Flexible Income Fund

(As of 12/31/17) — Equity markets ended 2017 on a strong note. The 4th quarter saw a continuation of trends that have influenced the market all year. Investor optimism about continued global economic growth and strong corporate earnings led to another quarter of higher stock prices. Strong holiday sales and the passage of tax reform legislation also provided tailwinds to equity markets. The CBOE Volatility Index continued to hover near record lows, and, for the first time since 1958, U.S. equities delivered positive returns in every single month of the year.

The S&P 500 Index produced a total return of 6.64% in the 4th quarter. Growth continued to outperform value, with the Russell 3000 Growth Index up 7.61%, beating the 5.08% return from the Russell 3000 Value. Large companies generally outperformed smaller companies during the quarter. The Russell 1000 returned 6.59%, the Russell Midcap Index returned 6.07%, the Russell 2000 returned 3.34%, and the Russell Microcap Index returned 1.80%. Consumer discretionary and technology were the best performing sectors in the 4th quarter. Utilities, health care, and consumer staples underperformed.

(As of 12/31/17) — The Buffalo Flexible Income Fund produced a return 5.50% for the quarter and unperformed the S&P 500 Index return of 6.64% but outperformed the ICE Bank of America Merrill Lynch High Yield Master II Index return of 0.41%. The fund’s peer group index, the Lipper Mixed-Asset Allocation Moderate Funds Index, produced a return of 3.17% for the quarter.

The equity portion of the portfolio outperformed the S&P 500 Index with a total return of 6.69% for the quarter. The relative outperformance was primarily driven by the energy and information technology sectors. The outperformance within energy was driven by security selection. Specific energy securities that provided positive relative performance included HollyFrontier, Marathon Petroleum, Helmerich and Payne, and BP. HollyFrontier and Marathon are refiners that benefited from refining margins and crude differentials. HollyFrontier also benefited from an improved operating environment associated with higher oil prices, which has led to better pricing and utilization for their products, while BP was also a beneficiary of higher oil prices.

The relative outperformance within the information technology sector was due to security selection. Specifically, Intel benefited from good earnings (margin expansion), positive trends in its data center segment, and stability in its PC segment.

The top three contributors to the fund’s performance during the quarter were HollyFrontier, Intel, and Boeing while the top three detractors were General Electric, Pitney Bowes, and GlaxoSmithKline.

The fixed income portion of the fund generated a return of 1.32% and outperformed the ICE Bank of America Merrill Lynch High Yield Master II Index return of 0.42%. Relative outperformance was led by the consumer discretionary and information technology sectors. Within the consumer discretionary sector, the primary driver of outperformance was the portfolio’s Lions Gate Entertainment convertible bond investment, which advanced due to better earnings guidance, driven by better-than-expected STARZ subscribers and cord cutting. The information technology segment outperformance was driven by both sector allocation and security selection. Bankrate refinanced their capital structure, which led to positive performance, and Nuance Communications 1.5% convert appreciated due to strong earnings driven by its healthcare segment, as well as positive bookings guidance.

The top individual contributors to the fund’s fixed income performance included Lions Gate Entertainment 1.25% convertible notes, Nuance 1.5% convertible notes, and Valeant’s 6.375% senior notes. The largest relative detractors to the fixed income return were Medicines Company 2.50% convertible bonds, Consolidated Communications 6.5% senior notes, and Cornerstone on Demand 1.5% convertible notes.

(As of 12/31/17) — We believe the market could experience more volatility in the coming quarters, as the Federal Reserve continues with its desire to normalize interest rates, along with a focus on the likelihood of the Trump administration to enact infrastructure spending, deregulation, and corporate tax reform. Prospective tailwinds for the economy include further job growth, wage increases, lower tax rates, and simply more optimism from both businesses and consumers; all of which could lead to higher Gross Domestic Product (GDP) growth. On the other hand, possible headwinds include potential strengthening of the U.S. dollar, further increases in interest rates, and stock price valuation metrics that are above historical market averages, leading us to believe that the stock market may have a hard time achieving further multiple expansion.

Despite the expectation of more volatility, we continue to focus on wide moat, large-capitalization companies that are trading at reasonable valuations, in our view. As always, the fund will continue to focus on competitively advantaged companies that can be purchased at a fair price, in our opinion. As the stock market has continued to climb, it is getting harder to find companies that fit our investment criteria, but we continue follow our process of finding new investment ideas and are ready when market declines provide better opportunities.

Within the fixed income portion of the fund, we continue to focus on higher quality, below investment grade credit securities. With credit yield spreads at cycle lows, in our opinion, we are being selective and disciplined with purchases, as we do not anticipate much price appreciation within fixed income markets, in general.