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Baron Asset Fund: Finding Growth in the Market's Sweet Spot

- By Holly LaFon

Bridging the gap between large and small cap equities, we think mid-cap equities have the potential to offer the best of both asset classes.


In our experience, mid caps can represent a lower risk option than their small-cap peers, as they generally have more experienced management teams, stronger balance sheets, readier access to capital markets, longer and deeper customer relationships, and more robust free cash flow streams to reinvest in their businesses. Compared to large caps, we have found that mid-cap companies tend to have more agile, less bureaucratic management and a greater entrepreneurial spirit that can help propel growth through faster decision making.



It is an excellent time to invest in mid-cap growth equities, in our opinion. Mid caps have underperformed other categories during the last five years, and mid-cap growth stocks have underperformed mid-cap value stocks over this same time period as well. Further, mid-cap growth stocks are currently about 4% cheaper than their historic average, with a P/E ratio of 20.8 over the trailing 12 month period (TTM) compared with a P/E ratio of 21.7 for the 20-year average.

Given likely reversion to the historic mean, we think mid-cap growth stocks are currently trading at an attractive price for investment. With a 4-star Morningstar rating for both its three-year and five-year performance, we believe Baron Asset Fund is a smart choice for the long-term investor.5

Baron Asset Fund is our mid-cap investment option. Portfolio manager Andrew Peck applies Baron's research-intensive, long-term investment approach to manage a concentrated, low-turnover, high conviction portfolio of mid-cap growth stocks. Andrew brings more than two decades of research experience to the Fund, which he has managed since 2003.


Andrew's differentiated strategy has produced excellent results. Year-to-date, the Fund increased 10.17%, outperforming its benchmark by 328 basis points. During this same time period, the Fund ranked in the 10th percentile of its mid-cap growth equity peer group as defined by Morningstar. As shown in the chart to the left, its longer term performance is strong as well. The Fund has achieved these returns with relatively less risk. Its Sharpe ratio, which measures risk-adjusted returns, is 0.70, compared with a 0.65 average for its peer group.


We invest with a long-term perspective, which allows us to take advantage of opportunities that may be overlooked by investors who are more focused on quarterly earnings reports, market swings, and other short-term events. We seek stocks that we believe have the potential to return 100% within four to five years. To help achieve this target, we look for companies with:


Growth opportunities


  • Large addressable markets



  • Secular, not cyclical, trends



Competitive advantages


  • Unique assets



  • Pricing power



  • Dominant market share



Business models that can support sustainable growth


  • Scalable



  • High incremental margins



  • Strong and visible cash flow



Exceptional management


  • Experienced



  • Visionary



The portfolio typically has positions in 50 to 60 companies, with its top 10 holdings comprising roughly 45% of net assets, and its top 20 holdings about 65% of net assets. This relatively low number of holdings allows us to invest only in companies in which we have high conviction. This approach to investing also results in a truly differentiated Fund, with a high active share of 86.0%.


Turnover is 11.9%, compared with average turnover of 65.4% among the Fund's peer group (3-year average). This low-turnover strategy allows Andrew and Baron's deep bench of research analysts to devote meaningful amounts of time to discovering and analyzing a wide range of public companies to add to the Fund, while investing only in the highest conviction ideas.


A stock by stock approach


We are bottom-up investors, building our portfolios one stock at a time. We identify these opportunities through extensive, in-depth, original research. We think this research-intensive approach gives us an edge in the mid-cap space, where stocks tend to be less closely followed by Wall Street analysts than their large-cap counterparts. We seek to differentiate ourselves through independent and creative thinking, which we believe is key to the development of the unique insights and perspectives that are the foundation of our competitive advantage.


While all of our holdings represent promising opportunities based on the investment philosophy that we have developed and followed for more than 35 years, many of them share certain attractive characteristics. In the mid-cap space, we favor companies with subscription-based or platform business models or unique assets. We believe these attributes offer sustainable competitive advantages - something that differentiates them from their competitors while creating barriers to entry into their markets. Following are some examples of these companies.


Subscription-based business models


The Fund has investments in a number of subscription-based companies, including three of our top 10 holdings: Gartner, Inc., Verisk Analytics, Inc. and FactSet Research Systems, Inc. While each targets a different market, these companies all play key roles in their clients' daily workflows, creating sticky customer relationships and high switching costs.


Companies built around a subscription-based business model tend to benefit from a number of attractive attributes, including:


  • Unique proprietary data and analytics that are difficult to replicate



  • Data that is embedded in client workflows



  • Highly visible, recurring revenue streams



  • Pricing power



Gartner (IT) provides syndicated information and technology research and advisory services to IT and other businesses. The low price of its research relative to value has produced retention rates running above 100%. The Gartner brand is highly regarded, and it is frequently cited in the media as a leading expert on IT trends. Its stock price has almost quadrupled since we first invested and it is currently the Fund's second largest holding. We think Gartner still has considerable room to expand both organically and through acquisitions such as research and advisory company CEB Inc., which it acquired earlier this year. We believe its key forward-looking metrics, including easing annual comparisons, improved sales force productivity, and increasingly refined sales tactics, point toward continued robust growth.


