Analysis of Baron Asset Fund
analysis, mutual fund

A recent story in Barron’s covers the Baron Asset Fund (BARAX; Retail class shares). This $3 billion, mid-cap fund has a 1.31% expense ratio and 13% turnover. According to the article

Over the past five years, the fund returned 15% a year on average, better than 84% of its Morningstar mid-cap growth peers.

The current manager took over the fund in late January 2008. Therefore, the following analyses will start in February 2008, the first full month under sole management.

The primary prospectus benchmark for the fund is the Russell Midcap Growth Index. One of the long-lived and accessible implementations of this index is the iShares Russell Mid-Cap Growth ETF (IWP). Alpholio™ calculations indicate that through June 2017 the fund returned more than the ETF in only 32% of all rolling 36-month periods, 39% of 24-month periods and 38% of 12-month periods.

Rolling 36-Month Returns of Baron Asset Fund (BARAX) and iShares iShares Russell Mid-Cap Growth ETF (IWP)

The median cumulative (not annualized) underperformance over a rolling 36-month period was 3%.

In contrast to our earlier post about the fund, this analysis will use a simpler variant of the patented Alpholio™ methodology, in which both the membership and weights of ETFs in the reference portfolio are fixed. Here is the resulting chart of the cumulative RealAlpha™ with statistics for Baron Asset:

Cumulative RealAlpha™ for Baron Asset Fund (BARAX)

With a comparable volatility, the fund cumulatively underperformed its reference ETF portfolio by over 52%.

The following chart with related statistics illustrates the constant composition of the reference ETF portfolio (the membership was limited to a maximum of six ETFs):

Reference Weights for Baron Asset Fund (BARAX)

The fund had major equivalent positions in the Consumer Discretionary Select Sector SPDR® Fund (XLY), iShares Morningstar Mid-Cap Growth ETF (JKH), iShares S&P Small-Cap 600 Growth ETF (IJT), First Trust US Equity Opportunities ETF (FPX), Guggenheim Insider Sentiment ETF (NFO), and iShares U.S. Medical Devices ETF (IHI). These positions constituted average exposures the fund generated over the entire analysis period. They should be viewed in the context of the overall investment portfolio of which the fund may be part.

The final chart with traditional statistics compares the total return of Baron Asset to that of the aforementioned IWP and JKH:

Total Return for Baron Asset Fund (BARAX), iShares Russell Mid-Cap Growth ETF (IWP) and iShares Morningstar Mid-Cap Growth ETF (JKH)

The fund performed similarly to JKH (best-fit mid-cap ETF) but underperformed IWP (benchmark mid-cap ETF). Despite a relatively low turnover, in each of the past four years the fund had significant long-term capital gain distributions, which made it much less tax-efficient than these two ETFs. At the end of August, the fund held only 55 equity positions, with top-ten holdings accounting for almost 43% of assets. Divesting just a few of these positions could result in additional large distributions.

In sum, under current management the Baron Asset Fund did not outperform the available investment alternatives on a risk-adjusted basis. Any value added was consumed by a sizeable management fee.

To learn more about the Baron Asset and other mutual funds, please register on our website.

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Analysis of Baron Asset Fund
analysis, mutual fund

A recent article in Barron’s emphasizes stock picking skills of the Baron Asset Fund’s manager:

Discerning the strengths and weaknesses of companies that make up the stock market is the job of a fund manager. Andrew Peck, 44, who runs the Baron Asset Fund (ticker: BARAX), is a particularly perceptive one. In 2013, his fund returned 38.88%, besting both the Standard & Poor’s 500 Index and the Russell Mid-Cap Growth Index. Peck believes the coming year again will play to his fund’s strengths. Even if they rise, interest rates remain low, flows into equities (for now) are positive, market multiples have room to expand, and Washington is making progress on budget issues. In this environment, “a long-term fundamental investor like we are can find great growth companies and watch them compound,” he says.

This mid-cap growth fund boasts $2.7 billion in AUM, an average expense ratio of 1.32%, and a relatively low turnover of 15.6% (three-year average). However, despite the latter, the fund may not be the most tax-efficient one: over the last three years, its long-term capital gain distributions averaged 11.5% of the distribution NAV.

The primary benchmark for the fund is the Russell Midcap® Growth index and the secondary benchmark is the S&P 500® index. Therefore, the primary benchmark will be used for further comparisons.

Commenting on the fund’s historical performance, the article says:

From 2004 to 2008, the fund posted strong returns, then dropped to the bottom rung of performance in 2009 and 2010 as companies with balance sheet and liquidity problems–the kinds of stocks he avoided–did best. But from 2012 on, performance improved sharply.

As a matter of fact, the fund failed to beat a practical implementation of its primary benchmark, the iShares Russell Mid-Cap Growth ETF (IWP), in 2007 and in each year from 2009 through 2012. The fund’s 2013 return was higher than that of IWP by 3.36% but at a level of over 35%, which means that the relative difference was not that big. According to data from Morningstar, the Sharpe ratio of the fund was higher than that of IWP in the three- and ten-year periods through January 2014, but lower in the five-year period.

Let’s investigate the performance of the Baron Asset Fund using Alpholio™’s methodology. Here is the cumulative RealAlpha™ chart for the fund:

Cumulative RealAlpha™ for BARAX

Since early 2005, the fund generated less than 0.1% of annualized regular RealAlpha™ relative to its reference portfolio of ETFs, which had a slightly lower volatility. The lag RealAlpha™ performance was even worse — annualized negative 1.1%. The latter indicates that some investment decisions made by the fund’s management backfired in subsequent sub-periods. In other words, in those cases the investor would have been better off by holding on to ETFs in the reference portfolio rather than changing the portfolio composition to most closely track the fund (hence the lag aspect; to learn more, please visit our FAQ).

The following chart shows ETF weights in the fund’s reference portfolio over the same analysis interval:

Reference Weights for BARAX

The fund’s top equivalent positions were in the iShares Morningstar Mid-Cap Growth ETF (JKH; average weight of 32.6%), Vanguard Consumer Discretionary ETF (VCR; 19.5%), iShares S&P Small-Cap 600 Growth ETF (IJT; 14.2%), iShares Russell 1000 Growth ETF (IWF; 8.6%), Vanguard Financials ETF (VFH; 6.5%), and Vanguard Industrials ETF (VIS; 6.4%).

It should also be noted that an equivalent cash and short-term investments position in the iShares 1-3 Year Treasury Bond ETF (SHY; included in the Other component of the above chart) was as high 18.7%. This implies that at times the fund may have engaged in market timing instead of being close to fully invested in equities, as it is at present (99.4% at the end of 2013). Alpholio™ discussed this topic in previous posts.

In sum, our analysis has demonstrated that since 2005 the Baron Asset Fund exhibited an unimpressive performance on a truly risk-adjusted basis. Its cumulative lag RealAlpha™ significantly lower than the regular RealAlpha™ indicates that not all stock picking ideas of the fund’s management produced the desired outcome. In many cases, the investor would have been better off by staying put with a reference portfolio of ETFs that emulated the fund’s returns in previous analysis sub-periods. Finally, the fund could be effectively substituted by small number of equity and fixed-income ETFs in a dynamic portfolio with a lower volatility.

To learn more about the Baron Asset Fund and other mutual funds, please register on our website.

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Analysis of Baron Growth Fund
analysis, mutual fund

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:

Cumulative RealAlpha™ for BGRFX

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:

Reference Weights for BGRFX

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.

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