The Oakmark Equity and Income Fund

Report from Clyde S. McGregor, Portfolio Manager

THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK EQUITY AND INCOME FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (9/30/97) AS COMPARED TO THE LIPPER BALANCED FUND INDEX

9/30/97 NAV $14.49 Total Return
Last 2 mos.		 Average Annual Total Return*
Through 9/30/97
From Fund Inception
11/1/95
The Oakmark Equity & Income Fund 3.7% 22.7%
Lipper Balanced Fund Index** 0.7% 19.2%
Lehman Govt./Corp. Bond** 0.4% 6.5%
S&P 500 w/inc** -0.4% 31.7%

*Total return includes change in share prices and in each case includes reinvestment of any dividends 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 Balanced Fund Index Composite is comprised of 30 balanced funds. The Lehman Govt./Corp. Bond Index includes the Lehman Government and Lehman Corporate indices. The S&P 500 is a broad market-weighted average dominated by blue-chip stocks. Past performance is no guarantee of future results.

FISCAL 1997 RESULTS

Welcome to the second annual report for The Oakmark Equity and Income Fund. Our first fiscal year lasted the usual 12 months, but for reasons explained elsewhere, fiscal 1997 ended after only eleven. The return of 31.2% in the period, however, nearly tripled what we had accomplished in 12 months in the first year. I would like to be able to argue that this outcome derived from our putting in 12 months of work into an 11-month year, but the real explanation is that this period has been unusually blessed, particularly for equity investors.

Looking at more conventional measurement periods, your Fund's (and mine—my family is still by far the largest shareholder) return of 25.5% for the nine months ended September 30 places it 3rd among the 351 funds of its type. The 12 month result was 33.3%, ranking 5th in the category. I am quite pleased with this outcome and wish to thank all who have contributed.

FIRMS WHERE MANAGERS SHAVE THEIR HEADS WHEN THE STOCK GOES UP

In early August I was riding in an airplane when I noticed that the gentleman with extremely short hair seated next to me was opening a folder marked "Catellus." Since Catellus is one of your Fund's important holdings (and a quite unusual word), I inquired as to whether he worked for the company. The gentleman turned out to be Ted Antenucci, a vice president of development at Catellus. Catellus is basically a large pool of real estate assets originally granted to the Santa Fe Railroad in the mid-1800s as part of the effort to develop the American West. We own the stock because of both its undervaluation compared to the company's asset value and our belief that the relatively new management team will put these assets to good use in an improving real estate environment.

Back to Ted. When Ted discovered that I represented a firm which was one of the largest shareholders of his company, he proceeded to tell me the story of why his haircut made him look as though he had recently enrolled at a military academy. Ted joined Catellus three years ago when the stock was trading for $6/share. Nelson Rising, newly installed as CEO of Catellus, recruited Ted to join the company, and during this process Nelson repeatedly expressed great confidence in the prospects for Catellus' stock. Ted accepted the job offer but remarked that should the stock ever actually reach $20/share, he would shave his head. In early July of this year with the stock at $18.50 Ted received a package in the mail. It turned out to be a deluxe shaving set, a gift from Nelson. In August the stock hit $20, and Ted, a man of his word, shaved his head.

Now "willingness of managers to shave their heads if their stock goes up" is not one of the criteria which we normally use for stock selection. It probably should be. We like companies with this kind of team spirit, where having fun while doing one's job is important. Catellus has been an excellent holding for your Fund, first in the form of a convertible preferred stock, now as the common. I salute Ted, Nelson, and the rest of the Catellus management team for their success and the corporate culture which has helped to make it possible.

MIGHTY OAKS AWARDS

Last year I shamelessly copied my partner Robert Sanborn of The Oakmark Fund and issued awards to each of the analysts who had produced the single most successful stock and bond ideas for your fund. I will continue that tradition for fiscal 1997, though given its 11-month time frame, I worry that the results are not really comparable.

Before announcing the awards, however, I must digress concerning the Mighty Oaks. Long-time readers may recall that "Mighty Oaks" is the name given to our firm's various athletic teams. This year's softball team had a season which resembles the stock market record of some of our investments. For most of the season the Oaks had a tough time, entering the playoffs with a losing record. In the playoffs, however, the team came together, eventually losing the championship game by one run on a perfect throw to home plate. Many of our stocks have periods like this where they look undistinguished but blossom when it is most important. Hats (Oakmark hats) off to the Oaks for their playoff run.

Now for the awards. Regrettably, I find that both of my award winners are repeaters. Many good ideas contributed to the Fund's results for fiscal 1997, but under the rules I must again recognize two of my fellow fund managers, Steve Reid (Oakmark Small Cap) for First USA/Banc One common stock, and Bill Nygren (Oakmark Select) for Telecommunications preferred stock.

I have previously written concerning Banc One's acquisition of First USA. We continue to hold the Banc One shares which we received in the merger because we perceive the stock to be undervalued. As well, we are quite optimistic concerning the impact of First USA's management on Banc One's all-important consumer banking division.

The common shares of Telecommunications and its offspring (e.g. Liberty Media) have been significant holdings for Harris Associates for many years. Bill Nygren also identified the company's preferred stock as offering above-average opportunity for a high-yield security. During fiscal 1997 investors regained their confidence in Telecommunications' financial stability, with the result that the preferred provided a total return of more than 50% to the Fund.

Since Bill and Steve are repeat winners, I don't know if another Mighty Oaks T-shirt will be as exciting a prize as it was a year ago. Perhaps softballs autographed by this year's near-champion Mighty Oaks squad?

Thanks for your support in fiscal 1997. Please feel free to e-mail me with your comments, questions, or ideas for quarterly reports.

