Transcript: Caroline Woods: Joining me now, Ashim Mehra, managing director, portfolio manager at Baron Capital. Ashim, great to have you. Thanks so much for being here. Ashim Mehra: Thanks, Caroline. Thanks for having me. Caroline Woods: All right. So as we think about finding the next AI winners, should investors be just focused on buying the dip and some of the biggest names we already know? Or should they be looking for the next generation of winners? Ashim Mehra: Caroline, we think it’s a combination of both. We think you should be looking at the existing companies that are winning and that continue to win in terms of taking market share, growing their business, secreting margins. And also there are new opportunities higher up the stack, specially at the application layer companies. That may not be just the AI infrastructure winners, but more at the application layer. Ashim Mehra: And we think there are plenty of those companies as well. Caroline Woods: Yeah. So is it that. So I was going to ask are the biggest opportunities still in companies building the infrastructure right now, or should we start to focus on the companies actually putting AI to work? Ashim Mehra: I think both. So I think again, the the infrastructure build out is still relatively early. So there is lots of opportunity within the infrastructure layer, both among obviously the larger cap companies but also a baron. We have a history of doing a lot of small and mid-cap investing. So among small and mid-cap, we think there are some really interesting companies. Ashim Mehra: And then I think there are companies that are at the application layer, companies that are using AI to really reinvent their own businesses or that are central to their business. And these companies are maybe less household names. Some of them might be, but companies like Spotify or Hinge Health that are really making AI centric to what they do and levering it to grow their business and to be more efficient. Caroline Woods: So we’ll get into more of those names in just a second, but should point out this is an ETF spotlight. Your fund is the Baron Technology ETF, BCTK. down about 7% this month as the AI trade has, you know, been receiving some increased scrutiny. Have you been taking advantage of the sell off or has anything that we’ve seen that’s played out, you know, in the month of October made you more cautious on areas of the AI trade? Ashim Mehra: Caroline we have added to our positions in semiconductors in the last several weeks, maybe in the last month, plus. And we have done that because we believe that some of these stocks have gotten unfairly beaten up. Understandable in terms of where investor concerns are both around capital, around power. But we think that some of these companies now discounting too much, and we have been able to been opportunistic in some of the names that we have added to. Ashim, Caroline Woods: can you give us some examples of names that you think are being unfairly discounted right now? Ashim Mehra: Yeah, we think companies like micron and NVidia, which are trading at some of their lowest multiples in years, despite having a very strong growth, growth outlooks. Nvidia I think in terms of the supply chain advantages it has, we know that SpaceX, another large holding for us and the exclusive they have with them and the added capacity they’re adding talking about ten gigawatts for next year potentially up to 20. Ashim Mehra: And then we think there’s also, you know, smaller and less known companies, companies like SiTime, which is a fabulous conductor company that makes timing chips. So these are components that generate and synchronize the clock signals that every electric system runs on. And this is called the technology called MEMS. And these are replacing quartz. And everything in these AI data centers requires more of these including LEO satellites which are outside of data centers and even autonomous driving. Ashim Mehra: So we think companies like that, which have been some of the fastest growing companies and also some of the fastest growing companies worth going forward, have actually had some of the greatest pullbacks. Caroline Woods: Okay. So I was taking a look at your largest holdings in Nvidia and SpaceX are number one and two making up more than 15% of the portfolio. You mentioned Spotify. Spotify is actually your third largest holding ahead of Alphabet and Amazon. What do you see in Spotify that makes it such an attractive investment here, especially for a tech fund? Ashim Mehra: Yeah. Look, we define tech broadly and we define it broader than maybe some of our peers. We look at companies that are not only doing tech infrastructure, but also companies of the application layer. The way we think about AI broadly is we start with power, kind of the base layer. And then above that you have semiconductors and then you have AI infrastructure