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Investment Quiz: Can you name the 5-STAR international fund managed by David Herro, Dan Jaworski, Ted Tyson and Mark Yockey?
Hint: It’s a No-load fund with significant benchmark-beating performance and below average expenses.

Click now to learn about this fund AND, get a FREE issue of the highly acclaimed No-Load Fund Analyst.

Size matters in the world of mutual fund investing, and in some cases small is better. Although most equity funds are hurting, some financial advisors are looking ahead to a point when the economy improves and making bets on which asset classes will rebound the fastest during a rising stock market.

Buffalo Funds’ Small Cap Fund manager Bob Male, who is an unabashed proponent of trend-focused investing, steered clear of steep losses during the collapse of the technology bubble and now envisions profitable days if the war in Iraqi is decided quickly. Male’s unique management philosophies, which incorporate spotting long-term market trends to pick stocks, have earned him a reputation as a visionary. Male is also part of a three-member team including veteran managers Kent Gasaway and Tom Laming.

However, the stock market’s fierce volatility in recent years has barely exceeded its unpredictability, and many fund gurus who were noted for long-rage vision have called it quits. Morningstar has every confidence in Male’s abilities and has bestowed Buffalo’s Small Cap Fund with its highest 5-star rating. Find out why Male thinks small cap funds are now the place to be and how he intends to navigate the uncertain road ahead.

Bob Male: The fundamentals, I believe, of the companies we own are pretty sound, and at the same time, the valuations are inexpensive.

That can be said of various sectors now. Are these conditions particular to small-cap stocks?

Overall, I think the economy is on the cusp of improving and a lot of small cap companies will benefit from that. Mainly the economy is pausing because of uncertainty of the future, and I am referring to the war. Hopefully once we start the war and finish it quickly, a pent up demand will be satisfied.

Morningstar calls the fund a “superstar” that achieves steady gains while keeping volatility under control. What is it about your management philosophy that minimizes the fund’s beta?

It’s a process that we go through. The first [part of the] process is to identify trends that are predictable. That’s the difference between a trend and a theme. A theme could be something like saying, “oh, we’re going to war and oil’s going to spike, so I’m going to buy oil stocks.” Themes go away every night but trends go on for a number of years. For example, we know what the demographics of the United States over the next five years is going to look like. We’ll buy companies that take advantage of what’s happening in the U.S.

The next stage is to filter through 10,000 actively traded companies and figure out which ones will benefit from the trends we identify. And the next filter after that is a small cap definition. You have a pool of small cap companies that fit the themes we identify. The next phase is a bottom up approach to look at valuations. We’re not going to buy a company because it fits-- we want to buy companies inexpensively. It’s more of a bottom-up approach where we look at who is a leader in an industry. Companies could pass through the trend portion, but once they get to the valuation/business model process, some of them fall out.

For example, e-commerce we believe is a trend but we didn’t own any companies during the dotcom craze before the bust because we didn’t believe in their business model.

For example, we believe that more people are going to use digital cameras, and its’ no surprise Polaroid went out of business. We own a company called SanDisk, Corp (Nasdaq: SNDK) that makes memory cards for digital cameras. During the technology craze it got to $169 per share but we didn’t start buying it until the stock hit the low 20’s. Just because a stock passes the trend stage of our process, we don’t buy it; we look the particular fundamentals of a company. Most of our companies don’t have any debt on the balance sheets. What you have in the finished product is a well-diversified portfolio that has consistent returns over time because our trend process.

Is there anything else about your management style that makes the Fund unique?

The trend approach to investing in companies that have long-term predictable growth and not deviating, and on top of that layering the bottom up approach is pretty unique. We won’t buy a stock at any price. Back in 1999, our technology exposure exceeded 33% of the fund, in the first quarter of 2000, but we decided it was becoming egregiously expensive and we sold our exposure down below 10%. It was a difficult decision because technology continued to go up. That’s how the fund differentiates itself by the management style.

