Transcript:Caroline WoodsAfter years of Mega-cap dominance, the tech trade has run into some turbulence and investors are widening the lens. Small and mid-cap stocks are starting to draw fresh attention. Joining us now for an ETF spotlight to discuss is Randy Gwitrzman portfolio manager at Baron Capital. Randy, thanks so much for joining us.

Randy GwirtzmanThanks for doing this, Caroline.

Caroline WoodsI really appreciate you being here. So, Randy, there’s been a lot of talk about the rotation that we’ve been seeing out of Mega-cap tech. We’re seeing money go into other sectors like energy and materials and staples, but also into small and mid-sized companies. What’s driving that shift?

Randy GwirtzmanIt’s really interesting. There’s I would say, three factors that are kind of driving this right now. The first is there’s an under allocation to small and big cap stocks right now. As my analytics group kind of pulled up, if you look at the overall allocation of Smid to the overall Russell 3000, it’s about 3% allocated now to that total equity group. Typically it’s 7.5%. So clearly under allocated. The second is you know, the valuations are pretty reasonable on a forward basis. Small cap stocks. That index the Russell 2500 growth is trading at about 21.5 times, which is about a half turn below the S&P 500. And you know, the S&P 500 typically trades in kind of a 15 to 17 multiple range, over the last 20 years. Now, we know we have some fast growers within within that segment. But it’s it’s above its range. Whereas for the 21.5 for the the Smid group, typically that’s more of a 20 to 22 range. So we’re kind of right in range on an absolute basis. And then the last thing I would say is, people are realizing that you’re getting, better growth, maybe from smaller stocks than you are from the larger stocks. So as concerns of, you know, overall growth across the entire large cap universe, kind of fade into the market a little bit. You’re seeing, kind of interesting situations. So this mid-cap index, on a forward sales basis is growing about 16%. For the S&P 500 is about 11%, for next year’s sales, and we’re 20% for the Baron Smith ETF, which is bxp. So, you know, we’re we’re faster growth. We’ve got good valuation. And the area of the market is pretty under allocated. And all this stuff with a good economic environment where we’re kind of seeing inflation go below or, you know, kind of at and heading down the 3% level, and potential, you know, exponential growth in GDP. You know, we’re kind of moving up to 5%, by some forecasts. It’s a pretty good environment for small cap stocks.

Caroline WoodsDoes the economic environment need to remain strong or resilient for this shift to continue? And I guess even broader than that, do you think this signals a broader shift, or is it a short term reset after years of large cap dominance and maybe some value hunting now?

Randy GwirtzmanYeah, I think, you know, other than some crosscurrents which we can we can get to in terms of technology and things like that, I think it’s a pretty typical economic situation to see small caps outperform, as the red cycle moves from higher rates towards lower rates. Particularly in an economy where we’re seeing good growth with low inflation. Now, there’s a lot of underlying factors behind that. But we’re seeing increased productivity kind of keep, labor, wage push inflation down. And the tariffs really haven’t, had too much of an impact which, which is good. So I think it’s a pretty good environment and it will continue that way. You know, barring some external macro shock.

Caroline WoodsDo you expect it to continue at the expense of Mega-cap tech, though, because it seems like the money is coming out of tech and going into some of these other areas. At what point do you think that’s stabilizes, or will it continue to be at the expense?

Randy GwirtzmanYeah. I you’re you’re seeing, much more particular investment in, in parts of it. And, you know, it’s, it’s the hardware and the semiconductor side of the, of the ledger that is benefiting at the expense of the software side of the ledger. So, data center buildout, particularly for AI, has gone up enormously. We had a $200 billion CapEx spend roughly in 2024 that went to 400 billion for AI data centers in, 2025. This year, they’re expecting 650 billion, or even more. You, you know, you’re seeing companies spend 150 to 200 billion each for these mega cap providers. So that’s benefited semi cap companies. Like coherent, which we own in the in the XM which provides optical networking. On the other side. Software is really getting hurt. You’re seeing software down 20% on average year to date. Over the last year, small cap software is down 40%. And that is because I while it’s benefiting, the hardware guys, you’re seeing, you know, you saw in Microsoft’s earnings, the software side of the business is, big concern because people believe that I can displace, enterprise software, and seat based business models. Software now is trading at multiples that are as low as the 2015 break. That we saw smaller, you know, kind of lower growth companies under 15% of trading at three and a half times forward sales. That’s below 2015. We’re seeing 20 to 25% growth is trading at, you know, kind of, six times 5 to 6 times sales, which is, it’s very low for the for that group. And, you know, we have great companies that we don’t think will be displaced companies that do, for example, observability companies like Datadog and Dimitri’s Dynatrace. This monitors network traffic and application performance. So large airlines use it to make sure that their systems are online and not losing reservations. Or if something goes wrong, they can fix it quickly on an automated basis. These companies actually use their own AI, and they’re not going to get to this place because they’re so embedded into the network infrastructure of these enterprises, which is very complicated. Dynatrace is trading at only 13 times free cash flow, and it’s growing free cash flow on high teens. So there’s some real bargains out there, the babies kind of being thrown out with the bathwater right now. And but we’re we’re pretty excited. To own the companies that we think will be the winners at bargain prices.

Caroline WoodsYeah. It’s funny day to dog a big today after earnings. So you mentioned that one in particular I see that’s a holding as well. So in terms of themes or particular areas who is outperforming the small and mid-cap space. It sounds like AI is still really the common thread here now.

