Small Cap Fund

(As of 3/31/19) — Equity markets rebounded sharply to start 2019. The widely followed S&P 500 Index returned 13.65% in the 1st quarter, its best quarterly performance in 10 years. The market advance can be largely attributed to the Federal Reserve’s decision to put quarterly short term interest rate hikes on hold and end its balance sheet runoff. Additionally, prospects for a trade agreement between the U.S. and China appeared to improve, and the U.S. Government reopened after its longest shut down in history.

The Russell 3000 Index advanced 14.04% in the 1st quarter. Growth outperformed value, with the Russell 3000 Growth Index returning 16.18% compared to a return of 11.93% for the Russell 3000 Value. By size, midcaps led the way this quarter with the Russell Midcap Index returning 16.54%, followed by a return of 14.58% for the small cap Russell 2000 Index and 14.00% for the large cap Russell 1000 Index. Technology, Real Estate, and Industrials were the best performing sectors, while Health Care and Financials were relative underperformers.

Small cap stocks rebounded from the deep selloff in the 4th quarter of 2018 as recession fears lessened over the past three months and investors scooped up oversold stocks. Energy, Technology, and Real Estate led the move higher as oil prices rose and 4th quarter earnings and 2019 outlooks for most technology companies were better than expected. All sectors of the small cap index rose during the period, though Financials and Industrials were notable laggards as were the more defensive sectors like Consumer Staples, Telecom Services, and Utilities.

(As of 3/31/19) — The Buffalo Small Cap Fund (the “Fund”) gained 21.83% during the quarter, comparing favorably to the Morningstar U.S. Small Cap Growth Index’s (the “Index”) gain of 19.43%. Technology and Telecom led returns, providing about 345 basis points of relative outperformance while Health Care and Consumer Staples were also meaningful contributors. Real Estate was the largest detractor from performance, as the Fund’s investments in the sector failed to keep pace with the Index’s almost 24% gain for the sector. Overall, stock selection drove the Fund’s outperformance for the period, while the sector allocation impact was a detractor from relative performance.

TOP CONTRIBUTORS
Paylocity was the largest contributor to performance, as the stock enjoyed a 50% gain in the quarter. The company has proven to be an extremely consistent provider of outsourced payroll and human capital software to small and medium-sized businesses, growing revenues between 23% and 28% for the past 9 quarters. The stock also got a boost during the quarter as a mid-market competitor, Ultimate Software, received an offer to be taken private.

The next largest positive contributor was Bandwidth, Inc. The company provides telecom services and software to enterprises, many of whom are involved in high growth areas such as voice assistants and unified communications as a service (UCaaS). After coming public with a fairly small market cap in late 2017, Bandwidth continued to attract more attention from Wall Street as it grows in size and is reminiscent of the success of peer companies, such as Twilio.

TOP DETRACTORS
Inogen was the largest detractor from performance during the period. However, as a newer investment in the Fund, its smaller weighting limited the negative impact. We initiated a position last quarter after the stock corrected to a more attractive valuation, by our analysis. On their 4th quarter earnings call, Inogen admitted to seeing some weakness from a home medical equipment customer, which further reduced investor sentiment for the company’s shares. We continue to own this stock as we believe the company is an industry leader in portable oxygen concentrators, and increased investments made last year in their direct-to-consumer sales force will accelerate growth and improve investor enthusiasm for the stock.

(As of 3/31/19) — To date, we are pleased with the start of the year. While large gains in a short period of time can cause investor angst, we note that small caps would still require another 12% increase to reclaim the previous high watermark made in early September 2018. Meanwhile, market fundamentals remain mostly positive. U.S. investors appear to have resigned themselves to slower economic growth expectations. However, we feel that the economy could accelerate if the Trump administration concludes the trade war with China, which seems likely to happen this summer. In Europe certain regions are showing signs of slowing, however most U.S. companies are not yet claiming that the continent has taken a leg down in economic activity. This is clearly an area to watch.

In the U.S., the Federal Reserve has moved to a more neutral position regarding monetary policy and is doing a much better job communicating its intentions relative to last year. Growth investing remains in favor compared to value investing, as slower economic activity means investors should continue to place a premium on faster growing companies that require less of an economic tailwind to excel. Furthermore, the market has historically performed well in the 3rd year of a presidential cycle.

As always, we remain steadfast to our process of identifying investment opportunities in smaller, faster-growing companies with the potential to benefit from long term trends, which are trading at attractive valuations, by our analysis. We appreciate your continued support and confidence in our investment capabilities over the long term.