The fund has a very low turnover ratio – only 6% according to Morningstar. Is this a function of picking small-caps stocks from a small pool of suitable companies or the reflection of a Berkshire Hathaway-like management style?

Back in 2000 it went up to 30% because of our movement out of technology stocks. It could move up to 30% in a particular year. We’re not going to own 157 stocks because you start looking like the index. That’s not our job; our job is to outperform the industry. As far as the number, we don’t think there are a limited number of stocks, there are plenty of stocks that fit our trend approach that we can buy.

Last year the fund underperformed the Russell 2000 significantly, what happened?

Our exposure in health care hurt us. We had some exposure in gaming that hurt us as a result of state budgets being cut back and increasing taxes on gaming.

In the short term it doesn’t. But in the long term, what are people gong to do? On a quarter-to-quarter basis, we could be wrong, but longer term, we’re right. Our trends are really predictable. You look at Wall Street analysts that cover the stocks on a quarter-to-quarter basis and they can’t get it right.

What kind of market trends favor small-cap investing, and how much of an average investor’s portfolio would you recommend allocating toward small cap stocks?

That depends on the investor and his time horizon and risk aversion. I think you should have multiple asset classes. It really depends on the individual. What favors small cap over large cap is that the domestic economy. Most small caps are domestic versus international. Procter & Gamble (NYSE: PG)has a lot of its operations overseas in countries like Brazil, which is doing significantly worse. Procter & Gamble is not the best example because it’s a consumer stable and people are going to continue to buy toothpaste, but you can tell what I’m trying to get at.

Small cap fund managers are sometimes troubled by core investment holdings growing into mid cap stocks. How does Buffalo stay ahead of this problem?

That can happen. According to the SEC definition of a small-cap fund, 80% of a fund’s assets need to be invested in small cap companies, which is a company with $2 billion or less. We don’t sell a company the minute it becomes a mid-cap company, we’ll eventually transition it over to our mid cap fund.

What are some of the biggest challenges today facing small cap investors, and what does the future hold for this group?

The biggest challenge regarding small caps is a liquidity issue. If you’re a not a very large fund, liquidity becomes an issue, and you need to be very careful. A small cap fund that has $500 million of assets is getting large, and you could encounter some liquidity issues when buying or selling a company.

Some large companies that dominated the top holdings of the largest mutual funds until last year have fallen from grace after accounting and management scandals. Were smaller companies run in a different manner and subsequently removed from the wave of corporate misconduct than larger companies?

I think there were some accounting problems with smaller companies. Just because it’s a smaller company doesn’t mean the management isn’t cooking the books. I don’t see any problems with our accounting rules. People broke the rules, and that’s the problem, going forward. I hope-- I hope, that management of all sizes take heed and embrace ethics. One of the problems with the market is investor confidence, and that’s partly because of accounting scandals.

The Fund closed in April, 2002 and then reopened in July. What could cause the fund to close again?

An increase in asset size. We don’t want to have the fund get so big that it becomes unmanageable. Even after closing the fund we want to manage the fund how we like to --we don’t want to have the decision to buy and sell stocks constrained by the size of the fund.

I read quite a bit outside of work. I like to exercise. I like to snow ski and I kind of like to watch sports. I like college sports more than professional sports because I spent 10 years of my life growing up in South Bend Indiana. My brother, Chuck Male, played for Notre Dame. That’s one of the reasons I like to watch Notre Dame.

What are your thoughts about the pending war with Iraq? Should investors buy more shares while the markets are depressed or wait for some type of resolution to the conflict?

I think it’s pretty much discounted in the market, and if the war starts tomorrow then shares will go up. I think we’re poised for an improving economy and improving fundamentals. In the fourth quarter, a lot of companies met or exceeded fundamentals, and I think that’s because of the war. Once we get that behind us, spending will pick up and consumer confidence will improve.