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Baron Funds

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Baron

Baron International Growth Fund Portfolio Structure Table IV. Top 10 holdings as of December 31, 2016 – Developed Countries Percent of Net Assets Eurofins Scientific SE 3.4% Softbank Group Corp. 2.9 Constellation Software, Inc. 2.7 Arch Capital Group Ltd. 2.7 Domino’s Pizza Enterprises Ltd. 2.6 RIB Software AG 2.5 Reckitt Benckiser Group Plc 2.2 Abcam plc 2.2 Julius Baer Group Ltd. 2.1 Fresenius Medical Care AG & Co. KGaA 2.1 Table V. Top five holdings as of December 31, 2016 – Developing Countries Percent of Net Assets Tencent Holdings, Ltd. 2.1% Alibaba Group Holding Limited 2.0 BM&FBOVESPA SA 1.4 Copa Holdings, S.A. 1.2 Multi Commodity Exchange of India Ltd. 1.2 Exposure by Country: At the end of the fourth quarter of 2016, the Fund was invested 67.6% in developed countries and 22.6% in developing countries, with the remaining 9.8% in cash. The Fund seeks to maintain broad diversification by country at all times. A detailed review of the Fund’s holdings by country is available at the back of this Baron Funds Quarterly Report. Table VI. Percentage of securities in developed markets as of December 31, 2016 Percent of Net Assets United Kingdom 12.6% Japan 12.5 Germany 6.6 Canada 6.2 United States 4.6 Australia 4.5 Israel 4.1 Spain 3.9 France 3.4 Switzerland 2.1 Hong Kong 1.8 Ireland 1.5 Netherlands 1.4 Norway 1.3 Denmark 1.1 Table VII. Percentage of securities in developing markets as of December 31, 2016 Percent of Net Assets China 9.4% Brazil 3.1 India 2.5 Indonesia 2.0 Panama 1.2 Russia 1.2 Mexico 1.1 Chile 1.1 South Africa 1.0 The Fund may invest in companies of any market capitalization, and we strive to maintain broad diversification by market cap. As of December 31, 2016, the Fund’s median market cap was $7.9 billion, and we were invested approximately 53.1% in large- and giant-cap companies, 31.2% in mid-cap companies, and 5.9% in small- and micro-cap companies, as defined by Morningstar, with the remainder in cash. Recent Activity During the fourth quarter we established several new investments, all of which were developed world companies. SMS Co., Ltd. is an entrepreneurial high growth company in Japan with the leading market position in recruitment and staffing of nurses in the country. We are enthusiastic about the long-term opportunity given demographics and a shortage of nurses, but are particularly intrigued with the company’s evolution into software-based productivity apps for the broader health care community. In addition, we initiated positions in several technology companies that we have been researching for some time, largely as the broad sell-off in quality growth stocks post the U.S. election provided what we believe was an attractive entry point. These investments include: InterXion Holding N.V., a Netherlands-based provider of carrier-neutral colocation data centers throughout Europe that we believe is well positioned to benefit from the shift to cloud-based applications and software provisioning; Cimpress N.V., an e-commerce company that is disrupting the global printing industry given its unique ability to mass customize printed items; Wix.com Ltd., a leader in the automation of “do-it-yourself” website building services; and we re-established an investment in Mobileye N.V., the leader in software and systems design for advanced driver assistance systems. We added to a number of existing investments, particularly in Japan, given our view that the Bank of Japan’s move to anchor longer-term interest rates will be broadly stimulative to the economy and corporate earnings. During the quarter, we exited positions in: Bellamy’s Australia Limited, a fast-growing organic infant formula manufacturer that recently experienced challenges with a transition of its distribution channels in China; Bharat Financial Inclusion Limited, given risks inherent in India’s demonetization move; and in easyJet plc, given concerns over a potentially adverse longterm impact from Brexit. 56

