High Yield Fund

(As of 3/31/19) — After producing negative returns in final quarter of 2018, the U.S. high yield sector reversed course and generated positive performance in the 1st quarter of 2019, with bond prices rallying in all three months. The market’s performance was driven by: (i) continued, albeit modest, economic growth of U.S. Gross Domestic Product (GDP); (ii) a more dovish sentiment from the Federal Reserve (Fed), signaling a pause in raising interest rates and timing of plans to reduce their balance sheet; (iii) a healthy labor market with additional jobs added and the unemployment rate near cycle lows; and (iv) the equity market indexes bouncing back after dismal performance to end last year. The Fed’s pause, and the resulting decline in the level of short-term interest rates (3-Month LIBOR ended the period down 20bps to 2.60%), encouraged investors to buy risky assets. The 10-year Treasury bond produced a return of 3.07% during the quarter while the S&P 500 Index returned a positive 13.65%.

Anticipation of a potentially longer credit cycle and decreased market volatility resulted in positive cash inflows for the high yield asset class during the quarter of about $12.2 billion compared to outflows of $19.2 billion for the year ago quarter ending March 31, 2018 (source: JP Morgan). The $65.4 billion in new issuance of high yield bonds during the quarter increased sequentially from $19.1 billion in the 4th quarter of 2018 quarter, but was down year-over-year compared to the $72.7 billion during the 1st quarter of 2018.

During the period, the 10-year Treasury bond yield dropped by 18 basis points (bps) from 2.69% to 2.41%. High yield issues across all ratings segments and industry sectors followed suit with positive returns and lower yields. According to data from JP Morgan, the heart of the ratings curve outperformed slightly with the single B rated bond segment producing the highest return at +7.38% and bank loans being the worst performer at +4.65%.

According to data from JP Morgan, the U.S. high yield market’s spread to worst for the period was 452bps, 42bps wider than the preceding quarter of 2018 but still 160 basis points below its 20-year historical average of 612 basis points. The yield to worst for the high yield market at quarter end was 6.83%, below the 8.95% 20-year average, and above the yield of 6.56% at the end of the last March 2018 quarter.

The market for high yield securities showed signs of life during the quarter as spread to worst tightened over 100bps and yield to worst shrank by 140bps. This is the strongest start to a calendar year on record for the high yield asset class, as a growing economy with modest inflation and a more dovish Fed stance toward monetary policy has created an increased appetite for risk assets. The U.S. high yield default rate of 0.94% was down 87bps from January 1, 2019 and down 133bps compared to the March 31, 2018 default rate of 2.21%, and still well below the 3.5% long-term average. New issuance activity steadily increased each month during the quarter, satiating some of the demand driven by $12.2 billion of inflows into high yield mutual funds.

(As of 3/31/19) — The Buffalo High Yield Fund posted a return of 5.28% for the quarter, underperforming the ICE BofAML High Yield Index return of 7.40% during the same period.

The Fund’s cash balance increased 332bps compared to December 31st as some holdings were either called by the issuers or sold outright and exceeded our new security purchases.

We ended the quarter with 122 positions compared to the previous quarter’s level of 124 positions (excluding cash).

As shown in the table above, all of the Fund’s asset classes with the exception of common stocks produced positive returns. The Fund’s convertible bonds and convertible preferreds outperformed the Index total return, while corporates, bank loans, and common stocks underperformed the Index total return.

TOP CONTRIBUTORS
Specific securities that contributed most positively to performance include LiveNation 2.500% convertible bonds, Andeavor Logistics 6.875% corporate bonds, and Triumph Group 4.875% corporate bonds. LiveNation advanced on better than expected earnings and sell-side speculation that the company is an attractive acquisition target. Andeavor bounced back after a dismal December as investors were bailing out of perpetual maturity issues. Triumph Group rose as the company continued to improve the business by selling assets, cutting costs, and focusing on higher margin businesses.

TOP DETRACTORS
Specific securities that detracted most from performance include Maxar Technologies bank debt, Greenbrier common stock, and Weight Watchers bank debt. The Maxar term loan declined on worse than expected earnings and management’s decision to cut the dividend which made debt holders wary. Greenbrier declined on earnings coming in below expectations, and the continued sluggish environment for railcar orders forced management to lower expectations for 2019. The Weight Watchers term loan was hurt by declining revenue concerns and increasing leverage.

(As of 3/31/19) — Given that we are possibly in the late stages of the economic cycle, we find ourselves confronted with relatively low spread and yield levels. We continue to be concerned about inflation growth acceleration, geopolitical tensions – specifically the trade tensions with China, and increasing protectionism efforts from the White House.

We are managing the Fund cautiously yet actively, focusing on high-quality issuers with defensive business models and manageable credit metrics. We will continue to deploy cash in opportunities that we believe offer the most appealing risk/reward trade-off with a bias toward shorter durations and less levered credits. Additionally, we believe bank loans offer a compelling opportunity as they offer senior positioning in the capital structure and floating interest rates. Finally, we continue to look for opportunities in convertible bonds and preferreds.