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Baron Funds

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Baron Energy and Resources Fund for both of these entities could become significantly clearer in the next several months. Materials: We reduced our exposure to the Materials sector as we exited our gold positions following the U.S. election and redeployed that capital in areas that we thought would be more productive. In addition, performance among our ongoing Materials investments was negatively impacted by poor performance in the quarter for companies such as Flotek Industries, Inc. and Kraton Corporation, which also reduced the size of our holdings in this sub-industry. At quarter end, Materials represented only 5.9% of the Fund. Oil & Gas Refining & Marketing: Independent refiners represented 2.9% of Fund assets at the end of the quarter. We trimmed exposure amid concerns about margins and tax policy following the outcome of the U.S. election. Our exposure is well below the 7.4% average weight for this sub-industry in our benchmark. We are cautious in the near term that rising oil prices will hurt refiner input costs and that the net effect of potential regulatory and tax policy changes will be a net negative for the sub-industry overall, but could have a differential impact on various companies. Until we have more clarity on the direction of regulation and policy, we see better opportunities elsewhere. Table IV. Top 10 holdings as of December 31, 2016 Year Acquired Market Cap When Acquired (billions) Quarter End Market Cap (billions) Amount (millions) Percent of Net Assets RSP Permian, Inc. 2014 $ 1.5 $ 6.3 $7.2 6.9% Parsley Energy, Inc. 2014 2.5 7.3 6.8 6.5 Encana Corp. 2016 5.2 11.4 6.2 5.9 Concho Resources, Inc. 2012 10.1 19.4 6.0 5.8 Newfield Exploration Co. 2015 3.9 8.1 4.9 4.8 Halliburton Co. 2012 31.4 46.8 4.1 3.9 Flotek Industries, Inc. 2013 1.2 0.5 3.5 3.4 Targa Resources Corp. 2016 4.6 10.1 3.5 3.4 Schlumberger Limited 2015 102.8 116.8 3.1 3.0 U.S. Silica Holdings, Inc. 2016 1.7 4.5 3.0 2.9 Recent Activity Table V. Top net purchases for the quarter ended December 31, 2016 Quarter End Market Cap (billions) Amount Purchased (millions) WPX Energy, Inc. $5.0 $2.5 Jones Energy, Inc. 0.4 1.6 Sanchez Production Partners LP 0.2 1.4 Infraestructura Energetica Nova S.A.B. de C.V. 6.7 1.1 Nabors Industries Ltd. 4.6 0.6 With the exception of Nabors Industries Ltd., where we added to the purchases we made in the third quarter, all of our top purchase activity in the quarter were the result of initiating new positions. The largest new position initiated in the fourth quarter was our investment in WPX Energy, Inc. WPX is a U.S.-based independent E&P company that is primarily focused on growing its production in two principal plays–the Bakken shale in North Dakota and the Wolfcamp shale in the Delaware sub-basin of the greater Permian Basin. As such, our purchase of WPX added to the Fund’s growing exposure to Permian-oriented E&P companies, as the company successfully entered the basin over a year ago through a well-timed acquisition in the core of the play. Our assessment of early well results indicates that WPX’s position in the Delaware is one of the best in the industry. It has the potential for multiple development zones and higherthan-average rates of recovery that we think will lead to faster growth and higher returns than currently anticipated by the Street. We have also been impressed with progress and success that WPX’s management team, which took over the company in 2014, has made in reshaping its asset portfolio and see additional steps that can be taken to further optimize the asset base. We view WPX as a company that has successfully repositioned itself with top-tier assets in the aforementioned plays and a capital structure that should enable it to achieve top-tier growth in oil production, cash flow, and net asset value. Jones Energy, Inc. is a small-cap independent E&P company that has a proven track record of low-cost operations and development success in the western Oklahoma/Texas Panhandle region. While the company’s historical asset base has generated solid returns for the company over the years, we view Jones in a similar vein as WPX in that the investment thesis revolves around the potential for a successful transition into a new play that could result in accelerating production, growth and net asset value creation. In the last year, the company bought into an acreage position in South Central Oklahoma that sits in the Anadarko Basin and lies between the two most interesting oil development plays in Oklahoma called the SCOOP and the STACK. This area between the two plays has been dubbed the “Merge” by several industry analysts and shares a similar geological makeup as portions of the SCOOP and STACK, both of which are considered to be among the most economic emerging oil shale plays in the U.S. The industry has drilled fewer wells testing the productivity of the “Merge” and Jones has not released any of its own well results yet. However, the initial data on well productivity that has been released by other operators indicate that the “Merge” could be an attractive and economic area for future development. Based on our risked analysis of Jones’ current asset base and prospective opportunity in the “Merge,” we think that this company offers one of the highest reward opportunities even in a flat oil price environment. However, due to the company’s smaller market cap, somewhat more leveraged balance sheet, and the more exploratory nature of its asset base, we have sized this new position to reflect both the upside opportunity as well as the higher risks. Sanchez Production Partners LP is a small-cap midstream company that principally gathers and processes oil, natural gas, and gas liquids in the Eagle Ford shale for its majority shareholder, Sanchez Energy Corp. The company has been expanding its logistics footprint through a combination of acquisitions and organic capex investment in gathering, processing, and transportation infrastructure to serve the growing production profile of its parent company better. We believe that the combination of recent acquisitions and ongoing investments will enable the company to grow its distributable cash flow and distributions to shareholders at a 6% to 10% rate over at least the next three years and a recent large acquisition by Sanchez Energy in the Eagle Ford could result in higher production growth rates that lead to additional transport and processing opportunities for this MLP and meaningfully extend the runway for future growth. In our view, the company’s current valuation does not reflect any future growth in distributions and even looks inexpensive if the company maintains its current rate of distributions, which at a $1.70/share annualized, has the company yielding almost 15% compared to comparable companies that are yielding 74

