Buffalo Mid Cap's holdings have rock-solid balance sheets and many have no debt. By Andrew Tanzer, Senior Associate Editor May 20, 2010 Some fund managers assemble a portfolio according to their view of the big picture. Others take a bottom-up approach, filling a fund stock by stock. Buffalo Mid Cap (symbol BUFMX) marries the two disciplines. The result is one of the better funds that focus on fast-growing, midsize companies.Buffalo’s three Kansas City-based managers start by analyzing trends. Robert Male, who runs the fund with Kent Gasaway and Grant Sarris, says the team has identified 25 long-term trends, which guide all stock selection. The trends are good for at least three to five years, and all are quantifiable. The idea is that they will point the managers toward sectors and companies that can increase earnings at a much faster pace than the overall economy. The trends touch on subjects such as demographics, globalization, outsourcing, energy efficiency and health-care cost containment. The next step is to identify beneficiaries of these trends. Once the managers define this pool, they spend nearly all of their time analyzing companies and picking the individual stocks that end up in their fund. They hold stocks for four to five years, on average. That’s lengthy by industry standards, so they need to be comfortable with what they buy. Advertisement One way Buffalo mitigates risk is by focusing on companies with rock-solid balance sheets. Many of the fund’s holdings (Buffalo currently has 47 stocks) have no debt, and most have more cash than debt. The managers like outfits that generate enough free cash flow (cash profits left after capital expenditures) to sustain growth without having to raise additional capital. Financially strong companies, says Male, can “weather downturns in the economy and take market share” from rivals. One trend that the Buffalo managers have found compelling lately is the idea that U.S. workers will have be retrained to remain competitive in a global economy. As the economy moves from manufacturing to services, and as industries migrate offshore, workers will need to learn new skills. One of the fund’s top five holdings is Career Education (CECO), a for-profit education firm. Buffalo also holds two other education companies, ITT Educational Services (ESI) and DeVry (DV). To tap the outsourcing theme, Buffalo holds shares of Hewitt Associates (HEW), which not only provides human-resources consulting services around the globe but also is an actor in the industry. Hewitt, for instance, will run entire personnel departments for its corporate clients. Abercrombie & Fitch (ANF), another top-five holding, is a beneficiary of globalization, says Male. He considers the retailer one of many U.S. brands with a strong lure for overseas shoppers. Buffalo projects that the share of Abercrombie’s revenues from foreign operations will double this year, to 25%, because the company is rapidly adding new stores overseas. Advertisement Buffalo’s approach works well. Over the past five years through May 14, the fund returned an annualized 6.3%, an average of four-tenths of a percentage point per year better than Standard & Poor’s MidCap 400-Stock index. Since 2002, the fund’s first full year, it has outpaced the average fund in its category seven times in nine years (including this one). The fund’s annual expense ratio is a below-average 1.02%. The initial minimum investment is $2,500 for a regular account and $250 for a retirement account.