that you have the model layers, which are companies like OpenAI and Anthropic. Ashim Mehra: And then you also have the application layer which is historically software companies. And in this case a company like Spotify. So Spotify is completely, you know, I would say gone through a metamorphosis in terms of their ability to take AI and make it central and core to everything they do. So at their last Investor Day a few months ago, they talked about having more products and more functionality. Ashim Mehra: So everything from an AI DJ to using AI to summarize your podcast to just recently integrated with news. Going forward, they’re going to have audiobooks plus plus, which they’ve already recently launched. So they’re having more and more products. But central to all of it is that they are using AI to inform their learning language models. So they’re using their own and third party language models, and they’re informing them with the data that is proprietary to them. Ashim Mehra: And so when, let’s say an artist wants to come out and make a new 80s remix, they can actually use Spotify’s tools to do so. And so this is a company again where we think, you know, growth can be in the mid teens. We think margins can expand dramatically over the next 4 or 5 years. We like the management team a ton. Ashim Mehra: And we think that they are really maybe not a household word in terms of any beneficiary. But I think, they are really from here, one of the companies that’s going to benefit broadly from AI. Caroline Woods: But they are up about 17% this month, still technically negative year to date down a little less than 2% year to date. So not too late to get into that opportunity Ashim Mehra: We still think it’s super compelling. We think there’s 50 plus percent upside over the next two years, and we think that the company can continue to grow and expand customer offerings, using AI to make those offerings even better and better, and make retention better as a result. Caroline Woods: Okay, I want to ask you about Neocloud stocks because they’re actually higher right now, but they’ve been getting hammered over concerns about debt and AI spending. I didn’t see any of those listed in the holdings in your fund. Is that intentional? Ashim Mehra: Yeah. We don’t own any Neoclouds. We’ve, in the in the Baron technology kiov, we’ve really held Amazon Web Services as part of Amazon. We’ve held Google and we’ve held on to some of the what we conceive is the largest adders of capacity. So if you look at obviously what came out from SpaceX last week, we think those are some of the largest compute capacity additions over the next several years. Ashim Mehra: We also think that those companies have an advantage in terms of their cost of capital. That’s not to say that Neoclouds don’t have a place. I think it’s just harder to underwrite, and their cost of capital is clearly gone up and seems like it will continue to go up. So I think those businesses have a place and but for us, we’ve, we centered really on the, on the more traditional and we think the more underwritable larger buyout businesses. Caroline Woods: Well, we had Elon Musk recently warned that 200 plus Neoclouds could face what he called a guppy level death and consolidation. If they start running into trouble, does that put some of your holdings at risk, too? And what sort of moves would you make if that’s the case? Ashim Mehra: Yeah, I think most of our positions are centered on, if you look at are centered on some of the highest quality hyperscalers, I think everyone in the ecosystem would suffer. All the neoclouds, for example, went out of business. But I, I think that is a little bit of an exaggeration in terms of what is the most likely scenario. I think some of these companies, even if you look at CoreWeave it is a small portion of their debt that’s really at the, you know, that’s had the issues in terms of being underwritten at a much higher cost of capital. Ashim Mehra: But if you look at where a lot of these neoclouds have underwritten has in the past, a lot of their, a lot of their underwriting has been done based on their access to NVidia compute to its chips. They’ve been able to securitize that in certain cases. And so we think there will be winners and losers among the neoclouds. Ashim Mehra: So I think our view is just that it’ll be more balanced. And just like most things, you’ll, be winners and there’ll be people who will leave the business. But we think some of those companies might be decent acquisitions because there is demand for computer and more importantly, there’s a lot of demand for power. And if they have access to power in terms of shells and land, we think those are interesting acquisitions for other, other companies. Caroline Woods: Are there any popular technology stocks that you’re deliberately avoiding putting into BCTK? Ashim Mehra: I think what