Baron Funds Q3 2023 Letter From Ron Baron

OWN IT!!!!

On November 10, 2023, more than 5,000 Baron Funds’ shareholders and institutional clients of Baron Capital, our family-owned investment manager, attended the 30th Annual Baron Investment Conference (the Conference).

Since our first annual conference in 1992, the only years we did not hold such a gathering were during the two COVID years, 2020 and 2021. Again, as we have for the past 20 years, Baron Capital held the 2023 Conference at New York City’s Lincoln Center. As attendance at our annual event has increased, Baron has steadily expanded our conference venue. From just one building in 2004, to all five buildings on the Lincoln Center campus last year. The Annual Baron Conference is now anchored at the largest of these buildings, the Metropolitan Opera House.

OWN IT!!! was the theme of our 2023 meeting. The OWN IT!!!! theme was intended to describe Baron’s strategy of investing for the long term in exceptionally well-managed, competitively advantaged growth businesses.

Baron Capital has investments in about 400 businesses. Regardless, only 30 investments represent about 59% of our Firm’s assets under management. The values of these 30 businesses have increased significantly since Baron first purchased their shares. CEOs of four of these businesses spoke in the morning about their opportunities for further significant growth.

Andy Florance, founder and CEO of real estate data firm CoStar Group, Inc. (CSGP), could not have been more optimistic about the prospects for CoStar’s expansion into residential real estate. He outlined how CoStar is supporting his vision by spending about $1 billion annually to make this happen. We began to invest in CoStar in 2001. As of December 31, 2023, its shares have since increased 50.4 times with an annualized return of 19.3%. CoStar is Baron’s fourth largest holding.

FactSet Research Systems Inc. (FDS) CEO Phil Snow spoke about his business’ growth potential for open-sourced data, including recently introduced private credit data…adding more services to those already being provided…and the derivation of FactSet’s name…”sets of facts.” Phil spoke not only about his totally fascinating background as well as the history and opportunities for FactSet. Baron began investing in FactSet in 2006. FactSet has since increased 11.2 times with an annualized return of 15.1%. FactSet is our sixth largest holding.

Michael Kehoe is the Founder and CEO of Kinsale Capital Group, Inc. (KNSL) Kinsale is a specialty insurer with a unique operating model based on data and exceptional response times to Kinsale’s brokerage clients. Kinsale is not your parents’ insurance company. Kinsale is Michael’s second big corporate success, and we think Kinsale still has a long way to go. If you’d met Michael, you’d understand why we feel that way. We began to purchase Kinsale shares in 2016. They have since increased 18.8 times and have earned an annualized return of 48.4%. Kinsale is our 13th largest holding.

Eric Green has been the CEO of West Pharmaceutical Services, Inc. (WST) since 2015. West’s vials and systems for packaging drugs undergo two years of stability testing for FDA approvals and are a critical part of the drug approval process. West’s packaging represents a very small percentage of drug dosage costs. We began to purchase West in 2013. The stock has since increased about 11.1 times with an exceptional annualized return of 25.6%. West is our 24th largest investment.

Ajei Gopal is the CEO of simulation business ANSYS, Inc. (ANSS) When he spoke at the 29th Conference in November of 2022, Ajei described how ANSYS computer simulation helps businesses design and manufacture cars…rocket ships…bathing suits for Olympic swimmers…and just about anything else you can think of better…faster…cheaper than if you tested a physical product. Since Ajei has been CEO of the business, he has penalized his firm’s annual profits by investing to become a much larger company. ANSYS is our 10th largest holding. Since we began to purchase its shares in 2009, it has increased 14.0 times with an annualized return of 19.3%.

During the past two months, three larger companies have offered to purchase ANSYS at a significant premium to the December 31, 2023 price. The winner in this bidding contest, another simulation business, Synopsys, agreed to purchase ANSYS at a price of nearly $400 per share. Approximately half the purchase price will be cash, the remainder in Synopsys (SNPS) stock. We assume that because Ajei thinks this is a good deal, after we study Synopsys carefully over the next several months, there is a good chance you will see Synopsys in our portfolios when this transaction is completed.