Randy GwirtzmanYeah. I mean, so I you know, we mentioned I mentioned the hardware side of it. And the software side of it, there’s also AI that’s being applied to, you know, kind of companies that use atoms and electrons. And, you know, this is kind of a phrase I heard that I really liked. But companies like axon. So axon makes, tasers and body cams that are used by law enforcement. They also have software that backs it all up. So well, that video gets backed up into their into their cloud based, software. And then I can analyze that software and help law enforcement officers write up reports, and maintain that, maintain the chain of evidence, for prosecutors and defense attorneys, that can’t be replicated by, you know, each tech based AI, models, because you need the physical atoms, right? The sensors themselves that generate the data. So we we really like that one. And, you know, so that’s some of what’s going on in AI, but we, we don’t believe that, for the most part, a genetic AI is going to take over every software company, but there will be software companies that are disintermediated, particularly companies that have high, high C based models in areas where, the, the AI itself can do some of the tasks of people who used to be the workers, like, you know, code generation. If you have a software company that is C based on code generation, that’s going to be pretty tough because existing software engineers can can do the work, maybe of 2 or 3 engineers. Now, legal software could be at risk. You know, we’re kind of seeing that in the market as well. So we’re picking our spots. But we are getting really, excited about some of the things going on an AI.

Caroline WoodsAre there other areas where you get exposure outside of tech through the Baron’s Mid-Cap ETF?

Randy GwirtzmanAbsolutely. So health care is a big area, that we’re invested in. One, you know, AI is used in healthcare as well. So we own a company called Tempest AI. Tempest is a, cancer diagnostics company. So they take blood samples, and tissue samples, and they run, high end DNA sequencing on them and look for genetic abnormalities. They then give test results, obviously, to oncologists who are, testing patients on that. But on top of that, they take all that, that data that’s generated. They have a huge database of data, and they use their own AI to analyze the data and find, kind of interesting patterns. But they’re also connected. And this is part of the, the, competitive differentiation of the company. They’re connected to oncologists and academic medical centers all around the country who can go back and forth with them and see patient outcomes and relay their own cancer findings of patients who have similar genetic, abnormalities. And in that way, they can then see that, which data is most important for drug development. And then they, they take all that and then they sell it to the largest drug companies in the world, because they have this sort of unique database, not only with the genetic data, but also with the outcomes based data on the drugs that were used to treat the patients. So really exciting stuff. We’re also invested in other companies that are kind of riding the biologics trend. So GLP ones obviously, the weight loss drugs are really huge. We own, a company called Revolution, which makes equipment that manufactures biologic drugs. And we also own a company called Stefan Otto, which makes glass tubing, which is used, for vials, but more importantly for the cartridges that go inside the auto injectors that a lot of people use for their, for their drugs, whether it’s, the GLP ones or Pcsk9, which are used for, lowering cholesterol and that sort of thing. So there’s a lot of other areas that are really interesting to invest in right now.

Caroline WoodsYeah, very interesting picks there and ways to play some of the broader themes that, you know, we’ve been talking about every day that aren’t necessarily just the big names that we’ve been talking about, but it seems like it could be harder to stock pick through all of these companies that investors might not be as familiar with. So obviously they can get exposure through your ETF. But what should investors be careful about or avoid when it comes to small and mid-cap companies?

Randy GwirtzmanYeah, I mean, listen, you know, I, I tell my friends and I kind of selling myself a little bit here, but, we do a lot of work. So we’re bearing capital is fundamentally based, and we have a long term, horizon that we’re focused on. It’s really hard to guess what’s going to happen, day to day in the market or even, you know, over a one year time frame. We think we have value by kind of looking over a 3 to 5 year time frame. We’re trying to find stocks that will double over that 3 to 5 year time frame. And so the stocks that I’ve mentioned have free cash flow that we think will double or even triple over that time frame. And if you get it at a similar multiple to what it’s trading now, obviously the stock would double over that time. With some of these software stocks, you can get a double in the free cash flow growth on top of multiple expansion. And that’s how you make really, really big money. But again, it’s all about deep fundamental research. Understanding. The company is interviewing management teams, experts in the industry, competitors, and putting that all together and understanding strategically where these companies can go over time, and what their competitive advantages are and how good the management teams are. And that’s really what we do day to day and what we’re focused on.

Caroline WoodsOkay. So because you said it’s hard to predict where the market’s going to go even over the next year. Of course I’m going to ask you, but we have to make this one quick. If small and mid-caps continue to be where the money flows, what does that mean for the direction of the overall market?

Randy GwirtzmanIt’s interesting. I think it’s healthy to have a more broadening of the market as opposed to, such extreme concentration and a handful of large cap stocks. So I think overall that would that bodes well for the overall economy. Kind of hoping the consumer, can benefit from some of the tax rebates that they should be getting over the next month. And, you know, two thirds of the economy obviously is consumer based. So, you know, we have consumer stocks as well in the fund. And we think that the broadening out, of economic benefit really should be good for, for the stock market as a whole, all the way through the caps. But again, again, back to my own book. But we do favor the smaller, stocks as they’ve been really ignored for the past few years. And, we’ve, we’ve had sort of extreme, valuation disconnects, historically between, this cohort of stocks and larger cap stocks.

Caroline WoodsAll right. Well, we appreciate you sharing some light on the Smid cap space. Randy Gwirtzman portfolio manager at Baron Capital, thank you so much.

Randy GwirtzmanThank you very much for the time.