December 31, 2016 Baron Energy and Resources Fund closer to 5%. Some portion of this valuation discrepancy can be attributed to Sanchez Production Partners having higher risks and lower long-term visibility than some peer companies that are related to larger more diversified E&P companies. However, we think the current discount and the visibility on capital returns over the next several years significantly mitigates these risks and creates an opportunity for significant upside reward. We initiated a position in Infraestructura Energetica Nova S.A.B. de C.V. (IEnova) because we believe the company will continue to benefit from privatization efforts occurring in Mexico’s Energy sector. IEnova, originally Sempra Energy’s Mexican unit, was one of the first private companies to build and acquire natural gas pipelines following the earliest reforms in 1996. We believe this operating experience puts IEnova in a great position to partner with a growing number of energy producers as exploration projects are auctioned to global participants and with consumers seeking to build and operate renewable energy assets. IEnova’s business is built upon a diverse set of assets with long-term, take-or-pay and primarily dollardenominated contracts providing stable and predictable cash flow. We believe the company can double its asset base and cash flow over the next several years based on its current portfolio of contracts and sanctioned development projects. Longer term, the opportunities to expand by acquiring the rights to build gas pipelines, power generation and distribution assets, and storage infrastructure should provide additional opportunities for profitable growth. Table VI. Top net sales for the quarter ended December 31, 2016 Amount Sold (millions) Rice Energy Inc. $2.1 Marathon Petroleum Corp. 2.1 PBF Logistics LP 1.3 Parsley Energy, Inc. 1.2 SolarEdge Technologies, Inc. 0.9 Our largest net sale in the quarter was Rice Energy Inc. We decided to take profits and reduce the size of the position because the rapid appreciation in the shares this year brought the stock much closer to our target price and diminished the upside on an absolute and relative basis. We exited our position in SolarEdge Technologies, Inc. during the fourth quarter as the competitive risks that plagued the shares in the third quarter became even more of an imminent threat. We decided to redeploy those assets into better risk/reward opportunities as discussed above. We exited our position in Marathon Petroleum Corp. due to growing fundamental concerns about the net effect of changes in the regulatory/policy environment postelection. However, given that Marathon subsequently became the target of activist investor Elliott Management, this proved to be a poor decision as we left money on the table. Parsley Energy, Inc. shows up on the list of top net sales for the quarter due to the fact that the Fund experienced a redemption in mid-December equal to about 7% of our AUM, prompting us to sell a portion of many of the stocks in the portfolio. Given the fact that Parsley was our largest position on average during the quarter, the redemption sales were largest in Parsley in dollar figures. Parsley remains a top position in the Fund and is an investment that we think still has an attractive risk/reward outlook over the next several years. Outlook Our outlook for investing in Energy in 2017 remains pretty optimistic and very similar to what we wrote about last quarter. We think there are three key messages that investors should think about as it pertains to investing in Energy over the next two to three years. 1. The worst Energy recession in a generation is over. 2. The U.S. Energy renaissance is alive and well. 3. Equity investors remain significantly underweight in their exposures to the Energy sector and, to a lesser extent, resourcerelated businesses. Clearly, after a difficult start, 2016 proved to be a very good year to be invested in the Energy sector, but we believe this is just the beginning of what we think will be a new upcycle that could continue for several more years. The macro setup for Energy is pretty good. The oil market has returned to balance and OPEC is intent on accelerating a rebalancing such that inventories return to normal. Oil demand has posted stronger-thantrend growth for several years despite disappointing economic growth. Global economic policies and priorities appear to be changing with increased priority to fiscal stimulus and not just monetary stimulus. The recent rise in interest rates seems to signal a move from a deflationary environment to an inflationary environment, and we think that the lack of inflation and fears of deflation in the 2011-2015 period was a big headwind for investing in commodities in general and energy in particular. The reappearance of even modest inflation should be seen as a good sign for investors in these areas. While it is still difficult to predict what will result from the outcome of the U.S. election in terms of exact policies, it does appear that the combined effect of changes being proposed or expected in taxation and regulation will be more of a tailwind than a headwind for the Energy sector. Energy remains a cyclical industry with pockets of secular growth, and we continue to try to position the portfolio to benefit from a combination of recovery from the brutal recession of the last two years and the key trends that will shape the industry in the next several years. Those key trends will continue to be the development of unconventional oil and natural gas in North America, growing global natural gas demand, ongoing challenges facing non-OPEC, non-North American producers in offsetting natural production declines, and budgetary shortfalls among key global oil producers inside and outside of OPEC. All of these items will factor into the shape, size, breadth, and length of the nascent recovery and present us with opportunities and challenges over the next several years. The Energy recession is over: We believe that the energy recession is over, that oil prices bottomed in early 2016 and have more risk to the upside than the downside. We are encouraged by the fact that the oil supply/demand balance has flipped from surplus to deficit since the middle of 2016, as seen in declining global inventories, and the prospects for a more rapid decline in inventories following the fourth quarter agreements by OPEC and key non- OPEC producers to further cut supply and return inventories to more normal levels. We are also enticed by the significant restructuring that has taken place across much of the energy industry in recent years to better align supply with demand and make companies more competitive. The industry has cut costs, closed excess manufacturing plants, pared non-core assets, reduced debt, been proactive in adapting to new technologies and adopting new business practices. All of these forces are expected to lead to improved operating efficiencies, higher normalized margins, and stronger growth for those companies that lead in the recovery. 75

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