we have done in BCTK is when we go through periods of dislocation and we can go back to 22, you can go back to the most recent semiconductor pullback because we tend to consolidate. So for us what we tend to do is focus more on the positions where we have the most conviction. And that’s what we have done. Ashim Mehra: I don’t think I think broadly we tend to be open minded and look at ideas across the board. And there may be other portfolios of Baron that own names that we may not in this portfolio. But I think one of the areas, for example, that we have avoided, is some of the newer technologies, or at least in this fund, nuclear. Things that are three, 4 or 5 plus years before they have a lot of positive free cash flow. Ashim Mehra: There’s just more risk there. And I think we really focused on companies that have free cash flow now or in the very near future. Caroline Woods: How are you thinking about the Anthropic IPO? Is that something you’d be quick to jump on? Or even if we eventually see the open AI IPO. Ashim Mehra: I think we’re evaluating it. I think the news that’s come out most recently is that their most recent, at least according to OpenRouter, which is one of the resources out in the market, their most recent model has been getting a lot of traction. It seems that in October their business really accelerated, reaccelerated. So I think to be determined, we’re doing a lot of work on it right now. Ashim Mehra: And, you know, obviously we can’t run what we’re going to do in terms of how we decide to participate or not. Caroline Woods: Let’s talk about some of the risks that the AI trade could face is facing. What is the biggest risk that investors might be overlooking right now, even despite some of the pullbacks that we’ve been seeing. I think Ashim Mehra: the two biggest risks in the market have been around capital, and I think that’s been very well discussed. I think the other risk that has been discussed also has been around, Is there enough power to capacity next year? And I think there’s a real debate in the market about how much capacity is and will be available next here for these chips to go into in terms of power data centers. Ashim Mehra: I don’t think, I think the information out there is less than perfect on both sides. So, I think whether you are bullish on that or bearish on that, I think the information is developing very quickly. I think there are companies like Bloom Energy that can help companies accelerate their access to power. It’s a company we own in our portfolio. Ashim Mehra: I think those are the two biggest risks that have been discussed in the market. I think the overall risk is obviously one of supply and demand. And I think the market tends to pivot on the most recent data point. That’s what gives us opportunities to buy more as being long term investors. But when we look out, we still think that demand and every indicator we have for demand has been incredibly positive. Ashim Mehra: The amount of tokens being used is only accelerating. We think there is some differentiation in when you talk, people talk about tokens. All tokens are not created equal between an open model and a closed model, which has been another debate. But really I think those are two largest ones. But I think this supply demand debate has been going on for two years and will continue. I think there’s been a debate around memory also recently whether you need as much memory. But if you see what’s happening in Muse and you see what’s happening with agents across the board, all of those agents require more memory, not less. Ashim Mehra: So we are actually much more bullish on memory. Caroline Woods: Bringing it back to power for just a second. You mentioned Bloom Energy as a holding. You also own Lumentum and Coherent. Other companies benefiting from the infrastructure needed to power AI. Which of those do you think has the most upside from here? Ashim Mehra: I think all three companies are extremely well positioned. They all have slightened. Lumentum and Coherent are more similar in that they are really powering the optics that go into a data center. Today, most data centers, most racks inside of data centers are connected by a copper. Over time, we believe that is going to move to optics and Lumentum and Coherent are two of the largest beneficiaries and have similar businesses. Ashim Mehra: On the other hand, I think Bloom Energy, which really helps companies get behind the meter power. This is essentially power for companies that don’t that cannot connect to the grid. Those types of companies need capacity, need electricity, and they need it. They need it clean. They need efficient so it’s price effective. And they need it so it can also withstand a lot of, a lot of changes in the load. Ashim Mehra: The load at these data centers can spike pretty dramatically from minute to minute. And so Bloom has a solution