High Yield Fund
Fund Objective & Investment Process
The investment objective of the Buffalo High Yield Fund is primarily current income, with long-term growth of capital as a secondary objective. The High Yield Fund normally invests at least 80% of its net assets in higher-yielding, higher-risk debt securities rated below investment grade by the major rating agencies (or in similar unrated securities), commonly known as “junk bonds”. Debt securities can include fixed and floating rate bonds as well as bank debt and convertible debt securities.
While the Fund maintains flexibility to invest in bonds of varying maturities, the Fund generally holds bonds with intermediate-term maturities. With respect to the remaining 20% of the Fund’s net assets, the Fund may invest in investment grade debt securities, U.S. Treasury Securities (typically with maturities of 60 days or less), money market funds, and equity investments, including dividend paying stocks and convertible preferred stocks.
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The Fund maintains a flexible investment policy which allows it to invest in debt securities with varying maturities. However, it is anticipated that the dollar-weighted average maturity of debt securities that the Fund purchases will not exceed 15 years and that the average maturity of all securities that the Fund holds at any given time will be 10 years or less. The lowest rated debt security that the Fund will hold is D quality (defaulted securities). Although the Fund will not purchase D quality debt securities, the Fund may continue to hold these securities and will sell them at the Fund managers’ discretion.
The Fund’s managers perform extensive fundamental investment research to identify investment opportunities for the Fund. When evaluating investments and the credit quality of rated and unrated securities, the managers look at a number of past, present and estimated future factors, including financial strength of the issuer, cash flow, management, borrowing requirements, sensitivity to changes in interest rates and business conditions, and relative value.
Our team brings many years of credit research experience to the bond market. We are proud to have provided our shareholders with what we believe is a conservative approach to investing in high yield bonds since 1995.
Jeff Sitzmann, Portfolio Manager
Overall Morningstar Rating™ based on risk-adjusted returns among 603 High Yield Bond funds as of 10/31/18.
|As of 10/31/18||3 MO||YTD||1 YR||3 YR||5 YR||10 YR||15 YR||Since Inception|
|BUFFALO HIGH YIELD FUND||-0.29||0.23||0.84||3.61||3.53||8.83||5.79||6.94|
|ICE BofAML U.S. High Yield Index||-0.35||0.84||0.86||6.64||4.69||11.16||7.38||7.13|
|Lipper High Yield Bond Funds Index||-0.58||0.36||0.53||5.54||3.96||9.59||6.27||5.85|
|Morningstar High Yield Bond Category||-0.53||0.28||0.45||5.12||3.52||9.19||6.16||5.85|
|As of 9/30/18||3 MO||YTD||1 YR||3 YR||5 YR||10 YR||15 YR||Since Inception|
|BUFFALO HIGH YIELD FUND||1.80||1.77||2.36||4.84||4.06||7.39||6.02||7.03|
|ICE BofAML U.S. High Yield Index||2.44||2.52||2.94||8.19||5.54||9.38||7.64||7.23|
|Lipper High Yield Bond Funds Index||2.23||2.08||2.70||6.97||4.82||7.86||6.55||5.95|
|Morningstar High Yield Bond Category||2.02||1.84||2.36||6.41||4.31||7.62||6.42||5.94|
Performance data quoted represents past performance; past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the fund may be lower of higher than the performance quoted and can be obtained here. Performance is annualized for periods greater than 1 year. Each Morningstar category average represents a universe of funds with similar objectives.
3 Year Risk Metrics
|vs ICE BofAML U.S. High Yield Index (As of 9/30/18)|
Hypothetical Growth of $10,000
This chart illustrates the performance of a hypothetical $10,000 investment made in the Fund on the Inception Date. Assumes reinvestment of dividends and capital gains. This chart does not imply future performance.
