Letter from Linda. March 31, The Large Cap Index Has Tended to Outperform the Small Cap Index Since 1978

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1 Baseball season is back, and that means spring is here. It also means that the first quarter of 2016 is over; and, like the Democratic and Republican presidential primary races, it was neither subtle nor boring. The year opened with a horrible January for U.S. equity investors, giving rise to speculation about the end of the seven-year bull market. By February 11, the S&P 500 was down 14.2% from its all-time high, which occurred on May 21, The Russell 2000 Growth went into hibernation (think bears), dropping almost 30% from its all-time high on June 23, 2015, before rebounding by 17.4% in the second half of the quarter. Investor anxiety was amplified by fluctuating energy prices, global economic weakness, and uncertainty about the monetary policies of the various central banks. With volatility comes the potential for opportunity. Like baseball teams at the beginning of a long season, we remain optimistic. We have conviction about the future of the U.S. economy. It continues to grow at a steady pace, unemployment rates are low, and interest rates remain at stimulative levels. We continue to identify and invest in companies we believe will benefit from the current environment. We think that small cap growth companies, in particular, are well-positioned to benefit, since their valuations relative to large caps are near their lowest level in more than a decade. The first quarter of 2016 was also the third consecutive quarter in which the Russell 1000 outperformed the. Looking at the 10-year monthly rolling relative returns of the two indexes since their inception in 1978, an investor who defines small cap stocks via the and large cap stocks via the Russell 1000 may hastily, and wrongly, decide that small cap stocks may not be a good longterm investment because (i) they have outperformed large cap stocks only about one-third of the time, and (ii) they may have recently entered a new cycle of underperformance. The Large Cap Has Tended to Outperform the Small Cap Since % 6% 4% 2% 0% -2% -4% -6% -8% -10% vs. Russell Year Annualized Excess Returns The Russell 2000 outperformed 35% of the time. Average Annualized Excess Returns of Russell 2000: -1.1% Mar-88 Mar-90 Mar-92 Mar-94 Mar-96 Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 Mar-16 Source: FTSE Russell via FactSet. Based on monthly rolling returns. Drawing such conclusions, and acting upon them, based on a partial data set, may be misguided and risky for investors. While public U.S. equities have been around for more than two centuries, the Russell indexes performance LINDA MARTINSON CHAIRMAN, PRESIDENT AND COO data covers less than 40 years, making long-term comparisons limited. A longer data set, like Dartmouth s Prof. Kenneth French s data library starting in 1926, presents a very different long-term story for smaller companies: on a 10-year basis, they have outperformed larger companies more than three quarters of the time, by over 300 bps annualized on average. In addition, the long-term chart below shows that while smaller companies sometimes went through periods of poorer performance, they always rebounded and outperformed significantly for extended periods. Small Cap s Have Tended to Outperform Large Cap s Since % 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% -6% -8% -10% Small Cap s vs. Large Cap s 10-Year Annualized Excess Returns Small Cap s outperformed 77% of the time. Small Caps vs. Large Caps (K. French) vs. Russell 1000 Average Annualized Excess Returns of Small Cap s: 3.1% Mar-36 Mar-40 Mar-44 Mar-48 Mar-52 Mar-56 Mar-60 Mar-64 Mar-68 Mar-72 Mar-76 Mar-80 Mar-84 Mar-88 Mar-92 Mar-96 Mar-00 Mar-04 Mar-08 Mar-12 Mar-16 Source: Kenneth R. French. Data set: Portfolio Formed on Size. Small cap stocks are represented by the value-weighted monthly returns of the second quintile and large cap stocks are represented by the value-weighted monthly returns of the top quintile.

