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Baron Funds

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Baron

Baron Discovery Fund Roche purchased over 50% of the company at $50 per share in early 2015. Now there is a definitive catalyst that we believe will be a game changer. Foundation Medicine has submitted an application to the FDA for approval of its tissue based test which could sanction its use as a companion diagnostic for FDA approved drugs covering over 40% of the metastatic cancer population in the U.S. Moreover, as part of the process, Foundation Medicine is simultaneously seeking CMS (the Medicare payer) coverage for the test. We expect approval to be obtained in the second half of 2017. Portfolio Structure Our key sector weightings at the end of December 2016 were 31.9% Information Technology (7.5% above the Russell 2000 Growth Index), 25.1% Health Care (4.2% above the Index), 14.1% Consumer Discretionary (1.3% below the Index), and 11.2% Industrials (5.6% below the Index). We have been overweight Health Care and underweight Consumer Discretionary and Industrials pretty consistently over the last few quarters. This hurt us in the fourth quarter as Industrials rallied and Health Care lagged. Given current relative valuations in these sectors, we believe that this will reverse, and we are comfortable with the existing weightings. Information Technology is an above index weighting as it was last quarter (when we first moved overweight). We continue to find new and exciting growth ideas within that sector. Our top 10 holdings at December 31, 2016 represented 28.2% of the portfolio. This is consistent with exposures that we’ve held over the life of the Fund at around 30%. Table IV. Top 10 holdings as of December 31, 2016 Year Acquired Quarter End Investment Value (millions) Percent of Net Assets MACOM Technology Solutions Holdings, Inc. 2015 $3.0 4.2% Qualys, Inc. 2013 2.6 3.7 Mercury Systems, Inc. 2015 2.4 3.4 JUST EAT plc 2014 1.9 2.6 Wingstop Inc. 2015 1.8 2.6 Dominion Midstream Partners, L.P. 2016 1.8 2.5 Liberty Expedia Holdings, Inc. 2016 1.7 2.5 Varonis Systems, Inc. 2014 1.7 2.4 The Trade Desk 2016 1.5 2.2 Education Realty Trust, Inc. 2015 1.5 2.1 Recent Activity Table V. Top net purchases for the quarter ended December 31, 2016 Year Acquired Quarter End Market Cap (billions) Amount Purchased (millions) Liberty Expedia Holdings, Inc. 2016 $2.3 $1.9 Dominion Midstream Partners, L.P. 2016 2.8 1.4 Qualys, Inc. 2013 1.1 1.2 Cerus Corporation 2014 0.5 1.0 MACOM Technology Solutions Holdings, Inc. 2015 2.5 1.0 Liberty Expedia Holdings, Inc. is a holding company where the majority of the value is derived from its stake in Expedia, Inc., and therefore the stock trades largely in tandem with Expedia. We are bullish on Expedia, the largest online travel agency (“OTA”) in the U.S. and the second largest in the world. We think the investments that Expedia is making in both its core OTA business and in its HomeAway business (acquired in December 2015) that caused a headwind to profitability this year, will ultimately show respectable returns in 2018. We believe we bought the company at a depressed multiple because of near-term earnings headwinds and, in time, we believe the stock has significant upside as these headwinds abate. Dominion Midstream Partners, L.P., a holder of natural gas storage, processing, and transportation assets, was also a new purchase in the quarter. The company is a high growth MLP formed by Dominion Resources, Inc., a diversified energy company that provides electricity and natural gas to homes and businesses in the eastern U.S. Dominion Resources recently acquired Questar and as part of that transaction, Dominion Midstream completed its acquisition of Questar Pipelines and the related financing. The market anticipated the equity financing and pushed the stock lower ahead of the equity offering. We took advantage of the pressure to buy what we believe is a long-term growth opportunity at an attractive price. As Dominion Midstream completed the equity offering, the stock price appreciated, validating our belief that recent stock pressure was purely technical in nature. We continue to like Dominion Midstream both because of its 22% guided distribution growth and its large “drop down” inventory of assets that can be sold from Dominion Resources to Dominion Midstream over time. On share weakness, we added to existing positions Qualys, Inc., Cerus Corporation, and MACOM Technology Solutions Holdings, Inc. (a terrific semiconductor company that we wrote about in detail in our June 2016 and March 2016 letters). Table VI. Top net sales for the quarter ended December 31, 2016 Year Acquired Market Cap When Acquired (billions) Market Cap When Sold (billions) Amount Sold (millions) Gaming and Leisure Properties, Inc. 2014 $6.5 $6.2 $0.9 Easterly Government Properties, Inc. 2016 0.4 0.7 0.6 Kennedy-Wilson Holdings, Inc. 2016 2.4 2.5 0.5 Sonic Corp. 2016 1.4 1.1 0.5 American Assets Trust, Inc. 2014 1.5 1.9 0.4 During the fourth quarter we sold our position in Gaming and Leisure Properties, Inc. We received Gaming and Leisure stock as a result of our investment in Pinnacle Entertainment, Inc. when Gaming and Leisure acquired Pinnacle’s real estate holdings. While we are believers in the longterm prospects of Gaming and Leisure, the market cap was significantly larger than the typical stocks in the Fund, so we used that holding as a source of cash for new smaller-cap ideas. We sold our positions in Easterly Government Properties, Inc., Kennedy-Wilson Holdings, Inc. and American Assets Trust, Inc. as we felt valuations were full in the context of the current interest rate environment. We also sold Sonic Corp., a franchisor and operator of quick service hamburger restaurants. While we are believers in 84

December 31, 2016 Baron Discovery Fund the company’s strategy to go “asset light” by converting company stores into franchise stores, the company was unable to lessen its general and administrative costs to the level we felt was necessary to make the “asset light” strategy successful. and sage advice. We hope that this letter gives our present and prospective investors a taste of why we are so excited about the Fund’s prospects going into 2017. Let’s all have a profitable and healthy new year! Outlook We want to thank our investors, as well as all of the terrific people at Baron who have helped us get to our three year milestone with such success. In particular, we would like to thank Cliff Greenberg for his unwavering support Randy Gwirtzman & Laird Bieger Portfolio Managers 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. The Adviser believes that there is more potential for capital appreciation in smaller companies, but there also may be more risk. Specific risks associated with investing in smaller 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 managers’ 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 Discovery Fund by anyone in any jurisdiction where it would be unlawful under the laws of that jurisdiction to make such offer or solicitation. 85

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