CLYDE S. MCGREGOR

Portfolio Manager
mcgregor@oakmark.com

October 8, 1997



The Oakmark Equity and Income Fund

Schedule of Investments—September 30, 1997

Shares Held Market Value

Equity and Equivalents—61.6%

Food & Beverage—2.0%
Philip Morris Companies Inc. 16,100 $ 669,156
Office Equipment—2.6%
Lexmark International Group, Inc., Class A (a) 26,000 858,000
Other Consumer Goods & Services—9.7%
Juno Lighting, Incorporated 61,300 $ 1,049,762
First Brands Corporation 31,000 829,250
National Presto Industries, Inc. 17,000 715,063
Armstrong World Industries, Inc. 9,600 643,800
3,237,875
Banks—5.0%
Banc One Corporation 17,022 $ 950,040
Mellon Bank Corporation 13,400 733,650
1,683,690
Insurance—6.2%
PartnerRe Ltd. 25,000 $ 1,076,563
Old Republic International Corporation 25,500 994,500
2,071,063
Broadcasting & Publishing—9.0%
Tele-Communications, Liberty Media, Class A (a) 35,200 $ 1,053,800
Dun & Bradstreet Corporation 35,000 993,125
Lee Enterprises, Inc. 33,900 961,912
3,008,837
Automotive—8.0%
Chrysler Corporation 30,000 $ 1,104,375
Borg-Warner Automotive, Inc. 15,000 853,125
Lear Corporation 15,000 738,750
2,696,250
Aerospace & Defense—2.3%
The Boeing Company 14,300 $ 778,456
Machinery & Metal Processing—3.0%
General Signal Corporation 23,000 $ 994,750
Other Industrial Goods & Services—3.0%
Premark International, Inc. 31,500 $ 1,008,000
Commercial Real Estate—7.0%
Catellus Development Corporation (a) 48,228 $ 1,000,731
LaSalle Partners, Inc. (a) 20,000 700,000
Equity Office Properties Trust (a) 19,000 644,813
2,345,544
Diversified Conglomerates—3.2%
U.S. Industries, Inc. 36,750 $ 1,065,750
Total Equity and Equivalents (Cost: $15,285,783) 20,417,371
Convertible Preferred Stock—0.6%
Insurance—0.6%
American Heritage Life Investment Corporation, Preferred, 8.50% 3,000 $ 186,000
Total Convertible Preferred Stock (Cost: $150,000) 186,000

Fixed Income—35.5%

Preferred Stock—5.9%
Banks—3.0%
BBC Capital Trust Preferred, 9.50% 21,200 $ 551,200
RBI Capital Trust Preferred, 9.10% 42,500 440,938
992,138
Broadcasting & Cable TV—1.5%
Tele-Communications, Inc., Preferred Junior Class B, 6.00% 5,800 $ 498,800
Other Industrial Goods & Services—1.4%
James River Corporation of Virginia, Preferred Series O, 8.25% 20,000 $ 490,000
Total Preferred Stock (Cost: $1,857,125) 1,980,938
Principal Value Market Value
Corporate Bonds—3.3%
Other Consumer Goods & Services—0.7%
Samsonite Corporation, 11.125% due 7/15/2005, Senior Subordinated Notes Series B $200,000 $ 229,000
Aerospace & Automotive—0.6%
Coltec Industries, Inc., 9.75% due 4/1/2000 $150,000 $ 160,500
Coltec Industries, Inc., 9.75% due 11/1/1999 25,000 26,531
187,031
Building Materials & Construction—0.5%
USG Corporation, 9.25% due 9/15/2001, Senior Notes Series B $150,000 $ 161,625
Utilities—0.5%
Midland Funding Corporation, 11.75% due 7/23/2005 $150,000 $ 177,000
Other Industrial Goods & Services—1.0%
UCAR Global Enterprises Inc., 12.00% due 1/15/2005, Senior Subordinated Note $300,000 $ 342,750
Total Corporate Bonds (Cost: $1,053,099) 1,097,406
Government and Agency Securities—26.3%
U.S. Government Bonds—25.4%
United States Treasury Notes, 7.125% due 9/30/1999 $3,300,000 $ 3,380,091
United States Treasury Notes, 7.50% due 5/15/2002 2,750,000 2,913,515
United States Treasury Notes, 7.875% due 11/15/2004 2,000,000 2,198,700
8,492,306
U.S. Government Agencies—0.9%
Federal Home Loan Bank, 6.405% due 4/10/2001, Consolidated Bond $300,000 $ 302,478
Total Government and Agency Securities (Cost: $8,672,256) 8,794,784
Total Fixed Income (Cost: $11,732,480) 12,059,128

Short Term Investments—4.1%

U.S. Government Bills—0.8%
United States Treasury Bills, 5.07% due 10/16/1997 $250,000 $ 249,472
Total U.S. Government Bills 249,472
Commercial Paper—2.2%
American Express Credit Corp., 5.58% due 10/6/1997 $250,000 $ 250,000
General Electric Capital Corporation, 5.56%­5.67% due 10/2/1997­10/3/1997 500,000 500,000
Total Commercial Paper 750,000
Repurchase Agreements—1.1%
State Street Repurchase Agreement, 5.95% due 10/1/1997 $381,000 $ 381,000
Total Repurchase Agreements 381,000
Total Short Term Investments (Cost: $1,380,472) 1,380,472
Total Investments (Cost $ 28,398,735)—101.2% (b) $ 33,856,971
Other liabilities in excess of other assets—(1.2)% (394,458)
Total Net Assets—100% $ 33,462,513

(a) Non-income producing security.

(b) At September 30, 1997, net unrealized appreciation of $5,458,236 for federal income tax purposes consisted of gross unrealized appreciation of $5,505,006 and gross unrealized depreciation of $46,770.

See accompanying notes to financial statements.