Ron Baron's Baron Funds Fourth Quarter 2014 Shareholder Letter

On November 7, more than 5,000 Baron Funds shareholders attended our 23rd Annual Baron Investment Conference. It was again held at the Metropolitan Opera House at Lincoln Center in New York City. The morning session was comprised of presentations by five CEOs of businesses in which Baron Funds has significant investments. We also held morning “breakout sessions” with our managers, analysts and executives for our institutional clients. After lunch we held our executive presentations and portfolio manager panel at the Met where our surprise entertainer, Sir Paul McCartney, performed at the end of the day.

Our conference no longer takes place only at the Metropolitan Opera House. We also use three additional Lincoln Center venues: Avery Fisher Hall, Alice Tully Hall and The Vivian Beaumont Theatre. These music halls provide our shareholders with comfortable venues to enjoy box lunches and more surprise entertainers during a midday intermission from our business presentations. In response to requests from our investors, next year we intend to use the music halls for additional morning “breakout sessions.” CEOs of Brookdale Senior Living, CaesarStone, ANSYS, Middleby and Manchester United spoke to our shareholders and answered their questions during the morning.

Brookdale CEO Andy Smith explained his business philosophy by noting, “It’s all about the people.” Thirty years ago, Dr. Thomas Frisk, who founded this operator of senior living communities, demanded that Andy put $5 into a cigar box whenever he used the word “facility” to describe Brookdale. That word implied nameless and faceless institutions. Brookdale does not have “facilities,” Andy told us. “We are a community. We take care of people.” This is a philosophy we share at Baron.

Under the leadership of CEO Yos Shiran, CaesarStone has almost tripled sales of its premium quartz countertops in the past four years. “When CaesarStone people ask ourselves what gets us out of bed in the morning, we think about the good things that we can bring to people through our products.”

CaesarStone’s goal is to be the number one surface company in the world. CaesarStone is significantly adding to its product designs as well as its manufacturing and distribution capabilities. We think Yos and CaesarStone are just getting started.

Selim Bassoul is the CEO of institutional kitchen equipment company Middleby. Selim’s dad taught him that “it doesn’t matter what tools you have. You can succeed.” There were no swimming pools in Lebanon, where Selim grew up, so his dad swam in the Mediterranean and became an Olympic swimmer! “The first time he got into a pool, it was to compete.” Selim learned that lesson well and turned around a languishing company with mediocre institutional kitchen products into a company with the most innovative products in its industry. It now dominates every market segment into which it sells…and, in our view, still has opportunity to grow significantly.

An engineer by training, ANSYS CEO Jim Cashman knows ANSYS engineering simulation software inside and out. It is much faster and cheaper for ANSYS clients to design and create new products virtually rather than physically. ANSYS is involved in products ranging from cars, airplanes and smartphones to household products and candy shells that don’t break. Famously, ANSYS software was used to create the Speedo swimsuit Michael Phelps wore to victory in the 2008 Olympics that was later banned for providing Michael Phelps with an unfair advantage. It’s that good. When I spoke to Jim after our conference to thank him for participating, he paid our firm a compliment I hear often from other executives in whom we have invested. “When I finish speaking to Neal Rosenberg, Andrew Peck and Mike Lippert about our long-term plans, I am exhausted. It feels like I’ve just been through a car wash.”

The 135-year-old English football team, Manchester United is the world’s most popular sports team. CEO Ed Woodward has transformed Man U into an unusually successful business by expanding its reach into more than 150 countries. It is beginning to monetize its powerful brand through licensing and sponsorship agreements. In July 2014, Man U inked a record-breaking $1.28 billion, 10-year agreement with Adidas. We think Manchester United has an opportunity to nearly double its revenues and more than triple its cash flow in the next six or seven years.

A fun lunchtime intermission . . .

During the lunch intermission following our CEO presentations, country star and “AllAmerican Girl” Carrie Underwood, winner of six Grammy Awards and 16 Billboard Music Awards, “Blew Away” our investors in Vivian Beaumont Theatre. Tony, Grammy and Emmy-nominated, former Miss America Vanessa Williams and the cast of Showboat gave Baron’s shareholders a joyful midday ride in Avery Fisher Hall. And, rising R&B star Janelle Monáe showed us why she is one of President Obama’s favorite and fun, regular entertainers at the White House in Alice Tully Hall.

After lunch, Baron investors returned to the Met. They then listened to and then questioned Baron Funds Chairman and Chief Operating Officer, Linda Martinson, and me, our Firm’s CEO and Chief Investment Officer, as well as our nine other portfolio managers. “Wow!!! Do you think he got Ringo?!!!” Baron Shareholder. Metropolitan Opera House.

At 2:45 p.m. , I began to tease the audience with hints about who was about to entertain them. As one after another “got it,” they began to stand and cheer. Of course, not everyone “got it.” One individual, standing and cheering next to one of my friends, yelled, “Wow!!! Do you think he got Ringo?!!!” When I got to the punch lines that “the first song at my wedding in 1978 was really “Something”…the ring tone for my phone is perfect for “Judy”…who wouldn’t want to “hold the hand” of their grandchild…and, finally, Baron shareholders…“come together” and “let me introduce to you to the act we’ve known for all these years…” the audience exploded. Cheers from the audience of “I love you, Paul!” made that afternoon seem almost like watching The Beatles’ first appearance 50 years ago on The Ed Sullivan Show only a few blocks away from the Met.