2 Despite the difference in the pictures presented by the two charts, both of them indicate a current period of poor relative performance for smaller companies. However, this, too, may be misleading as the performance of both data sets is measured based on popular index construction methodologies. And, very importantly, indexes and stocks are not the same thing. es were originally introduced as a rough gauge of the performance of the overall stock market or segments of it. They were not intended to be templates for creating portfolios that mirror their performance. With the advances of technology and financial ingenuity, indexed investment vehicles have become more popular and, in many cases, are becoming the preferred investment option for all kinds of investors. The first equity index fund was launched in 1976 and the first equity ETF started in 1993, but these passive products have been gaining a meaningful market share only in the past dozen or so years. Currently, passive U.S. equity products represent about 40% of all equity fund assets. In 2015, active U.S. equity mutual funds had outflows of $163 billion while passive funds, including index mutual funds and ETFs, had net inflows of $129 billion, showing the shift in investors mindset. The Assets of Passive Products Have Increased Significantly $4,500 $4,000 $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 Asset Under Management of Active and Passive U.S. Equity Products ($Bn) Source: Morningstar Direct Asset Flows. Total Active Total Passive Funds The poor relative performance of the majority of active managers in recent years has been one of the main drivers of this trend. The exceptionally strong and extensive bull market, with low volatility, above-average intra-stock correlations, and low dispersion of stock returns, has offered little opportunity to U.S. active managers to outperform their benchmarks. In our opinion, this is not a sound reason for long-term investors to abandon active management. While investing in passive products may have recently produced better results, indexed investment vehicles may not be the best choice for long-term investors since they are subject to considerable deficiencies and shortcomings of the index construction and rebalancing methodologies. The primary factor in the construction of popular indexes, like the Russell or the S&P indexes, is market capitalization. A company s market capitalization ETFs determines if it will be a constituent of a given index. For example, a company with capitalization greater than $3.6 billion on May 29, 2015 would not have been an eligible constituent of the June 30, 2015 reconstitution of the. If it was lower than that, it would have been eligible. Market capitalization is also used to determine a company s weight in the index. The larger the market capitalization, the larger the weight. Thus, more successful companies that have grown will carry larger weights and will have larger impacts on the index s performance in the future. Essentially, the index is betting that past success will result in future success. There are secondary criteria that also affect index membership. These include trading requirements such as minimum volume and/or minimum stock price, country of incorporation, etc. Some indexes, like the popular Russell indexes, do not include companies with specific structures, such as limited partnerships (e.g., LLCs and MLPs) or stocks at their IPOs. While some of these criteria may sound sensible, all of them automatically limit the investment universe in a purely mechanical way which may prevent investors from capitalizing on great opportunities. Another purely mechanical control of the structure of indexes is their periodic reconstitution. The broadly used Russell indexes are reconstituted annually, on the last Friday of June. Since the reconstitution list is published a month in advance, the prices of the stocks that are added or dropped may be negatively affected, leading to embedded transaction costs associated with passive investing. Reconstitution takes place regardless of current market and economic conditions or ongoing trends. It is purely backwardlooking, readjusting the index portfolio to what has worked best in the past instead to what is likely to work best in the future. Also, companies that have been very successful in the past and have great potential for even bigger success in the future may be dropped out of the index simply because they have grown beyond a certain market capitalization. In our opinion, this mechanical portfolio construction and management processes are subject to much inefficiency that cripples investors ability to take advantage of great opportunities and limits their long-term returns to just average. One of the major advantages of a buy & hold strategy is that it allows companies to realize their long-term growth potential, while the small cap indexes tend to drop the winners too early due to reconstitution rules. For example, Under Armour, Inc. went