Small Cap Fund

Manager Commentary as of 06/30/10

The equity markets declined sharply in the second quarter due to increased concerns over global economic growth and the sustainability of an economic recovery.  This was the first significant correction in the market since the bottom in March of 2009; the markets are now down midway through 2010. The Buffalo Small Cap Fund declined 11.49% in the quarter, underperforming both the Russell 2000 Growth Index and the Russell 2000 Index, which were down 9.22% and 9.92%, respectively.  Year to date, the fund is down 1.96%, performing slightly better than the benchmarks which are down 2.31% for the Russell 2000 Growth Index and 1.95% for the Russell 2000 Index.

Data represented reflects past performance and is no guarantee of future results. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original value. Current performance may be lower or higher than the performance quoted. Performance current to the most recent quarter end may be obtained by clicking here. Performance current to the most recent month end may be obtained by clicking here.

Our underperformance in the quarter was due primarily to stock selection.  Sector allocation was a slight positive as we were underrepresented in some of the worst performing sectors, namely energy, utilities and health care. All sectors declined in the quarter.  Our stock selection was worse than the index primarily in two sectors: industrials and financials.  Within industrials, our exposure to the for-profit education sector hurt our performance in the quarter, as increased regulatory scrutiny trumped continued strong earnings and cash flow performance from the companies.  In the financial sector, we are invested in asset managers and fee-based companies whose assets under management declined in conjunction with the drop in equity markets.  We have maintained our investment exposure in both sectors.

Given the increased concern over the strength of the global economy, companies with good long-term, secular growth prospects generally outperformed companies with greater economic sensitivity, regardless of valuation.  Our top performers included American Medical Systems and Pharmaceutical Product Development in the health care sector; Lifetime Fitness within the consumer discretionary sector; FTI Consulting, a relatively new position within industrials.  Some of the biggest detractors included for-profit education companies Corinthian Colleges and Career Education, asset manager Waddell & Reed, and more economically sensitive stocks like Monster Worldwide and Coldwater Creek.
   
We used the market decline in the quarter to invest the inflows we had received most of last year.  Although we are not "market timers" specifically, we do pay close attention to valuation and we are disciplined about the price we pay for specific securities.  Many of our holdings hit acceptable buy targets in the quarter and we reduced our cash from over nine percent at the start of the quarter to under five percent at the finish, which is a more normal level.  We ended the quarter with 58 stock holdings in the portfolio, the most in some time.  Although we do share many of the market's concerns regarding the magnitude and sustainability of the recovery, we now feel that valuations are such that reasonable returns are achievable given the commensurate risks. Companies' balance sheets are very healthy and cash flow generation is strong despite below normal levels of economic activity. This makes stocks look attractive to us relative to other low-yielding alternatives.

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"Given the increased concern over the strength of the global economy, companies with good long-term, secular growth prospects generally outperformed companies with greater economic sensitivity, regardless of valuation."