Report from Steven J. Reid, Portfolio Manager
Greetings!!!
Let me offer you a warm welcome from the salt-encrusted streets of Chicago. January 31, 1997 marked the end of the first quarter of the new fiscal year. It was truly a prosperous period for us, the shareholders. During the quarter, The Oakmark Small Cap Fund gained 15.1%. This was significantly better than the relevant market indices, as well as the broader market indices. However, the Fund’s performance was dwarfed by the Packers’ victory over those amiable Northeasterners in the Super Bowl. I hope we can both repeat our recent triumphs, but the reality is that it will be an uphill climb.
A significant part of this quarter’s gain can be attributed to the performance of your Fund’s top three holdings (which I highlighted in our annual report): Catellus Development Corp., SPX Corp. and U.S. Industries. During the quarter, these three companies’ shares gained an average of 36%. Although these holdings have appreciated significantly, we remain optimistic about their prospects. Other strong contributions to the Fund’s results came from catastrophe reinsurer Renaissance Re Holdings Ltd., graphite electrode producer Carbide/Graphite Group Company, and the mutual holding company Peoples Bank of Connecticut. We are off to a strong second quarter so far. The current quarter began with a bang when Kysor Industrial Corp. agreed to be acquired by Scotsman Industries Inc. We will miss our friends at Kysor, but not too much, since Scotsman is also a holding of the Fund. We remain encouraged by the attractive investment opportunities available to us in the small cap universe.
The Small Cap Investment Universe
Many of you have expressed the concern that as the assets of The Oakmark Small Cap Fund grow, the Fund will cease to be a small cap investment vehicle. This will not be the case. A common misconception is that The Oakmark Fund, managed by my colleague Robert Sanborn, was once a small cap fund that migrated to large company investments. This is incorrect. From its inception, The Oakmark Fund owned a variety of different size companies. The Oakmark Small Cap Fund is specifically designed to invest in small cap companies. We have defined our investment universe as those companies whose market capitalization are within the market capitalizations of the S&P Small Cap 600 Index (See the prospectus for further details). The common thread between The Oakmark Fund and The Oakmark Small Cap Fund, as well as the entire Oakmark Fund Family, is our value-oriented investment philosophy.
Another concern that many of you have expressed is that The Oakmark Small Cap Fund’s assets may become too great. I share your concern. The fact is that there is a limit to how large the Fund can grow and still be managed effectively. It is my desire to be diversified, but not to the point of over-diversification. The average mutual fund owns shares in approximately 120 companies. I plan on keeping the number of companies your Fund invests in well below that of the average mutual fund. Owning a large number of companies will only dilute the returns of our most attractive investments.
Currently, we have enough attractive opportunities in which to invest the assets of your Fund. Should those opportunities not be available, or asset growth become so rapid that we can’t invest the assets in a reasonable and prudent manner, closing the Fund may become a necessity. The Fund’s size is an issue that both myself and the trustees of the Fund are sensitive to. At the point where asset size hinders our ability to add value, we will address that issue.
Outlook
By the next quarterly report winter will have passed and the monsoon season of April will have arrived. As you know, we don’t make forecasts of the stock market, interest rates, the economy, etc. Don’t take stock in my weather predictions either, it will probably snow in May.
Once again, I would like to thank everyone involved, especially our shareholders, for your support of The Oakmark Small Cap Fund.
Steven J. Reid
Portfolio Manager
sreid@oakmark.com
January 31, 1997
| 1/31/97 NAV $15.18 | Average Annual Total Return* Through 1/31/97 |
||
|---|---|---|---|
| Total Return Last 3 mos. |
From Fund Inception 11/1/95 |
||
| The Oakmark Small Cap Fund | 15.1% | 39.5% | |
| Lipper Small Co. Growth** | 4.6% | 17.6% | |
| Russell 2000 w/inc** | 9.0% | 21.1% | |
| S&P Small Cap 600 w/inc** | 8.2% | 23.5% | |
*Total return includes change in share prices and in each case includes 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 Lipper Small Company Growth Fund Index is comprised of 30 Small Cap Funds. The Russell 2000 Index measures the performance of smaller companies, and represents approximately 10% of the total value of publicly traded companies in the U.S. The S&P 600 Index measures the performance of selected U.S. stocks with a small market capitalization. Past performance is no guarantee of future results.