Before our Conference begins every year, CNBC’s Squawk Box visits and interviews me and guests during a two hour program segment. This year, two of our special guests were Choice Hotels International, Inc. (CHH) Chairman Stewart Bainum and CEO Pat Pacious. Several years ago, Stewart described Pat to me as the most effective CEO in Choice’s history. If you watched the raucous conversation between Stewart, Pat, Squawk Box anchor Andrew Ross Sorkin, and me, I’m certain you could glean why that is so. In 1969, I was attending law school on scholarship and at night while working as a Patent Examiner for the U.S. Patent Office in the daytime. I invested in Manor Care in 1969 at the time of its IPO. I then borrowed money at usurious rates to invest after I read about that company and the Bainum family in The Washington Post. I thought Manor Care would be a beneficiary of President Lyndon Johnson’s Medicare Bill that passed Congress in 1965. I was right. Manor Care has been an enormously successful investment for us.

Manor Care was the parent of Choice Hotels, the largest hotel franchiser in our nation. Choice has also been an incredibly successful investment for Baron. Baron has been Choice Hotel’s largest institutional investor since it was spun out of Manor Care in 1996. Choice has since increased in value 32.2 times for an annualized return of 13.6%…and Stewart has become a very good friend. When he started to lavishly compliment me on Squawk Box, I handed him a wad of bills to thank him. When he initially refused to return the money, we both cracked up.

We were introduced to FIGS, Inc. co-founder and CEO Trina Spear about a year ago. We have been investing in her unique, health care uniform, direct to consumer, and importantly, replenishment business soon after that. FIGS has grown from zero revenue 10 years ago to more than $500 million in annual revenue since…which Trina believes will ultimately reach many billions. Trina and her co-founder, Heather Hasson, were recently subjects of a Harvard Business School case study. If you can get your hands on that study or somehow watch it on film, it will not be hard for you to understand why we purchased 15% of their company…at what we regard as very depressed prices over the past several months. Andrew Ross Sorkin’s and my interview with Trina at the Conference that morning was really fun. I will shortcut your FIGS research efforts and write a lot more about FIGS and Trina in the months to come. FIGS is not yet one of our top 30 investments. In the not too, too distant future we expect it to become one…due to appreciation…not because we purchase a lot more. One more thing. Just like I regard Stewart Bainum as a good friend, I think about Trina the same way, just as I do of dozens of CEOs and executives of businesses in which we invest. Sure makes my “job” fun…and easier…when we invest in people I like…admire…think are unbelievably talented…and trust.

Baron Capital’s investment process is straightforward…

We do not try to predict wars…interest rates…commodity prices…elections…stock market trends…or any other macro events that we believe cannot be predicted. We also do not try to predict whether such developments will impact stock prices. We don’t trade stocks. We just invest for the long term in publicly traded businesses using our proprietary research and steadily growing staff of 45 investment professionals…many of whom are unusually long tenured…to identify and study and become unusually knowledgeable about such businesses.

Our underlying assumptions? That the price of everything we want to purchase will double about every 14 to 15 years…which means that the purchasing power of our savings will fall in half about every 14 to 15 years…and that our stock markets and economy will double about every 10 to 11 years. This has been the case during my entire lifetime. We try to double our money every 5 to 6 years by owning businesses that sustainably grow double digits per year, not the nominal high single-digit growth rate of our economy…6% to 7% per year including inflation. This is how we protect the purchasing power of your hard-earned savings from inflation.

I often remark that, “We Invest in People.” In the executives who manage businesses in which we invest on behalf of ourselves and clients…and in the 209 individuals who we recruit, train, and retain. The reason we have long-tenured analysts and executives? We hire the best…those we judge to be the most talented…and best educated…and provide them with an incredible environment in which to work. That includes access to among the most interesting and talented executives of public companies…while working alongside other exceptional Baron individuals…and offer all opportunity for career advancement. We have never had a layoff in the 42-year history of our business. Whether our business is having a very strong…or average…or, on occasion, difficult year. We rely on our analysts and managers and all the rest of our fellow employees who provide our researchers and investors a platform to show their stuff. Since we rely on our fellow employees, we, in turn, want them to rely on us.

Unlike Warren Buffett who tries to invest in competitively advantaged businesses that can be “run by any idiot… since sooner or later they will be,” we pride ourselves doing what algorithms cannot. We invest in mission-driven, extraordinarily talented individuals whom we believe to be awesome leaders. Like Elon Musk, for example. Such individuals most often surround themselves with like people.

