Buffalo Small Cap Tech Fund Tops Ranking with 61% Return

John Bichelmeyer, portfolio manager, Buffalo Funds
John Bichelmeyer's Emerging Opportunities fund scored a 61 percent return over one year and an average of 32 percent over five investing in small tech firms. Photograph: Michael Sharkey/Bloomberg Markets

When John Bichelmeyer’s mutual fund fell 48 percent in 2008, he decided his portfolio needed an upgrade. The Buffalo Emerging Opportunities Fund would still invest in small companies with the potential to become big ones. What it wouldn’t do is invest in businesses that were burning cash, or in biotechnology firms whose prospects were difficult to gauge, Bloomberg Markets magazine will report in its April issue.

“We were still looking for companies with a better mousetrap,” says Bichelmeyer, 38, from his office in Shawnee Mission, Kansas, a suburb of Kansas City. “We just didn’t want to go too far out on the risk curve.”

Bichelmeyer, the son of a Kansas City meat company executive, bet on stocks such as Stratasys Ltd., a maker of three-dimensional printers, and Medidata Solutions Inc., a medical software firm.

Stratasys shares climbed about 12-fold in the five years ended on Dec. 31. Medidata, a 2011 purchase, rose more than fivefold in the two years ended on Dec. 31.

Those stocks helped the $580 million Buffalo Emerging Opportunities Fund return 32.4 percent annualized over the five years ended on Dec. 31. Its 61.3 percent gain in 2013 was among the best for any U.S. equities fund. The results make Buffalo Emerging Opportunities No. 1 in the diversified U.S. stock category in Bloomberg Markets’ annual ranking of mutual funds.

The fund was also No. 1 in the small-cap U.S. equities category.

Buying Opportunities

Bichelmeyer says that, despite the drop in the Standard & Poor’s 500 Index in the first seven weeks of 2014, he sees accelerating growth for the U.S. economy that could drive equities higher. The decline, he says, will create buying opportunities. And if troubles in emerging markets persist, he says, commodities prices could fall, a plus for U.S. growth. The companies in Buffalo Emerging Opportunities generate about 85 percent of their sales in the U.S.

“I think the pullback is healthy after such a long period when the market went straight up,” Bichelmeyer says.

The ranking of stock and bond funds includes U.S.-domiciled funds with more than $250 million under management as of Dec. 31. Funds are ranked by total returns for one, three and five years and by their Sharpe ratios for three and five years. The Sharpe ratio measures the performance of a fund adjusted for risk. Each of the five measures is given equal weight.

Matthew 25

Last year’s winner in diversified equities was Mark Mulholland’s Matthew 25 Fund, No. 2 in this year’s ranking, with an average return of 31.5 percent over five years.

In the global equities category, the winner was the New Economy Fund. The $13 billion fund, run by the American Funds unit of Capital Research & Management, invests in businesses that exploit new technologies and services, a mandate broad enough to include Gilead Sciences Inc., a U.S. biotechnology firm, and Galaxy Entertainment Group Ltd., a Hong Kong–based company that operates casinos in Macau, China.

Shares of both Gilead and Galaxy, the fund’s two largest holdings as of Dec. 31, more than doubled last year. Gilead’s new treatment for hepatitis C is expected to generate more than $10 billion in revenue by 2018, analysts say.

New Economy can invest up to 45 percent of its money in non-U.S. companies.

“Innovation doesn’t stop at the border,” says David Polak, a senior vice president at Los Angeles–based Capital Group Cos., which owns American Funds. The fund returned 22.5 percent annually during the five years ended Dec. 31 and 43.4 percent in 2013, compared with 15.9 percent and 32.4 percent for the S&P 500.

Taking Profits

Polak says the fund is likely to trim some of its best-performing holdings after the bull run of 2013.

“We are paid to worry about valuations more after good years,” he says.

Polak says that the market decline in early 2014 didn’t lead to major changes in the portfolio because the fund typically holds on to stocks for an average of four years.