Schedule of Investments—January 31, 1997
| Shares Held/ Pricipal Value |
Market Value | |
|---|---|---|
| Common Stocks—94.3% | ||
| Food & Beverage—6.5% | ||
| Ralcorp Holdings, Inc. (a) | 902,000 | $20,746,000 |
| GoodMark Foods, Inc. | 400,000 | 7,400,000 |
| 28,146,000 | ||
| Retail—4.6% | ||
| Carson Pirie Scott & Co. (a) | 350,000 | $9,362,500 |
| Cole National Corporation (a) | 325,000 | 9,262,500 |
| Rex Stores Corporation (a) | 200,000 | 1,625,000 |
| 20,250,000 | ||
| Other Consumer Goods & Services—5.2% | ||
| First Brands Corporation | 325,000 | $8,775,000 |
| Scotsman Industries, Inc. | 260,100 | 6,242,400 |
| Triarc Companies, Inc. (a) | 400,000 | 5,250,000 |
| Justin Industries, Inc. | 207,400 | 2,255,475 |
| 22,522,875 | ||
| Banks—6.1% | ||
| Peoples Bank of Bridgeport Connecticut | 418,600 | $13,918,450 |
| Harbor Federal Savings Bank | 160,000 | 5,400,000 |
| Northwest Savings Bank | 227,500 | 3,355,625 |
| Pocahontas Federal Savings & Loan Association | 140,000 | 2,537,500 |
| Savings Bank of Finger Lakes | 86,500 | 1,146,125 |
| Fidelity Bancshares, Inc. | 5,700 | 111,150 |
| 26,468,850 | ||
| Insurance—13.1% | ||
| Highlands Insurance Group, Inc. (a) | 848,100 | $19,400,288 |
| Renaissance Holdings, Ltd. | 500,000 | 18,750,000 |
| Chartwell Re Corporation | 375,000 | 10,125,000 |
| PXRE Corporation | 250,000 | 6,625,000 |
| Danielson Holding Corporation (a) | 192,500 | 1,949,062 |
| 56,849,350 | ||
| Other Financial—2.0% | ||
| Duff & Phelps Credit Rating Company | 275,000 | $7,046,875 |
| First USA Paymentech Inc. | 50,000 | 1,668,750 |
| 8,715,625 | ||
| Broadcasting & Publishing—9.4% | ||
| Cablevision Systems Corporation (a) | 507,500 | $15,922,813 |
| TCI Satellite Entertainment, Inc. Class A (a) | 1,200,000 | 9,750,000 |
| Granite Broadcasting Corporation | 600,000 | 6,525,000 |
| Lee Enterprises, Incorporated | 184,300 | 4,238,900 |
| Central Newspapers, Class A | 100,000 | 4,550,000 |
| 40,986,713 | ||
| Data Storage—1.0% | ||
| Imation Corporation (a) | 150,000 | $4,368,750 |
| Managed Care Services—1.0% | ||
| Healthcare Services Group, Inc. | 355,000 | $4,215,625 |
| Aerospace & Defense—1.2% | ||
| Logicon, Inc. | 150,000 | $5,193,750 |
| Machinery and Metal Processing—10.0% | ||
| The Carbide/Graphite Group | 625,000 | $13,046,875 |
| Northwest Pipe Company | 500,000 | 9,625,000 |
| Gardner Denver Machinery Incorporated | 500,000 | 8,000,000 |
| Kysor Industrial Corporation | 175,800 | 6,504,600 |
| Matthews International Corporation | 188,500 | 5,348,688 |
| Graco, Inc. | 41,200 | 1,323,550 |
| 43,848,713 | ||
| Building Materials & Construction—1.5% | ||
| NVR, Inc. | 502,400 | $6,468,400 |
| Oil & Natural Gas—3.4% | ||
| Titan Exploration, Inc. | 1,172,000 | $14,796,500 |
| Other Industrial Goods & Services—14.3% | ||
| SPX Corporation | 600,000 | $24,375,000 |
| MagneTek, Inc. (a) | 1,000,000 | 13,750,000 |
| Premark International, Inc. | 425,000 | 9,775,000 |
| Zurn Industries, Inc. | 400,000 | 9,650,000 |
| Dal-Tile International Inc. (a) | 250,000 | 4,718,750 |
| 62,268,750 | ||
| Commercial Real Estate—9.2% | ||
| Catellus Development Corporation (a) | 2,000,000 | $27,500,000 |
| Castle & Cooke, Inc. (a) | 560,200 | 9,103,250 |
| Innkeepers USA Trust | 255,000 | 3,378,750 |
| 39,982,000 | ||
| Diversified Conglomerates—5.8% | ||
| U.S. Industries, Inc. New (a) | 750,000 | $25,406,250 |
| Total Equity (Cost: $352,078,755) | 410,488,150 | |
| Corporate Bonds—0.7% | ||
| Harrah’s Jazz Bonds, 14.25% due 11/15/2001(b) | $6,700,000 | $3,199,250 |
| Total Fixed Income (Cost: $3,304,413) | 3,199,250 | |
| ShortTerm Investments—6.0% | ||
| Commercial Paper—4.6% | ||
| Ford Motor Credit Corporation, 5.32% due 2/6/1997 | $ 2,000,000 | $2,000,000 |
| Ford Motor Credit Corporation, 5.28% due 2/18/1997 | 3,000,000 | 3,000,000 |
| Ford Motor Credit Corporation, 5.30% due 3/3/1997 | 10,000,000 | 10,000,000 |
| Ford Motor Credit Corporation, 5.30% due 3/7/1997 | 2,000,000 | 2,000,000 |
| Ford Motor Credit Corporation, 5.29% due 3/10/1997 | 2,000,000 | 2,000,000 |
| General Electric Capital Corporation, 5.32% due 2/3/1997 | 1,000,000 | 1,000,000 |
| Total Commercial Paper | 20,000,000 | |
| Repurchase Agreements—1.4% | ||
| State Street Repurchase Agreement, 5.47% due 2/3/1997 Collateralized by US Treasury Securities | $ 6,244,000 | $6,244,000 |
| Total Repurchase Agreements | 6,244,000 | |
| Total Short-Term Investments (Cost: $26,244,000) | 26,244,000 | |
| Total Investments (Cost $381,623,168)—101.0% | 439,931,400 | |
| Other liabilities, less other assets—(1.0%) | (4,505,567) | |
| Total Net Assets—100% | $435,425,833 =========== |
Notes:
(a) Non-income producing security.
(b) This bond is currently in default and the Fund is no longer accruing interest.