BARONINSIGHT

S E C O N D Q U A R T E R 2 0 1 5

One of the keys to Baron's approach to investing in energy is to seekgrowth companies and growth opportunities brought about by changesin technology, trade flows, infrastructure investment, and capitalintensity. This approach first led us to opportunities driven bytechnological advancements that helped to unlock new reserves andproduction from unconventional (mostly shale) resources in the U.S., andthe concomitant demand for infrastructure to process, store, andtransport products to markets from these new geographies.

In the past 18 months, our focus on growth has led us in a new directionwithin the energy industry: renewable energy, and in particular, solarenergy. As with unconventional resources, we believe renewable energyis one of the most significant growth opportunities in energy today. Twomajor trends are driving the adoption of solar: (1) technological andother improvements that are making solar an increasingly cost-competitive source of electricity in many countries (grid parity); and(2) increasing consumer and geopolitical desire to reduce pollution,which encourages the use of renewables. The emergence of innovativefinancing models known as yieldcos is acting as an additional catalystfor the conversion to renewables by significantly reducing the cost ofcapital and enabling companies to raise more capital at these lower, alsomore attractive rates.

Global Solar Demand to Grow at CAGR of 14.5%

Source: Credit Suisse estimates

A decade ago, the solar industry was in a nascent stage, largely dependenton government subsidies to stay in business. Most companies that wentpublic were commodity-type manufacturing businesses, focusing on pricecompetition to sell relatively undifferentiated products or services, orengaged in a technology arms race with few clear winners. It was a challengeto find investment opportunities that met the Baron criteria: significant

Investing in Renewable Energy

competitive advantage, strong long-term growth potential, experiencedmanagement, and attractive valuation. Recent transformative developmentsin the solar energy industry, however, are producing what we believe areexcellent investment opportunities and we fully expect more to come.

Grid Parity Is HereIn the past few years, the cost of solar panels has plummeted, driven downby technological advances in photovoltaic (PV) cells and an explosion insolar panel manufacturing in China. The average solar panel now costsabout 75% less than it did just five years ago, and the price continues tofall. The newest method for producing the PV polysilicon used in makingpanels takes a tenth of the energy than that of previous techniques. Thisshortens the manufacturing time, allowing faster and cheaper productionof solar panels. In addition, the energy conversion efficiency of both PVand thin film technologies has increased significantly, further driving downthe cost/watt for all forms of solar energy. In the past three years, the costof installing utility-scale solar has fallen 57% in the U.S. and costs forresidential solar has seen a similar decline in cost.

As the use of solar grows, solar businesses are also starting to enjoy thebenefits of economies of scale. As solar companies add customers, costsassociated with functions such as sales, marketing, regulatory andcompliance do not increase commensurately. We believe customeracquisition costs will continue to decline significantly as customerawareness increases, soft costs come down, and more supportive policiesare put in place. This creates a virtuous circle of lower costs drivinggreater demand.

As Industry Scales, Prices Fall

Source: GTM Research, SEIA

James Stone, VP, Portfolio Manager, Baron Energy and Resources Fund; Rebecca Ellin, VP, Research Analyst

Other markets

Europe

India

Japan

US

China

99

86

74

656253

4436

2927

21

120

100

80

60

40

20

-2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E

CAGR of14.5%

GW

$9.00

$8.00

$7.00

$6.00

$5.00

$4.00

$3.00

$2.00

$1.00

$-

7,000

2005 2006 2007 2014201320122011201020092008

6,000

5,000

4,000

3,000

2,000

1,000

0

Blen

ded Ave

rage

Solar PV

Price

($/w

att)

Solar PV

Inst

allations

(M

Wdc

)

Solar PV Installations Solar PV Prices

The steep decline in cost means that solar energy in now at levels of gridparity in many regions across the globe, especially in emerging markets,where electricity costs tend already to be high. At least 30 countries arecurrently at grid parity on an unsubsidized basis, including Australia,Brazil, China, France, Germany, India, and Spain, according to DeutscheBank Market Research. In the U.S., more than 14 states are currently atgrid parity, and by 2016, that number is expected to climb to close to 47states, according to the same research.