Record Date: November 19 | Payable Date: November 20
Record Date: December 17 | Payable Date: December 18
|(As of 9/30/18)|| |
|# of Holdings||131|
|3-Yr Annualized Turnover Ratio||38.85%|
|Average Duration||3.22 years|
|Average Maturity||5.78 years|
|30-day SEC Yield||4.19%|
Top 10 Holdings
|Name of Holding||% of Net|
|MacDonald Dettwiler (Term Loan B, 7/5/24)||2.25%|
|Consolidated Communications (6.500%, 10/1/22)||1.91%|
|Quad Graphics (7.000%, 5/1/22)||1.85%|
|Triumph Group (4.875%, 4/1/21)||1.75%|
|FTI Consulting (6.000%, 11/15/22)||1.68%|
|Phillips Van Heusen (7.750%, 11/15/23)||1.65%|
|Wildhorse Resource Dev (6.875%, 2/1/25)||1.62%|
|Andeavor Logistics (6.875%, 8/15/23)||1.57%|
|Brunswick (7.375%, 9/1/23)||1.55%|
|Live Nation Entertainment (5.375%, 6/15/22)||1.43%|
|TOP 10 HOLDINGS TOTAL||17.26%|
As of 9/30/18. Security weightings are subject to change and are not recommendations to buy or sell any securities. Sector Allocation may not equal 100% due to rounding.
Percentages of Total Assets as of 9/30/18. Allocation percentages may not equal 100% due to rounding.
|Duration Breakout (%)*|
|Quality Breakout (%)|
|A & Above||0.00|
All ratings are as of 9/30/18. Standard & Poor’s is the rating source for the Quality Breakout Table. A credit rating is an assessment provided by a nationally recognized statistical rating organization (NRSRO), such as Moody’s or Standard & Poor’s. The firm evaluates the of credit worthiness of an issuer with respect to debt obligations, including specific securities, money market instruments, or other bonds. Ratings are measured on a scale that generally ranges from AAA (highest grade) to D (lowest grade); ratings are subject to change without notice. Not Rated (NR) indicates that the debtor was not rated by an NRSRO and should not be interpreted as indicating low quality.
CAPITAL MARKET OVERVIEW
(As of 9/30/18) — After producing positive returns in the 2nd quarter of 2018, the U.S. high yield sector stayed on course, generating positive performance in the 3rd quarter, with positive returns in all three months, although each month’s return was lower than the prior month. The market’s performance was driven by:
• continued, albeit modest, economic growth of U.S. Gross Domestic Product;
• a healthy labor market with additional jobs added and the unemployment rate remaining near cycle lows;
• the Federal Reserve maintaining a gradual pace of increasing interest rates and timing of plans to reduce their balance sheet; and
• a quiet new issue market which provided support for secondary pricing.
Headwinds in the quarter were:
• rising treasury rates;
• continued concerns regarding disruptions in international trade due to the Administration’s escalating trade wars with the North American Free Trade Agreement (NAFTA) countries and particularly with China;
• increasing oil prices; and
• an evolving geopolitical landscape and risks.
Despite uncertain market conditions, equity markets and high yield markets performed well during the quarter despite the level of short-term interest rates moving higher. The 3 Month Intercontinental Exchange London Interbank Offered Rate, LIBOR, increased 9 basis points (bps) to 2.42%, as investors continued to gravitate towards higher risk assets. The 10-Year Treasury Note returned -1.08% during the quarter while the JP Morgan Domestic High Yield Index generated 2.37% and the S&P 500 Index returned 7.71%.
During the quarter, the 10-year Treasury yield rose 20bps from 2.86% to 3.06%. Despite the increase in Treasury yields, demand for high yield caused spreads to tighten across the asset class.
Changing course from the last few quarters, higher-rated issues tightened more than lower-rated issues. Spreads on the CCC-rated segment tightened 30bps while the spreads on higher rated BB-rated bonds tightened 44bps. According to data from JP Morgan, the BB-rated segment returned 2.32%, slightly better than the B-rated segment return of 2.29%, but still less than CCC-rated segment, which returned 2.99%. The Buffalo High Yield Fund was underexposed to the CCC sector with a weighting of about 4.9% compared to the JP Morgan CCC weighting of 11.5%.
According to data from JP Morgan, the U.S. high yield market’s spread-to-worst for the period ended September 30th was 365bps, 50bps tighter than the preceding September quarter and 249 basis points below its 20-year historical average of 614bps. The yield-to-worst for the high yield market at quarter-end was 6.53%, below the 9.02% 20-year average, and below the yield of 6.72% at the end of the 2nd quarter.
Counterintuitively, high yield mutual funds continued to experience cash outflows during the September quarter of about $1.0 billion compared to outflows of $4.5 billion in the previous quarter, according to data from JP Morgan. High yield new issuance for the quarter was $42.1 billion, the lowest volume since the $38.2 billion in the 4th quarter of 2011, and well below the average quarterly volume of $83 billion during that seven-year span.
