1 year ago

Baron Funds



Baron Global Advantage Fund Table II. Top contributors to performance for the quarter ended December 31, 2016 Quarter End Market Cap (billions) Percent Impact BlackLine, Inc. $ 1.4 0.69% First Republic Bank 14.2 0.38 Noble Midstream Partners LP 1.1 0.33 Cetip S.A. – Mercados Organizados 3.6 0.15 JUST EAT plc 4.9 0.14 We participated in the initial public offering of a cloud-based accounting software company BlackLine, Inc. The offering was exceedingly well received by the market with shares rising 63% from the price of the IPO, as the company grew its market share in the mid and high-end segments of the market. Though we would not be surprised to see a short-term pullback in the stock, we think BlackLine’s unique and expanding product offering and significant investments in its sales capabilities should enable the company to sustain its rapid growth trajectory for years to come. There is a more detailed write-up on BlackLine later in this letter. First Republic Bank provides banking and wealth management services to affluent clients in metropolitan areas of the U.S. The stock appreciated 19% during the quarter as it participated in the post-election rally for financial companies and on expectations for faster economic growth and higher inflation. In addition, First Republic reported good financial results with 18% loan growth and 24% deposit growth. We added to our investment during the quarter and continue to believe the bank has an advantaged business model and a long runway for growth. Noble Midstream Partners LP is a master limited partnership midstream energy company that was spun out of Noble Energy, Inc. in the third quarter of 2016. Noble Midstream owns and operates portions of the oil and gas gathering, transportation and processing assets that are primarily located around Noble Energy’s operations in Colorado and Texas. The shares rose 29% during the quarter after Noble Midstream reported its first quarter as a public company with results well ahead of the Street’s consensus expectations. Substantial growth in water service volumes driven by the drilling methodology of its parent company increased confidence in Noble Midstream’s long-term growth targets and potential. We see significant opportunity for this entity to grow over time, which we think is not fully appreciated by the market. Cetip S.A. – Mercados Organizados administers over-the-counter markets in Brazil for trading and registration of fixed income securities, derivatives, and auto liens. The stock increased in the fourth quarter as the pending acquisition by BM&FBOVESPA kept Cetip’s share price stable while other stocks in developing markets fell. The company also reported good financial results despite the challenging Brazilian economy. We continue to own the stock because we expect the merger with BM&FBOVESPA will create significant shareholder value. Shares of JUST EAT plc, an online marketplace for restaurant delivery in Europe, Latin America, and Canada, were up 4% in the quarter, primarily on a solid third quarter order update despite weather-related headwinds, as well as an increase in full-year guidance. The company’s leading market share position across all of its major markets suggests continued growth in margins, earnings, and returns on invested capital, in our view. Table III. Top detractors from performance for the quarter ended December 31, 2016 Quarter End Market Cap (billions) Percent Impact, Inc. $356.3 –1.26% Alibaba Group Holding Limited 219.1 –1.12 Illumina, Inc. 18.8 –0.91 Naspers Limited 64.4 –0.78 International, Ltd. 19.9 –0.61 Shares of, Inc., declined 10% during the fourth quarter. After a streak of stellar quarterly earnings reports, which showed meaningful margin and profitability upside, Amazon reported mixed results with operating margins and guidance slightly below the Street’s heightened expectations driven by weaker retail margins and investments in India and abroad. Amazon is continuing to invest heavily in several growth initiatives, including Amazon studios, Alexa, India, Amazon Web Services, and distribution and fulfilment center expansions. We see the company as the undisputed global leader in the two secularly growing, multi-trillion dollar markets of e-commerce and cloud computing, and it remains our highest conviction long-term investment idea. Alibaba Group Holding Limited is the largest e-commerce and cloud services provider in China and the second largest one in the world. Stock price declined 17% during the quarter despite reporting strong financial results. Concerns regarding the weakening Chinese economy and the further depreciation of the Yuan were weighing on investors’ confidence, which were further exacerbated by the U.S. election results. We continue to believe that Alibaba represents a unique and compelling opportunity to invest in the long-term growth of e-commerce, mobile, and cloud-computing in China. Shares of Illumina, Inc., the leading provider of DNA sequencing technology to academic and commercial laboratories, fell almost 30% after reporting disappointing third quarter financial results. The shortfall was caused primarily by weak high-throughput instrument sales in North America and general weakness in Europe. Illumina’s growth is very much driven by new product introductions, and in 2016 sales suffered as the high-throughput instrument line reached the end of its life cycle. In early 2017, Illumina launched a new high-throughput sequencing platform that should reaccelerate growth. In addition, Grail, the start-up funded by Illumina which is developing a blood-based cancer screening test, announced it received capital commitments of $1 billion and would become one of Illumina’s largest customers over time. 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. Shares of Naspers Limited, a South African internet and media platform company, fell 15% during the quarter largely due to the weakness of Tencent Holdings, a company in which Naspers has a large ownership stake. Additionally, the company’s pay TV business was impacted by the devaluation of the South African Rand. We believe that shares will recover as Tencent grows and Naspers takes steps to provide visibility into its internet investments. Shares of China’s largest online travel company International, Ltd. declined 14% in the fourth quarter as a result of concerns regarding the 78

