Like the companies she targets, portfolio manager Elizabeth Jones, who has co-managed the Buffalo Discovery Fund since 2004, has made it her business to embrace change and make it work to her advantage.

Her fund’s investing sweet spot is companies that can take advantage of long-term trends in markets and company operations. Those trends might include the growth of internet commerce or the long-term tendency of robots to replace human labor.

Launched in 2001, the Buffalo Discovery Fund, a $1.9 billion mid-cap growth fund, has a five-star Morningstar rating. In the last three years, it’s been less volatile than both the Standard & Poor’s 500 and its peers.

Her journey, however, has been a long and sometimes painful one. From 1992 to 1996, Jones was a practicing physician working at the University of Chicago Hospitals in internal medicine and pediatrics. From 1996 to 2000, she served in the U.S. Public Health Service/Indian Health Service in Phoenix treating HIV patients and starting a clinic dedicated to Native American adolescents.

In these early years of her career, the relentless long hours and emotional strain of the health-care rat race took their toll. “When I started doing my residency, I wasn’t entirely happy, but I was too far in to stop,” she recalls. “I remember going through the park on my way to work on Saturdays and being jealous of people who had the time to just hang out or walk their dog.”

After her residency was completed, her stint as a physician on a vastly underserved Indian reservation confirmed those sentiments. Still, working in the public health space for several years meant her vast pile of government medical school loans would be forgiven. Once that financial burden was lifted, she took some time off and eventually obtained a master’s degree from Arizona State University.

Her father and two siblings, all physicians, were skeptical of the move at first. “Now they are jealous of me,” she says. “I found my passion in investing. I was born to do this.”

She joined Kornitzer Capital Management (KCM), advisor to the Buffalo Funds, in 2003 as a health-care analyst and became a co-manager of the Buffalo Discovery Fund a few months later.

Jones, who specializes in evaluating health-care and biotechnology companies, believes that many of the skills she acquired in her previous professional life apply to her current job. “With patients, you need to gather information and use deductive reasoning to arrive at a conclusion,” she says. “The same holds true when you’re evaluating stocks.”  

Her Buffalo fund co-manager Dave Carlsen usually takes the lead on industrials and information technology stocks while a third co-manager, Clay Brethour, has a background in the oil, material and industrial sectors. “We complement each other,” she says. “This team has been together for 14 years, which is truly unique in this industry.”

The team does its work from KCM’s home base in Mission, Kan., a Kansas City suburb with less than 10,000 residents whose website posts things like Rotary Club plant sale announcements and warnings about diseased raccoons. But Jones views this location, far from the din of Wall Street and Silicon Valley, as an advantage.

“If we were a hedge fund trading on data points, this wouldn’t be a good place to be,” she says. “But that’s not what we are. We invest in high-quality companies over the long term, find innovation and trim positions when they get stretched. So for us, it’s an advantage to be removed from all the noise that might influence our decisions.”

Like other actively managed mutual funds, the Buffalo Fund family has lost assets over the last few years to index-based exchange-traded funds and mutual funds. At the same time, many investors abandoned the firm’s flagship small-cap fund when performance lagged. Assets in the firm’s mutual funds total about $4 billion, down from a peak of $8 billion a few years ago.

Jones admits that while indexing is here to stay, she sees today’s increased market volatility as an opportunity for a well-managed, actively managed mutual fund to add value to advisor portfolios. “Nine years into the bull market, it’s a good idea to be in a fund that offers some downside protection,” she says. “There’s more risk in passive investing than a couple of years ago.” Over the three years ending March 31, the fund has captured 93% of its benchmark’s upside and 86% of its downside.

Widening the Playing Field

Launched in 2001 as the Science & Technology Fund, the Buffalo Discovery Fund’s focus was once limited to mostly technology and health-care stocks. When the current management team took over in 2004, they decided to gradually expand the portfolio’s range to include other sectors in its benchmark, the Russell 3000 Index. By the time the fund changed its name to “Buffalo Discovery” in 2012, it already had a fairly diversified portfolio, and it has spread its bets even more over the last few years.

