The Oakmark Equity and Income Fund
Report from Clyde S. McGregor, Portfolio Manager
The Oakmark Equity and Income FundReport from Clyde S. McGregor, Portfolio Manager |
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| THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK EQUITY AND INCOME FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (12/31/97) AS COMPARED TO THE LIPPER BALANCED FUND INDEX | ||
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| 12/31/97 NAV $13.76 | Total Return Last 3 mos. |
Average Annual Total Return* Through 12/31/97 From Fund Inception 11/1/95 |
| The Oakmark Equity & Income Fund | 0.9% | 20.3% |
| Lipper Balanced Fund Index** | 1.5% | 17.6% |
| Lehman Govt./Corp. Bond** | 3.2% | 7.3% |
| S&P 500 w/inc** | 2.9% | 29.2% |
| *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 or funds 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. | ||
RESULTS
The Equity and Income Fund turned in another positive result in the December quarter. The total return of 0.9% contributed to a gain of 26.6% for the calendar year which placed the Fund fourth out of 350 funds in its category according to Lipper Analytical Services. 1997 was a period in which both The Fund's equities and fixed income holdings shone. I am most pleased that the fixed income segment of the portfolio earned a return which exceeded that which long term bond indices realized even though that segment was always invested primarily in Treasury notes with intermediate maturity. But in a year where the S&P 500 return tripled that which bonds earned, the real story, which accounts for The Fund's excellent calendar year result, was the stock segment.
ASSET ALLOCATION PHILOSOPHY
A recent article in the Wall Street Journal questioned the wisdom of investing one's assets in a 60% stock 40% fixed income ratio. Since that has been the average asset allocation of your Fund, the article quickly grabbed my attention. The author of this piece argues that investors are either "stock investors" or "bond investors" depending on their life situation and that they should orient their portfolios heavily (80-90%) to the appropriate category. I discussed asset allocation at length in The Fund's second report, but since most of you have become shareholders since that time, a brief review is in order.
The two primary reasons for using a 60:40 asset allocation are that this structure mediates effectively between the needs for current income and long term growth and that it has proven able to handle some of the frailties of human nature. Many trustees have the problem of administering trusts for two groups of beneficiaries with divergent interests. One group needs income while the second desires a larger pool of capital in the future. Over many decades trustees in this position have gravitated to 60:40 because it does a good job of meeting both objectives. One does not have to be a trustee, however, to have investment objectives which conflict.
Perhaps more important is the point that 60:40 asks very little of human nature. For an asset mix to be effective, it must prove itself in times of stress. After the 1987 Crash, my partners and I observed several charitable fund investment committees which had previously embraced equity-oriented asset allocations flee that asset class entirely. Precisely at the moment when their asset allocation could have provided the most value, it was abandoned. Experience has demonstrated that investors who maintain a 60:40 asset allocation are unlikely to panic when times are tough. In fact, the discipline of this approach leads one to lean against the prevailing trend, adding funds to stocks when they are down and pulling back when they are up.
The Wall Street Journal writer correctly points out that in periods with unexpected significant increases in the rate of inflation such as the 1970's the 60:40 asset mix did not provide a perfect shield. Conditions are far different today, however; unexpected deflation seems more probable, and 60:40 offers many advantages in that environment.
I will close this section by noting that I do not think of Oakmark Equity and Income as a 60:40 fund. Rather, I maintain a core position in US Treasury Notes and build the rest of the portfolio from there. When I find plentiful opportunities in high yield bonds and preferred stocks, the portfolio will have an allocation of as much as 20% in that sector (currently 10%). The equity allocation also develops from the bottom up: when we have a sufficient pool of attractive ideas, stocks will gravitate toward their maximum of 65% of the portfolio. In essence the asset allocation is an outcome of our search for value.
DIFFERENCES
Some investors have asked how Oakmark Equity and Income differs from other funds in its category. Aside from the unique stamp which Harris Associates' style of value investing places on the portfolio, the basic difference is that The Fund is more eclectic. Most competing funds shun high yield securities. Others will only hold equities which pay dividends. And, few hold any small capitalization issues.