December 31, 2016 Baron Global Advantage Fund devaluation of the Yuan and the harsh rhetoric used during the political campaigning period by the incoming U.S President raising fears of a potential trade war with China. We believe the impact on Ctrip’s business would be minimal at worst, and with China recently becoming the world’s biggest outbound tourism spender, we think the potential reward is substantially higher. The company has a stated goal of doubling its bookings to one trillion Yuan (~ $145 billion at today’s exchange rate) by the end of 2020. We suspect it will happen sooner. Potentially, a lot sooner. Portfolio Structure The portfolio is constructed on a bottom-up basis with the quality of ideas and conviction level having the highest roles in determining the size of each individual investment. Sector or country weights tend to be an outcome of the portfolio construction process and are not meant to indicate a positive or a negative “view.” The top 10 positions represented 56.1% of the Fund, the top 20 were 81.6% and we exited the quarter with 34 holdings. Close to 90% of the Fund continues to be invested in stocks in the Information Technology, Consumer Discretionary, and Health Care sectors as classified by GICS, with about half the assets invested in companies that are domiciled outside of the United States. The Fund’s turnover in 2016 was 21.5%. Table IV. Top 10 holdings as of December 31, 2016 Quarter End Market Cap (billions) Quarter End Investment Value (thousands) Percent of Net Assets, Inc. $356.3 $1,164.5 12.0% Alibaba Group Holding Limited 219.1 569.2 5.9 Alphabet Inc. 538.6 537.2 5.5 Facebook, Inc. 332.4 528.3 5.4 Constellation Software, Inc. 9.6 503.0 5.2 TAL Education Group 5.7 485.6 5.0 Naspers Limited 64.4 468.3 4.8 JUST EAT plc 4.9 431.2 4.4 Mellanox Technologies Ltd. 2.0 388.2 4.0 International, Ltd. 19.9 380.3 3.9 Exposure By Country Table V. Percentage of securities by country as of December 31, 2016 Percent of Net Assets United States 53.2% China 15.9 Israel 7.7 Canada 5.2 South Africa 4.8 United Kingdom 4.4 Brazil 3.3 Netherlands 1.8 Japan 1.7 Argentina 1.3 Recent Activity During the December quarter, we initiated four new investments by purchasing small positions in Daiwa Securities, BlackLine, Greenlight Capital Re, and Splunk. We also added to First Republic Bank turning it into a medium-sized position. In a fully unintended act of symmetry, we eliminated four holdings–Sarana Menara Nusantara, Worldpay, Westlake Chemical Group, and TerraForm Global, and reduced a medium-sized position in Check Point Software into a small one. Table VI. Top net purchases for the quarter ended December 31, 2016 Quarter End Market Cap (billions) Amount Purchased (thousands) Daiwa Securities Group, Inc. $10.8 $167.8 BlackLine, Inc. 1.4 115.9 Greenlight Capital Re, Ltd. 0.9 99.6 Splunk, Inc. 6.9 82.1 First Republic Bank 14.2 23.5 BlackLine, Inc. is a cloud-based software company that enables its customers to modernize and automate manual accounting processes such as the quarterly closing of financial statements, account reconciliations, and intercompany accounting and controls assurance. BlackLine’s solutions allow the customer to gain dynamic workflows embedded within a real-time, highly automated framework, a process the company refers to as “continuous accounting.” By leveraging software automation of these processes, the company facilitates significant improvement in the integrity and accuracy of customer’s financial reporting. As a result, customers gain efficiencies and enhanced real-time visibility into their operations. BlackLine’s strong brand and product differentiation are driven by the software’s ease of use and deployment with flexibility to meet customers’ diverse needs. Existing integration with third-party applications, deep domain expertise, and cloud delivery results in lower cost of ownership and enables faster deployment. We believe that the market opportunity will continue to grow as companies realize the impact and benefits embedded in the transition to the unified software-based solution. This should allow BlackLine to continue to attract new customers and expand within existing accounts for years to come. We have owned the shares of Cayman Islands-based re-insurer Greenlight CapitalRe, Ltd. in the past and re-initiated a small position immediately after the unexpected results of the U.S. presidential election. We think David Einhorn’s investment style is suited particularly well to the current environment and, with GreenlightRe’s stock trading below book value, we thought the risk-reward was attractive enough to get back in. Splunk, Inc. is one of the few pure-play publicly traded companies that stand to benefit from the proliferation and popularization of Big Data. Splunk has built a unique suite of products that allow customers to collect, index, store, and analyze structured, semi-structured and unstructured data. We believe that Splunk is likely to succeed in what is a fast growing, multibillion dollar market due to its software’s flexibility, which allows different users to run a variety of queries regardless of changes in format to the data input, and its range of deployment mechanisms including cloud, on premise, and hybrid environments. Our research suggests that the company’s large and growing ecosystem provides its customers with significantly richer functionality compared to other solutions. We expect its first mover advantage to allow the company to maintain and potentially expand its brand, technology, and ecosystem advantages. The explosion of data and every company’s desire to retain and understand it has been well documented over the last decade. We believe Splunk is strategically positioned to be one of the largest beneficiaries of the proliferation of data and data analytics, and has earned itself an opportunity to become the Big Data platform in the world of the IOT (Internet of Things). We added to our position in First Republic Bank because our confidence in the company’s uniqueness, business model, and management continues to grow. The election results clearly suggest potential for higher interest rates, faster economic growth, lower corporate tax rates, and a more benign regulatory environment. We first purchased First Republic Bank earlier in the year because we believed it was a highly differentiated bank with a long runway for growth. First Republic Bank employs a unique, high-touch business model to serve wealthy customers in fast-growing, coastal markets of the U.S. A singular focus on client service leads to high customer 79

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