A recent story in Barron’s profiles the Buffalo Discovery Fund (BUFTX). This $642 million no-load fund, formerly known as Buffalo Science and Technology, sports a reasonable expense ratio of 1.01% and portfolio turnover of 53%.
According to the article, the fund’s manager
Carlsen attributes his fund’s success—it has returned 28% annually over the past five years, beating 93% of other mid-cap growth funds, and 11% over the past 10, beating 84%—to his go-anywhere approach. Though the portfolio mainly consists of midsize companies (with an average market value of $7.3 billion, smaller than the category’s average of $8.4 billion), Buffalo Discovery defines itself as an all-sizes fund specializing in innovation.
The primary benchmark for Buffalo Discovery is the Russell 3000® Growth index. The fund returned more than the practical implementation of its benchmark, the iShares Russell 3000 Growth ETF (IWZ), in all but two of the last ten years. However, this may not be a proper index benchmark for the fund, which has 41% in technology and 26% in technology-oriented healthcare stocks, according to the article. Indeed, according to the fund’s description, it
Invests in companies which create value through the commercial application of innovative products, services, or intellectual property [and is] not benchmark-driven.
The majority of the fund’s holdings are classified as mid-cap, which is why Morningstar applies a Mid-Cap Growth category to the fund.
Let’s assess the fund’s performance using Alpholio™’s methodology. Here is the cumulative RealAlpha™ chart for the fund:
From early 2005 through 2011, the cumulative lag RealAlpha™ for the fund was roughly flat. In 2012, the fund generated some RealAlpha™ only to lose it all by the end of that year. The fund’s RealAlpha™ strongly rebounded in the second half of 2013. As a result, in the overall analysis period, the fund generated only a slightly positive (fraction of a percentage point) annualized lag RealAlpha™.
The chart also shows that the lag cumulative RealAlpha™ was generally lower than the regular one. This is an indication that in many sub-periods, new investment ideas did not produce desired outcomes. To put it another way, investors would have been better off by sticking to the lag reference portfolio. (To learn more about the relationship between the regular and lag RealAlpha™, please visit our FAQ.)
The following chart depicts ETF weights in the reference portfolio for the fund in the same analysis period:
The fund’s top equivalent positions were in the following ETFs:
- Vanguard Information Technology ETF (VGT; average weight of 20.3%)
- Vanguard Small-Cap Growth ETF (VBK; 14.1%)
- Vanguard Health Care ETF (VHT; 13.6%)
- SPDR® Morgan Stanley Technology ETF (MTK; 10.6%)
- iShares North American Tech-Multimedia Networking ETF (IGN; 9.7%)
- iShares Morningstar Mid-Cap Growth ETF (JKH; 9.1%).
The Other component in the above chart includes six additional ETFs, such as the iShares Nasdaq Biotechnology ETF (IBB) or iShares North American Tech-Software ETF (IGV). Combined, all these equivalent positions prove that the fund was predominantly of a technology and healthcare, and not just general mid-cap growth, nature at its core.
In conclusion, the above analysis demonstrated that Buffalo Discovery could be effectively substituted by a relatively small number of technology and healthcare ETFs, which formed a portfolio of a similar volatility. While the fund has lately generated positive RealAlpha™, history shows that this outperformance streak may not continue for a long time.
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