Small Cap Fund

Manager Commentary as of 12/31/10

The fourth quarter of 2010 saw continued strength in equity markets, particularly among smaller companies. Increased consumer confidence and the promise of a more business-friendly political environment helped to boost investor interest in the markets. For the quarter and the year, equity markets were up.

The Buffalo Small Cap Fund continued to be affected by the same issues which have played out over the last two quarters, resulting in significant underperformance in the Fund relative to the benchmarks. The Buffalo Small Cap Fund was up 10.31% for the fourth quarter and 16.59% for the year, compared to 17.11% and 29.09% for the Russell 2000 Growth Index, and 16.25% and 26.85% for the Russell 2000 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.

Our underperformance for the quarter was due to weak stock selection in the Industrials, Health Care, and Consumer Discretionary sectors. Within Industrials, our holdings in for-profit education continued to be a drag on performance while these companies attempt to strengthen their business models in anticipation of final Department of Education regulations. We have read the proposed rule changes and attempted to position the portfolio in higher-quality companies which we feel will be well-positioned to fare better once the final regulations are enacted, creating long-term growth for the Fund. The Health Care sector has also been hindered by the specter of continued government involvement, creating uncertainty and inhibiting growth.

These laggards were somewhat offset by positive returns in some stocks that, prior to the fourth quarter, held the Fund back because of their economic sensitivity. As more confidence in the economy has been established by recent political and monetary movements, those names have experienced a bounce. Our top-performing stocks for the quarter include Monster in the Industrials sector, Gentex and WMS Industries in Consumer Discretionary, and MKS Instruments and Fairchild Semiconductor in IT. Detractors include education names Corinthian Colleges and ITT Educational Services, Coldwater Creek and Christopher and Banks in Consumer Discretionary, and Amylin Pharmaceuticals in Health Care.

We continue to use valuation as a guide to buy and sell stocks. During the period, we sold five companies out of the Fund and added two new holdings, ending the quarter with 53 stocks. Additionally, we added to a handful of existing positions that have both attractive growth prospects and compelling valuation, and we finished the quarter with 3.6% cash, flat with the end of September. Despite periodic performance setbacks, we do not abandon our discipline in pursuit of higher multiple stocks or more cyclical contributors. We favor high-quality companies with strong balance sheets that generate free cash flow. We believe these are the types of companies that should generate superior relative performance over the long term. Overall, we believe equities look attractive relative to low-yielding alternatives.

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