Kent Gasaway

Buffalo Small Cap fund

Age: 49

Credentials: BA in Business Administration, Kansas State University

Experience: portfolio manager, Buffalo Small Cap (1998-present); partner, Kornitzer Capital (1991-present); research analyst and portfolio manager, Waddell & Reed (1981-1991)

Ticker: BUFSX

Inception of fund: April 1998

Style: small growth

Assets under management: $1.2 billion

Three- and five-year performance as of April 6, 2009: -10%; -1.8%

Expense ratio: 1%

Front load: none

Minimum investment: $2,500

Alpha: 3.72% vs. S&P 500

Although the dwindling fortunes of big companies like AIG, GM and Alcoa grabbed the headlines of late, small companies have struggled mightily too. In 2008, the Russell 2000 index of small caps fell 33.8% as the S& P 500 dropped 37%. That's something the managers of the $1.2 billion Buffalo Small Cap fund, Kent Gasaway, Robert Male and Grant P. Sarris, are all too aware of. The Mission, Kan., offering's performance has suffered alongside the small-cap growth category where they find themselves. Yet the fund is holding up better than most.

"When the economy contracts, smaller companies, which have greater operating leverage in their business, don't have the ability to maintain margins as well as larger companies," Sarris says. Thus, the small fry's earnings are hit and stock prices suffer, he adds.

Yet in a recovery, small companies perform better. "The margin acceleration is much greater coming out of a recession for small-caps," Sarris says. Larger firms' margins aren't as variable.

The team has made an art of following the movements of these little companies, which it defines as those with market caps under $2 billion. The fund couldn't sidestep the damage imposed by the overall economy, but Buffalo Small Cap's well-timed moves helped to stanch some damage others suffered.

For the year ended April 6, the fund is down 19.8%, handily beating the 35.5% loss of the average small-cap growth fund tracked by Morningstar, and in the top 1% of the category. The fund has an equally impressive showing over three years, down 10%-in the category's top 5%-and off by 1.8% for the last five years, ranking in the top 8%.

On The Defensive

Over the past 12 months, the number of stocks the fund holds shrank to around 60. "We wanted to make sure that the companies we owned had staying power and could withstand a difficult economic period," Sarris says of the concentrated portfolio. Any names that had questionable balance sheets and financial weaknesses were weeded out. In their place, the managers added to their highest-conviction picks and sought others that were in better financial shape.

The trio, who all came from same-town rival Wadell & Reed's mutual fund group at various times, seek a balance between staying defensive and therefore avoiding some of the market carnage, and still being positioned to profit from several long-term secular growth trends. Among the trends they've identified is the international expansion of U.S. brands, outsourcing and demographics.

Firms benefiting from these trends should be able to grow two to three times the rate of GDP, the managers say. "Our companies have to have secular, organic unit growth, so they have to have some type of a trend that's driving their growth," Gasaway says. "That doesn't allow us to buy a company with no growth, where you're just betting on cyclicality."

But the downturn is making these trends difficult to capitalize on, the managers acknowledge. "The cyclical environment can overwhelm the secular in the short term, but when we emerge from this downturn, we can fall back on these long-term trends and that gives us the conviction to buy high-quality companies," Sarris says.

Dual Benefits

Private education companies, though, fit the bill. Buffalo has bet big on these companies. Three of the fund's top 10 holdings are for-profit colleges: Corinthian Colleges, ITT Educational Services and DeVry. These stocks benefit from long-term population trends, but they also happen to be counter-cyclical. In a recession, laid-off workers often head back to the classroom to brush up on skills or make career changes. Those who are still employed try to pad their resumes with new skills to stave off layoffs. Enrollments at the schools have grown dramatically, helping most of the companies' stock prices. Corinthian is up 14.5% and ITT is up 18.9% in 2009, though DeVry's stock is down 17%.