December 31, 2016 Baron International Growth Fund Outlook The year 2016 was unusual in that we perceived two clear inflection points that dominated global market activity. First, the G20 meeting of the world’s most influential central bankers and finance ministers in late February marked what we phrased the resynchronization of global monetary policy. After a protracted period of asynchronous policies which led to upward pressure on the dollar; and downward pressure on commodity prices, emerging market currencies, and their sovereign credit quality; this important, coordinated policy shift led to a reversal in such trends. This trend reversal was accentuated after the surprise Brexit referendum result, due to a material decline in sovereign bond yields worldwide, which would be particularly stimulative to emerging market economies given significant pent-up demand and compressed corporate profit margins. The second major inflection point proved less friendly to international markets. Prior to the U.S. presidential election, several global policymakers had already signaled a tolerance for higher inflation, particularly wage inflation intended to stabilize or reverse the widening wealth gap that has largely driven a global populist resurgence over the past year. The election of Donald Trump added fuel to the fire of rising inflation and interest rate expectations, while also opening a Pandora’s box of potential outcomes with regard to fiscal and monetary policy, taxation, trade, protectionism, and foreign policy. While policy details will remain unclear for some time, the direction of change is fairly apparent, and represents greater uncertainty particularly for emerging market economies. At face value, Trump appears to be a catalyst for a stronger dollar, higher inflation and bond yields, a steeper yield curve, and potentially a reversal of the long-term trend towards trade globalization. Markets were clearly caught off guard by the U.S. election results, and a fairly dramatic repricing occurred in the final weeks of 2016. A key question now is whether the sizeable magnitude of change discounted to date is appropriate or overdone. In our view, while we believe the adjustment in market prices and shift in leadership across many asset classes may be directionally appropriate, for several reasons we believe the magnitude of change is likely too severe given the likely dilution to President Trump’s favored policies. Thus, we suspect the strength in U.S. equities and weakness in international currencies and emerging market equities are likely to at least partially mean revert in coming months. First, it remains unknown how aggressive a position Trump will take with respect to import taxation and other forms of protectionism. An aggressive position would elicit a strong response from China, particularly if based on a straw man accusation of currency manipulation. Next, should his proposed policies be endorsed by Congress or pursued by executive order, we believe that a further marked rise in interest rates and the dollar could ensue, which at some point may result in a choke point on the global economy. In fact, we are becoming increasingly concerned that enthusiasm over the U.S. and global growth outlook may already have peaked as a result of Fed tightening, market-based tightening implied by the reversal in post-Brexit yield declines, and the beginning of tightening measures in China. Such a phenomenon would be consistent with the established post-crisis pattern, where expectations regarding economic and interest rate normalization rise, leading ultimately to disappointment and concern over the efficacy of policymakers. While our broad conclusion is that it will take time for the policy outlook and implications to crystallize, and that therefore a wide range of potential outcomes remains possible, we are confident that new themes and investment opportunities will emerge. Should Trump’s ultimate policy path remain a challenge for the international markets, we believe these markets are far better prepared to weather such a development than they were just a few years ago. First, Europe and Japan appear financially stable and are demonstrating clear signs of an economic upturn on a lagged basis relative to the U.S. cycle. The U.K. is demonstrating solid domestic growth in spite of Brexit, while a weaker currency is lending strength to export activity. Second, we continue to believe that emerging market corporate earnings have begun a cyclical recovery; we do not believe oil, other commodity prices and/or emerging market currencies will return to the lows of early 2016, and we are confident that the longer-term structural reforms and political redirection now underway in countries such as India, Indonesia, Brazil, Argentina, Chile, China, and Mexico will provide support and ultimately restore productivity and value creation. China, always a key barometer of emerging market health, remains stable in the face of widespread negative sentiment, with various signs of improving economic activity. We recognize, however, that Chinese authorities have begun to unwind some stimulus measures and we are monitoring key variables including trade tensions and capital flows as well as financial sector funding costs. On balance, we remain optimistic regarding the long-term potential for the high quality growth businesses in which we invest, and we look forward to our next update. Sincerely, Michael Kass Portfolio Manager 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. Non-U.S. investments may involve additional risks to those inherent in U.S. investments, including exchange-rate fluctuations, political or economic instability, the imposition of exchange controls, expropriation, limited disclosure and illiquid markets. This may result in greater share price volatility. Specific risks associated with investing in small and medium-sized 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 manager 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 International Growth Fund by anyone in any jurisdiction where it would be unlawful under the laws of that jurisdiction to make such offer or solicitation. 57

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