which really addresses all of these. And for the first time, they have a meaningful contract with now an electric utility, which is whose customer is actually Alphabet or Google. And so we think they’re making a lot of, headway in terms of getting traction for their solutions. Ashim Mehra: And actually, the company is trading at a fairly reasonable multiple for the first time in a while. And we think shares of Bloom are also pretty attractive here. Caroline Woods: You know, there’s a lot of talk about finding the next in NVidia. And as we discussed earlier, some of your holdings aren’t obvious AI stocks, whether it’s Spotify. You mentioned Hinge Health. I saw Shopify also on the list. Could the biggest technology winner over the next five years be a company that isn’t primarily an AI investment? Are we sort of thinking about winners all wrong here? Ashim Mehra: I think it comes back to again, we take a balanced approach. We don’t try to overweight one part of the AI build out more than dramatically more than others. What we try and really look at is, again, back to the application layer. We think some of the most exciting companies and really going forward will be companies that are able to take that application, are able to take AI. And by that I mean all the compute and differentiate on the product level, whether that’s with a consumer or with Hinge Health, its with physical therapy and benefits plans or if it’s in the case of Spotify, again with consumers and have a very differentiated product because they’re Ashim Mehra: showing you products that don’t exist elsewhere, they’re showing you efficiency in time spent that you can now use Spotify to summarize three different podcasts, instead of having to listen to them all three at for an hour each. And so we think some of those companies will be at the application layer. We recently made a private investment in a company called Legora, which is does uses AI for law firms. Ashim Mehra: And we think that’s a really interesting application. So we do think that the application layer represents the the greatest upside or maybe areas where not everyone is looking as much. But I think you have to be you really have to look under the hood and see that these companies are special, that the AI is showing up in incremental revenue because you can you can talk about this. And a lot of companies talk about AI, a lot of companies are spending money. Ashim Mehra: But really the check comes when can you accelerate revenue? Can you can you announce new products but then have products that actually have impact to the marketplace? And that’s what we’re looking for. We’re looking for those kind of financial checks that show us that this isn’t just this isn’t just window dressing. This is core to what they’re doing. It’s accelerating their business, accelerating what they do. And it’s showing up in the finances. Caroline Woods: All right. So bringing it back to the funds, why should investors choose an actively managed tech ETF like BCTK over simply buying the Nasdaq 100 or the S&P 500, which we know offers a lot of exposure to big tech? Ashim Mehra: Yeah, I think there’s a couple of things. Really, one is we invest in competitive advantage at Baron, and that’s really been our hallmark for as long as we’ve been around. And so we are looking for companies that we believe can not only have structural advantages, but also can have this innovation velocity that will help companies accelerate. But that innovation velocity has to have real durable impact in the marketplace and then that marketplace, it shows up in the financials. Ashim Mehra: So that’s competitive advantage. I think one, we have another we have a more balanced fund. And by that I mean both. We have you know we have international names like Spotify and others. But we also have exposure to mid caps and small caps and about as of the last quarter, our exposure to small and mid caps was about 24% of the fund. Ashim Mehra: Now if you look at the Nasdaq 100 or you look at a lot of other tech funds, you will find that they are largely large cap funds that you don’t really get exposure to small and mid caps to a lot of those properties. Lumentum, company we mentioned earlier, you know, we’ve owned it for well over a year, and it was only recently brought into the Nasdaq 100 at a very small weighting. Ashim Mehra: But at this point, you know, it has had you know, it had gone up 4x at the time. It got brought up into the Nasdaq, but it had seen some of its best accretion. And then again we think holistically about these businesses. We look for companies to see what they can be over a period of time, over years, not months or quarters. Ashim Mehra: And then we really look for, you know, that balance question again, of having companies that are not all correlated. One, one of the lessons we learned out of 2022 was that, you know, when