High Yield Fund

(As of 9/30/19) — After producing positive returns in the 2nd quarter of 2019, the U.S. high yield sector continued to push higher during the 3rd quarter, albeit to a lesser extent. The market’s performance was impacted by: (i) continued modest economic growth of U.S. gross domestic product (GDP); (ii) a widely anticipated 25 basis point (bps) cut from the Federal Reserve (the “Fed”) with a signaled “wait and see” approach going forward; (iii) volatile movements in crude oil prices that affected the energy space; and (iv) the equity market indexes continuing their climb higher. The Fed’s cut, and the resulting decline in the level of short-term interest rates (3 Month LIBOR down 23bps to 2.09%), encouraged investors to buy risky assets. The 10-year Treasury bond returned 3.37% during the quarter, outpacing the S&P 500 Index return of 1.70%.

Despite increased market volatility, high yield mutual funds experienced positive cash inflows during the quarter of about $3.8 billion. This follows a flat 2nd quarter and a 1st quarter inflow of $12.6 billion, which was the largest quarterly inflow in the last five years. The $67.7 billion in high yield new issuance during the quarter was down sequentially ($74.7 billion in the 2nd quarter) but higher year-over-year ($42 billion 3rd quarter 2018).

During the quarter, the 10-year Treasury Bond yield dropped by 33 bps from 2.00% to 1.67%. The U.S. high yield universe as a whole followed suit with positive returns and lower yields despite the energy sector continuing to be punished by plunging crude oil prices. According to data from JP Morgan, the higher quality end of the credit spectrum, single B-rated issues and above, continued its year-to-date trend of outperforming lower rated issues. The split BBB segment produced the highest return at 2.14% while the split B segment was the worst performing group at -4.36%.

According to data from JP Morgan, the U.S. high yield market’s spread to worst for the period was 4.75%, 110 bps wider than the preceding September quarter but still 135 basis points below its 20-year historical average of 610 basis points. The yield to worst for the high yield market at quarter-end was 6.39%, below the 8.83% 20-year average, and below the yield of 6.53% at the end of the last September 2018 quarter.

(As of 9/30/19) — The Buffalo High Yield Fund increased 1.24% in the 3rd quarter, a result in-line with the ICE BofAML U.S. High Yield Index return of 1.22%. The Fund also outperformed the Lipper High Yield Bond Funds Index and the Morningstar High Yield Bond Category for the quarter.

TOP CONTRIBUTORS

Specific securities that contributed most positively to performance include Medicines Company 2.750% convertible bonds, Performance Food Group 5.500% corporate bonds, and Brunswick 7.375% corporate bonds. Medicines Company convertible bonds rose due to favorable study results for its new cholesterol lowering medication. The Fund participated in the new issuance from Performance Food Group in September that quickly popped several basis points after being released. Brunswick 7.375% corporate bonds are investment grade and continued to rally as treasury yield spreads tightened.

TOP DETRACTORS

Specific securities that detracted most from performance include LSC Communications 8.75% corporate bonds, 8×8 Inc. 0.500% convertible notes, and Air Transport Services 1.125% convertible notes. The LSC bonds declined after the Department of Justice announced that it was blocking the acquisition of LSC by Quad Graphics. 8×8’s convertible notes declined as the underlying common stock was negatively impacted by a sell-side analyst downgrade in September. Air Transport Services converts followed its common stock lower in August after a peer reported worse-than-expected performance and uncertainty from the China trade tensions that weighed on the sector.

(As of 9/30/19) — A growing economy with modest inflation has created a favorable environment for risky assets. However, market participants are becoming increasingly concerned about the trade war with China, political uncertainty in Washington, and escalating tension in the Middle East. The U.S. high yield default rate decreased to 2.52% in September, down slightly from 2.55% in June 2019, and still below the 3.46% long-term average. New issuance activity in the quarter declined to $67.7 billion, below the $75.2 billion in the 2nd quarter. We continue to be concerned about the late stages of this economic cycle, geopolitical tensions – in particular the trade tensions with China, and increasing protectionism efforts from the White House.

Given the late stages of the economic cycle, we find ourselves confronted with still relatively low spread and yield levels. We are managing the Fund cautiously yet actively. We ended the quarter with 131 positions compared to the previous quarter’s level of 126 positions (excluding cash).

We are managing the portfolio to focus 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 tradeoff 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 preferred securities.