” (we can buy up to a 5% position at cost) our CoStar investment. Over the 15 years we’ve been investors in CoStar, we’ve witnessed first-hand the company’s successful track record of investments and believe this latest one will be no different. The stock has already recovered a good amount, and sits around $200 at this writing. Press Ganey Holdings, Inc. was acquired by EQT Equity for $40.50 in cash. Alphabet Inc. (aka, Google) and Facebook, Inc. were trimmed to fund other investments in the digital media space, but both remained large positions, with Alphabet in the Fund’s top three. We sold Willis Towers Watson Public Limited Company because its growth profile was below what we target for the Fund and to fund fastergrowing investments. We trimmed Netflix, Inc. on strength–it currently sits close to its all-time high–but we continue to retain high conviction and Netflix remains our eighth largest holding. Sincerely, Michael A. Lippert Portfolio Manager Table VI. Top net sales for the quarter ended December 31, 2016 Quarter End Market Cap or Market Cap When Sold (billions) Amount Sold (millions) Press Ganey Holdings, Inc. $ 2.1 $5.0 Alphabet Inc. 538.6 4.4 Willis Towers Watson Public Limited Company 16.9 3.8 Facebook, Inc. 332.4 3.1 Netflix, Inc. 53.1 2.2 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 securities of high growth businesses benefiting from innovation through development of pioneering, transformative or technologically advanced products or services, but there also is more risk. Companies propelled by innovation, including technological advances and new business models, may present the risk of rapid change and product obsolescence and their successes may be difficult to predict for the long term. Securities issued by small and medium sized companies may be thinly traded and 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 manager’s 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 Opportunity Fund by anyone in any jurisdiction where it would be unlawful under the laws of that jurisdiction to make such offer or solicitation. 37