Emerging Opportunities Fund
Recent Media Coverage
Fund Objective & Investment Process
The investment objective of the Buffalo Emerging Opportunities Fund is long-term growth of capital. The Fund invests primarily in equity securities, consisting of a portfolio of between 50-70 domestic common stocks, preferred stocks, convertible securities, warrants and rights, of companies that, at the time of purchase by the Fund, have market capitalizations of $1.5 billion or less.
The Fund managers seek to identify companies for the Fund’s portfolio that are expected to experience growth based on the identification of long-term, measurable secular trends, and which, as a result, may have potential revenue growth in excess of the gross domestic product growth rate. Companies are screened using in-depth, in-house research to identify premier early-stage growth companies which generally demonstrate:
- Strong management teams
- Little or no debt
- Potential for increasing free cash flow
- Scalable business models with a competitive advantage
- Potential for increasing margins
- Attractive risk/reward given the market framework
Craig Richard, Portfolio Manager
Overall Morningstar Rating™ of BUFOX based on risk-adjusted returns among 583 Small Growth funds as of 5/31/20.
|As of 5/31/20||3 MO||YTD||1 YR||3 YR||5 YR||10 YR||15 YR||Since Inception|
|BUFFALO EMERGING OPPORTUNITIES FUND - Investor||4.95||-2.39||10.91||12.24||9.46||14.45||8.93||8.73|
|BUFFALO EMERGING OPPORTUNITIES FUND - Institutional||5.07||-2.27||11.12||12.42||9.63||14.63||9.10||8.89|
|Morningstar U.S. Small Growth Index||6.80||0.12||11.83||11.16||8.85||12.97||9.35||9.26|
|Morningstar Small Growth Category||3.37||-3.84||7.66||9.60||7.75||11.79||8.84||8.20|
|As of 3/31/20||3 MO||YTD||1 YR||3 YR||5 YR||10 YR||15 YR||Since Inception|
|BUFFALO EMERGING OPPORTUNITIES FUND - Investor||-25.33||-25.33||-14.38||4.50||3.48||10.80||6.98||7.00|
|BUFFALO EMERGING OPPORTUNITIES FUND - Institutional||-25.31||-25.31||-14.28||4.64||3.63||10.96||7.14||7.16|
|Morningstar U.S. Small Growth Index||-21.45||-21.45||-16.07||3.43||3.71||9.79||7.73||7.70|
|Morningstar Small Growth Category||-24.59||-24.59||-17.66||1.69||2.77||8.81||7.13||6.66|
3 Year Risk Metrics
|BUFOX vs Morningstar U.S. Small Growth Index (As of 3/31/20)|
Hypothetical Growth of $10,000
|(As of 3/31/20)|| |
|# of Holdings||58|
|Median Market Cap||$829.52 M|
|Weighted Average Market Cap||$1.37 B|
|3-Yr Annualized Turnover Ratio||36.80%|
|% of Holdings with Free Cash Flow||60.34%|
|% of Holdings with No Net Debt||48.28%|
Top 10 Holdings
|Holding||Ticker||Sector||% of Net|
|LHC Group||LHCG||Health Care||2.74%|
|Hamilton Lane||HLNE||Financial Services||2.59%|
|Community Healthcare Trust||CHCT||Real Estate||2.59%|
|Kinsale Capital Group||KNSL||Financial Services||2.52%|
|Air Transport Services Group||ATSG||Industrials||2.26%|
|TOP 10 HOLDINGS TOTAL||26.57%|
CAPITAL MARKET OVERVIEW
(As of 3/31/20) — Global equity markets fell sharply in the 1st quarter of 2020 in reaction to the global spread of COVID-19. As the case count increased exponentially, the only effective response was for countries to go into lockdown. The economic impact of these actions became clear as the quarter progressed and virtually all asset classes suffered as a result. From February 19 through March 23, the U.S. stock market, as measured by the S&P 500 Index, declined around 34%, which was the fastest meltdown in history. Central banks and governments responded quickly to this event, with the U.S. Federal Reserve (the “Fed”) cutting interest rates twice in March and announcing unlimited quantitative easing. The U.S. Senate passed a $2 trillion stimulus package, providing assistance to individuals and businesses in distress. Optimism around these efforts helped the market rally into quarter end, leaving the S&P 500 Index down 19.60% from the start of the year.
The broad market Russell 3000 Index declined 20.90% in the 1st quarter. Growth outperformed value, with the Russell 3000 Growth Index declining 14.85% compared to the Russell 3000 Value Index decline of 27.32%. By capitalization size, large cap stocks held up best, with a -20.22% return in the quarter, represented by the Russell 1000 Index. The Russell Mid Cap Index fell -27.07%, followed by the smaller cap Russell 2000 Index which declined -30.61%. Best performing sectors were the Technology, Health Care, and Consumer Staples sectors. The Energy sector was hit hardest as falling demand and rising supply from Saudi Arabia caused oil prices to crater. The economically-sensitive Financial and Industrial sectors were also among the worst performing sectors in the quarter.
(As of 3/31/20) —The Buffalo Emerging Opportunities Fund (BUFOX) posted a negative 25.33% return in the quarter ending March 31, 2020. This compares to the Morningstar U.S. Small Growth Index’s (Funds’ primary benchmark) return of negative 21.45%. The Russell 2000 Growth Index and the Russell MicroCap Growth Index returned negative 25.76% and negative 26.59%, respectively.
