High Yield Fund

The Buffalo High Yield Fund posted a total return of 2.14% for the quarter ending March 31, 2017 underperforming the Bank of America Merrill Lynch High Yield Master II Index (the “Index”) which returned 2.71% during the same period.

The high yield market generated a return of 2.71% during the quarter while the yield on the U.S. 10-Year Treasury Note declined only 6 basis points (bps) and the Federal Reserve increased its target Fed Funds rate by another 25 bps in March. We believe the returns reflected the following events: (i) the failed repeal/replace of the Affordable Care Act (ii) continued improvement in the U.S. economy (with unemployment rates near cycle lows), and (iii) the Federal Reserve’s reassurance that a measured and gradual set of rate hikes through 2018 is still the game plan.

According to data from JP Morgan, high yield mutual funds experienced negative outflows during the first quarter of about $7.4 billion compared to inflows of roughly $600 million in the prior quarter. The high yield new issuance calendar totaled $98.7 billion in the quarter which was up significantly from the prior quarter’s $52 billion.

During the quarter, the yield on the 10-Year Treasury Note decreased slightly from 2.45% to 2.39% while high yield spreads compressed 20 basis points to 456 bps over the 10 Year-Treasury according to JP Morgan. As mentioned above, bullish sentiment on the U.S. economy parlayed with a fairly dovish stance from the Fed, gave investors confidence that high yield was still a relatively attractive asset class. According to data from JP Morgan, the best performing sector during the quarter was Healthcare (+4.33%) due to the failed House vote on the Affordable Care Act (Obamacare) repeal/replace in March. Also, the best performing sectors in the high yield market during the quarter continued to be the lower quality securities as the CCC segment returned 4.28% followed by the single B segment return of 2.33% and the BB return of 2.02%. The Fund’s high yield bond allocation is focused on the higher credit quality segments of the market which is mostly comprised of the BB and B segments. This quality bias largely explains our underperformance during the quarter.

The U.S. high yield market’s spread to worst as of March 31, 2017 was 456 bps which was 20 bps tighter than the preceding quarter and 297 bps below the same time last year. The yield to worst for the high yield market at 3/31/17 was approximately 6.24% versus 8.80% last year at this time.

The fund’s cash balance at the end of the quarter was 9.3% which is up from the prior quarter of 7.6% due to called bonds and selling activity by our management team. The funds composition by asset class at quarter end and over the previous four quarters was as follows:

The approximate rate and contribution of return from the various asset classes in BUFHX during the quarter was as follows:

The table above provides returns by asset class. Convertible preferreds were the best performing asset class and straight corporates were the largest contributor to the Fund’s quarterly returns. Specific securities that positively contributed the most to performance within this asset class during the quarter included the Medicines Company 2.500% and 2.750% convertible bonds as well CEB 5.625% straight corporate bonds which increased in price due to better underlying fundamentals. Within the straight corporate debt category, CEB, Valeant Pharma and KCG Holdings were the best performers. CEB increased in value due to a takeout, while Valeant and KCG improved due to better earnings. Bank loans that contributed the most to performance during the quarter include Valeant and Digital Globe. Securities that detracted most from performance during the quarter included Horizon Global 2.750% convertible bonds, Consolidated Communications 6.500% senior notes and Wildhorse Resources 6.875% senior notes. Horizon Global and Consolidated Communications decreased in value due to disappointing quarterly earnings and Wildhorse Re-sources was lower due to lower crude oil prices.

As noted above, high yield performance remained strong with yields and spreads compressing throughout the past year. High yield spreads are now approaching their lowest level in the past few years and below the 30 year historical average as an improving economy has boosted fundamentals and default rates remain muted. As a result, we believe high yield returns going forward will likely be lower than those in 2016 and may experience more volatility given current prices and spreads. The positives for high yield securities are the same as they were at the end of 2016: overall are the improving economy, a new President that is focused on fiscal stimulus and reduced regulations, and lower default rates. The potential risks to high yield assets are the prospects for interest rates to rise faster than expected, geopolitics, and protectionism.

The portfolio remains well diversified with over 122 individual positions. We continue to manage the fund in a conservative manner and are focused on higher quality credits with shorter durations. Additionally, we also believe that bank loans offer a compelling opportunity as they are senior in the capital structure and increase in value as rates increase. Lastly, we remain opportunistic as it relates to convertible bonds.