public in November of 2005 and wasn t added to the until a month later. In June of 2011, with its market cap at about $4 billion, Under Armour was removed from the small cap index and was added to the Russell Mid Cap and the Russell 1000 es. While Under Armour was a constituent of the it returned 169%. Since its removal from the index, the stock returned an additional 356%. Investors in a ETF missed a significant portion of the return generated by Under Amour since its IPO just because of the mechanics of inclusions and reconstitution. Baron Growth Fund d the stock at its IPO in 2005 and, because we invest for the long term and continue to hold it, we have participated in the upside. Since Baron Growth Fund s first investment in Under Armour, the stock has appreciated by 2,597%. There were other similar examples among Baron small cap investments, like SBA Communications Corp., Choice Hotels International, Inc., and

3 TransDigm Group, Inc., that were constituents of the small cap index for a period of time. The charts below show a few examples of the meaningful returns that were missed by small cap index investors when the stocks were deleted from the index. Opportunities Missed by Small Cap Investors Under Armour, Inc. SBA Communications Corp. $25 $20 $15 $5 120% Baron Growth 169% 356% $18 $16 $14 $12 $8 485% -97% 105% $6 $4 $2 686% Baron Small Cap 323% Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Baron Growth Fund - Total Return Since First Purchase: 2,597% Choice Hotels International, Inc. $4.5 $4.0 $3.5 $3.0 $2.5 $2.0 $1.5 $1.0 $0.5 49% Baron Growth 169% 283% Jun-96 Jun-97 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-98 Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Baron Small Cap Fund - Total Return Since First Purchase: 2,421% TransDigm Group, Inc. $14 $12 $8 $6 $4 $2 14% Baron Small Cap 51% 938% Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Baron Growth Fund - Total Return Since First Purchase: 1,430% Source: FTSE Russell, Factset, Bloomberg. We performed an extensive analysis of the Russell 2000 Growth constituents, looking back more than 30 years, and measured their longterm performances beyond the reconstitution date. We chose this small cap growth index because it is the benchmark for the small cap Baron Funds. We found many examples like Under Armour, but there were also many examples of poor performers that were removed from the index. Reasons for their removal include bankruptcies, market caps that fell below the floor, share prices below $1.00, and corporate actions. Our analysis showed that the returns generated by the top performers significantly outweighed the losses of poorly performing companies, implying that a buy and hold investment approach could be a better strategy for a long-term small cap investor than a small cap index portfolio. Baron Small Cap Fund - Total Return Since First Purchase: 1,692% Baron s investment approach has always recognized the advantages of holding stocks for the long term and allowing them to realize their true growth potential. We do not believe that buying and selling based only on market capitalization criteria, like index funds and ETFs do, is optimal for achieving above-average long-term results. Yet, when we invest, we don t simply rely on holding stocks over many years to achieve our objective. We use fundamental analysis and years of experience in our efforts to add additional value for our shareholders, while keeping an eye on style drift. Our established small cap funds, Baron Growth Fund and Baron Small Cap Fund, invest in small cap growth stocks and remain invested in those stocks if we believe that their growth opportunities continue to be attractive.

4 Aside from significant opportunities for growth, before we invest in a company we also assess its competitive advantages and look for strong, visionary management and an attractive valuation. If our criteria are met, we carefully establish positions and patiently wait for our investment thesis to materialize, re-evaluating it periodically. We believe that our exhaustive research process, combined with significant experience in various investment environments, have given us an edge and have helped us create alpha. When compared to the Russell 2000 Growth and to the performance of large cap stocks, both Baron Growth Fund and Baron Small Cap Fund, on average, outperformed significantly over three-, five-, and 10-year periods, as shown in the table below. This comparison suggests that small caps, particularly in the growth space, can be a pretty good idea for long-term investors if in a portfolio that differs from a pure-form index-based approach. Furthermore, the performance of the Baron Funds is calculated net of fees while the performances of the indices are gross of fees. Baron Growth Fund Has Tended to Outperform At Baron Funds, we have always seen tremendous opportunity in small cap stocks. We believe that since small cap companies are not as well covered as larger cap companies, we have