Growing Commitment to RenewablesWhile solar currently accounts for only 1.2% of electricity generationworldwide, the percentage is growing rapidly and is expected toaccelerate. In 2014, investments in solar powered electricity projects rose25% to $149.6 billion, representing a record high share of total energyinvestments. According to Bloomberg New Energy Finance, investmentsin electricity generating assets over the next 25 years may total about$12 trillion, of which renewable energy should account for $8 trillion, andsolar for as much as $3.7 trillion of the total. This compares to only about$1.2 to $1.3 trillion for coal and nuclear, respectively. A key driver of thegrowth in solar continues to be the declining cost and increasingefficiency of the technology, as well as emerging technologies for energystorage that will further enhance the competitiveness of solar and otherrenewables in the electricity markets. It should also be noted that thegrowth opportunity in renewables should be largely divorced from the oilprice outlook, as oil is scarcely used around the globe to generateelectricity. Furthermore, over time, we anticipate that natural gas priceswill continue to decouple from oil prices around the world as natural gasremains an important fuel source for power generation.

Across the globe, the appeal of renewables is building amonggovernments and consumers, both at the residential and commerciallevels. China, whose capital city, Beijing, has become notorious for itssmog levels, has a target to install 100 gigawatts (GWs) of solar by 2020.India plans to install 100 GWs of solar by 2022. The European Unionplans to increase renewables to 20% by 2020. To put this in perspective,the total solar installed base worldwide was only about 250 GW at theend of 2014.

In the U.S., 29 states and the District of Columbia have enactedregulatory programs known as Renewable Portfolio Standards (RPS)mandating that electric utilities produce or purchase certain levels ofpower from renewable sources. The legislation typically sets a renewableenergy target between 10% and 30% of total energy capacity by aspecific date. Nine other states have non-binding goals supportingrenewable energy. California has the most aggressive RPS program, callingfor one-third of electricity to be generated by renewables by 2020. Earlierthis year, the California governor proposed expanding that goal to 50%by 2030.

Large corporations are also increasingly turning to renewable energy topower their operations. According to a survey conducted by Ceres in late2012, 60% of Fortune 100 companies and more than two-thirds of theFortune Global 100 have set a renewable energy commitment, agreenhouse gas (GHG) emissions reduction commitment, or both.

For many companies, electricity is one of the largest operating expenses,and renewables can help significantly reduce long-term operating costs.In addition, the use of renewables can help companies achieve GHGemissions reduction goals, demonstrate leadership on corporateresponsibility, and hedge against volatility in conventional fuel markets.

Early adopters such as Intel Corporation, Nokia Oyj, and Keurig GreenMountain, Inc. already source 100% of their electricity from renewables.Other companies are moving in that direction. A number of major retailerswith large flat rooftops ideal for solar, including Wal-Mart Stores, Inc., IKEA,Kohls Corporation, Macys, Inc., and Walgreen Co., are installing rooftopsolar. Across other sectors, corporations ranging from Campbell SoupCompany, General Motors Company, and The Procter & Gamble Companyto Cisco Systems, Inc. and Verizon Communications, Inc., are converting torenewable energy to power all or large parts of their businesses.

With governments, corporations and individual consumers increasinglyturning to renewables to meet their electricity needs, we think the marketsmay underestimate the projected impact of the solar revolution on theutility industry. Many commentators seem unduly focused on the disruptiveeffects of solar and overlook the opportunities that large solar projects bringto the utility value chain. Contrary to popular belief, solar is not primarily aresidential phenomenon. In 2012-13, 80% of solar installations were utility-or large-scale projects. While the prospects for small scale distributed solargeneration look favorable, we are equally, if not more, enthusiastic regardingthe outlook for commercial and utility-scale solar markets.

