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 (3/31/98) AS COMPARED TO THE LIPPER BALANCED FUND INDEX | ||
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| 3/31/98 NAV $14.95 | Total Return Last 3 mos. |
Average Annual Total Return* Through 3/31/98 From Fund Inception 11/1/95 |
| The Oakmark Equity & Income Fund | 8.7% | 22.2% |
| Lipper Balanced Fund Index** | 7.9% | 19.3% |
| Lehman Govt./Corp. Bond** | 1.5% | 7.2% |
| S&P 500 w/inc** | 14.0% | 32.9% |
| *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. | ||
QUARTER UPDATE
I am pleased to report that your Fund earned 8.7% in the January through March quarter. This quarter was the third best in the Fund's history, exceeded only by last year's second and third calendar quarters. Virtually all of this splendid outcome originated in the equity segment of the portfolio. Fixed income prices ended the quarter unchanged, meaning that the segment's only contribution to return was income. It has been uncommon in the 1990's for stock prices to march ahead without the aid of declining interest rates. In the first quarter, however, it would appear that equity investors regained the confidence that the fourth quarter's Asian market meltdown had shaken while fixed income investors fretted about the strength of the US economy. Highlights in the Fund in the quarter included Liberty Media, Banc One, Borg-Warner Automotive, Juno Lighting, and Old Republic International, all of which returned more than 20%.
DIFFERENCES II
For the last 20 years my position as an investment manager has required me to make presentations to trustees, board members, and every other kind of fiduciary that exists. Recently it became my privilege to sit on the other side of the table as I joined the investment committee of a charitable organization. In March, as part of my duties on that committee, I interviewed the principal manager of US common stocks for the charity. The investing process which the manager articulated for his organization is similar to the one in which I was trained at my first employer. His team divides the investing universe into industry groups, decides which groups should be emphasized, and then selects the most attractive 2 or 3 stocks from each industry. This firm's analysts become specialists in narrowly defined niches, and their job is to determine correctly which stocks will do the best within the area which they cover. The consulting community generally refers to this style as "core."
Our methodology is quite different. We build our portfolios from the bottom up based on finding value on a security by security basis. Our analysts are all generalists who are merely charged with the responsibility of discovering undervaluation. The search for value does not begin with preconceived ideas of which industries might be fertile to exploit. Rather, the search begins with an insight as to how we might look at a business or an industry from a different perspective and thereby gain an edge in terms of valuing the associated securities. If we do not have that insight, if we cannot get our arms around a company and develop a firm understanding of its value, we will not invest in that company no matter how attractive its characteristics.
Our approach often results in industries not being represented in the Fund. Usually technology issues are absent because we are uncomfortable valuing companies in businesses which can be obsolete tomorrow. It can also be the case that our analysis tells us that undervaluation is not to be found in a specific industry. This sometimes leads to questions relating to the issue of diversification.
I believe that diversification is both overrated and misunderstood. The academic community argues that most benefits of diversification are achieved by the time an equity portfolio has 8-10 holdings. As the asset listing on the next four pages depicts, our process develops a portfolio with holdings in a wide variety of industries even though I have not built the portfolio with that intent.
The securities markets exist to provide price information for intangible assets. The market periodically misprices securities. Our tactical mission is to exploit these mistakes wherever and whenever they occur.
QUIET PERIOD
Last year one of your Fund's holdings (General Signal) announced that it would have a "quiet period" while company leadership worked out plans for restructuring. The just completed quarter was a quiet period for your Fund, but in a different manner. The Fund ended the quarter with the same 23 equity issues with which it began the quarter. I added to many of the holdings as cash came into the Fund, but I did not initiate or eliminate any equity positions.
Many years ago one of our firm's founding partners said to me that in our business sometimes the hardest thing to do is to do nothing. And, in fact, many mutual funds demonstrate this by reporting turnover ratios (measures of how many times in a 12-month period the dollars in the portfolio are "turning over" from one security to another) which exceed one or even two.
In The Oakmark Equity and Income Fund I strive to keep equity turnover low. Low turnover generally implies low capital gains distributions, something which the Fund's taxable investors will appreciate. But perhaps more importantly, I believe that having a long-term investing horizon provides us with an edge. When I invest in a company's stock, I know that our analysis has measured a gap between the price of the shares and their fundamental value. Our analysis, however, is unable to determine when that gap will close. So, when you observe the Fund in a quiet period, understand that this is a normal outcome of our investing process.
As always, please e-mail me with your questions or comments.
