Flexible Income Fund

(As of 6/30/18) — Supportive economic data drove positive domestic equity performance in the 2nd quarter. The unemployment rate declined to 3.8%, the lowest level in 18 years. Wages have continued to rise, with average hourly earnings up 2.7% as of May. Corporate earnings growth continued to be robust. The Federal Reserve increased their target rate by 0.25% and raised their forecast for growth and inflation again in June. Meanwhile, economic growth outside the U.S. slowed, with the divergence driving strength in the U.S. dollar. Increasing trade protectionism along with the dollar’s strength, led to the relative outperformance of domestically focused industries and smaller capitalization companies, which generally do less international business than large caps. Crude oil prices continued to rise, despite the strong dollar, driven by lower stockpiles in the U.S. and President Trump’s decision to withdraw from the Iran nuclear accord.

The Russell 3000 Index returned 3.89% in the quarter. Growth continued to outpace value, with the Russell 3000 Growth Index up 5.87% and the Russell 3000 Value Index up 1.71%. By size, the Russell Microcap Index led the way with a return of 9.97%, followed by the small cap Russell 2000 Index at 7.75%. The large cap Russell 1000 Index was up 3.57%, and the Russell Midcap Index was up 2.82%. Energy was the best performing sector, driven by strength in crude oil prices. The Consumer Discretionary, Information Technology, and Real Estate sectors also had strong quarters. Meanwhile, trade fears and rising input costs caused the underperformance of Industrials, and Financials were weaker as a result of the yield curve flattening.

(As of 6/30/18) — For the quarter ended 6/30/18, the Buffalo Flexible Income Fund returned 4.18% compared to the S&P 500 Index return of 3.43% and the ICE Bank of America Merrill Lynch High Yield Master II Index return of 1.00%.

For the quarter, the equity portion of the portfolio returned 5.05% compared to 3.43% for the S&P 500 Index. The Fund’s equity component is primarily focused on large cap dividend payers, which we believe possess significant competitive advantages. The sectors that led to outperformance during the period were Energy and Financials. The outperformance in the Energy sector was driven by both sector allocation and security selection. The Fund maintained its overweight allocation to Energy for the period, which was the best performing sector in the S&P 500 Index.

Overall, the top contributors to fund performance in the quarter were HollyFrontier, ConocoPhillips, and Hess Corp., while the top detractors in the quarter were AT&T, Pitney Bowes, and IBM. HollyFrontier had a strong 1st quarter earnings report, which benefited from wider spreads, as pipeline capacity wasn’t able to keep up with Permian oil production. ConocoPhillips and Hess also reported strong 1st quarter earnings, driven by improved oil prices. Meanwhile, our portfolio’s outperformance in the Financials sector was due to sector allocation — we are underweight versus the Index, and Financials was the worst performing sector for the Index during the 2nd quarter.

The fixed income portion of the Fund generated a return of 1.18% for the quarter, which outperformed the ICE Bank of America Merrill Lynch Master II Index return of 1.00%. The top contributors to the Fund’s fixed income performance included Consolidated Communications, Medicines Company, and Approach Resources, while the top detractors were Nuance Communications, Brunswick, and Everi Payments.

(As of 6/30/18) — Given that we believe the U.S. is in the later stages of the current economic cycle, we continue to find ourselves confronted with relatively low spread and yield levels with the non-investment grade fixed income asset class that we prefer over the long haul. This backdrop has resulted in a bond allocation that is close to the low end of our expected range in terms of the Fund’s overall asset mix of stocks, bonds, and cash. Within the fixed income portion of the portfolio we continue to focus on high-quality, non-investment grade issuers with defensive business models and manageable credit metrics.

We expect the market to experience volatility in the coming quarters as the Federal Reserve is expected to continue with its plan to normalize interest rates. We are also concerned about the Federal Reserve taking a more aggressive tightening policy stance than investors currently anticipate. Other areas we are monitoring include inflation growth acceleration, geopolitical issues, and increasing protectionism efforts from the White House. Valuation metrics are also above historical market averages, leading us to believe the stock market may have a hard time achieving further multiple expansion.

On the positive side, we see prospective tailwinds for the economy that 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 and a continued move higher in the stock market.