We believe solar demand is set to grow strongly in the U.S. and emergingmarkets as a result of ongoing solar electricity cost reduction andsupportive government policies. As noted, Bloomberg New EnergyFinance and other experts are forecasting that renewable energy and inparticular solar projects will garner the lion share of new investment inelectricity generation with strong growth in all three end markets utilityscale, commercial & industrial, and residential. In the next 25 years globalpower-generating capacity is set to transform, shifting from two-thirdsfossil fuel-based to 56% zero carbon-emissions. Many existing nuclearplants are nearing retirement age. Solar projects are far quicker, cheaper,and less problematic from a political and regulatory perspective toconstruct. Similarly, many coal plants are being retired for age, efficiencyand environmental reasons. Solars comparatively clean environmentalprofile is especially compelling in emerging markets like China and India,where air quality has become a significant quality of life concern. In fact,in markets heavily dependent on coal for electricity generation, the ratioof coal-based wholesale electricity to solar electricity has alreadydropped from 7:1 four years ago to less than 2:1 today, according toDeutsche Bank Market Research. That ratio could likely approach 1:1 withthe next year, according to the same report.

Global Gross Annual Capacity Additions by Technology, 2013-30 (GW)

Source: Bloomberg New Energy Finance

400

20132015 2020 2025 2030

350

300

250

200

150

100

50

0

Flexible capacity

Solar thermal

Small-scale P V

Utility-scale P V

Offshore wind

Coal

Oil

Gas

Other

Nuclear

Hydro

Geothermal

Biomass

Onshore wind

Investing in RenewablesOur first meaningful foray into investing in renewable energy wasSunEdison, Inc. Formerly known as MEMC Electronics, a semiconductormanufacturing company, SunEdison has transformed itself into arenewable energy project developer with a global sales and installationcapability. SunEdison is now the world's largest renewable energydevelopment company, and it has a large inventory of existing generatingassets and future development projects. In 2014, it expanded beyondsolar into owning and operating wind assets as well, further expanding itstotal addressable market.

In 2014, SunEdison also created TerraForm Power, Inc. to own andoperate renewable power generating and transmission assets, principallysolar, with long-term power purchasing power agreements that areexpected to deliver stable cash flows to be paid out to investors asdividends. TerraForm is a yieldco, an innovative financing structure thatoperates as the renewable energy equivalent of the master limitedpartnerships (MLPs) used by conventional energy companies. Yieldcos aregrowth-oriented public companies created by a parent company thatbundle long-term contracted operating assets to generate predictablecash flows. The recurring dividends that result are similar to bondpayments but like MLPs, yieldcos are traded like a stock.

Corporate Structure of a Yieldco

Source: Bloomberg New Energy Finance

The structure of yieldcos has been around for a long time but was firstapplied to renewable energy only in 2013, when the energy giant NRGEnergy created a yieldco that included renewable energy assets. In lessthan two years, 13 more yieldcos have launched. Developers ofrenewable energy projects have found that yieldcos are their leastexpensive cost of capital. Like MLPs and real estate investment trusts(REITs), developers structure yieldcos to maximize tax loss carryforwardsand use depreciation to minimize the tax bill at the corporate level andavoid double taxation, in order to maximize returns for investors.Yieldcos also allow developers to separate the risk profile of differentaspects of their business, providing investors with an attractive pure playopportunity to invest in de-risked renewable power generation cashflows.

As growth investors, we take positions in yieldcos that we expect toincrease in valuation. However, the 3-6% dividend payment on yieldcosis also attractive, especially to fixed income investors in search of yield.Many yieldcos plan on growing their dividend by more than 15% over thenext 3-10 years. Yieldcos also provide investors with geographic andcustomer diversification by bundling projects from different regions ofthe U.S. and the world, with different end markets.

SunEdison plans to retain a substantial portion of its developed solarprojects and drop them into TerraForm, rather than sell the projects tothird parties as it did previously. This change will more than tripleSunEdisons retained value for each project due to the substantially lowercost of capital of TerraForm and SunEdisons ability to capture theresidual value of each project. We think this change will enable SunEdisonto create substantial value for shareholders, as well as increase itsparticipation in the rapidly growing market for solar power.

SunEdison has announced its plans to form another yieldco calledTerraForm Global, Inc., to be focused on renewable power plants inemerging markets. The company is purchasing wind, solar, and hydroassets in developing nations to drop down into the new yieldco. Baronparticipated in a private placement deal by TerraForm Global ahead of itsIPO. Given the virtually open-ended opportunity in countries and regionssuch as China, India, the Middle East, and South America, we believeothers will soon follow SunEdisons move into emerging market-focusedyieldcos. We expect to see more yieldcos forming overall as eachsuccessful yieldco IPO and increase in share price creates confidence inthe strategy among other developers.