you have everything that’s extremely highly correlated to each other, your results are going to be the same. And we like having a Spotify because not only because it’s idiosyncratic in terms of it has its own return path, but it’s unrelated to what happens in AI infrastructure. Ashim Mehra: We like having companies like that and Axon and Hinge Health, because individually they’re great companies, but also holistically they make the portfolio more diverse and really more differentiated. Caroline Woods: Okay. And I have to ask this because I’m sure someone will say this in the comments. I was taking a look. BCTK is up about 14% year to date. The Nasdaq 100 is up about 18%, 17 or no 16% year to date. So, you know, slightly underperforming, but with a fee. So someone’s going to say, why would I pay a fee to underperform? Caroline Woods: Your response would be. Ashim Mehra: My response would be to look at the long term. And if you look over since inception, our returns have far exceeded the Nasdaq. And I think if you get beyond where this current semiconductor pullback has been, we hope to be again back above for year to date. But I think investing is a long term game as you know. Ashim Mehra: And for us we look super long term. We’re trying to find the best companies. And there are going to be periods of time where we do underperform. And that’s okay because we’re really trying to build a track record for investors who are invested long term. Caroline Woods: Okay. All right. I think this is a great time to pivot to our rapid fire round of This or That. Quick questions, quick answers, no hedging if you can help it. Are you ready? Ashim Mehra: I’ll try my best. Caroline Woods: All right. Here we go. AI infrastructure or AI applications? Ashim Mehra: Really tough. We talked about being balanced. I would say both. Okay, AI application in the very long term. Caroline Woods: Semiconductors are a software. Semiconductors NVidia or Broadcom. Nvidia. Micron or AMD. Caroline Woods: Micron Microsoft or alphabet. Alphabet Amazon or Shopify.? Ashim Mehra: Amazon. Caroline Woods: Meta or Spotify? Ashim Mehra: Very difficult. Both amazing companies I would say Spotify. Caroline Woods: SpaceX or Tesla? SpaceX. Speaker 3 Caroline Woods: More upside from here. Mega cap tech or small and mid cap tech? Ashim Mehra: Really depends what you own on mid-cap. Small mid-cap is, okay we’ll go with mega cap. Caroline Woods: No, but but clarify. Ashim Mehra: I think it depends on who you own. And I think there’s, I think there’s a lot of small and mid cap that has been completely dislocated. And I think there’s a lot of opportunity there. So I think if you’re focusing on that subset, yes. But there’s also some parts of small mid-cap tech that are really outperformed where I’m more neutral. Caroline Woods: One smaller mid cap. So one smaller mid cap tech name that will outperform mega cap tech. Ashim Mehra: SiTime. Caroline Woods: Next breakout AI trade. Oh sorry. Next next breakout AI trade, memory chips or optical networking. Ashim Mehra: Memory. Caroline Woods: I forgot I was going to give you this or that options here. Better long term investment AI infrastructure or cybersecurity. Ashim Mehra: From here probably AI infrastructure. Cybersecurity has incredible run. Caroline Woods: Better investment over the next three years. Companies building AI or companies using AI to replace workers. Ashim Mehra: Let’s just say companies using AI for the very long term in a differentiated way. Caroline Woods: Biggest risk to AI stocks. Too much spending or too much competition. Ashim Mehra: I think they’re part of the same, I would say too much competition. Caroline Woods: And finish this sentence. The most overlooked technology stock right now is. Ashim Mehra: Again, I think SiTime. Caroline Woods: The next trillion dollar technology company will be. Ashim Mehra: I think it was a trillion before but probably will be again will be Broadcom.. Caroline Woods: The AI stock with the most upside that isn’t Nvidia is. Ashim Mehra: SiTime. Caroline Woods: The popular tech stock I wouldn’t buy right now is. Ashim Mehra: Popular.. Speaker 4 Ashim Mehra: I can’t think, maybe a Neocloud, pick yours. Caroline Woods: The biggest mistake AI investors are making is. Ashim Mehra: Being super short term oriented. Caroline Woods: And the one stock in BCTK I’d hold for the next ten years is. Ashim Mehra: Probably Alphabet. Caroline Woods: Ashim Mehra, Managing Director Portfolio Manager, Baron Capital. Thanks so much for playing along and for sharing your insights, your perspective. Really appreciate it. Ashim Mehra: Thank you so much. Caroline Woods: If you enjoyed this interview, check out our ETF spotlight with Johnny Woo, where he shares his top picks among Korean chipmakers and the companies benefiting from AI bottlenecks.
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