Emerging Opportunities Fund
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
We believe investing in an actively-managed portfolio of premier, early-stage, growth companies could lead to growth of capital over time. We look for companies that could benefit from long-term industrial, technological, or general market trends, and are trading at what we view as attractive valuations.
Craig Richard, Portfolio Manager
Overall Morningstar Rating™ based on risk-adjusted returns among 591 Small Growth funds as of 10/31/18.
|As of 10/31/18||3 MO||YTD||1 YR||3 YR||5 YR||10 YR||Since Inception|
|BUFFALO EMERGING OPPORTUNITIES FUND||-6.03||4.74||5.78||13.94||6.13||16.60||8.35|
|Morningstar U.S. Small Growth Index||-6.96||4.78||6.85||12.03||8.85||14.39||9.26|
|Russell 2000 Growth Index||-9.39||1.11||4.13||10.72||8.75||13.89||9.24|
|Lipper Small Cap Growth Fund Index||-6.30||6.63||10.60||12.50||8.94||13.94||8.71|
|Morningstar Small Growth Category||-6.47||5.20||8.31||11.98||8.58||13.81||8.45|
|As of 9/30/18||3 MO||YTD||1 YR||3 YR||5 YR||10 YR||Since Inception|
|BUFFALO EMERGING OPPORTUNITIES FUND||5.41||18.57||20.13||19.83||9.18||14.67||9.34|
|Morningstar U.S. Small Growth Index||7.61||20.07||26.30||19.32||12.34||13.15||10.36|
|Russell 2000 Growth Index||5.52||15.76||21.06||17.98||12.14||12.65||10.33|
|Lipper Small Cap Growth Fund Index||7.49||20.79||28.23||19.06||12.12||12.64||9.71|
|Lipper Micro Cap Funds Index||2.61||11.96||14.15||16.59||10.10||11.51||8.75|
|Morningstar Small Growth Category||7.00||18.94||24.44||18.39||11.75||12.57||9.43|
Performance data quoted represents past performance; past performance does not guarantee 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 cost. Current performance of the fund may be lower of higher than the performance quoted and can be obtained here. Performance is annualized for periods greater than 1 year. Each Morningstar category average represents a universe of funds with similar objectives.
As of July 27, 2018 the Morningstar U.S. Small Growth Index has replaced the Russell 2000 Growth Index as the Fund’s primary benchmark. The Advisor believes that the new index is more appropriate given the Fund’s holdings.
3 Year Risk Metrics
|vs Morningstar U.S. Small Growth Index (As of 9/30/18)|
Hypothetical Growth of $10,000
This chart illustrates the performance of a hypothetical $10,000 investment made in the Fund on the Inception Date. Assumes reinvestment of dividends and capital gains. This chart does not imply future performance.
|(As of 9/30/18)|| |
|# of Holdings||69|
|Median Market Cap||$1.06 B|
|Weighted Average Market Cap||$1.26 B|
|3-Yr Annualized Turnover Ratio||66.50%|
|% of Holdings with Free Cash Flow||44.93%|
|% of Holdings with No Net Debt||36.23%|
Top 10 Holdings
|Holding||Ticker||Sector||% of Net|
|Community Healthcare Trust||CHCT||Real Estate||3.00%|
|LHC Group||LHCG||Health Care||2.29%|
|Foundation Building Materials||FBM||Industrials||2.17%|
|TOP 10 HOLDINGS TOTAL||23.96%|
As of 9/30/18. Security weightings are subject to change and are not recommendations to buy or sell any securities. Sector Allocation may not equal 100% due to rounding.
As of 9/30/18. Market Cap percentages may not equal 100% due to rounding.
CAPITAL MARKET OVERVIEW
(As of 9/30/18) — U.S. economic strength and solid corporate earnings growth drove healthy equity returns in the 3rd quarter. The widely-followed S&P 500 Index had a total return of 7.71%, its best quarterly gain since 2013. In September, initial jobless claims fell to the lowest level since 1969, wages grew at the fastest rate since 2009, consumer confidence reached the highest level since 2000, and the National Federation of Independent Business (NFIB) survey of small business optimism was at an all-time high (the survey dates back to 1974). Against this strong economic backdrop, the Federal Reserve raised the targeted federal funds rate by another 25 basis points to a range of 2.00% to 2.25%. Slowly rising interest rates led to flat bond returns.