Verisk (VRSK) provides risk information to the insurance, financial services, and energy industries. We think Verisk has a unique competitive position. The company is investing to expand its product set in Insurance and Financials. It also acquired two companies over the last two years to give it energy exposure, creating a path to sustained double digit growth. The stock has almost tripled since our initial investment. Verisk generates robust margins and significant free cash flow, which it has been using to repurchase stock and make acquisitions.


FactSet (FDS) is another subscription-based company that we believe still has a long trajectory of growth ahead. FactSet provides financial data and analysis to the investment community. The company aggregates data from multiple sources into proprietary data sets, and overlays unique analytical capabilities, which we believe give it a competitive advantage. This open approach to content, coupled with a commitment to a high level of customer support, has resulted in an exceptionally sticky business model, with retention rates of more than 95%. The stock has tripled since we first purchased it. Like most information services companies, FactSet generates outstanding cash flow. As the company prefers to rely on organic product development rather than acquisitions to improve its portfolio, it has also been able to return excess cash to shareholders.


Platform businesses


A number of the Fund's holdings are what we consider to be high quality platform companies. With platform companies, we emphasize the following:


  • Economies of scale



  • Network effect



  • Dominance within their vertical market



  • Large, global, addressable markets



Platform companies have constructed a platform that third parties can use to connect their businesses, sell products and services, and co-create value. The economies of scale, network effect, and barriers to entry that characterize a platform company can lead to dominance within its vertical market, which can be extended across geographies. Moreover, once a platform company has established itself as the leader in its market, it creates formidable barriers to entry. A disproportionate percentage of the market's revenues accrue to the market leader, frequently at high incremental margins.


The Priceline Group, Inc. (PCLN) is a Consumer Discretionary company that operates online platforms connecting retailers in the travel space - hoteliers, airlines, rental cars, and restaurants - with consumers. Priceline is the global leader among online travel agencies, operating in more than 200 countries through six primary brands: Booking.com, priceline.com, agoda.com, KAYAK, Rentalcars.com, and OpenTable. The stock has increased more than nine-fold since our initial investment. We think Priceline has a continued long runway for growth, especially in emerging markets, where industry penetration levels are still much lower than in developed countries.


Within the Financials sector, MarketAxess Holdings Inc. (MKTX) owns and operates the dominant electronic platform for trading corporate bonds and other fixed income securities. Trading across asset classes continues to migrate away from trading pits and phones to electronic venues. Regulations enacted after the global financial crisis of 2007-08 have accelerated this shift as higher capital and liquidity requirements for banks have restricted their ability to act as market-makers. We believe the corporate bond market is in the early stage of a secular transition from voice-based to electronic trading, and that MarketAxess, as a leading electronic platform, will be a prime beneficiary of this shift.


Equinix, Inc. (EQIX), which is classified under Real Estate as a specialized REIT, is the leading provider of internet business exchanges. Early in its lifecycle, Equinix leveraged its scale and "network neutral" policy, which allows its customers to connect with one another, to take on large telecom networks as customers. Once Equinix had solidified its leading market position, other telecom networks, major enterprises, web commerce companies, and cloud computing companies felt compelled to join the Equinix "ecosystem" in order to easily and efficiently access these networks. Its stock has appreciated more than five-fold since we first invested. We believe it will continue on its strong growth trajectory driven by key long-term trends, including growth in internet traffic (including video), globalization of financial markets, IT outsourcing, cloud computing, and mobility. Equinix has also been active on the acquisition front, including its largest European competitor. As these acquisitions become fully integrated, we believe they will create meaningful cost and revenue synergies, further enhancing Equinix's global platform.


Unique assets


We are invested in several companies that own and operate what we consider to be assets that are difficult to replace or replicate, due to lack of new supply, regulatory restrictions, or other constraints.


Ski resort owner and operator Vail Resorts, Inc. (MTN) is the Fund's third largest holding, representing 5.2% of net assets. The stock has increased more than eight-fold since we first invested. Restrictions on and expenses associated with developing new ski resorts create high barriers to entry. Vail is focused on increasing season pass sales, which helps immunize it from poor snowfall seasons. It has embarked on an aggressive acquisition strategy to enhance the attractiveness of its multi-resort season passes. In the last several years, it has added Park City in Utah, Perisher in Australia, Whistler Blackcomb in Canada, and most recently, Stowe in Vermont. It has also been upgrading its properties to offer new and improved services and amenities.


Another top ten holding, SBA Communications Corp. (SBAC), is the third largest independent owner of wireless towers in the U.S., with a growing presence in Canada, Central America, and Brazil. SBA owns and operates over 25,000 towers in total. Because of regulatory and zoning requirements, supply is restricted, creating an advantage for existing tower operators like SBA. At the same time, demand in increasing as consumers use increasing amounts of wireless data bandwidth, forcing carriers to augment their networks. To increase network density, carriers lease space for equipment on towers. We think SBA can generate additional revenue from new lease and amendment activity, leading to strong cash flow growth. Given its strong balance sheet, we believe SBA has many opportunities to grow internationally, particularly in Brazil, where SBA has acquired over 5,000 towers.

This article first appeared on GuruFocus.