the chance to find what we think are great companies before other investors. What is particularly appealing is that many ideas are born in the small cap space, which offers us the opportunity to identify plenty of businesses that we believe have the potential to become disrupters, making money for investors as they grow into larger companies. We believe our thorough and disciplined research process allows us to consistently uncover these opportunities early in their life cycle. We build portfolios stock by stock and hold on to businesses we believe will be successful over the long term. We don t sell them just because they reach an arbitrary market cap. We have been investing in small cap businesses for over 30 years. We believe our way of investing gives us an edge over small cap index funds and ETFs, where long-term small cap investors may strike out. We are at the beginning of a long season, and we look forward confidently and optimistically. We think our seasoned Baron team will continue to get hits, score runs, and win titles. Sincerely, Performance of the Baron Growth Fund vs. the Russell 2000 Growth and vs. the Russell 1000 based on rolling monthly data since the Fund s inception % Time Average Annualized Outperformance Excess Return 3-Yr 5-Yr 10-Yr 3-Yr 5-Yr 10-Yr Periods Periods Periods Periods Periods Periods Baron Growth Fund vs. Russell % 71% 90% 4.84% 4.97% 4.78% Growth Baron Growth Fund vs. Russell % 87% 98% 3.18% 4.14% 4.39% vs. Russell % 66% 82% 0.02% 1.05% 1.73% Linda S. Martinson Chairman, President, and COO April 20, 2016 Source: FTSE Russell via FactSet, Baron Capital Baron Small Cap Fund Has Tended to Outperform Performance of the Baron Small Cap Fund vs. the Russell 2000 Growth and vs. the Russell 1000 based on rolling monthly data since the Fund s inception % Time Average Annualized Outperformance Excess Return 3-Yr 5-Yr 10-Yr 3-Yr 5-Yr 10-Yr Periods Periods Periods Periods Periods Periods Baron Small Cap Fund vs. Russell % 66% 82% 3.53% 3.40% 2.87% Growth Baron Small Cap Fund vs. Russell % 90% 94% 3.95% 4.14% 3.65% vs. Russell % 78% 87% 0.23% 2.42% 2.13% Source: FTSE Russell via FactSet, Baron Capital

5 The discussion of market trends and companies are not intended as advice to any person regarding the advisability of investing in any particular security. Some of our comments are based on current management expectations and are considered forward-looking statements. Actual future results, however, may prove to be different from our expectations. Our views are a reflection of our best judgment at the time and are subject to change any time based on market and other conditions, and we have no obligation to update them. Investors should consider the investment objectives, risks, and charges and expenses of the investment carefully before investing. The prospectus and summary prospectuses contain this and other information about the Funds. You may obtain them from the Funds distributor, Baron Capital, Inc., by calling BARON or visiting Please read them carefully before investing. Past performance is no guarantee of future results. The investment return and principal value of an investment will fluctuate; an investor s shares, when redeemed, may be worth more or less than their original cost. The Adviser has reimbursed certain Fund expenses for Baron Opportunity, Fifth Avenue, Focused Growth, International Growth, Real Estate, Emerging Markets, Energy and Resources, Global Advantage and Discovery Funds (by contract as long as BAMCO, Inc. is the adviser to the Fund) and all the Funds transfer agency expenses may be reduced by expense offsets from an unaffiliated transfer agent, without which performance would have been lower. Current performance may be lower or higher than the performance data quoted. For performance information current to the most recent month end, visit or call BARON. Baron Asset Fund s annualized returns as of March 31, 2016: 1-year, (4.68)%; 5-years, 9.67%; 10-years, 6.42%. Annual expense ratio for the Institutional Shares as of September 30, 2015 was 1.04%. Baron Growth Fund s annualized returns as of March 31, 2016: 1-year, (8.13)%; 5-years, 8.63%; 10-years, 6.42%. Annual expense ratio for the Institutional Shares as of September 30, 2015 was 1.04%. Baron Small Cap Fund s annualized returns as of March 31, 2016: 1-year, (12.61)%; 5-years, 6.63%; 10-years, 5.49%. Annual expense ratio for the Institutional Shares as of September 30, 2015 was 1.04%. Baron Opportunity Fund s annualized returns as of March 31, 2016: 1-year, (10.12)%; 5-years, 4.96%; 10-years, 6.61%. Annual expense ratio for the Institutional Shares as of September 30, 2015 was 1.10%. Baron Partners Fund s annualized returns as of March 31, 2016: 1-year, (7.45)%; 5-years, 9.85%; 10-years, 6.38%. Annual expense ratio for the Institutional Shares as of December 31, 2014 was 1.26% (comprised of operating expenses of 1.06% and interest expense of 0.20%). Baron Fifth Avenue Growth Fund s annualized returns as of March 31, 2016: 1-year, (3.47)%; 5-years, 11.30%; 10-years, 5.77%. Annual expense ratio for the Institutional Shares as of September 30, 2015 was 1.04%. Baron Focused Growth Fund s annualized returns as of March 31, 2016: 1- year, (6.20)%; 5-years, 6.11%; 10-years, 6.78%.