We have also invested in Abengoa Yield plc, a yieldco created by theSpanish multinational Abengoa, S.A. focused on renewable electricitygeneration and transmission in North America. We expect most of thegrowth at Abengoa Yield to come from the acquisition of developedrenewable electricity generating and transmission assets in the form ofdropdowns from its parent company, or the acquisition of similarprojects from third party developers.

ConclusionWe believe that renewable energy, and in particular solar energy, is one ofthe most significant growth opportunities within the energy industrytoday. Declining costs have shrunk the economic gap between solar andconventional sources of energy, and solar energy is now at levels of gridparity in many regions in the U.S. and across the globe. We expect theeconomics of solar to continue to improve as a result of a continueddecline in the costs of solar panels, balance of system (all PV systemcomponents except panels), and financing. In addition to lowering the costof capital, the innovative financing structure of the yieldco has served tode-risk renewable assets and increase the appeal of pure play renewableopportunities for investors. While the percentage of energy fromrenewables is still relatively small, we believe the growth rate over the nextseveral years and likely beyond could be quite meaningful. Therefore, wehave increased our commitment to this segment of the energy industry inthe past 18 months and our investments in renewable energy representaround 10% of the Baron Energy and Resources portfolio. We continue tolook for additional investment opportunities in this sector.

PRODUCTS WE OFFER

We offer thirteen mutual funds in retail and institutional share classes, separately managed accounts,sub-advisory services and an offshore fund.

STRATEGIES

BARON ALL CAP GROWTH STRATEGY

BARON DISCOVERY STRATEGY

BARON EMERGING MARKETS STRATEGY

BARON ENERGY & RESOURCES STRATEGY

BARON FOCUSED GROWTH STRATEGY

BARON FOCUSED HIGH GROWTH STRATEGY

BARON GLOBAL ADVANTAGE STRATEGY

BARON HIGH GROWTH STRATEGY

BARON INTERNATIONAL GROWTHSTRATEGY

BARON LARGE CAP GROWTH STRATEGY

BARON MID CAP GROWTH STRATEGY

BARON REAL ESTATE STRATEGY

BARON SMALL CAP GROWTH STRATEGY

BARON SMALL TO MID-CAP GROWTHSTRATEGY

MUTUAL FUNDS

BARON ASSET FUND (BARAX, BARIX)

BARON DISCOVERY FUND (BDFFX, BDFIX)

BARON EMERGING MARKETS FUND(BEXFX, BEXIX)

BARON ENERGY AND RESOURCES FUND(BENFX, BENIX)

BARON FIFTH AVENUE GROWTH FUND(BFTHX, BFTIX)

BARON FOCUSED GROWTH FUND(BFGFX, BFGIX)

BARON GLOBAL ADVANTAGE FUND(BGAFX, BGAIX)

BARON GROWTH FUND (BGRFX, BGRIX)

BARON INTERNATIONAL GROWTH FUND(BIGFX, BINIX)

BARON OPPORTUNITY FUND(BIOPX, BIOIX)

BARON PARTNERS FUND (BPTRX, BPTIX)

BARON REAL ESTATE FUND (BREFX, BREIX)

BARON SMALL CAP FUND (BSCFX, BSFIX)

BARON CAPITAL, INC.767 FIFTH AVENUENEW YORK, NY 101531-800-99BARON OR 1-212 583-2000 www.BaronFunds.com

INSTITUTIONALJAMES BARRETT VP, Head of Institutional Sales, 212-583-2076, jbarrett@baronfunds.comDAVID KAPLAN VP, Senior Director, Institutional Sales, 212-583-2033, dkaplan@baronfunds.comMEETA SINGAL VP, Director, Institutional Sales, 212-583-2055, msingal@baronfunds.comJENNIFER NIGRO VP, Director, Institutional Sales, 212-583-2101, jnigro@baronfunds.com

FINANCIAL INSTITUTIONSCARLA F. AVILA VP, Head of Financial Institutions, 212-583-2056, cavila@baronfunds.comROGER MACK Director, Financial Institutions, 212-583-2131, rmack@baronfunds.comASHLEY BRADLEY Director, Financial Institutions, 212-583-2169, abradley@baronfunds.comCHELSEA M. AMEEN Director, Financial Institutions, 212-583-2158, cameen@baronfunds.com

