THE OAKMARK FUND

Report from Robert J. Sanborn, Portfolio Manager

These are benign times in which to invest in equities, particularly those of larger-capitalization US companies. (The smaller cap stocks have continued to lag behind their big cap brethren.) Inflation remains subdued (both the price of gold and oil declined in the six-month period), US business is super-competitive globally, and Boom-ers continue to allocate more of their assets to equities.

I would inject a cautionary note, however. In the six months between October 31, 1996 and now, the yield on the US government 30-year bond has risen from 6.7 percent to 6.9 percent. All things equal, this decoupling of the performance of US stocks and bonds means that bonds are now tougher competition. Just as consumers alter their buying patterns in response to changing relative prices, so do investors.

This does not mean that we prefer bonds to stocks. It does mean that generally valuation for the overall market has deteriorated in the past six months. The real value of a business is dependent on the level of long-term interest rates. With interest rates up a bit (and, of course, bond prices down) and stock prices up a lot, the stock market is not as attractive as it was. Some of our holdings have attained our estimates of value, and we have sold them. Our cash level is at an all-time high. Again, this does not mean that we “don’t like the market.” It does mean that we are having a tougher time finding individual holdings that meet our criteria.

We have not made major changes to your Fund. Any prospective holding must dominate our current holdings; we never shuffle our investments merely for the sake of change. Our current twenty largest holdings were all substantial holdings in October. We have increased our investments in Black & Decker and Polaroid as the market over-reacted to some short-term developments. In general, your Fund remains heavily invested in high-quality businesses, particularly consumer brands and financial services. In fact, I consider seventeen of our twenty largest holdings as being structurally superior businesses.

Your Fund remains concentrated, with the twenty largest holdings constituting over 75 percent of our holdings. The five largest constitute 33 percent of our holdings. We believe that attractive investment opportunities are scarce, and we believe most mutual funds (let alone most mutual fund investors!) are overly diversified and offer scant chance to outperform an index fund over the long term.

Much of the media treats the equity market as if it were a casino or a sporting event. I find it amusing to tune into one of the ubiquitous market shows on a big up or down day; the corresponding gleeful or funereal tone is a hoot. People, do not let all the noise out there deter you from what you are trying to accomplish with your investment in The Oakmark Fund, and that is increasing your spending power in the long run.

VALUE VS. MOMENTUM INVESTING, WITH A GUEST APPEARANCE FROM BILLY "WHITE SHOES" JOHNSON

I have received many letters from you asking the differences between value and momentum investing. In brief, value investing: good; momentum investing: bad.

Seriously, these two philosophies frame the investment process quite differently. At the risk of oversimplification, the major difference is that value investors like ourselves focus on price, and what you are getting for that price. Momentum investors tend to focus on those companies with the fastest growth rates—period. At conferences at which I have attended, I have heard many momentum fund managers state, “In the WXYZ Fund, we aim to own the best, fastest-growing companies in America.”

The appeal of value investing to all of us at The Oakmark Funds is that it has the happy characteristic of being simpatico with how people conduct virtually all their economic and financial affairs. If price did not matter, most cars on the road would be Ferraris or BMWs. But—alas!—price does matter, and car shoppers, thinking like value investors, frame their car purchases with respect to budgets and alternatives. Similarly, when entire businesses are bought, the buyer always is relating to what one is getting relative to what one is paying.

A relative indifference to valuation introduces a significant risk element, in the form of added volatility, to a portfolio. Of the 250-plus funds with five-year records in the Lipper Growth (for growth in capital) category, The Oakmark Fund has the highest total return for the five years ending April 30, 1997. The runner-up is a large, well-known momentum fund. However, the two funds are quite different when it comes to risk.

For the 21 calendar quarters ending March 31, 1997, The Oakmark Fund had two negative-return quarters; the momentum fund, let’s call it WXYZ Fund, had six. The range of The Oakmark Fund’s returns ran from -4.2 percent to +15.5 percent; the range of WXYZ’s returns was -19.8 percent to +42.2 percent.

Momentum funds tend to trade a lot, which is expensive and tax-inefficient. WXYZ Fund’s turnover for the years 1992-6 is as follows: 115%, 209, 94, 119, and 45; The Oakmark Fund’s turnover for those same years: 34%, 18, 29, 18, 19. In simple terms, the WXYZ momentum fund turns over its portfolio every ten months, whereas The Oakmark Fund turns over our portfolio every five years!

What does this have to do with Billy “White Shoes” Johnson? Well, those of you who read these carefully may remember that he first appeared in our July 31, 1995 quarterly. In that letter, I discussed the overheated IPO market, especially for technology issues. I mentioned a few recent IPOs that had soared on the first day of trading, and explained why we in The Oakmark Fund avoided earning this sort of “easy” money. ARCSYS (now called Avant!) went public at $13, soared to $26 on the first day, got as high as $51, and now trades at $21. Oak Technology went public at $14, ran to $21 on day one, got as high as $29, and now trades at $9. Netscape came public at $14, traded to $38 on day one, got as high as $87, and now trades at $30.

I said at the time that this sector was very vulnerable, and if I were proved right, I would do a victory dance ala' Billy, the seminal genius of end-zone celebrations while a receiver for the Houston Oilers. At the risk of flouting the investment gods, this fund manager is now doing the “Billy.” (Count yourselves fortunate that your eyes do not have to witness this spectacle.) Many of the momentum funds like WXYZ own these sorts of stocks, and are down 20 percent or more year-to-date. It was a little frustrating not making the “easy” money in 1995 and 1996, but it sure is gratifying keeping the “hard-earned” money in 1997.

ROBERT J. SANBORN
Portfolio Manager
rsanborn@oakmark.com*
May 9, 1997

*Please note my new e-mail address.

*Total return includes change in share prices and in each case, except for the Value Line Index, 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 S&P 500 is a broad market-weighted average dominated by blue-chip stocks. The Dow Jones Average includes only 30 big companies. The Value Line Index is an unweighted average of more than 1,000 stocks. Past performance is no guarantee of future performance.

THE OAKMARK FUND

Schedule of Investments—April 30, 1997 (Unaudited)

Notes:
(a) Non-income producing security.
(b) Represents an American Depositary Receipt.
(c) At April 30, 1997, net unrealized appreciation of $1,219,475,468 for federal income tax purposes consisted of gross unrealized appreciation of $1,264,288,669 and gross unrealized depreciation of $44,813,201.
(d) See footnote number five to the financial statements regarding transactions in securities of affiliated issuers.

See accompanying notes to financial statements.