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Navigating Volatility: Baron Asset Fund's Strategic Approach in a Shifting Market

Overview of Third Quarter Market Trends and Fund Performance

During the third quarter of 2025, U.S. stock markets experienced an upward trajectory, extending gains from the previous period. This growth was largely propelled by the Federal Reserve's decision to lower interest rates, coupled with robust corporate earnings, easing trade tensions, strong consumer spending, increased merger and acquisition activities, and ongoing excitement surrounding artificial intelligence. A significant portion of the S&P 500 Index's quarterly rise was attributed to a select group of leading technology companies, colloquially known as the 'Magnificent Seven.' These companies were instrumental in driving the outperformance of sectors such as Information Technology, Communication Services, and Consumer Discretionary, while others like Consumer Staples, Real Estate, and Financials lagged. The Russell Midcap Growth Index also saw its performance heavily influenced by a limited number of high-valuation stocks, many of which exhibited lower earnings quality. This market environment presented unique hurdles for the Baron Asset Fund, which typically prioritizes high-quality, growth-oriented companies at sensible valuations.

Detailed Analysis of Market Returns and Index Contributions

The Russell Midcap Growth Index's 12.84% return during the first three quarters of 2025 was disproportionately driven by just 10 stocks, which accounted for roughly 90% of the gains. The remaining 343 companies in the index collectively contributed only 1.35%, with nearly half experiencing negative returns. These dominant stocks often featured high volatility and elevated valuations, exemplified by companies trading at extreme multiples of next-twelve-month earnings or showing negative earnings per share. This trend marked a historical divergence in performance, where companies with high-quality earnings significantly underperformed those with lower-quality earnings. Such unusual market dynamics posed considerable challenges for the Fund's established investment philosophy of acquiring financially sound companies with competitive advantages and reasonable price tags.

Contributors and Detractors to Fund Performance in Q3

The Baron Asset Fund experienced a decline of 4.23% for its Institutional Shares in the third quarter, trailing the Index's 2.78% gain. This underperformance was primarily due to the Fund's strategic underexposure to certain market styles, such as Momentum, Beta, and Residual Volatility, which proved costly as stocks aligned with these factors surged. Conversely, the Fund's emphasis on Earnings Quality hindered performance amidst the rally in lower-quality stocks, marking the worst three-month period on record for this factor. Sector-wise, stock selection in Information Technology and Communication Services was responsible for about 75% of the underperformance, with notable declines from Gartner, Inc. and StubHub Holdings, Inc. Weakness in Consumer Discretionary, Financials, and Industrials also impacted results, driven by companies like Choice Hotels International, Inc., On Holding AG, FactSet Research Systems Inc., Morningstar, Inc., and Verisk Analytics, Inc. However, strong stock selection in Health Care, particularly IDEXX Laboratories, Inc., and higher exposure to Real Estate partially offset these negative trends.

Key Contributors: Highlighting Successful Investments

IDEXX Laboratories, Inc., a leader in veterinary diagnostics, positively impacted performance due to better-than-expected financial results, reflecting improved foot traffic to veterinary clinics and successful deployment of its inVue Dx cellular analyzers. Amphenol Corporation, a major supplier of advanced interconnect systems, also contributed significantly as investor expectations for data center capital spending rose with increased AI adoption. Its acquisition of CommScope's Connectivity and Cable Solutions business was well-received, underscoring Amphenol's consistent ability to create shareholder value. Space Exploration Technologies Corp. (SpaceX), a privately held company founded by Elon Musk, continued to generate substantial value through the expansion of its Starlink broadband service and its leadership in reusable launch technology, including the development of the powerful Starship rocket.

Key Detractors: Examining Underperforming Holdings

Gartner, Inc., a provider of IT-related syndicated research, detracted from performance after reporting disappointing earnings, characterized by decelerating contract value growth and market concerns about AI's impact on its business model. Despite this, the Fund maintains conviction in Gartner's proprietary data, strong ROI for clients, and its potential to benefit from companies seeking AI-related insights. StubHub Holdings, Inc., a leading marketplace for live event ticket resales, underperformed following its September IPO, impacted by heavy investments in market expansion and challenging revenue comparisons from previous successes. Verisk Analytics, Inc., a data and analytics vendor for the property and casualty insurance industry, saw its stock decline due to a conservative outlook, a dilutive acquisition, and industry-wide uncertainty regarding AI and a slowing insurance pricing backdrop. Despite these headwinds, Verisk reported strong quarterly earnings, and the Fund remains confident in its long-term growth prospects.

Strategic Portfolio Allocation and Long-Term Holdings

As of September 30, 2025, the Fund maintained a portfolio of 55 positions, with the 10 largest holdings accounting for 47.2% of net assets and the top 20 representing 69.4%. The largest sector weighting was in Information Technology (24.9%), followed by Industrials (23.6%), Health Care (14.7%), Financials (11.6%), and Consumer Discretionary (9.4%). A notable characteristic of the Fund's portfolio is the long-term tenure of its major holdings, with six of the top 10 positions held for over a decade. This reflects the Fund's commitment to investing in companies that benefit from enduring growth trends, possess significant competitive advantages, and are led by top-tier management teams.

Recent Portfolio Adjustments and New Investments

During the quarter, the Fund made several adjustments, including initiating new positions in Loar Holdings Inc. and Skyryse, Inc. Loar Holdings Inc., a niche manufacturer of aerospace parts, was added due to its proprietary product portfolio, strong aftermarket sales, and significant pricing power within the aerospace and defense industry. Its strategy of acquiring smaller firms and compounding EBITDA organically and through M&A aligns with the Fund's growth objectives. Skyryse, Inc., a private company focused on enhancing aviation safety and accessibility, was invested in for its development of SkyOS, a comprehensive flight operating system that uses software and AI to automate complex in-flight controls, with potential applications in both existing fleets and new production lines, including a collaboration with the U.S. Army. Concurrently, the Fund reduced its weightings in long-held positions such as IDEXX Laboratories, Inc., Guidewire Software, Inc., Arch Capital Group Ltd., and Gartner, Inc. Dayforce, Inc. was sold following an agreement for acquisition by a private equity firm.

Future Outlook and Investment Philosophy

After a period of strong outperformance during the first quarter's equity market downturn, the Fund faced challenges in the third quarter due to an unusual market environment that favored speculative, lower-quality stocks. Despite these short-term headwinds, which represented one of the most difficult periods in history for high-quality companies, the Fund remains steadfast in its investment philosophy. Historically, while certain stock types may fluctuate in investor favor, the intrinsic value of high-quality businesses eventually garners recognition and reward. The Fund believes its holdings continue to exhibit strong growth opportunities, competitive strengths, and increasingly attractive valuations, reinforcing its confidence in a long-term, fundamental, active approach to growth investing.