Unlike many of its peers, Baron Growth Fund (BGRFX; retail shares) prefers a buy-and-hold strategy. As an article in The Wall Street Journal points out, the fund’s turnover ratio is only about 10% vs. about 84% of an average mid-cap growth fund.
The fund typically invests in small-cap stocks and divests them as they reach a mid-cap level after an average holding period of eight years. Hence, a mixed classification of the fund by Morningstar: small-cap growth (SG) category through 2010, and mid-cap growth (MG) afterwards.
This strategy has apparently succeeded:
Through Nov. 30, Baron Growth has gained an average of 14.1% a year since inception, outpacing the 7.9% annual return of the Russell 2000 Growth Index, according to Morningstar. This year, through November, the fund is up 34.8%, vs. an average 30.8% for Morningstar’s midcap-growth category.
Or, has it? The fund currently has about $8.1 billion in assets compared to a median of $433 million for the small-cap growth and about $758 million for the mid-cap growth categories (average figures are skewed higher due to a few big funds). A large size makes it more difficult for this smid-cap fund to outperform. As of the beginning of December 2013, the annualized 10-year return for the fund was 10.27%, compared to 10.08% for the iShares S&P MidCap 400 Growth ETF (IJK) and 10.84% for the iShares S&P Small-Cap 600 Growth ETF (IJT).
The following chart shows the relative performance of the fund from the Alpholio™ perspective:
The cumulative RealAlpha™ of the fund had three distinct phases: it was mostly flat from early 2005 through early 2008, subsequently declining through 2011, and finally rebounding in early 2012. In the entire analysis period, the annualized RealAlpha™ was negative, and the volatility of the fund was higher than that of its reference ETF portfolio. It is also worth noting that the lag cumulative RealAlpha™ curve was generally below the regular curve, which indicates that some of the new investment ideas were not as good as the previous ones. (For a detailed explanation on how to interpret the relationship between these curves, please see the FAQ.)
The next chart illustrates percentage weights of ETFs in the reference portfolio for the fund:
The fund’s three equivalent positions with highest average weights were in iShares S&P Mid-Cap 400 Growth (IJK; average weight of about 18.4%), iShares Morningstar Mid-Cap Growth (JKH; 15.6%), and iShares S&P Small-Cap 600 Growth (IJT; 11.8%).
An equivalent position in the iShares Russell 2000 Growth ETF (IWO), included in the Other component in the above chart, had an average weight of only 8.1%. This makes questionable the choice of the Russell 2000 Growth index as the prospectus benchmark for the fund.
The article cites one potential negative — the fund has a 1.32% expense ratio. However, its manager claims otherwise:
Mr. Baron says the fund is a bargain considering its performance.
Well, the above analysis clearly demonstrated that the investor would be better off, from both the return and risk perspectives, by substituting the fund with a dynamic portfolio of ETFs. For more information about Baron Growth, please register on our website.