(As of 9/30/18) — The Buffalo High Yield Fund increased 1.80% in the 3rd quarter, underperforming the ICE BofAML U.S. High Yield Index by 64bps, which returned 2.44% during the same period. We ended the quarter with 131 positions compared to the previous quarter’s level of 140 positions (excluding cash).
The Fund’s cash balance at the end of the quarter decreased 33bps from the prior quarter’s level, as sales of existing positions were exceeded by new security purchases and investor withdrawals in the Fund. The Fund’s composition by asset class at quarter-end was as follows:
|Fund Composition by Asset Class|
|Approximate Rate and Contribution of Return from the Fund’s Various Asset Classes in 2Q18|
|Unweighted Return||Contribution to Return|
Specific securities that contributed most positively to performance include Live Nation 2.500% convertible notes, Greenbrier common stock, and Andeavor Logistics 6.875% perpetual notes. Live Nation advanced throughout the quarter on better-than-expected earnings and growing speculation that the company is becoming an acquisition target. Greenbrier improved on strong earnings and expectations for railcar orders to improve. The fixed-to-floating rate feature in the Andeavor notes attracted investors looking to gain more floating rate exposure as treasury yields were increasing.
Specific securities that detracted most from performance include Medicines Company 2.750% convertible notes, Twitter 1.000% convertible notes, and PRA Group 3.500% convertible notes. The Medicines Company converts were down as the stock sold off in September, after a strong rally in the previous quarter. Twitter declined on disappointing earnings in July. PRA Group was hurt by disappointing earnings, and supply of defaulted consumer debt remains tighter than expected.
(As of 9/30/18) — A growing economy with modest inflation has created a favorable environment for risky assets. However, market participants are becoming increasingly concerned about potential trade wars with China and physical confrontations with North Korea and Russia/Syria.
The U.S. high yield default rate increased to 2.02%, up 74bps year-to-date, up 95bps from 1.07% as of September, 30 2017, but still well below the 3.0-3.5% long-term average.
On the positive side, the slowdown in new issuance activity has reduced the supply of bonds available for purchase, which has helped support bid levels. We continue to be concerned about the Federal Reserve taking a more aggressive tightening policy stance, inflation growth acceleration, geopolitical issues such as North Korea or tensions in the Middle East escalating, and increasing protectionism efforts from the White House.
Given that we are likely in the late stages of the economic cycle, we still find ourselves confronted with relatively-low spread and yield levels. We are managing the Fund cautiously, yet actively.
We continue to focus on higher-quality, non-investment grade issuers with defensive business models and manageable credit metrics. We will continue to deploy the Fund’s 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 preferreds.
The opinions expressed are those of the Portfolio Manager(s) and are subject to change, are not guaranteed and should not be considered recommendations to buy or sell any security. Earnings growth is not representative of the fund’s future performance.
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The Morningstar Rating™ for funds, or "star rating", is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating™ for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year (if applicable) Morningstar Rating™ metrics. The weights are: 100% three-year rating for 36-59 months of total returns, 60% five-year rating/40% three-year rating for 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods.
The Buffalo High Yield Fund received 2 stars among 603 for the three-year, 3 stars among 505 for the five-year, and 3 stars among 332 High Yield Bond funds for the ten-year period ending 10/31/18.
In each Morningstar Category, the 10% of funds with the lowest measured risk are described as Low Risk, the next 22.5% Below Average, the middle 35% Average, the next 22.5% Above Average, and the top 10% High. Morningstar Risk is measured for up to three time periods (three, five, and 10 years). These separate measures are then weighted and averaged to produce an overall measure for the fund. Funds with less than three years of performance history are not rated. ©2018 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. The Morningstar Style Box™ reveals a fund’s investment strategy by showing its investment style and market capitalization based on the fund’s portfolio holdings.
Bond ratings are grades given to bonds that indicates their credit quality as determined by a private independent rating service such as [Standard & Poor's or Moody’s, etc.]. The firm evaluates a bond issuer's financial strength, or its ability to pay a bond's principal and interest in a timely fashion. Ratings are expressed as letters ranging from 'AAA', which is the highest grade, to 'D', which is the lowest grade. Not Rated category includes holdings that are not rated by any rating agencies.