* As of December 31, 2014, annual operating expense ratio for the Institutional Shares was 1.09%. Baron International Growth Fund s annualized returns as of March 31, 2016: 1-year, (2.88)%; 5-years, 3.34%; Since Inception (12/31/08), 11.01%. As of December 31, 2014, annual operating expense ratio for the Institutional Shares was 1.34%, but the net annual expense ratio was 1.25% (net of the Adviser s fee waivers). Baron Real Estate Fund s annualized returns as of March 31, 2016: 1-year, (12.72)%; 5-years, 12.44%; Since Inception (12/31/09), 15.70%. Annual expense ratio for the Institutional Shares as of December 31, 2014 was 1.06%. Baron Emerging Markets Fund s annualized returns as of March 31, 2016: 1-year, (9.91)%; 5-years, 2.11%; Since Inception (12/31/10), 1.76%. As of December 31, 2014, annual operating expense ratio for the Institutional Shares was 1.27%, but the net annual expense ratio was 1.25% (net of the Adviser s fee waivers). Baron Energy and Resources Fund s annualized returns as of March 31, 2016: 1-year, (35.54)%; Since Inception (12/30/11), (8.59)%. As of December 31, 2014, annual operating expense ratio for the Institutional Shares was 1.52%, but the net annual expense ratio was 1.10% (net of the Adviser s fee waivers). Baron Global Advantage Fund s annualized returns as of March 31, 2016: 1-year, (8.67)%; Since Inception (4/30/12), 7.70%. As of December 31, 2014, annual operating expense ratio for the Institutional Shares was 2.92%, but the net annual expense ratio was 1.25% (net of the Adviser s fee waivers). Baron Discovery Fund s total return as of March 31, 2016: 1-year, (23.34)%; Since Inception (9/30/13), 3.39%. As of September 30, 2015, annual operating expense ratio for the Institutional Shares was 1.25%, but the net annual expense ratio was 1.10% (net of the Adviser s fee waivers). *Reflects the actual fees and expenses that were charged when the Fund was a partnership. The predecessor partnership charged a 15% performance fee through 2003 after reaching a certain performance benchmark. If the annual returns for the Fund did not reflect the performance fees for the years the predecessor partnership charged a performance fee, the returns would be higher. The Fund s shareholders will not be charged a performance fee. The predecessor partnership s performance is only for periods before the Fund s registration statement was effective, which was June 30, During those periods, the predecessor partnership was not registered under the Investment Company Act of 1940 and was not subject to its requirements or the requirements of the Internal Revenue Code relating to registered investment companies, which, if it were, might have adversely affected its performance. If a Fund s historical performance was impacted by gains from IPOs and/or secondary offerings, there is no guarantee that these results can be repeated or that a Fund s level of participation in IPOs and secondary offerings will be the same in the future. Portfolio holdings as a percentage of net assets as of March 31, 2016 for securities mentioned are as follows: Under Armour, Inc. Baron Growth Fund (4.9%), Baron Opportunity Fund (1.1%*), Baron Fifth Avenue Growth Fund (1.8%); SBA Communications Corp. Baron Asset Fund (2.7%), Baron Small Cap Fund (3.4%), Baron Opportunity Fund (1.5%*), Baron Real Estate Fund (1.2%); Choice Hotels International, Inc. Baron Asset Fund (1.4%), Baron Growth Fund (2.7%), Baron Focused Growth Fund (4.5%); TransDigm Group, Inc. Baron Small Cap Fund (4.3%). Portfolio holdings may change over time. *% of Long Positions. Definitions (provided by BAMCO, Inc.): The Russell 2000 Growth is an unmanaged index that measures the performance of small-sized U.S. companies that are classified as growth. The Russell 1000 is an unmanaged index that measures the performance of large-sized U.S. companies. Russell Midcap is an unmanaged index that measures the performance of medium-sized U.S. companies. Russell 2000 is an unmanaged index that measures the performance of small-sized U.S. companies. An ETF, or exchange traded fund, is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. About Risk: The value of investments in equity securities is subject to unpredictable declines in the value of individual securities and periods of below average performance in individual securities and the equity market as a whole. Growth stocks are generally more sensitive to market movements than other types of stocks primarily because their stock prices are based heavily on future expectations. If our assessment of the prospects for a company s growth is wrong, or if our judgment of how other investors will value the company s growth is wrong, then the price of the company s stock may fall or not appreciate as we expect.