Q&A: RONALD BARON — SCHWAB "WILL SOON BE CONSIDERED A VIRTUAL NATIONAL BANK"

Until the start of this year, Ronald Baron had built a spectacular record picking small stocks. His formula — investing in a concentrated portfolio of companies whose growth is driven by what he calls megatrends — still places his flagship Baron Asset Fund among the top 10% of small-cap growth funds over the last three years.

Mr. Baron, 55, worked as a Wall Street analyst for a dozen years before

launching his own money management shop in 1982 (George Soros was an early client), so he’s been around long enough to know what he’s doing.

But as $916 million in assets poured in during the first quarter — more than half 1997’s total inflow — the $5.2 billion fund has swooned, and prompted Internet bulletin boards to liken Baron Asset to a dancing hippo. Some are even urging him to close his doors to new investors.

He dismisses such critics as people too preoccupied with market zags to

understand his low-turnover, long-term investing approach. He focuses mainly on service, health care and financial services names like ski operator Vail Resorts International, nursing home giant Manor Care Inc. and discount broker Charles Schwab Corp.

Still, his fund’s 2.89% return through this year’s first five months means he’ll have some catching up to do.

Q You have an exceptional long-term management record, but there are some questions as to whether the fund’s rapid growth in assets has led to performance weakness.

A The weakness is a question of our concentrated portfolio. We have 42% of our money invested in 11 stocks and if a couple of them go down at the same time then we are going to underperform. The whole essence of what we do is investing in the long term. If you look at two stocks — Schwab and Manor Care — they are down 20% to 25% from earlier this year and alone account for our underperformance. Yet we remain as optimistic as ever in those two holdings.

Q In fact, haven’t you been adding to your position in these companies?

A Yes. They were both significant purchases in the last quarter. Now Manor Care has agreed to merge with Health Care and Retirement Corp. HCR is the only publicly owned company in the entire nursing home services industry that is comparable to Manor Care. You’ve taken Manor Care — a company with the best assets in the industry — and put it together with a company that arguably has the best management in the industry. My initial disposition toward this is very favorable. But I haven’t met with the executives of HCR yet.

And we still think Schwab can make four to five times today’s price over the next four to six years. Schwab continues to add assets at about $6 billion per month. It will soon be considered a virtual national bank, as it adds additional services and achieves greater revenues per dollar of customer assets. Schwab is valued at 2.2% of its $414 billion in assets, a significant discount to banks.

Q In your quarterly report you appear to have eased your goal to double investors’ money in three to five years to four to five years. Can you talk more about this?

A We don’t want investor expectations above what we think we’re going to achieve — with a cushion. We are investing in businesses that are doubling in size every three to five years. In the past three years, we’ve doubled the per-share value of our portfolio. That means that the businesses in many instances have not grown as fast as the stock prices. So there is a good chance that they won’t do as well in the next three to four years. We’ve always told people 15% to 20% per year. We’re still going to make money — we just won’t make as much if the market doesn’t do as well.

Q What else are you buying? Your quarterly report mentioned Libbey Inc.

A We just acquired 500,000 shares in the past seven days so we now own 2.7 million shares. Libbey is the leading U.S. supplier of glassware to the food service industry. This is a stable replacement business. Drink glasses last about 100 servings before they are broken or stolen. You might think it ought to be a 5% or 6% margin business. But it’s 17% — three times that. Competitors see a relatively limited market with one firm dominating it and steep capital costs in the furnaces. A recent joint venture in Mexico offers tremendous potential savings, since about half the cost of making glassware is represented by labor, and U.S. labor rates are 10 times what they are in Mexico.

Q Do you have any plans ever to close the fund?

A We have no plans to close the fund. In this environment where small cap stocks are underperforming large cap stocks so dramatically, we’re having no problems investing the money flows into the fund.

Vite

Ronald Baron, 55, portfolio manager of Baron Asset Fund and Baron Growth and Income Fund; president of Baron Capital Inc., New York.

Baron Asset Fund (assets $5.2 billion): Year-to-date, 2.89%; 1-year, 27.13%; 3-year, 27.11%; 5-year, 22.00%.

Small-cap growth peer group: Year-to-date 4.20%; 1-year, 18.34%; 3-year, 19.31%; 5-year 15.35%.

Baron Growth & Income Fund (assets $472.8 million): Year-to-date, 1.00%; 1-year, 22.30%; 3-year, 28.31%.

Russell 2000 Index: Year-to-date 4.68%; 1-year, 21.22%; 3-year, 20.80%; 5-year, 16.15%.

S&P 500 stock index: Year-to-date, 13.11%; 1-year, 30.67%; 3-year, 29.49%: 5-year, 22.15%.

Data through May 31

Source: Morningstar Inc.