High Yield Fund

Manager Commentary as of 12/31/10

The fourth quarter of 2010 continued to show growth in the bond market, with all indexes ending in positive territory. The Buffalo High Yield Fund slightly outperformed the Bank of America Merrill Lynch High Yield Master Index with a return of 3.38% compared to 2.98% for the Index. For calendar year 2010, the Fund returned 12.45% compared to the 15.24% for the Index.

Data represented reflects past performance and is no guarantee of 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 value. Current performance may be lower or higher than the performance quoted. Performance current to the most recent quarter end may be obtained by clicking here. Performance current to the most recent month end may be obtained by clicking here.

The primary reason for the Fund's outperformance was the approximate 6.7% return from the portfolio's convertible bond exposure which represented 16% of the portfolio at the end of 2010. Within the convertible bond basket, several securities had double-digit returns in the quarter, including Ciena, Wesco and General Cable. The corporate bond portfolio returned approximately 3.2%, which was slightly ahead of the benchmark's return of 3.1%. In addition, several bonds provided above average contributions to the corporate bond portfolio, including Isle of Capri, Education Management, Lions Gate Entertainment and United Auto Group.

The high yield market's return in the fourth quarter, as measured by the Bank of America Merrill Lynch High Yield Master Index, reflects a general improvement in outlook for the global economy as well as a stronger equity market. Investors began to reallocate into equities as political and economic messages signaled the promise of growth and stability. The riskiest part of the high yields market (those bonds rated CCC and lower) continued to outperform the broader high yield market with a return of 6.5% according to Bank of America Merrill Lynch. Single B and double-B Bonds gained 3.3% and 1.6% respectively during the quarter.

According to data from Bank of America Merrill Lynch, the high yield market's spread to worst ended December at 560 basis points, which is basically in line with its 20-year historical average of 591 basis points, while the yield to worst for the high yield market was 7.5% at the end of December, below the 20-year average of approximately 10.7% and reflects the decline in treasury yields (3.3% as of December 31, 2010). Default activity continued to decline as only two issuers defaulted in the fourth quarter and new issue activity also remains robust as the fourth quarter of 2010 was one of the strongest quarters on record with $91 billion in new issuance, according to data from JPMorgan.

We continue to look for new names to add to the Fund, and also to deploy cash into existing holdings with relatively high yields. Our primary focus in identifying companies is those that have the following credit characteristics: leading market positions in growth industries; high barriers to entry; sustainable margin structures; manageable balance sheet leverage; adequate liquidity; improving credit metrics; and with business models that will be relatively stable regardless of the state of the external economic environment.

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