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1 year ago

Baron Funds

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Baron

Baron Global Advantage Fund retention and word-of-mouth referrals. Despite growing much faster than the overall banking industry, First Republic Bank is a disciplined underwriter with much lower credit losses than peers. We believe First Republic Bank can continue growing profitably for many years given its strong reputation and low penetration in large markets. Table VII. Top net sales for the quarter ended December 31, 2016 Quarter End Market Cap or Market Cap When Sold (billions) Amount Sold (thousands) PT Sarana Menara Nusantara Tbk. $ 2.7 $300.3 Worldpay Group plc 6.7 280.6 Westlake Chemical Partners LP 0.6 99.5 TerraForm Global, Inc. 0.7 74.7 Check Point Software Technologies Ltd. 14.8 16.5 All of the investments we exited this quarter were trimmed due to various concerns that we outlined before. The Indonesian tower company PT Sarana Menara Nusantara Tbk., proved to be much more cyclical than we anticipated causing us to move on to what we believe are more attractive opportunities. We sold out of Worldpay Group plc due to concerns about European economic growth. The Brexit vote introduced significant uncertainty and contributed to the British Pound weakening to a 30-year low against the U.S. Dollar. Worldpay showed solid growth in the first half of the year, but a reputational hit from an IT malfunction, a management change at the U.S. segment, and the ongoing platform migration may lead to more modest growth going forward. Westlake Chemical Partners LP was an investment gone wrong almost right away when the IRS unexpectedly came out with changes in the definition of what constituted qualifying income, putting Westlake’s MLP status in question. This caused a dramatic sell-off in the stock, and its stock price bottomed at about $15.35 per share in November 2015. While waiting for the IRS to give a final verdict on its MLP status, the company pursued the growth strategy it set two years earlier. Despite this uncertainty, the stock price recovered somewhat as Westlake demonstrated steady cash flow growth, and we exited our position at the modestly better price of $22 per share on average and redeployed the capital into faster growing opportunities. Check Point Software Technologies Ltd. has been a long-term holding for the Fund. During the quarter, we decided to reduce our position in the company as we saw the relative valuation gap from its competitors narrow while the marketplace for cyber solutions appeared to become more competitive. We still believe in CheckPoint’s prospects and growth opportunities in cybersecurity and will continue to evaluate our position based on our due diligence and intrinsic value analysis. OUTLOOK We are excited about the long-term prospects of the companies that constitute this portfolio. We invest no time in trying to figure out what global GDP growth will be next year, whether China will devalue the Yuan, or how many times the Federal Reserve will raise interest rates. Our goal remains to maximize long-term returns without taking significant risks of permanent loss of capital. We believe the best strategy for long-term capital appreciation is to collect a mix of unique companies that sell into different end markets and different geographies. We will continue to focus on identifying and investing in companies that we believe have sustainable competitive advantages and the ability to reinvest excess capital at high rates of return. Sincerely, Alex Umansky 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. Growth stocks can react differently to issuer, political, market and economic developments than the market as a whole. 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, resulting in greater share price volatility. Securities of small and medium-sized companies may be thinly traded and more difficult to sell. 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 Global Advantage Fund by anyone in any jurisdiction where it would be unlawful under the laws of that jurisdiction to make such offer or solicitation. 80

