Summary and Conclusion

Manager Cliff Greenberg of Baron Small Cap (BSCFX) looks for well-run small cap businesses with the potential for strong long term growth. And when he finds them, he holds on for the long-term as well. The fund’s current turnover is a very low 33% and has averaged just 45% since the funds inception in 1997, which shows that Cliff hasn’t changed his investment strategy in his 7+ years on the fund.

However, Cliff brings a value-sensitivity to his pursuit of growth, only pulling the trigger when he can buy those high-growth potential firms at a significant discount to what he believes is their true value.

Cliff’s strict criteria has led to a more concentrated portfolio than his peers, with 94 holdings (versus 170 for the typical small-cap fund) and 32% of the fund’s assets in his top 10 stocks (compared to 24% for the average small-cap offering).

It has also led to impressive performance versus his peers. Baron Small Cap has outperformed 90% of the funds in the small-cap growth universe over the past five years and has bettered 98% of them so far in 2005.

And, not surprisingly, he has outperformed his benchmark, the Russell 2000 Growth index, in 6 of the past 7 years. The only year the fund did not beat the benchmark was in 2003, but the fund was still up 39% for the year.

Unfortunately, a by product of this success, and our main concern for the fund, has been significant asset growth. With $2.6 billion to invest, Cliff faces a more challenging task than the average fund in the category which has less than $600 million to manage. Fortunately, Baron has been monitoring this issue as well and closed the fund to new investors effective April 22, 2005.

Management
Investment Advisor
Baron Capital Management, a registered investment advisor, was founded by Ron Baron in 1982 and is located in New York City. The firm initially managed private accounts and sold investment research to financial institutions. In 1987, they introduced another registered investment advisor to manage mutual funds called BAMCO, Inc. and established the Baron Asset Fund. Now there are six Baron Funds totaling over $12 billion assets under management. The firm employs 6 investment professionals and 11 research analysts.

Portfolio Manager
Cliff Greenberg joined Baron in January 1997 as a Senior Analyst and became portfolio manager of Baron Small Cap in October of that year when the fund was launched. He is now a senior VP of the company as well as portfolio manager of Baron Small Cap. Prior to that, he worked at HPB Associates, an investment partnership, for 12 years starting off as a security analyst and moving up the ranks to fund manager. He became a General Partner there in 1991. He has a BA from Cornell University and J.D. from Columbia University.

Philosophy
Cliff shares the same philosophy as Ron Baron and the rest of the company. He believes in long-term investing, using their own research, investing in businesses that have long-term growth opportunities, and purchasing good businesses at attractive prices. He typically buys stocks when they are out of favor and have the potential for rapid earnings growth.

He looks for three basic types of companies; classic growth companies; fallen angels (companies that have long-term growth potential but have recently experienced a steep decline in price because of a short-term problem); and special situations (companies that have recently developed new products, brought on new management, or emerged from bankruptcy).

Classic growth companies make up the majority of the portfolio. He expects that these companies will grow 100% in the next four to five years and then grow another 100% in the next four to five years after that.

At Baron the emphasis is that you are investing in management, not just the companies they run. Ron Baron recently said, “We invest in the people, identify the businesses they operate, buy them at good prices, and then hold on to them for a long time.”

Allocation
Cliff has always favored consumer service companies and the fund currently has 38.4% of its assets in this sector (vs. 10.8% for the Russell 2000 Growth index). Within the consumer services sector, Cliff likes recreation and resorts (8.7% of the fund’s assets) and education companies (6.9%). Cliff rarely invests in technology stocks since he does not think the risk/reward trade-off is very good. He has just 1.6% of the fund in software and hardware vs. 20.2% for his benchmark.

He does like telecomm, however, placing 10.6% of his assets in this sector compared to just 2.1% for the index. At the end of the quarter, cash had risen to a higher-than-normal 13%, but Cliff has since put some of it to work, and cash is now back down to the fund’s norm of around 9%.

Sector Breakdown % of Net Assets (as of 4/30/05)
Sectors	Baron Small Cap		Russell 2000 Growth
Software	0.80		8.40
Hardware	0.80		11.80
Media	4.50		1.70
Telecommunications	10.60		2.10
Healthcare	11.50		18.40
Consumer Services	38.40		10.80
Business Services	16.30		12.50
Financial Services	5.00		10.00
Consumer Goods	5.60		5.30
Industrial Materials	6.40		13.00
Energy	0.00		5.90
Utility	0.00		0.00

Performance
Baron Small Cap continues to outperform its peers this year. The major contributor to the fund’s success is Cliff’s excellent stock selection. His stock selection returns are in the top quartile in his peer group. Another factor helping the fund is that it holds a mix of both small-cap growth (41% of its assets) and mid-cap growth companies (40%), since mid-growth stocks have outperformed small growth stocks by 6.7% year-to-date. Cliff’s aversion to tech stocks has helped the fund’s performance as well since technology has taken a big hit so far this year.

Still it’s remarkable that the fund is currently in the top 2% of its peers without any exposure to energy and an underweight in healthcare, since energy and medical services are the top performing sectors this year.

While the fund has solidly outperformed its peers again this year, it is still underwater. Besides the fact that small caps as a whole have endured a very tough start to the year (the Russell 2000 Growth index is off nearly 13%), his lack of energy exposure and his large concentration in education (a long-term theme of Cliff’s) along with business service companies have contributed to the fund’s negative performance so far in 2005.

However, Cliff still has high conviction in the stocks in the fund and remains committed to the company’s belief that the businesses they own will succeed over the long-term. And we remain committed to Cliff and the continued success of this fund.

Baron Small Cap Performance (as of 4/30/05)
	YTD	1-Year	3-Year	5-Year
Baron Small Cap	-4.03%	6.29%	8.99%	7.00%
Peer Category: Small Growth	-10.33%	1.08%	2.57%	-3.43%
Russell 2000 Growth	-12.76%	-0.55%	2.50%	-5.83%
% Rank in Peer Category	Top 2%	Top 22%	Top 7%	Top 10%