Can This (Red) Baron Fund Fly Again?
Ron Baron founded Baron Capital Management, a registered investment adviser in 1982 before branching out into mutual funds in 1987, with the launch of Baron Asset Fund (BARAX). He simultaneously introduced BAMCO, an additional registered investment advisor to help manage the fund. Baron has long been an advocate of taking a long-term approach to picking stocks, using a bottom-up philosophy to identify growth opportunities. To do so, valuation models are used to develop price targets based on internal projections of company fundamentals. Specifically, he seeks companies that have sustainable growth and solid management teams, with a particular penchant for “sunrise industries”, which he describes as the businesses that are believed to create opportunities for our children and our grandchildren.
The stable of funds under his supervision has since grown to nine, with specific offerings now concentrating on real estate as well as international markets. Although the primary focus of the flagship fund was on small- and mid-cap stocks, the strategy was altered a bit over time as some of these issues grew in size. Enter Baron Fifth Avenue Growth Fund (BFTHX). Introduced in 2004, this offering is a large-cap growth fund. It is managed by Randall Haase, who applies Baron’s techniques to the stocks of larger companies in order to uncover those possessing above-average growth potential. He typically looks for companies with market capitalizations greater than $5 billion, and that have the potential to double in size within five years. He employs many of the same research-intense procedures that are used in the other Baron funds, with the belief that large-cap markets can be just as inefficient and volatile as its smaller counterparts, and, therefore, just as opportune.
Because of its internal screens the fund has historically been heavily skewed towards telecommunications, energy, financial services, health care, and consumer discretionary stocks, and has had light exposure to technology. Not much has changed of late, either, with this trend clearly evident with recent additions to the roster. Indeed, three of management’s more significant and recent bets were Community Health Systems Inc. (CYH), Teva Pharmaceuticals (TEVA), and 3M Company (MMM), all of which were added in the March quarter.
Community is a leading operator of non-urban and mid-sized market for-profit hospitals in the U.S. with 18,000 beds in more than 120 hospitals in 29 states. Haase and his team of analysts believe that Community will be the beneficiary of a strong industry foothold, as well as its aggressiveness on the acquisition front. We agree, and estimate that this stock will produce above-average returns for investors over the next three to five years, as many of its customers, struggling with capital restraints, will need to look to more established and financially healthy partners, i.e. Community.
Elsewhere, Teva has taken a prominent position in the portfolio too. And we see why. The company is a sizable drug provider with a healthy generic stable. Not only are people living longer and requiring greater medical attention, but generics ought to continue gaining popularity, as governments and employers look to curtail escalating healthcare costs. Haase’s team estimates that over $150 billion in branded drug sales will lose patent protection over the next five years and believes that Teva will be one of the biggest beneficiaries of such developments. Once again we agree, and think that recent acquisitions will help to fuel above-average share-earnings in the meantime.
Last but not least is diversified manufacturer 3M. It produces more than 50,000 products worldwide that span the gamut from industrial to healthcare products. Hasse suggests that the company’s size and scale should help it maintain industry leading margins, while its financial wherewithal allows management to continue reinvesting in the company and rewarding shareholders. Although we share some of the optimism about the company’s prospects, we are not as bullish on the stock at the current price.
Although management’s strategy has not worked out too well so far (it was in negative territory for the year-to –date period through March and thus has slightly underperformed the S&P since inception), it is important to remember that long-term growth remains the goal and that near-term volatility often brings opportunity. Whether or not management can use the same investment tactics that helped some of its smaller-cap offering come to prominence on blue-chips remains to be seen, though.