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Baron Funds



Baron Partners Fund Table II. Performance Periods of euphoria and stress “Yesterday” Clinton Years 1992-2000 12/31/99 P/E Inception 1/31/1992 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 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 1/31/1992 to 12/31/2016 Baron Partners Fund (Institutional Shares) 22.45% 59.72% 1.54% 22.55% 4.00% 12.23% Russell Midcap Growth Index 19.26% 110.65% (4.69)% 23.37% 6.23% 9.20% S&P 500 Index 20.21% 32.29% (3.60)% 17.94% 8.87% 9.26% Percentile rank in Morningstar Mid-Cap Growth Category* 15** 84** 16 26 51 1** # of Share Class in the Category 83** 416** 366 531 588 30** Morningstar US Fund Mid-Cap Growth Peer Group Avg 18.00% 120.57% (3.33)% 20.97% 3.98% 8.72% * The Morningstar US Fund Mid-Cap Growth Category 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 do not include sales charges. Total returns do account for management, administrative, and 12b-1 fees and other costs automatically deducted from fund assets. As of December 31, 2016, the Category consisted of 644, 504 and 368 funds for the 1- and 5-, and 10-year periods. Baron Partners Fund Institutional Share Class ranked in the 60 th ,14 th and 65 th percentiles, respectively, in the Category. The Category consisted of 83, 416, 366, 531, 588 and 30 funds during the time intervals 1/31/1992–12/31/1999, 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 1/31/1992–12/31/2016, respectively. Baron Partners Fund Institutional Share Class ranked in the 15 th ,84 th , 16th, 26 th ,51 st and 1 st percentiles, for the respective time intervals. **Source: Morningstar Direct–Performance Reporting. Table III. 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 The Charles Schwab Corp. 1992 $1.0 $52.3 25.29% 1.48% Arch Capital Group Ltd. 2002 0.6 10.6 8.87 1.12 Hyatt Hotels Corp. 2009 4.2 7.2 12.27 1.09 Gartner, Inc. 2013 5.7 8.3 14.27 0.60 Robert Half International, Inc. 2016 4.9 6.3 29.17 0.59 Shares of brokerage business The Charles Schwab Corp. increased in the fourth quarter on the potential of multiple interest rate increases into 2017, which will potentially improve the company’s earnings. Charles Schwab also reported solid asset growth reaching over $2.7 trillion. The business continued to shift to fee-based advice from trading activity, a move that we believe creates more stability and the potential for increased profitability. (Michael Baron) Arch Capital Group Ltd. is a specialty insurance and reinsurance company based in Bermuda. Shares were up in the fourth quarter on good financial results with profitable underwriting, modest catastrophe losses, and favorable reserve development. Arch Capital also benefited from increasing optimism toward its acquisition of United Guaranty which makes Arch the largest provider of mortgage insurance, a market we think has attractive profitability and growth prospects. We continue to own the stock due to Arch’s strong management team and underwriting discipline. (Josh Saltman) Shares of global hotelier Hyatt Hotels Corp. increased in the fourth quarter as investors rotated into lodging stocks, which we think will be one of the biggest beneficiaries of higher inflation. The company maintained its fiscal year 2016 guidance for revenue per available room and indicated on-track growth for 2017, which helped boost investor confidence in the business and the continued upward trajectory of the lodging cycle. (David Baron) Table IV. Top detractors from performance for the quarter ended December 31, 2016 Year Acquired Market Cap When Acquired (billions) Quarter End Market Cap or Market Cap When Sold (billions) Total Return Percent Impact CoStar Group, Inc. 2005 $ 0.7 $ 6.1 –12.95% –2.12% Under Armour, Inc. 2016 16.0 11.8 –24.86 –1.48 Illumina, Inc. 2013 6.8 18.2 –33.74 –1.32 Inovalon Holdings, Inc. 2015 4.1 1.5 –33.56 –1.29 Manchester United plc 2014 2.8 2.3 –15.09 –0.89 Shares of CoStar Group, Inc., a real estate information and marketing services company, fell in the fourth quarter on news that it is planning a $20 million investment for 2017 to expand its research, sales, and marketing capabilities. We believe this strategy will enable CoStar to upsell existing LoopNet customers to its core CoStar product, potentially driving $200 million of annual recurring revenue. We think trends in the core business are excellent, with revenue growth of 14% and margin improvement of 13% in the most recently reported quarter. (Neal Rosenberg) 40

