Flexible Income Fund

Equity markets got off to a strong start in the first quarter of 2017, thanks to an improving economic outlook. In February, small business optimism, as measured by the National Federation of Independent Businesses, was at its highest level in 12 years. In addition, the University of Michigan’s March consumer confidence survey showed that consumers were more confident in the economy than they have been at any time since 2000. Against this backdrop, growth stocks outperformed value stocks, led by technology, health care, and consumer discretionary companies.

The recent strength in infrastructure companies, banks, and high-tax-rate stocks stalled late in the quarter when, following Congress’s failure to agree on a health care reform bill, investors began to question the Trump administration’s ability to enact elements of its pro-growth agenda. Within commodities, the price of West Texas Intermediate (WTI) crude oil fell 6% during the quarter in response to better than expected U.S. oil inventories and production.

The Russell 3000 Index advanced 5.74% in the first quarter and larger cap stocks outperformed smaller cap stocks. The Russell 1000 Index returned 6.03%, followed by the Russell Mid Cap Index return of 5.15%, and the Russell 2000 Index result of 2.47%. The Russell Micro Cap Index advanced just 0.38% in the quarter. The Russell 3000 Growth Index outperformed the Russell 3000 Value Index by 5.64%. Technology was the best performing sector during the quarter while the energy sector was the worst performer, driven by the decline in crude oil.

The Buffalo Flexible Income Fund produced a returned 1.61% for the quarter. During the same time period, the S&P 500 Index returned 6.07% and the Bank of America Merrill Lynch High Yield Master II Index returned 2.71%. The equity portion of the portfolio, which represented about 80% of the Fund’s total investments at the end of the period, produced a return of 1.47% during the quarter.

The Fund’s equity component is primarily focused on large capitalization companies that are current or potential dividend payers which we also believe possess significant competitive advantages. The primary sectors that led to the underperformance during the period were energy and information technology. The underperformance in energy was primarily driven by sec-tor allocation as the Fund was significantly overweight the worst performing sector of the S&P 500 Index. The underperformance in information technology was due to both sector allocation and security selection. The Fund was underweight in its exposure to technology, which was the best performing sector during the quarter. As it relates to disappointing stock performance in technology, QUALCOMM and Intel were the primary detractors to relative results. QUALCOMM was negatively impacted during the quarter by several lawsuits including one by Apple, Inc. (a large customer) and by regulatory reviews from the U.S. Federal Trade Commission and Korea. Meanwhile Intel’s stock declined due to lower guidance for 2017 on its earnings call during the period. On an absolute basis, the top contributors to the Fund in the quarter were Boeing, Dow Chemical and GlaxoSmithKline while the top detractors were HollyFrontier, Pitney Bowes and ExxonMobil.

The fixed income portion of the Buffalo Flexible Income Fund generated a return of 2.15% for the first quarter and underperformed the Bank of America Merrill Lynch Master II Index which generated a return of 2.71%. The primary sectors detracting from performance were consumer discretionary and energy. The underperformance in the discretionary sector relative to the benchmark reflects both an overweight sector allocation and disappointing security selection. Lions Gate Entertainment, Inc. underperformed due to a mixed fourth quarter earnings report. Meanwhile within energy, the underperformance was due to Approach Resources and Wildhorse Resource Development. Both of these companies were negatively impacted by weaker oil prices during the quarter. The top contributors to the Funds fixed income performance included Medicines Company, Valeant and Nuance Communications while the three top detractors were Lions Gate Entertainment, Approach Resources and Consolidated Communications.

We expect the market to experience continued volatility in the coming quarters as the Federal Reserve continues to normalize interest rates along with a focus on the ability 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, potential headwinds include potential strengthening of the U.S. dollar, further increases in interest rates, and 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.