“Innovative companies can be found beyond the health-care and technology sectors, and the portfolio reflects that,” says Jones. “Broader diversification also helps lower volatility and offers the potential for better downside protection.”

The innovation demonstrated by a potential Buffalo portfolio company can take a variety of forms, depending on the sector. For some companies, it means offering a new product or service that drives their top-line growth. For others, it may be a new manufacturing or distribution strategy.

Jones emphasizes that the diversified portfolio keeps a comfortable distance from the benchmark and avoids closet indexing. It has an 81% active share and a three-year annualized turnover ratio of 51%, which testifies to the co-managers’ willingness to hang on to their off-the-beaten track picks over the long haul.

Although the fund is classified as “mid-cap growth,” it also owns some dominant players in the large-cap space, such as Apple and Amazon. Still, with one-quarter of its stocks bearing market capitalizations of less than $7.5 billion, and a roughly equal percentage devoted to stocks with market caps of $7.5 billion to $15 billion, the Buffalo Discovery Fund is squarely in mid-cap territory.

All of its portfolio holdings must benefit from at least one of the 26 long-term trends KCM has identified as drivers of growth opportunities. The goal of the strategy is to focus on businesses exposed to growth markets with the wind at their backs, while avoiding declining, flat or cyclical industries. Besides showing off their ability to ride trends, the target companies must also have high and sustainable margins, little or no debt, strong leadership positions, and solid balance sheets. The Buffalo managers set upside/downside targets when they buy a stock, and to qualify for purchase, a stock’s upside potential must be significantly greater than its downside risk.

One of the more seemingly mundane innovators in the portfolio, and a beneficiary of the trend toward automation, is Republic Services Group. This waste management company has significantly boosted its market share and return profile by implementing automated collection vehicles, which now account for over 70% of its residential fleet. These vehicles reduce the need for expensive human labor and enhance safety by allowing the operators to remain inside the trucks. Another large fund holding, MSCI, is a U.S. provider of equity, fixed-income and alternative indexes that are used as the basis for many exchange-traded funds and other passive investments. While the holding may seem somewhat out of place in an actively managed fund, Jones says the trend toward passive investing and the need to have benchmarks makes it a good fit for the portfolio.

The stock price of Facebook, another fund holding, has fluctuated widely this year over reports about the Cambridge Analytica data breach and the Federal Trade Commission’s investigation into how the company mines user information. Jones says that while these issues have had a short-term impact on the stock, the company’s entrenched position in the market and anticipated growth in digital ad spending by users will overcome recent controversy. “In the U.S., about one-third of all advertising spend is for digital, so there is room for growth,” Jones says. “Over the long term, Facebook will work through all this.”

In the health-care sector, she cites fund holding Nevro, which makes high-frequency spinal cord stimulation devices that treat back and leg pain more effectively than competing low-frequency devices. Jones says that this innovator has significant potential for growth. Tests show its unique technology produces significantly better outcomes than other spinal cord stimulators, and the company has rapidly gained a nearly 15% market share. With opioid addiction in the headlines, demand for drug-free solutions like those Nevro offers should remain strong.

Another health-care holding, Athena Health, should continue to benefit from long-term trends in health care. Health-care costs in the U.S. are rising faster than GDP, which means opportunities for companies like Athena that can reduce health-care expenditures. The company, which has been in the portfolio since 2007, specializes in health-care information technology services for physicians’ offices and other medical groups.

On May 7, Athena received an offer to be acquired for $160 a share from Elliott Management, which already held 9.1% of the company. The offer represented a 27% premium to where its share price traded on the previous Friday afternoon.

Jones believed that its cloud software offering allows health-care providers to build more efficient practices and electronic medical records. This way, she says, the company can help providers improve outcomes and reduce waste. No doubt the transaction should help lift her performance in May.