Daniel Ivascyn’s performance won him a promotion. Ivascyn was named deputy chief investment officer at Pacific Investment Management Co. in January, one of six money managers picked to help Chief Investment Officer Bill Gross make decisions at the world’s largest bond manager.

His elevation was part of a reorganization that followed the surprise resignation of Pimco Chief Executive Officer Mohamed El-Erian in January, effective March 15.

Pimco Income

Ivascyn got the job after his $32 billion Pimco Income Fund took the No. 1 spot in Bloomberg Markets’ U.S. corporate bond ranking for the second consecutive year. The fund returned 13.9 percent a year over the five years ended on Dec. 31 and 4.4 percent in 2013. Co-managed by Alfred Murata, the fund beat 97 percent of its peers, according to data compiled by Bloomberg, even as many of Pimco’s biggest funds, including Gross’s $236 billion Total Return Fund, trailed two-thirds of rivals.

“It’s been pretty clear for a while that Dan is part of the next generation of leadership at Pimco,” says Michael Rosen, chief investment officer at Angeles Investment Advisers LLC., a Santa Monica, California–based consultant to institutional investors. “He has done well, and he’s a good guy.”

Ivascyn outperformed by concentrating in so-called nonagency mortgages, securities that were crushed during the financial crisis and rebounded as the U.S. housing market revived. The mortgages, which aren’t backstopped by Fannie Mae, Freddie Mac or the Federal Housing Administration, rose 28 percent in 2012 and 10 percent in 2013, according to Los Angeles–based money manager TCW Group Inc.

Cutting Exposure

Ivascyn said in December that he was cutting his exposure to the loans and boosting the fund’s investment in Treasuries as U.S. interest rates climbed.

Thomas Cooper’s $3 billion GMO Emerging Country Debt Fund rose to No. 1 among global bond funds by buying bonds from countries such as Venezuela and Argentina, where the political and economic climates have been dicey.

“Some of the stories are lousy and getting worse,” Cooper says, “but in many cases, we think we are being overpaid for holding the bonds.” The fund had 8.6 percent of its money in Venezuela and 3.8 percent in Argentina as of Dec. 31, GMO LLC data show.

Cooper also scoops up bond issues other investors shun because their small size or long maturities make them less liquid.

Buying Cheap Bonds

“Our goal is not to buy illiquid bonds,” he says. “It is to buy cheap bonds.”

Like many bond funds, GMO Emerging Country had a negative return in 2013, which it compensated for with a 20.5 percent annual return during the five years ended on Dec. 31.

Meat, not money management, is what runs in John Bichelmeyer’s family. He descends from a long line of butchers, with the first one, Mathias Bichelmeyer, arriving on U.S. shores from Germany in 1880, according to the Bichelmeyer Meats website.

The company was founded in 1946 by John’s grandfather. It owns and slaughters cattle and has a retail butcher shop in Kansas City. The company is run by Bichelmeyer’s father, brother and uncle. One of his aunts wrote a book in 2006 called “Lunchmeat and Life Lessons: Sharing a Butcher’s Wisdom,” about the founder’s philosophy of life and work.

Creighton Grad

Bichelmeyer spent summers and weekends working at the company while in high school. He studied finance at Creighton University in Omaha, Nebraska. He was a walk-on outfielder for the school’s baseball team -- and was good enough to win a scholarship for his last two years of school, he says.

After graduation, Bichelmeyer worked first as an analyst and then as a fund manager for a Florida money-management firm started by one of his Creighton professors. He joined Shawnee Mission–based Kornitzer Capital Management Inc., which runs the Buffalo funds, in 2005.

The company, which manages $11 billion, is located in a suburban office park, flanked by a bank and an assisted-living facility. Bichelmeyer’s desk is piled high with research reports.

“This place is like a library,” he says. “There is not a lot of hubbub.”