December 31, 2016 Baron Discovery Fund Dear Baron Discovery Fund Shareholder: Performance What a year! Baron Discovery Fund (the “Fund”) turned in a really nice performance in 2016, up 21.73% (Institutional Shares), or 10.41% ahead (after fees) of the Russell 2000 Growth Index. In the fourth quarter, the Fund’s performance was flat, and the Fund lagged the index by 3.57%. Table I. Performance † Annualized for periods ended December 31, 2016 Baron Discovery Fund Retail Shares 1,2 Baron Discovery Fund Institutional Shares 1,2 Russell 2000 Growth Index 1 S&P 500 Index 1 Three Months 3 (0.07)% 0.00% 3.57% 3.82% One Year 21.40% 21.73% 11.32% 11.96% Three Years 5.51% 5.79% 5.05% 8.87% Since Inception (September 30, 2013) (Annualized) 10.19% 10.46% 7.21% 11.54% Since Inception (September 30, 2013) (Cumulative) 3 37.06% 38.16% 25.41% 42.61% The Fund lagged in the fourth quarter due to some very unusual circumstances that we do not believe will affect its potential to outperform the benchmark on a long-term basis. Whether or not the election of Donald Trump as the 45 th President of the United States will unleash significant GDP growth in the U.S. economy, it has certainly uncaged a lot of animal spirits in the market. This was a head-snapping finish to the year. The Fund’s industry exposures match where we believe there will be secular growth in the economy, but they do not sync with a violent upswing in cyclicals (banks, commodities and materials, and industrials, to name a few). According to a December report from Bank of America, in the first half of that month “investors rotated out of ‘growth’ (tech, health care) and ‘bond proxies’ (utilities, telecommunications, staples) and into resources, banks and cyclicals, with a big majority of investors expecting cyclical value to beat quality growth until ‘well into next year.’” Some of the statistics are mind bending. Trim Tabs, which tracks fund industry flows, said that U.S. equity ETFs “received a record $97.6 billion RANDY GWIRTZMAN AND LAIRD BIEGER PORTFOLIO MANAGERS Retail Shares: BDFFX Institutional Shares: BDFIX R6 Shares: BDFUX from Tuesday, November 8 through Thursday, December 15.” To put this in context, this flow is equal to one and a half times the $61.4 billion inflow in all of 2015. In other words, investors jammed into equity exposure as fast as they could. And where did the money go? In small cap, it went to value as opposed to growth. According to a Jefferies report from December 19, 2016, over the last month (approximating the post-election period highlighted by Trim Tabs), ETF flows into small-cap value were $2.83 billion versus inflows of $858 million into small-cap growth. Therefore, value flows exceeded growth flows by a 3:1 ratio – and that’s what outperformed in the quarter (the Russell 2000 Value Index was up 14.07%, while the Russell 2000 Growth Index (our benchmark) was up 3.57%. We believe that the performance disparity in the fourth quarter due to sector rotation will reverse sooner rather than later. But we never rest. While we are excited about our performance during 2016, we know that the scoreboard resets on January 1. Given that we are being trusted by you, our investors, as well as our wives (given our own substantial holdings of the Fund), we feel compelled to explain why we continue to be bullish into 2017. In a recent presentation to our sales team, we laid out the catalyst Performance listed in the above table is net of annual operating expenses. Annual expense ratio for the Retail Shares and Institutional Shares as of September 30, 2016 was 1.88% and 1.49%, but the net annual expense ratio was 1.35% and 1.10% (net of the Adviser’s fee waivers which the Adviser has contractually agreed to for so long as it serves as the adviser to the fund), respectively. The performance data quoted represents past performance. Past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate; an investor’s shares, when redeemed, may be worth more or less than their original cost. The Adviser has reimbursed certain Fund expenses (by contract as long as BAMCO, Inc. is the adviser to the Fund) and the Fund’s transfer agency expenses may be reduced by expense offsets from an unaffiliated transfer agent, without which performance would have been lower. Current performance may be lower or higher than the performance data quoted. For performance information current to the most recent month end, visit www.BaronFunds.com or call 1-800-99BARON. † The Fund’s historical performance was impacted by gains from IPOs and/or secondary offerings. There is no guarantee that these results can be repeated or that the Fund’s level of participation in IPOs and secondary offerings will be the same in the future. 1 The indexes are unmanaged. The Russell 2000 ® Growth Index measures the performance of small-sized U.S. companies that are classified as growth and the S&P 500 Index of 500 widely held large cap U.S. companies. The indexes and the Fund are with dividends, which positively impact the performance results. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell is a trademark of Russell Investment Group. 2 The performance data in the table does not reflect the deduction of taxes that a shareholder would pay on Fund distributions or redemption of Fund shares. 3 Not annualized. 81