The divergence between domestic and international equity market performance continued during the quarter, with the MSCI EAFE Index advancing just 1.35%. The Russell 3000 Index gained 7.12% in the 3rd quarter. By style, growth continued to outperform value, with the Russell 3000 Growth Index increasing 8.88% compared to the Russell 3000 Value Index’s advance of 5.39%. Large caps did better than small caps as the Russell 1000 Index returned 7.42%, the Russell Midcap Index returned 5.00%, and the Russell 2000 Index returned 3.58% in the quarter. Every economic sector was positive this quarter, with Health Care and Industrials the top performers, while Materials and Energy lagged the indexes.
(As of 9/30/18) — The Buffalo Emerging Opportunities Fund (the Fund) posted a return of 5.41% in the quarter. This compares to the Morningstar U.S. Small Growth Index return of 7.61%. During the quarter, the Fund changed its primary performance benchmark to the Morningstar U.S. Small Cap Growth Index from the Russell 2000 Growth Index, which gained 5.52% in the third quarter.
Returns were skewed higher at the higher end of the market capitalization spectrum within the growth universe during the 3rd quarter. The Russell 1000 Growth Index posted a 9.17% return compared to the Russell MicroCap Growth Index with a return of 3.16% during the quarter.
The Fund had two holdings announce they were being acquired in the quarter. Invuity, a medical device company with solutions that help illuminate body cavities for surgery, is being acquired by Stryker. Additionally, Nexeo Solutions, a specialty chemicals and plastics distributor, is being acquired by Univar. In both cases the acquisitions are being made by strategic buyers (larger peers). This marks four acquisitions of Fund holdings in the first nine months of calendar 2018, with the purchases of Financial Engines and CommerceHub by financial buyers earlier this year.
We have noted previously the potential for a pick-up in mergers and acquisitions activity, given we are in the later stages of the bull market, and large companies with access to low cost capital have the desire to boost revenue and earnings growth through acquisitions.
The Fund added six new positions in the quarter and sold out of one, ending with 69 holdings.
Omnicell was the largest contributor to the Fund’s 3rd quarter returns. The company generated accelerated bookings growth in the 1st half of 2018 along with several new product releases that could potentially position them well for continued strong growth in calendar 2019. Omnicell is a leading provider of hardware and software for medication management and adherence (medication cabinets, pill blister packs, etc.) that enables the oversight of prescription drug flows in an acute care setting. The company is in the midst of a major upgrade cycle and continues to consistently take market share from their major competitor.
The Fund also benefited from the performance of i3 Verticals, a payment processing company that recently came public in June 2018 and focuses on providing services to small and medium size businesses in the education and public sector verticals. The management team at i3 Verticals has had success at building previous businesses in this space through organic growth and acquisitions, and the pipeline for deals at attractive valuations remains solid.
The largest detractor in the quarter was Optinose. Optinose has an approved drug delivery device to treat nasal polyps (growths in lining of nasal sinuses). The device delivers the drug through the patient exhaling into it and results in much better absorption of the drug in the nasal passageway. The commercial launch since March 2018 has been disappointing as doctors have shown some hesitancy to prescribe given concern
over commercial payer coverage (“Are my patients going to have larger out of pocket expense?”). Optinose is doing the work to increase doctor and patient awareness of the benefits of the device/drug combination and cost neutrality to patients, and we expect the commercial launch to continue to improve.
(As of 9/30/18) — The domestic macroeconomic picture continues to remain positive for small cap stocks given near record levels for consumer sentiment and small business confidence. Additionally, the trade war dynamics should have less of an impact on our holdings, given a higher portion of their business-related activities are domestically-focused compared to larger cap stocks. That being said, sentiment and asset flows can have a forceful and immediate impact as seen in the first part of the 4th quarter, with small cap growth stocks pulling back more than 10% from recent highs. As always, we will be playing close attention to the valuations of our holdings, and we will utilize market volatility to trim or add to our holdings as risk/reward profiles improve or degrade.
The Buffalo Emerging Opportunities Fund is focused primarily on identifying innovation within U.S. companies with primarily North American revenue bases. We continue to look for prudent ways to deploy cash, and we remain long-term focused, aiming to be shrewd when the market environment presents opportunity and more cautious when it does not. With an active share of greater than 95%, we believe the Fund will continue to offer a distinct offering from the Index and peers.
The opinions expressed are those of the Portfolio Manager(s) and are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security. Earnings growth is not representative of the fund’s future performance.
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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.
The Buffalo Emerging Opportunities Fund received 4 stars among 591 for the three-year, 1 stars among 516 for the five-year, and 4 stars among 392 Small Growth funds for the ten-year period ending 10/31/18.
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. ©2018 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.