We invest all of our portfolios by going wherever value takes us within the guidelines for that portfolio. This has the following outcomes for The Equity and Income Fund:
| • | The Fund owns high yield bonds and preferred issues (where we can identify value) and does not own investment grade debt (where we cannot). |
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The Fund is invested in stocks of small-cap, mid-cap, and large-cap companies as well as foreign-domiciled concerns. |
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The Fund owns stocks with above average dividend yields and stocks which pay no dividend at all. |
We believe that outstanding investment opportunities are comparatively scarce. Not only does this lead to our rejecting the kinds of limitations mentioned above, but also to the Fund being considerably more concentrated than its peers. Generally, The Fund's 10 largest equity holdings will comprise at least 30% of The Fund's assets.
A final differentiating point which is true for all of the funds in the Oakmark group is that the managers invest a significant portion of their net worth in their funds. In the case of Oakmark Equity and Income, the McGregor Family is by far the largest shareholder group.
Happy belated New Year! Please feel free to E-mail me with your questions or comments.
CLYDE S. McGREGOR
Portfolio Manager
mcgregor@oakmark.com
January 8, 1998
THE OAKMARK EQUITY AND INCOME FUND |
| Shares Held | Market Value | ||
|
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| Equity and Equivalents—57.9% | |||
| Food & Beverage—1.8% | |||
| Philip Morris Companies Inc. | 16,100 | $729,531 | |
| Office Equipment—2.4% | |||
| Lexmark International Group, Inc., Class A (a) | 26,000 | $988,000 | |
| Other Consumer Goods & Services—6.1% | |||
| Juno Lighting, Incorporated | 61,300 | $1,072,750 | |
| Armstrong World Industries, Inc. | 9,600 | 717,600 | |
| National Presto Industries, Inc. | 17,000 | 672,563 | |
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| 2,462,913 | |||
| Banks—4.3% | |||
| Banc One Corporation | 17,022 | $924,507 | |
| Mellon Bank Corporation | 13,400 | 812,375 | |
| 1,736,882 | |||
| Insurance—5.2% | |||
| PartnerRe Ltd. | 25,000 | $1,159,375 | |
| Old Republic International Corporation | 25,500 | 948,281 | |
|
| |||
| 2,107,656 | |||
| TV Programming—3.1% | |||
| Tele-Communications, Liberty Media, Class A (a) | 35,200 | $1,276,000 | |
| Publishing—5.1% | |||
| Dun & Bradstreet Corporation | 35,000 | $1,082,812 | |
| Lee Enterprises, Inc. | 33,900 | 1,002,169 | |
|
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| 2,084,981 | |||
| Computer Services—4.1% | |||
| Electronic Data Systems Corporation | 38,000 | $1,669,625 | |
| Data Storage—2.9% | |||
| Imation Corporation (a) | 72,200 | $1,155,200 | |
| Automotive—7.2% | |||
| Chrysler Corporation | 40,000 | $1,407,500 | |
| Borg-Warner Automotive, Inc. | 15,000 | 780,000 | |
| Lear Corporation | 15,000 | 712,500 | |
|
| |||
| 2,900,000 | |||
| Aerospace & Defense—1.7% | |||
| The Boeing Company | 14,300 | $699,806 | |
| Machinery & Metal Processing—2.4% | |||
| General Signal Corporation | 23,000 | $970,313 | |
| Other Industrial Goods & Services—2.3% | |||
| Premark International, Inc. | 31,500 | $913,500 | |
| Commercial Real Estate—3.8% | |||
| Catellus Development Corporation (a) | 77,728 | $1,554,560 | |
| Diversified Conglomerates—3.1% | |||
| U.S. Industries, Inc. | 41,750 | $1,257,719 | |
| Foreign Securities—2.0% | |||