Sir Paul then treated our shareholders to an incredible 93-minute performance. Virtually the entire 5,000 person audience was standing, dancing and singing along with him for most of the show! Paul had never before performed at the Met. Swept up by the metaphysical presence of opera stars past and present, like Luciano Pavarotti, Placido Domingo and Enrico Caruso, all of whom had performed on the same stage, Paul seemed to be having as much fun as the audience. Several times he vamped into operettas to show us that!

But, I am getting ahead of my story. At 12:45 p.m., just before we planned to start our afternoon sessions, I was backstage when Paul’s manager knocked on my dressing room door. “Would you like to meet Paul McCartney? He’s two doors away. Let me take you there.” When we entered his dressing room, Paul asked me to sit next to him on a piano bench. We then spoke for about 15 minutes. At first I didn’t know exactly how to address him. Since I felt like I was talking to the Pope, “Sir Paul” seemed right to me. “Please call me Paul,” he said. “Interesting theme for your conference, ‘Built to Last.’ Fifty years ago when we came to America, the crowds of hysterical fans at the airport overwhelmed us. When we performed on stage at The Ed Sullivan Show, the girls in the audience were screaming so loudly I couldn’t hear John singing … and he was standing right next to me!” Paul went on, “Bands like The Beatles were then generally popular for two or three years. We asked each other, ‘Lads, how long do you think this will last?’ None of us would have believed that 50 years later our fans would be gynecologists, dentists and investors like you…”

Sir Paul McCartney is “Built to Last.”

We chose Sir Paul McCartney to entertain you at our 2014 “Built to Last” conference because we thought he symbolizes that theme perfectly. We believe Paul and his music have endured for 50 years not only because we love to listen to his songs as much now as when we first heard them in 1964. It is because, like other great artists, he has kept his core values, while still striving to constantly reinvent himself to remain contemporary and relevant., The beat and lyrics of his songs are now different than they were in the 1960s …because the world has also changed. What hasn’t changed? McCartney’s process. He works relentlessly on his lyrics and creates timeless songs, as he always has. He continues to study all music genres: classical, opera, popular and rock, as he always has. This conforms to our idea about great works and the artists who create them. Whether it is architecture by Frank Lloyd Wright or Frank Gehry, plays and movies directed by Mike Nichols, sonatas written by Mozart or Bach, paintings by Picasso or Matisse, or investment strategies of Warren Buffett (Trades, Portfolio). Great works are all built upon a foundation of prior great works. Finally, when Paul performs, his fans cannot miss the passion Paul still displays; his talent, energy and love for his work; and the wonderful poetry in his lyrics…all elements that we think make his work “built to last” for at least another 50 years! Of course, when you listen to his music and lyrics, they make you feel happy and they make it difficult for you to remain in your seat.

Paul McCartney, like other great artists, is a model for us all. The companies in which Baron Funds invests are different than at the beginning of my career in 1970. But the process that allows us to discover these businesses is still the same. Diligent research. Investing in people. Investing for the long term. Investing in businesses with competitive advantages that are difficult for competitors to overcome. Sir Paul McCartney says, “People remember the music, not the words.” What he means is that the creative process is more important than any specific piece of art. We think our investment strategy fits McCartney’s dictum.

We hope you will join us this fall for the 24th annual Baron Investment Conference.

If you didn’t have a chance to join us at the 23rd Annual Baron Investment Conference, we hope you will plan to be with us next fall at our 24th. If you missed our last meeting in November, and, if you are a shareholder and would like a “Built to Last” Baron Funds 2014 T-shirt, please let us know, including your size, and we will send you one at no charge.

You can watch presentations by Linda and me at this year’s meeting on our web site, www.baronfunds.com. You can also watch our portfolio manager panel at the conference on that site. Presentations by the five CEOs of businesses in which we have invested and who spoke that morning can also be found on our web site. If instead of watching you’d like to read Linda’s and my presentations, they are included in the “Letter from Ron” and the “Letter from Linda” that follow this introduction.

One more thing. The annual Baron conference is paid for in its entirety… breakfasts, lunches, entertainment, T-shirts and chocolate covered pretzels to our departing shareholders…by BAMCO, Inc., our privately owned investment management company. No expenses for this meeting or any other annual Baron conference have been paid for by Baron Funds.

Thank you for joining us as fellow Baron Funds shareholders.

The annual Baron Investment Conference is intended to allow our shareholders to meet and listen to executives of businesses in which their hard earned savings have been invested. These entrepreneurial individuals discuss their backgrounds, businesses and why they believe their businesses are “built to last”…and can become much larger. Our annual conferences are also intended to let our shareholders meet and listen to Baron Funds’ analysts, managers and executives. This is so our investors can make a more informed decision about whether we are continuing to follow our vision of “investing in people”… and whether they think the executives who have spoken are capable, trustworthy, hardworking and inspirational leaders… and whether their businesses are attractive. It is also so we can say “thank you” in person for investing with us.

We look forward to seeing you this fall.

Sincerely,

Ronald Baron

CEO and Chief Investment Officer

Baron Funds

January 22, 2015