RIAFRANK MAIORANO VP, Head of RIA Sales, 212-583-2183, fmaiorano@baronfunds.comROBIN THURAU RIA Sales East/Midwest, 212-583-2083, rthurau@baronfunds.comLIZ CASSAL RIA Sales West, 212-583-2138, lcassal@baronfunds.comSETH DUNLAP RIA Sales Midwest, 212-583-2167, sdunlap@baronfunds.comSAMANTHA RODE RIA Sales East, 212-583-2079, srode@baronfunds.com

INTERMEDIARYDAVID JUDICE VP, Head of Intermediary Sales and National Accounts, 212-583-2034,

djudice@baronfunds.com

STEPHANIE GISRIEL National Account Manager, 212-583-2187, sgisriel@baronfunds.comBILL ZOROVICH External Wholesaler Northeast, 646-556-5473, bzorovich@baronfunds.com BRIAN CULLEN External Wholesaler Mid-Atlantic, 917-715-9605, bcullen@baronfunds.comBRIAN McNAMARA External Wholesaler Midwest, 773-718-7444, bmcnamara@baronfunds.comCHARLES KRUGER External Wholesaler Southwest, 917-882-2095, ckruger@baronfunds.comJENNIFER ROMMEL External Wholesaler Central, 773-450-7495, jrommel@baronfunds.comMARK J. WHITEHOUSE External Wholesaler New England, 603-661-8887, mwhitehouse@baronfunds.comRON STANKIEWICZ External Wholesaler NY Metro, 917-287-7248, rstankiewicz@baronfunds.comSCOTT KOZIOL External Wholesaler Southeast, 404-433-6137, skoziol@baronfunds.comWAYNE OUIMETTE External Wholesaler West, 310-292-6255, wouimette@baronfunds.com

Baron Sales & Relationship Management

The BaronBlog

Launches

Our blog is designed to be your new go to place for business-building ideas. Well provide concise, timely andaction-oriented ideas on a weekly basis to help you leverageyour time and grow your business. We understand how busyyou are, so well make sure that each post will quickly addvalue to you, your clients or your practice. Go towww.BaronFunds.com/blog/ for more information.

You should consider the investment objectives, risks, charges, and expenses of the Funds carefully before investing.The prospectus and summary prospectus contain this and other information about the Funds and can be obtainedfrom the Funds distributor, Baron Capital, Inc., by calling 1-800-99BARON or visiting www.BaronFunds.com. Pleaseread them carefully before investing.The discussion of market trends and companies throughout this report are not intended as advice to any personregarding the advisability of investing in any particular security. Some of our comments are based on currentmanagement expectations and are considered forward-looking statements. Actual future results, however, mayprove to be different from our expectations. Our views are a reflection of our best judgment at the time of thepublication of this report and are subject to change any time based on market and other conditions, and we have noobligation to update them. Investing in the stock market is always risky. Baron may not achieve its objective. Portfolioholdings may change over time.Portfolio holdings as a percentage of net assets as of June 30, 2015 for securities mentioned are as follows:SunEdison, Inc. Baron Opportunity Fund (2.5%), Baron Fifth Avenue Growth Fund (2.0%), Baron Energy andResources Fund (3.5%), Baron Global Advantage Fund (5.6%); TerraForm Power, Inc. Baron Asset Fund (1.3%),Baron Opportunity Fund (1.4%), Baron Focused Growth Fund (2.0%), Baron Energy and Resources Fund (1.9%), BaronGlobal Advantage Fund (2.8%); TerraForm Global, Inc. Baron Opportunity Fund (1.1%), Baron Fifth Avenue GrowthFund (1.9%), Baron International Growth Fund (1.1%), Baron Emerging Markets Fund (1.0%), Baron Energy andResources Fund (3.0%), Baron Global Advantage Fund (4.1%); Abengoa Yield plc Baron Small Cap Fund (0.2%),Baron Energy and Resources Fund (1.4%). Portfolio holdings may change over time.

Welcome to the Baron Advisor Forum

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