THE OAKMARK SELECT FUND

Report from Bill Nygren, Portfolio Manager

During its first three months of operation, The Oakmark Select Fund increased in value by 25 percent. Two things were very unusual about the quarter. First, the S&P 500 rose 12 percent — placing it in the top 10 percent of quarters for the last 25 years. Second, our value investing approach frequently finds us underperforming short-term advances but in this quarter, acquisitions of two large holdings added greatly to our results. Although it’s tempting to take credit for how rapidly some of our holdings achieved full valuations, the truth is that in the short run, random factors influence our results much more than our investment ability. Three cheers for random factors!

Rather than go into a detailed explanation of the last quarter, I’d like to take the advice of the late Satchel Paige, “Don’t look back, something might be gaining on you,” and use this opportunity to discuss what we see ahead. A recent Lou Harris poll of mutual fund investors found that 41 percent don’t expect a 10 percent drop in the market at any time during the next decade and 78 percent don’t expect a 20 percent drop. Further, 42 percent of “investors” said they would sell if the market fell 25 percent. We hope that survey didn’t include any Oakmark Select Fund investors because not only are those expectations historically unprecedented, but selling after such large declines has been a losing strategy.

If the next decade is consistent with the past century, it will probably include about half-a-dozen times when the market falls by more than 10 percent, and four or so times when it falls by more than 20 percent. We won’t be smart enough to sell our stocks ahead of those declines, and in fact, we don’t even try. Over long periods, stock performance usually exceeds most other investment alternatives. Owning stocks is like having a winning ticket in a must-be-present-to-win-drawing, but not knowing when the drawing will occur. Trying to time the market is like leaving the room hoping your name won’t be called while you are out. We hope that as an Oakmark Select Fund investor, you will not be surprised by market declines, but will be mentally prepared to use them as opportunities to add to your investment.

We do think that a decade is a very fair length of time to judge the ability of a money manager, and I would like to share with you what I would like to see over that period. I would be very pleased if in the year 2007, The Oakmark Select Fund had a ten-year return that placed it among the top 5 percent of equity mutual funds. The funds that now have the best 10 year records have achieved annualized returns of nearly three percentage points above the S&P 500. Our attempt to achieve that level of performance is centered on consistent application of our investment philosophy: buying undervalued stocks with owner-oriented managements. With this approach to stock selection, most of our out-performance should come during periods when the stock market is weak. We aren’t likely to make money during those periods, but we hope to lose less than the market. Likewise, since we will rarely own the most popular stocks, it will be unusual for us to be up significantly more than the market when it’s up a lot. A nice feature of this performance pattern (the academics call it a beta less than one) is that it improves risk-adjusted returns, and someday people will again look at risk levels!

We currently plan that at most times The Oakmark Select Fund will own 20 or fewer stocks, with about 50 percent of it’s assets in its five largest positions. At the end of January, we owned 18 stocks and the five largest accounted for 51 percent of the portfolio. By concentrating in my favorite stocks, I hope to increase the probability of achieving our out-performance goal. The downside is that the short-term results will show more ups and downs. During one week last quarter, negative news hurt two of our holdings. McDonnell Douglas lost an important government contract and Liberty Media was removed from the “buy” recommendations of an influential analyst. For that week, the NAV of The Oakmark Select Fund fell eleven cents. Had it instead performed exactly as the S&P 500 did, the NAV would have grown by sixteen cents. (Incidentally, our assessment of both events was that the stock market overreacted and we took advantage of the opportunities to add to our positions at more favorable prices.) These larger shortterm swings are part of owning a more concentrated portfolio and shouldn’t cause concern when they occur.

Finally, I would like to comment on two of our stocks. In selecting which stocks we own, we not only look for undervalued stocks, we look for those undervalued stocks which management owns personally. Last summer when McDonnell Douglas CEO Harry Stonecipher was in our office, we asked him our standard questions about how he wanted to invest the company’s money. We ask these questions to determine whether a CEO will act like a hired manager or like an owner when confronting important strategic decisions. Referring to the many shares of MD stock he owned personally, Harry stated “I’ve got a lot of reasons to do the right thing!” In December, when confronted with the fact that MD was worth more as a part of Boeing than it was as an independent company, he did do the right thing. During January, the same event happened at First USA. Those of you who have followed The Oakmark Fund are certainly familiar with the exceptional performance this credit card issuer has achieved under its leader, John Tolleson.

Banc One also noticed, and due to overlaps in their business, could justify paying a large premium to own First USA. Congratulations, Harry and John!

In closing, I want to thank our Oakmark employees who made the Fund’s launch go so smoothly and our Research Department for finding the investment ideas that make my job so much easier. Most importantly, I want to thank those of you who have entrusted us with your savings. A friend recently told me that his children were depending on The Oakmark Select Fund to help finance their college education. All I can say is, mine are too!

Bill Nygren
Portfolio Manager
bnygren@oakmark.com
February 4, 1997

1/31/97 NAV $12.50

*Total return includes change in share prices and in each case, except for the Value Line Index, included reinvestment of any dividends, interest and capital gain distributions.

**Each of the three indexes or averages is an unmanaged group of stocks whose composition is different from the Fund. The S&P 500 is a broad marketweighted average dominated by bluechip stocks. The S&P 400 consists of 400 domestic stocks chosen for market size, liquidity, and industry group representation. The Value Line Index is an unweighted average of more than 1,000 stocks. Past performance is no guarantee of future performance.

THE OAKMARK SELECT FUND

Schedule of Investments—January 31, 1997 (Unaudited)

Notes:
(a) Non-income producing security.