The spread of SARS-CoV2 and the resulting pandemic created a new chapter in history books in the first quarter of 2020. The major issues just a few quarters ago that included U.S./China trade war and flare ups in geopolitical issues between U.S./Iran have become nearly irrelevant as COVID-19 has taken center stage and created an environment few of us could have ever foreseen. The market sell-off as the virus spread throughout the European Union and the U.S. was the swiftest in history, with the S&P 500 Index falling 35% from peak to trough in just over one month. Even worse was the performance of smaller growth stocks as measured by the Russell 2000 Growth Index, declining 43% from peak to trough.
However, final first quarter returns were less ugly than the peak-to-trough declines, given a strong start to the year and a sharp rebound that began in the final week of the quarter. During the 1st quarter, investors preferred the perceived relative safety of larger companies. This is best illustrated by the fact that the large cap Russell 1000 Index dramatically outperformed both the small cap Russell 2000 Growth Index and the Russell Microcap Growth Index. Domestically, growth stocks outperformed value stocks by a wide margin. As an example, the Russell 2000 Value Index declined 35.66% in the 1st quarter, nearly 10% worse than its growth counterpart.
With shelter-in-place orders across the U.S. and the world affecting close to half the global population, numerous industries saw sales and profits decrease dramatically. At the time of this writing in late April, states in the U.S. and countries in Europe are beginning to ease restrictions on households and businesses. However, it remains unknown as to how consumers and businesses will rebound. Additionally, there is significant risk that COVID-19 cases could spike again as a result of the loosening of these restrictions and the potential government response the second time around. In this environment, almost universally, companies are withdrawing previous financial guidance and declining to give updated financial guidance for upcoming quarters and the remainder of the year.
However, investor enthusiasm has come roaring back, perhaps because of the significant stimulus packages provided by the U.S. government. The U.S. Treasury Department and the Fed have combined to create approximate $3 trillion of new money, which has been given to businesses and individuals through payroll protection programs, enhanced unemployment benefits, and stimulus checks. Additionally, the Fed has completed record levels of various asset purchase/backing programs in an effort to support credit markets. The chart below indicates the spike in the Fed’s balance sheet (buying U.S. treasuries and other financial assets) just in the last month. In the last two months, the Fed’s balance sheet has grown from $4.2 trillion to $6.7 trillion as seen in the chart below from the St. Louis Federal Reserve.
This expansion of the Fed’s balance sheet is correlated with a sharp spike in the money supply. In particular, the M2 money supply metric has spiked in the last month. M2 measures the amount of money held at households in the form of cash, checking accounts, savings accounts, money market accounts, and other accounts easily converted to cash. The chart below from the St. Louis Fed depicts this growth with this metric increasing from $15.5 trillion to $16.9 trillion in one month, a 10% increase in the money in the hands of households in the U.S. Some of this excess capital is likely finding its way into the stock market.
With this backdrop, the broader market as measured by the Russell 3000 Growth Index is now down just 2% year-to-date as of this writing. The sharp rebound (up 36% off the lows for this particular index) and resilience of the market in the face of COVID-19 has been nearly as spectacular as the sell-off.
As has been the case over the last decade, the Fed has shown its ability to support and boost markets, and it appears to have been successful in the short-term again at this point in time. However, disciplined investors believe that a rational market should be driven more by earnings than the multiple investors will pay for those earnings. As we will be in a recessionary environment for the 14th time since 1935, it is important to look at historical results. On average, it has taken the market 2.5 years to regain its prior peak earnings. The range has been as short as 6 months to as long as 4+ years. This recession is obviously unique in that it is event-driven, and the economy was not showing real weakness prior to COVID-19, but the challenges COVID-19 has created are real. Time will tell as to the shape of the recovery curve.
With regards to the Fund, management exited investments where the outlook was more challenged than most, particularly those linked to travel/leisure and the aerospace industries. Additionally, we scrubbed the Fund for balance sheet/cash flow related problems, given the drastic nature of the downturn and the financials issues it could create. The Fund ended the quarter with 58 holdings, down from 66 in the previous quarter.
During the quarter, a new position was initiated in NIC, Inc. NIC dominates the market of enabling online transactions to occur between state government agencies and its citizens and businesses. Driver license record retrievals for insurance companies, hunting and fishing licenses for consumers, business registrations, and property lien filings are just a few of the online services made available by NIC for its state partners. NIC has no competition outside of states providing the services themselves and has a very stable track record of generating 10% organic growth and solid cash flows. With the stock down in tandem with the market, we built a position during the 1st quarter, given we felt the market was under-appreciating the stability of the business model.
The Fund remains overweight the Technology sector. We continue to have high conviction that through market cycles, small cap technology companies with solid fundamentals (solid growth potential, recurring revenue, high margins or the potential for high margins) that are disrupting previous ways of conducting business could be the place to concentrate a small cap growth portfolio, as long as valuations remain reasonable.
(As of 3/31/20) — There remains a lot of uncertainty regarding the path back to a new normal. As covered above, we know the federal government has and appears willing to continue to do what is necessary to support the economy and especially the financial markets. Additionally, market risk exists around the coming U.S. elections in November.
While we acknowledge the challenging macro-economic backdrop, our job continues to be to find attractive small cap companies that have not been fully appreciated by the market or are mispriced due to recent results or events. We believe less investor interest in our segment of the market creates opportunity to uncover value. Given recent volatility, this is perhaps even more true today.
The Fund typically invests at the smaller end of the small cap growth spectrum, and the managers continue to seek companies with sustainable growth due to secular growth trends or innovative or disruptive products.
The Buffalo Emerging Opportunities Fund is focused primarily on identifying innovation within U.S. companies with primarily North American revenue bases. Finally, with an active share of greater than 95%, the Fund will continue to offer a distinct offering from the Index and category peers.
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. ©2020 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.