Innovation in Action
Portfolio Managers Clay Brethour and Dave Carlsen discuss how their focus on secular growth trends and innovation helps drive their investment strategy for the Buffalo Discovery Fund.
“Innovation in its most simple terms is change for the better. We look for companies that embrace change, think differently, think outside the box to create something new…”
~ Dave Carlsen, CFA, Co-Portfolio Manager
Overall Morningstar Rating™ of BUFTX based on risk-adjusted returns among 538 Midcap Growth funds as of 8/31/19.
FUND OBJECTIVE & INVESTMENT PROCESS
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.
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.
Clay Brethour, CFA, Co-Portfolio Manager
|As of 8/31/19||3 MO||YTD||1 YR||3 YR||5 YR||10 YR||15 YR||Since Inception|
|BUFFALO DISCOVERY FUND - Investor||6.76||27.69||6.82||14.44||11.33||15.17||11.78||9.53|
|BUFFALO DISCOVERY FUND - Institutional||6.81||27.83||6.99||14.61||11.50||15.34||11.94||9.70|
|Morningstar U.S. Mid Growth Index||5.75||27.79||5.21||15.94||10.78||14.88||11.28||8.15|
|Russell Midcap Growth Index||7.53||26.68||5.96||14.92||10.72||14.85||10.88||9.05|
|Morningstar Mid-Cap Growth Category||6.28||24.21||1.66||13.62||9.38||13.39||9.89||6.93|
|As of 6/30/19||3 MO||YTD||1 YR||3 YR||5 YR||10 YR||15 YR||Since Inception|
|BUFFALO DISCOVERY FUND - Investor||6.33||27.08||13.12||16.47||11.27||16.34||10.92||9.60|
|BUFFALO DISCOVERY FUND - Institutional||6.37||27.17||13.29||16.64||11.43||16.51||11.08||9.76|
|Morningstar U.S. Mid Growth Index||7.06||29.58||15.64||17.94||11.62||16.08||10.71||8.31|
|Russell Midcap Growth Index||5.40||26.08||13.94||16.49||11.10||16.02||10.25||9.11|
|Morningstar Mid-Cap Growth Category||5.61||24.97||9.88||15.59||9.78||14.53||9.29||7.04|
3 Year Risk Metrics
|BUFTX vs Morningstar U.S. Mid Growth Index (As of 6/30/19)|
Hypothetical Growth of $10,000
|(As of 6/30/19)|| |
|# of Holdings||82|
|Median Market Cap||$14.94 B|
|Weighted Average Market Cap||$18.06 B|
|3-Yr Annualized Turnover Ratio||59.68%|
|% of Holdings with Free Cash Flow||90.48%|
Top 10 Holdings
|Holding||Ticker||Sector||% of Net|
|The Cooper Cos.||COO||Health Care||1.94%|
|IDEXX Labs||IDXX||Health Care||1.77%|
|International Flavors & Fragrance||IFF||Materials||1.60%|
|Align Technology||ALGN||Health Care||1.58%|
|Exact Sciences||EXAS||Health Care||1.56%|
|TOP 10 HOLDINGS TOTAL||17.02%|
CAPITAL MARKET OVERVIEW
Central banks and trade policies continued to drive financial markets during the period. The threat of increasing tariffs against China and Mexico contributed to the sell-off early in the quarter, and the June rally was largely a result of dovish central bank commentary, leading investors to anticipate rate cuts in the coming months.
The Russell 3000 Index returned 4.10% in the quarter. By style, growth outpaced value, with the Russell 3000 Growth Index up 4.50% and the Russell 3000 Value Index up 3.68%. Large caps generally outperformed small caps in the quarter. The Russell 1000 Index returned 4.25%, just ahead of the Russell Mid Cap Index return of 4.13%. The Russell 2000 returned 2.10% during the quarter. Financials were the best performing sector, followed by Materials and Information Technology. Energy was the only sector to post a negative return, driven by a decline in oil prices. Health Care and Real Estate also underperformed relative to the broad market.
Among the top contributors during the quarter were MSCI and IDEXX Labs. MSCI, an index and investment analytics services provider, rallied on strong investment flows into passive products and leverage to a rising market, and asset-based fees support continued strong growth prospects. IDEXX Labs, a lab analysis company for pets and livestock, reported better than expected quarterly results, driven by share gains and better than expected margins due to strong adoption of their premium-priced, single-use, on-site diagnostic test kits.
The biggest detractors in the period were Blackberry and Arista Networks. Blackberry’s stock was pressured when growth in its software category, which is key to the company’s long-term value creation story, did not meet the pace at which investors expected in the near term. Arista Networks, a datacenter software and equipment provider, fell after it guided to lower than expected revenue growth, as its tier 1 cloud customers temporarily slowed spending to digest recent capacity additions.
Countering this healthy backdrop are high valuations and deteriorating leading indicators on global trade. Easy money for much of the past 10 years and rising expectations for more to come, have led to asset inflation and generally elevated growth stock valuations. Meanwhile, global trade tensions are weighing on consumer and business confidence, where recent surveys point to a slowdown amongst global purchasing managers. In the near to intermediate term we suspect pockets of weakness could emerge, particularly for the more global and cyclically oriented companies. We have trimmed positions in this area to avoid asymmetric risk associated with high valuation and the potential for downward estimate revisions.
We believe a volatile, more discerning market could materialize through 2019. The volatility may favor judicious growth stock investors where a steady hand and active management with an eye toward quality, improving profit cycle dynamics, and relatively attractive risk-adjusted returns could hold an advantage.
Economic conditions may ebb and flow, but our focus remains steadfast on investing in attractively priced, financially strong, well-managed companies whose innovative strategies should fuel secular growth opportunities. We seek those opportunities where thoughtful management teams are in a favorable position to use innovation for market advantage and sustained value creation. Successful innovation may often lead to disruptive share gains in large existing markets, or the creation of large new market opportunities, a strategy which we believe is less dependent on the overall macro environment for growth.
The Fund continues to invest in disruptive and innovative growth companies with relatively attractive valuations, a strategy we believe should be a key driver of above-index, risk-adjusted returns over the long term.
DISCOVERY FUND NEWS
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.
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