Bichelmeyer is one of 12 members of the Buffalo funds’ growth team, which runs six stock funds. The equities managers generate a list of roughly two dozen trends they agree will drive business and consumer spending during the next three to five years. The trends include cost containment in health care, cloud computing and the aging of the U.S. population.

Tail Winds

Managers look for stocks that will benefit from the tail winds the trends create. The funds are divided by market capitalization, and Bichelmeyer focuses on stocks with a market value of less than $1 billion. Because the team buys into firms that can grow in any economic climate, the portfolio is heavy on technology and health-care stocks and light on energy, materials and banks.

Bichelmeyer, who manages the Emerging Opportunities Fund with Craig Richard, first bought 3-D printer-maker Stratasys in the second quarter of 2008, when the technology was catching on with manufacturers, who use it to design and build products ranging from auto parts to dental crowns and bridges. The company was self-financing and had little debt. The stock fell steadily through 2008 -- “We were a little early,” Bichelmeyer says -- reaching a low of $7.77 in March 2009. It finished 2013 at $134.70.

Medidata Outperforms

Bichelmeyer bought Medidata in the third quarter of 2011 after the stock stumbled. The company, which works with drug and biotech firms, sells software as a service, a distribution model in which software and data are stored in the cloud rather than on customers’ own computers.

Software as a service, a cheaper alternative to traditional installed software, is one of Buffalo’s favorite themes, and Bichelmeyer owns a number of similar businesses.

Medidata closed at just over $60 a share on Dec. 31, up from an average of $9.25 in the third quarter of 2011. Concluding that the stock had peaked, Bichelmeyer sold the last of his Medidata shares in the fourth quarter. The shares were up 8 percent for 2014 as of March 6.

After a period of rapid growth, Stratasys “graduated” to the $4 billion Buffalo Small Cap Fund, which invests in companies with market values of $1 billion to $4 billion. Stratasys shares were down 14 percent in 2014 as of March 6.

Bichelmeyer used some of the extra cash to boost holdings of Proofpoint Inc., an enterprise software firm, and PDF Solutions Inc., which provides services to makers of semiconductors.

Floodgates Open

The Emerging Opportunities Fund closed to new investors in November. Assets in the fund grew more than eightfold last year as investors, attracted by its strong track record, added $384 million to its coffers, according to Morningstar Inc. In the previous four years the fund amassed a total of $26 million in deposits.

“The floodgates opened,” says Bichelmeyer.

Those gates could close quickly if the Emerging Opportunities Fund has a bad run, Bichelmeyer says. It was up 3.4 percent for 2014 as of March 5. Still, if the world of finance sours, Bichelmeyer Meats would welcome him home.

“It is always there if I want a career change,” he says with a smile.

How We Crunched the Numbers

We used two Bloomberg functions to create the mutual-fund rankings. The first was Fund Screening (FSRC), which we used to generate separate lists for global, diversified U.S. and small-cap U.S. equities funds and for U.S. corporate and global bond funds.

The second was Fund Scoring (FSCO), which we used to create a model with five criteria: total returns for one, three and five years and Sharpe ratios for three and five years, all as of Dec. 31.

All searches included only active, open-end, U.S.-domiciled funds with more than $250 million in total assets as of Dec. 31. We excluded institutional-class, index, sector and market-neutral funds.

For global equities funds, we limited the universe to funds described as global in the Bloomberg database. For global bond funds, we included funds with at least half of their assets invested outside the U.S.

In scoring the funds, we blended returns with the Sharpe ratio because that measure shows how well the return of a fund compensates investors for risk. A fund that takes substantial risk to produce a high return may have a lower Sharpe ratio than a fund that takes less risk and gets a lower return.

Our model gave equal weight to the five criteria, with each fund in the same group awarded a score from zero to 100 based on its performance in the group. The winning funds were those that received the highest scores.

Bloomberg Markets also ranked exchange-traded funds, measuring their growth over the past three years. Topping the list were two European funds, signaling a bottom to a market that has seen years of lackluster returns.

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