Total Assets $1.78 Billion (3/31/21)
Expense Ratio 1.02% / 0.87%
Benchmark Morningstar U.S. Mid Growth
FUND OBJECTIVE & INVESTMENT PROCESS
The investment objective of the Buffalo Discovery Fund is long-term growth of capital.
The Fund managers seek to identify companies expected to benefit from innovation and experience growth based on the identification of long-term, measurable secular trends, and which, as a result, the managers believe may have potential revenue growth in excess of the gross domestic product growth rate.
Companies engaged in innovative strategies are those who, in the Fund managers’ opinion, are engaged in the pursuit and practical application of knowledge to discover, develop, and commercialize products, services, or intellectual property.
Companies are screened using in-depth, in-house research to identify those which the Fund managers believe have favorable attributes, including attractive valuation, strong management, conservative debt, free cash flow, scalable business models, and competitive advantages.
Management of the Buffalo Discovery Fund integrates ESG (Environmental, Social, and Governance) related factors into the investment decision making process. ESG-related factors material to the risk and return of investments are explicitly considered, alongside traditional financial factors, when making investment decisions.
To us, innovation means to discover and transform new ideas into meaningful commercial value. The greater the economic impact and the longer the staying power, the better.
We seek under-appreciated stock opportunities in companies where thoughtful management teams are in a favorable position to use innovation for market advantage and sustained shareholder value creation.
Dave Carlsen, CFA, Co-Portfolio Manager
Overall Morningstar Rating™ of BUFTX based on risk-adjusted returns among 547 Midcap Growth funds as of 5/31/21.
|As of 5/31/21||3 MO||YTD||1 YR||3 YR||5 YR||10 YR||15 YR||20 YR||Since Inception|
|BUFFALO DISCOVERY FUND - Investor||0.68||4.20||37.28||18.02||17.63||14.50||12.56||10.27||10.65|
|BUFFALO DISCOVERY FUND - Institutional||0.71||4.25||37.47||18.20||17.80||14.68||12.73||10.44||10.81|
|Morningstar U.S. Mid Growth Index||0.91||2.34||38.56||22.79||20.74||14.47||11.79||9.38||9.93|
|Morningstar Mid-Cap Growth Category||1.65||6.24||46.40||19.80||19.05||13.43||11.06||9.35||8.68|
|As of 3/31/21||3 MO||YTD||1 YR||3 YR||5 YR||10 YR||15 YR||Since Inception|
|BUFFALO DISCOVERY FUND - Investor||2.70||2.70||67.49||18.64||17.86||14.82||12.03||10.66|
|BUFFALO DISCOVERY FUND - Institutional||2.76||2.76||67.75||18.83||18.05||15.00||12.20||10.83|
|Morningstar U.S. Mid Growth Index||-1.62||-1.62||73.26||22.37||20.59||14.32||11.16||9.80|
|Morningstar Mid-Cap Growth Category||3.96||3.96||81.95||20.29||19.16||13.38||10.47||8.62|
3 Year Risk Metrics
|BUFTX vs Morningstar U.S. Mid Growth Index (As of 3/31/21)|
Hypothetical Growth of $10,000
|(As of 3/31/21)|| |
|# of Holdings||82|
|Median Market Cap||$19.15 B|
|Weighted Average Market Cap||$22.28 B|
|3-Yr Annualized Turnover Ratio||94.71%|
|% of Holdings with Free Cash Flow||75.31%|
Top 10 Holdings
|Holding||Ticker||Sector||% of Net|
|Penn National Gaming||PENN||Consumer Discretionary||2.11%|
|TOP 10 HOLDINGS TOTAL||18.10%|
CAPITAL MARKET OVERVIEW
(As of 3/31/21) — Equity markets continued to move higher in the 1st quarter of 2021, with the S&P 500 Index returning 6.17%. The period was marked by outperformance of value stocks as the market rotation that began in the last quarter of 2020 became even more pronounced. The vaccination rollout, combined with prospects for more fiscal stimulus, bolstered optimism towards companies that could benefit from the economy reopening. Additionally, an 80+ basis point move higher in the 10-Year U.S. Treasury yield during the quarter left sentiment towards growth stocks relatively more subdued.
The broad market Russell 3000 Index advanced 6.35% in the quarter. Value outperformed growth for the second straight quarter, with the Russell 3000 Value Index up 11.89% compared to the Russell 3000 Growth Index returning 1.19%. Relative performance was inversely-correlated with market cap size in the quarter, with the Russell Micro Cap Index up 23.89%, the small cap Russell 2000 Index up 12.70%, the Russell Midcap Index up 8.14%, and the large cap Russell 1000 Index returning 5.91%. The more cyclically-sensitive Energy, Financial, and Industrial sectors performed best in the quarter. Consumer Staples, Information Technology, and Utilities were the bottom three performing sectors. All sectors produced positive returns.
(As of 3/31/21) — The Buffalo Discovery Fund (BUFTX) gained 2.70% during the quarter, outperforming the Morningstar U.S. Mid Growth Index’s decline of 1.62%. The Fund outperformed the Index in all of the major sectors that comprise the bulk of the benchmark – Consumer Discretionary, Healthcare, Technology, and Industrials – but lagged slightly in Financials and Telecommunications Services. Stock selection drove all of the outperformance while sector allocation was a slight drag on relative performance. The overall rotation to “value” from “growth” led to a decline in the Index in traditional growth areas of Consumer Discretionary, Healthcare, and Technology. Despite this backdrop, the Fund managed to post positive returns in all of these sectors, as our valuation discipline and focus on downside protection kept us out of most of the high growth stocks that were hit hard by the rotation.