CLYDE S. McGREGOR
Portfolio Manager
mcgregor@oakmark.com
April 3, 1998
THE OAKMARK EQUITY AND INCOME FUND |
| Shares Held | Market Value | |
|
| ||
| Equity and Equivalents—59.4% | ||
| Food & Beverage—1.6% | ||
| Philip Morris Companies Inc. | 20,000 | $833,750 |
| Office Equipment—2.2% | ||
| Lexmark International Group, Inc., Class A (a) | 26,000 | $1,173,250 |
| Other Consumer Goods & Services—3.8% | ||
| Juno Lighting, Inc. | 61,300 | $1,294,962 |
| National Presto Industries, Inc. | 17,000 | 732,063 |
| 2,027,025 | ||
| Banks—4.4% | ||
| Banc One Corporation | 23,674 | $1,497,380 |
| Mellon Bank Corporation | 13,400 | 850,900 |
| 2,348,280 | ||
| Insurance—5.7% | ||
| PartnerRe Ltd. | 32,500 | $1,596,562 |
| Old Republic International Corporation | 33,000 | 1,462,313 |
| 3,058,875 | ||
| TV Programming—3.4% | ||
| Tele-Communications, Liberty Media, Class A (a) | 52,800 | $1,815,000 |
| Publishing—5.0% | ||
| Dun & Bradstreet Corporation | 45,000 | $1,538,437 |
| Lee Enterprises, Inc. | 33,900 | 1,137,769 |
| 2,676,206 | ||
| Computer Services—3.4% | ||
| Electronic Data Systems Corporation | 40,000 | $1,835,000 |
| Data Storage—3.2% | ||
| Imation Corp. (a) | 92,200 | $1,705,700 |
| Automotive—7.7% | ||
| Chrysler Corporation | 56,000 | $2,327,500 |
| Borg-Warner Automotive, Inc. | 15,000 | 961,875 |
| Lear Corporation (a) | 15,000 | 845,625 |
| 4,135,000 | ||
| Aerospace & Defense—2.5% | ||
| The Boeing Company | 25,800 | $1,344,825 |
| Machinery & Metal Processing—2.0% | ||
| General Signal Corporation | 23,000 | $1,075,250 |
| Building Materials & Construction—1.6% | ||
| Armstrong World Industries, Inc. | 9,600 | $831,000 |
| Other Industrial Goods & Services—2.0% | ||
| Premark International, Inc. | 31,500 | $1,043,438 |
| Commercial Real Estate—4.6% | ||
| Catellus Development Corporation (a) | 132,728 | $2,463,763 |
| Diversified Conglomerates—4.7% | ||
| U.S. Industries, Inc. | 84,250 | $2,532,766 |
| Foreign Securities—1.6% | ||
| DeBeers Centenary AG (b) | 40,000 | $877,500 |
| Total Equity and Equivalents (Cost: $23,467,531) | 31,776,628 | |
| Fixed Income—34.5% | ||
| Preferred Stock—5.7% | ||
| Banks—4.9% | ||
| PennFirst Capital Trust 1, Preferred, 8.625% | 70,000 | $726,250 |
| BBC Capital Trust 1, Preferred, 9.50% | 28,000 | 724,500 |
| Pennfed Capital Trust, Preferred, 8.90% | 27,500 | 701,250 |
| RBI Capital Trust I, Preferred, 9.10% | 42,500 | 451,562 |
| 2,603,562 | ||
| Other Financial—0.8% | ||
| Fidelity Capital Trust I, Preferred, 8.375% | 43,500 | $445,875 |
| Total Preferred Stock (Cost: $2,970,738) | 3,049,437 | |
| Corporate Bonds—3.1% | ||
| Other Consumer Goods & Services—0.4% | ||
| Samsonite Corp., 11.125% due 7/15/2005, Senior Subordinated Note Series B | $200,000 | $231,500 |
| Aerospace & Automotive—0.4% | ||
| Coltec Industries, Inc., 9.75% due 4/1/2000 | $150,000 | $159,375 |
| Coltec Industries, Inc., 9.75% due 11/1/1999 | 25,000 | 26,406 |
| 185,781 | ||
| Building Materials & Construction—0.3% | ||
| USG Corporation, 9.25% due 9/15/2001, Senior Notes Series B | $150,000 | $162,938 |
| Utilities—0.3% | ||
| Midland Funding Corporation, 11.75% due 7/23/2005 | $150,000 | $176,438 |
| Other Industrial Goods & Services—1.7% | ||
| Scotsman Industries, Inc., 8.625% due 12/15/2007, Senior Subordinated Note | $565,000 | $574,181 |
| UCAR Global Enterprises Inc., 12.00% due 1/15/2005, Senior Subordinated Note | 300,000 | 336,750 |
| 910,931 | ||
| Total Corporate Bonds (Cost: $1,611,530) | 1,667,588 | |
| Government and Agency Securities—25.7% | ||
| U.S. Government Bonds—25.1% | ||
| United States Treasury Notes, 7.50% due 5/15/2002 | $5,000,000 | $5,326,650 |
| United States Treasury Notes, 7.875% due 11/15/2004 | 3,750,000 | 4,187,550 |
| United States Treasury Notes, 7.125% due 9/30/1999 | 3,800,000 | 3,881,548 |
| 13,395,748 | ||
| U.S. Government Agencies—0.6% | ||
| Federal Home Loan Bank, 6.405% due 4/10/2001, Consolidated Bond | $300,000 | $304,797 |
| Total Government and Agency Securities (Cost: $13,502,564) | 13,700,545 | |
| Total Fixed Income (Cost: $18,084,832) | 18,417,570 | |
| Short Term Investments—7.0% | ||
| Commercial Paper—5.6% | ||
| American Express Credit Corp., 5.52% due 4/2/1998-4/3/1998 | $1,000,000 | $1,000,000 |
| Ford Motor Credit Corp., 5.54% due 4/6/1998 | 500,000 | 500,000 |
| General Electric Capital Corporation, 6.02% due | ||
| 4/1/1998 | 1,500,000 | 1,500,000 |
| Total Commercial Paper (Cost: $3,000,000) | 3,000,000 | |
| Repurchase Agreements—1.4% | ||
| State Street Repurchase Agreement, 5.75% due 4/1/1998 | $729,000 | $729,000 |
| Total Repurchase Agreements (Cost: $729,000) | 729,000 | |
| Total Short Term Investments (Cost: $3,729,000) | 3,729,000 | |
| Total Investments (Cost $45,281,363)—100.9% (c) | $53,923,198 | |
| Other Liabilities In Excess Of Other Assets— (0.9)% | (468,113) | |
| Total Net Assets—100% | $53,455,085 | |
(a) Non-income producing security.
(b) Represents an American Depository Receipt.
(c) At March 31, 1998, net unrealized appreciation of $8,641,836, for federal income tax purposes consisted of gross unrealized appreciation of $8,862,701 and gross depreciation of $220,865.