Engineering positions at Tesla, Inc. (TSLA) and Space Exploration Technologies Corp. (SpaceX) are the two most sought-after career positions for top-of-class engineering students, despite the challenging workloads at both companies. That’s to work with Musk…and the unusually talented and driven people he attracts…and to be involved in super interesting projects at both companies. Last year, at a time when many businesses struggled to attract qualified workers, Musk’s businesses had 3.5 million job applicants for 30,000 open positions!!! These two fast growing, unique businesses employ 142,000 individuals.

Executives of Utah’s Eccles family foundation recently visited us. This foundation, one of the largest in our nation, was created from a family business that eventually included more than 50 banks and dozens of large industrial companies. It was founded about 150 years ago by David Eccles, a hard-working and obviously immensely talented immigrant. David was 14 years old when he, an impoverished individual, arrived in America from Paisley, Scotland in 1863…in the midst of our Civil War! David was able to come to America because of charitable gifts from his homeland that he repaid many times over. “Surrounded by giants you become a giant” was how this entrepreneurial business founder described his hiring process. In fact, David was so kind and generous to the exceptional individuals with whom he worked that when he passed away, they mentored his children and grandchildren. So learned, disciplined, and talented were his family members, that, in 1933, in the midst of the Great Depression, his son, Marriner, was called to testify before Congress. Marriner’s ideas were the basis for FDR’s New Deal!!! Marriner Eccles became the seventh Head of The United States’ Federal Reserve. What an amazing country in which we are privileged to live…

The Annual Baron Investment Conferences are intended to inform…and for us to thank you for investing with us…

We held the first Annual Baron Investment Conference in 1992 at the Harmonie Club in New York City. Our idea was to allow Baron investors to meet the managements of businesses in which we had invested their savings. The first two meetings featured “The Chucks,” Chuck Mathewson and Chuck Schwab. Maybe 40 to 50 shareholders showed up for each. At the time, those 40 to 50 investors probably represented a significant portion of the $100 million (“m” for million) assets we then managed.

You would have benefited from investing with “The Chucks”…and not selling. Chuck Mathewson’s International Game Technologies’ (IGT) idea was to link IGT slot machines in all Las Vegas casinos to produce slot wins comparable to lottery jackpots. His IGT increased in value 100 times from $100 million when he acquired control to $10 billion. Chuck Schwab’s brokerage business revolutionized mutual fund distribution. Arguably, without his innovation, Baron wouldn’t exist. In 1992, Charles Schwab (SCHW) had customer accounts valued at about $60 billion. Schwab’s customer assets now exceed $8.5 trillion! Schwab’s share price has since also increased more than 100 times.

Lunchtime entertainment in 1992 was Beatlemania, a Beatles tribute band, complete with 1960s wigs and mustaches. Our lunch service consisted of a buffet table with shrimp and chocolate chip cookies. In the center of the table, crouching beneath, her head protruding disguised as a table ornament wearing sunglasses and a huge hat covered with fruit, was entertainer Hedda Lettuce. When a guest was too greedy about the cookies, the head slowly turned and spoke in a weird voice, “Put those down.” Luckily there were no heart attacks.

Since then, our entertainment offerings have improved. Sir Paul McCartney…Barbra Streisand… Billy Joel…Sir Elton John…Jerry Seinfeld…Bette Midler…Hugh Jackman…Rod Stewart…Alicia Keyes…Cher…Faith Hill and Tim McGraw…Bruno Mars…Billy Crystal…and, as Andrew Ross Sorkin likes to say on CNBC…”so much more…” You could get the full list on Wikipedia. CNBC Squawk Box now spends more than two hours with us on Conference day.

This year lunch entertainment was the legendary John Legend…comedian Adam Sandler…and performances from the Broadway Show Beautiful Noise about the life and music of Neil Diamond. Neil Diamond was our real-life entertainer in 1999! The final entertainment to end Conference Day this year was the amazing…unbelievable…astonishing…Justin Timberlake singing and dancing and hanging out with the audience for an hour…and my two grandsons 11-year old Leo and 9-year old Ari after the show talking about what professional basketball team Leo, Ari, and 8-year old Sirus Timberlake would play for after college! All are less than 5′ tall!!! Except Justin, of course.