The top contributor for the portfolio in the 1st quarter was Ligand Pharmaceutical, which gained 53%. A highly shorted stock coming into the quarter, Ligand surged on a short squeeze alongside other highly shorted stocks as it was disclosed that troubled hedge fund Melvin Capital owned put options on Ligand as well as other companies like GameStop and Bed Bath & Beyond. We had been quite surprised that the short interest remained stubbornly high throughout 2020 despite strong fundamentals that even improved during the COVID outbreak, as Ligand’s product Captisol is in Gilead’s drug Remdisivir to improve its tolerability, which led to a windfall in revenues and cash flow for Ligand. We believe there is additional upside potential to come from Ligand as its lead drug discovery platform, OmniAb, continued to see licensees get closer to commercialization, which could generate high margin royalty revenue for Ligand.
Generac was the next largest contributor during the quarter. Generac continues to gain investor attention as demand for its home standby generators likely increased massively during the Texas power crisis in February 2021. When combined with rolling blackouts in California, increased frequency and intensity of hurricanes, and their entry into the home battery backup market, it is easy to see why demand for Generac’s products has increased immensely and the stock has responded.
Tenable, a security software company, was the largest detractor to performance in the quarter. The stock rallied in the December 2020 quarter as the high profile SolarWinds hack caused investors to bid up many cybersecurity stocks in anticipation of an acceleration in revenue growth. When the company gave 2021 revenue guidance that assumed no incremental increase in revenues due to the hack, it was considered a disappointment by investors and the stock gave back all of the December gains. We believe management is smartly setting guidance that allows for them to beat consensus and potentially raise guidance through the year, and the pull back in the stock is an opportunity for long term investors.
(As of 3/31/21) — The outlook remains generally positive as robust monetary and fiscal stimulus provides an inviting backdrop for investors. While a quick rise in interest rates has given some pause on growth stocks and facilitated a catchup trade for value stocks, we do not believe the prospect of a low single digit yield on a ten-year government bond is going to provide a suitable enough return for investors to begin to abandon equities.
2021 should continue to benefit from a recovering economy with above average gross domestic product (GDP) growth, but as we return to pre-COVID economic levels, we believe economic growth likely gets stymied, as higher federal debt levels and higher taxes eventually slow the economy, which may again put premium multiples on companies that can grow faster than the market. While there is also chatter about inflation ruining the party, we believe we are still a ways away from seeing enough inflation sustaining at a level that gets the Federal Reserve concerned enough to take action on interest rates. Meanwhile COVID variants and the durability of responses to vaccinations remain a wildcard, but the rapid dissemination of vaccines by the new administration is definitely a positive for economic recovery and a return to normalcy. Higher tax rates will be required to pay for additional fiscal stimulus and could take a small bite out of earnings growth, but we do not believe there is enough political capital or will to raise taxes high enough to choke the market.
We continue to tighten up the portfolio and focus on our favorite ideas – there are now 82 positions in the Fund. We have continued the process we started last year in getting a little more cyclical exposure in the portfolio and remain ever mindful of valuations as there are still signs of excess in areas like high growth software. We have also steadily added companies at the lower end of the market cap range as smaller companies generally outperform coming out of periods of recession. They are also trading at attractive valuation and have solid operating leverage. As always, we continue to focus on premier, innovative companies that benefit from long-term trends and trade at attractive valuations, and we appreciate your continued support.
DISCOVERY FUND NEWS
Total Assets $1.78 Billion (3/31/21)
Seven Buffalo Funds were named to Investor’s Business Daily Best Mutual Funds 2021 list, including the Best U.S. Diversified, Growth, Large Cap, Mid Cap, Small Cap, International, and U.S. Taxable Bond Fund categories.
Dave Carlsen, Buffalo Discovery Fund co-portfolio manager, was recently interviewed by The Wall Street Transcript where he discusses growth drivers for companies in several sectors, including power grid security, orthopedic products, and wireless towers.
Ken Laudan, Buffalo Discovery Fund co-portfolio manager, recently appeared on the Money Life with Chuck Jaffe podcast, discussing his investment viewpoints and portfolio strategy.
We get to know the companies we invest in and learn how they run their business.
Top-Down & Bottom-Up
We identify Top-Down broad, secular growth trends and search for companies from the Bottom-Up.
We construct our portfolios based on our own proprietary investment strategy.
Sticking to our disciplined investment strategy ensures we maintain a consistent, balanced approach.
The Morningstar Rating™ for funds, or "star rating", is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating™ for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating™ metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.
In each Morningstar Category, the 10% of funds with the lowest measured risk are described as Low Risk, the next 22.5% Below Average, the middle 35% Average, the next 22.5% Above Average, and the top 10% High. Morningstar Risk is measured for up to three time periods (three, five, and 10 years). These separate measures are then weighted and averaged to produce an overall measure for the fund. Funds with less than three years of performance history are not rated. ©2021 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. The Morningstar Style Box™ reveals a fund’s investment strategy by showing its investment style and market capitalization based on the fund’s portfolio holdings.