December 31, 2016 Baron Partners Fund Shares of athletic apparel company Under Armour, Inc. fell in the fourth quarter due to several challenges, including increased competition, weak consumer dynamics, and decreased distribution as a result of retailer bankruptcies. The company has lowered 2017 earnings guidance as it plans to increase spending to drive sales growth. We believe many of these issues are temporary and the long-term demand and earnings potential for the company remain relatively intact. (Michael Baron) Shares of Illumina, Inc., the leading provider of DNA sequencing technology to academic and commercial laboratories, fell in the fourth quarter after reporting disappointing third quarter financial results. The third quarter shortfall was driven by weak high-throughput instrument sales. The Fund exited its position. (Neal Kaufman) Recent Portfolio Additions Table V. Top net purchases for the quarter ended December 31, 2016 Market Cap When Acquired (billions) Quarter End Market Cap (billions) Amount Purchased (millions) Norwegian Cruise Line Holdings, Ltd. $6.5 $9.7 $2.2 In the quarter, we increased our position in Norwegian Cruise Line Holdings, Ltd., one of the three major global cruise lines in the industry. We think the company should benefit from a reacceleration of North Americans booking cruises to Europe as these customers represent two-thirds of Norwegian’s European bookings and Europe comprises 25% of the company’s capacity. In addition, 2017 is expected to have lower capacity increases in the Caribbean, which is 40% of Norwegian’s capacity, and should allow for an improvement in pricing in the region. This should generate increases in cash flow for the company and allow them to reduce their debt throughout 2017. Combine that with the fact the stock is trading at just 11.5 times 2017 EPS for a company that should grow their EPS at a mid-teens rate over the next few years, and we believe the stock is an attractive investment. Investment Strategy Baron Partners Fund is a bottom-up, fundamental, long-term investor in what we believe are fast growing, competitively advantaged, well-managed businesses. We believe that over the long term the stock market and economy are closely linked and both will continue to double in value about every twelve years…as has been the case since 1960. We are not trying to beat our benchmark in the short term by making “macro” judgments. We invest only in growth businesses that we think will double the value of their businesses on average about every five years. In the short term, investment performance is often influenced by external factors. That was the case in 2016. Investors believe Trump programs, if enacted, will create a favorable environment for highly regulated businesses (promises to repeal regulations); infrastructure and materials contractors (promises to undertake building projects); and highly taxed enterprises (promises to lower taxes). We cannot predict how much of President Trump’s agenda will be achieved. But over the most recent period, our shortterm relative performance was penalized. This was, in part, because the growth companies in the Fund are generally investing in their businesses at the expense of short-term profits to increase their long-term potential for success. During the past three years, as we have noted, the multiples attributed to these businesses have been reduced. Certain companies in which the Fund invests will likely benefit from Trump’s proposals if implemented. Robert Half International, Inc., the specialized staffing company, achieved the highest percentage return in the quarter. The company could achieve higher booking rates as economic growth improves and demand for its specialized technology and competitively advantaged internal audit staff increases. Charles Schwab, the brokerage business, contributed the most to the Fund’s three-month returns. Charles Schwab is currently underearning on the assets its customers hold at Schwab and it should gain additional high margin revenue if interest rates rise. The company’s revenues are only 50% higher than 10 years ago while its customers’ assets have doubled. Hyatt Hotels Corp.’s fixed assets and management fees benefit from inflation and stronger GDP growth, while Fastenal Co. should improve sales if domestic manufacturing improves. Regardless, these short-term benefits are not the crux of our long-term investment theses, which remain unaltered. We think that Robert Half can duplicate its success in internal audits with the newer temporary staffing of technology professionals, a segment that could more than double its addressable market. Schwab continues to gain assets that are now more valuable to the firm because it provides more services and products rather than being reliant on the volatile trading business. Hyatt Hotels’ pristine balance sheet and premier brand should result in a stronger growth rate of new international projects. We believe Fastenal should gain increased share of the $150 billion industrial supply market as it increases the number of onsite and vending locations, which will improve client efficiencies. Further, many of the Fund’s stocks during the past three years have made costly investments to improve their products and categories and strategic acquisitions at attractive prices that, we believe, will eventually be evident in the financial statements as faster-than-expected revenue growth, greater profitability and higher cash flow. We believe our investments generate their best returns as these results become apparent to other investors. This is why the 52.0% of the Fund’s investments held more than five years have achieved 15.0% annualized returns compared to 10.6% for its benchmark. The 47.8% of its portfolio investments held less than five years have earned only 5.9% annualized return compared to 5.6% for its benchmark index. This offers Baron Partners Fund significant opportunity. Manchester United plc has improved its on-field product through costly new coaches and players to make its broadcasting, sponsorships, and licensing deals more attractive in new markets. These enhancements have increased costs without immediately achieving better results on “the pitch” and higher revenues. CoStar Group is integrating its acquired LoopNet services and customers into its legacy product in order to improve its offering and sales. However, the winding down of the acquired low margin, $40 million revenue business will result in a near-term headwind as the low margin revenue is purposefully removed. Client upgrades to CoStar’s comprehensive offering provide that firm more than $200 million higher margin replacement revenue. Under Armour is investing in new lines of distribution, products, and international markets as its traditional domestic wholesale business is reorganized. The bankruptcy of an important domestic account, The Sports Authority, is a near-term headwind but should result in Under Armour obtaining more of the economics as their loyal customers purchase products directly from the company through its own stores and e- commerce sites. 41

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