I had worried that Justin was too young for our audience. Boy, was I wrong! This guy is one of the very best entertainers I have ever seen…and a super nice guy to boot. From his entrance to the stage down the Opera House aisles amid our shareholders and dancing and singing with my Rabbi, Central Synagogue’s Angela Buchdahl, in our audience…just perfect. The day closed with surprise performer, 23-year old Noa Kirel, Israeli pop star, singing Hatikva the Israeli national anthem. Hatikva means Hope, which all in the audience clearly felt after the October 7th medieval and depraved slaughter…torture…rape…… and hostage taking by Hamas…at the Israeli peace concert and kibutz bordering Gaza. Noa’s performance was met with total silence…except for audible sobs.

As our attendees quietly filed out of the Opera House to get their Baron swag…and complimentary Scream Ice Cream cones from four Scream Ice Cream trucks (two last year weren’t enough…four weren’t enough this year either…six next year?)…to view Tesla cars and the Tesla CyberTruck for the first time in NYC…thousands stood in line to thank me for the day…and especially for Noa’s performance. Jews and non-Jews alike. Made me cry.

Hope we will see you next year. Thank you again for investing with us.

Respectfully,

Ronald Baron, CEO

Almost forgot. This year, as we have for the past five years, we gave away three Tesla Model Ys as door prizes. I got the idea from Oprah’s book gifts. Tesla wants to make sure you know that Baron Capital, our privately owned management company, bought these cars….and paid full retail price…no discounts.

All expenses for this meeting, as has been so for all our prior meetings, were also paid by Baron Capital. No expenses for these meetings are paid by our guests/shareholders. The intent of these meetings, as noted, is to inform…and to say thanks to you.

Baron’s Mission

1. My dad was an engineer for the Army. My parents were never able to invest in stocks. Baron Capital’s Mission is to enable middle class individuals like my parents to invest in growing businesses and participate in the growth of America’s economy…and to protect their savings purchasing power from inflation. Just like the opportunities the wealthy among us have always had.
2. We guard our reputation fiercely and regard our reputation as the cornerstone of our business. It is one of the most important elements of our business that allows us to attract exceptional individuals to work at Baron. “Would your younger self like you? Would he or she be proud of the life you have lived?” That’s a question I have asked myself since one of our Rabbi’s posed it to our congregation several years ago. My belief and my hope is that individuals with whom I work feel the same way about their careers at Baron as I do.
3. We understand that our success is not just about hard work…experience…investing in talented people…and finding unusual, distinctive, advantaged businesses in which to invest. We believe that our success, as well as virtually everyone else’s, entails a certain amount of good luck. We give an appreciative “shout out” to two very special financial executives in our business, Peggy Wong, our CFO since she joined us in 1987, and Jane Liang, our Corporate Treasurer, since she joined us in 2007. In accord with Chinese culture, about which Peggy and Jane try to educate me, we recognize that the number 8 connotes wealth and good luck. Accordingly, we opened a koi pond on the 48th floor of our offices in the General Motors Building on August 8, 2008, 08-08-08!!! Koi fish are also supposed to bring good luck. We were taking no chances!

How have we performed?

One more thing. It is unusual that mutual fund investors or any investors for that matter have been able to perform over the long term better than benchmark indexes. Since their respective inceptions as mutual funds, 16 funds, representing 98.6% of Baron Funds’ AUM, have outperformed their benchmarks and 14 funds, representing 96.6% of Baron Funds’ AUM, rank in the top 20% of their respective Morningstar categories. Five funds, representing 46.5% of Baron Funds’ AUM, rank in the top 1% of their categories. Further, Baron Partners Fund is the top performing U.S. Equity fund (out of 2,101 share classes) since its conversion in 2003 from a partnership to a mutual fund.[1]The Fund also had a better performance record than the top performing U.S. Equity fund since its inception as a partnership in 1992. If you had hypothetically invested $10,000 in a fund designed to track Baron Partner Fund’s benchmark index in 1992, that investment would now be worth $204,000. If it had been hypothetically invested in Baron Partners Fund it would now be worth over $900,000.

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