| DeBeers Consolidated Mines Limited ADR (b) | 40,000 | $817,500 | |
| Total Equity and Equivalents (Cost: $18,649,627) | 23,495,186 | ||
| Convertible Preferred Stock—0.4% | |||
| Insurance—0.4% | |||
| American Heritage Life Investment Corporation, Convertible Preferred, 8.50% | 3,000 | $171,000 | |
| Total Convertible Preferred Stock (Cost: $150,000) | 171,000 | ||
| Principal Value | Market Value | ||
| Fixed Income—34.3% | |||
| Preferred Stock—6.3% | |||
| Banks—6.3% | |||
| BBC Capital Trust 1, Preferred, 9.50% | 28,000 | $735,000 | |
| PennFirst Capital Trust 1, Preferred, 8.625% | 70,000 | 700,000 | |
| Pennfed Capital Trust I, Preferred, 8.90% | 27,500 | 697,812 | |
| RBI Capital Trust I, Preferred, 9.10% | 42,500 | 440,938 | |
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| 2,573,750 | |||
| Total Preferred Stock (Cost: $2,535,738) | 2,573,750 | ||
| Corporate Bonds—4.1% | |||
| Other Consumer Goods & Services—0.6% | |||
| Samsonite Corporation, 11.125% due 7/15/2005, Senior Subordinated Note Series B | $200,000 | $224,250 | |
| Aerospace & Automotive—0.5% | |||
| Coltec Industries, Inc., 9.75% due 4/1/2000 | $150,000 | $159,188 | |
| Coltec Industries, Inc., 9.75% due 11/1/1999 | 25,000 | 26,406 | |
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| 185,594 | |||
| Building Materials & Construction—0.4% | |||
| USG Corporation, 9.25% due 9/15/2001, Senior Notes Series B | $150,000 | $161,437 | |
| Utilities—0.4% | |||
| Midland Funding Corporation, 11.75% due 7/23/2005 | $150,000 | $175,875 | |
| Other Industrial Goods & Services—2.2% | |||
| Scotsman Industries, Inc., 8.625% due 12/15/2007, Senior Subordinated Note | $565,000 | $567,119 | |
| UCAR Global Enterprises Inc., 12.00% due 1/15/2005, Senior Subordinated Note | 300,000 | 338,250 | |
|
| |||
| 905,369 | |||
| Total Corporate Bonds (Cost: $1,614,057) | 1,652,525 | ||
| Government and Agency Securities—23.9% | |||
| U.S. Government Bonds—23.1% | |||
| United States Treasury Notes, 7.125% due 9/30/1999 | $3,300,000 | $3,378,276 | |
| United States Treasury Notes, 7.875% due 11/15/2004 | 2,750,000 | 3,074,142 | |
| United States Treasury Notes, 7.50% due 5/15/2002 | 2,750,000 | 2,933,783 | |
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|
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| 9,386,201 | |||
| U.S. Government Agencies—0.8% | |||
| Federal Home Loan Bank, 6.405% due 4/10/2001, Consolidated Bond | $300,000 | $304,146 | |
| Total Government and Agency Securities (Cost: $9,490,022) | 9,690,347 | ||
| Total Fixed Income (Cost: $13,639,817) | 13,916,622 | ||
| Short Term Investments—6.3% | |||
| Commercial Paper—5.1% | |||
| Ford Motor Credit Corp., 5.80% due 1/2/1998 | $750,000 | $750,000 | |
| American Express Credit Corp., 6.00%6.65% due 1/2/19981/5/1998 | 950,000 | 950,000 | |
| General Electric Capital Corporation, 5.79%6.08% due 1/5/19981/6/1998 | 350,000 | 350,000 | |
| Total Commercial Paper (Cost: $2,050,000) | 2,050,000 | ||
| Repurchase Agreements—1.2% | |||
| State Street Repurchase Agreement, 6.00% due 1/2/1998 | $503,000 | $503,000 | |
| Total Repurchase Agreements (Cost: $503,000) | 503,000 | ||
| Total Short Term Investments (Cost: $2,553,000) | 2,553,000 | ||
| Total Investments (Cost $34,842,444)—98.5% | 39,964,808 | ||
| Other Assets in Excess of Other Liabilities—1.5% | 601,441 | ||
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| |||
| Total Net Assets—100% | $40,566,249 | ||
(a) Non-income producing security.