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 (6/30/98) AS COMPARED TO THE LIPPER BALANCED FUND INDEX |
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6/30/98 NAV $15.03 |
Total Return |
Average Annual Total Return* |
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The Oakmark Equity & Income Fund |
0.5% |
20.2% |
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Lipper Balanced Fund Index** |
1.5% |
18.2% |
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Lehman Govt./Corp. Bond** |
2.6% |
7.5% |
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S&P 500 w/inc** |
3.3% |
31.0% |
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*Total return includes change in share prices and in each case includes reinvestment of any dividends and capital gain distributions. |
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**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. |
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QUARTER UPDATE
Last quarter I wrote that the stocks in The Equity and Income Fund had generated all of the substantial return realized by the Fund between January and March. The June quarter was quite different. Stocks, particularly smaller and mid-cap issues, struggled, leaving it up to the fixed income segment to provide sufficient returns to push the Fund into positive territory. These disparate outcomes are two sides of the same coin. The economic decline in Asia has caused profit shortfalls for many US concerns while at the same time diminishing the probability that the Federal Reserve will increase interest rates. In addition, the strength of the dollar against most foreign currencies reduces reported profits for US companies with international operations while it enhances the attraction of US bond issues to foreign investors. The results in these two quarters once again demonstrate the benefits of diversification across asset classes. The usual 60% equity 40% fixed income mix in The Equity and Income Fund enables investors to capture those benefits.
CHRYSLER
The Fund's holding in the shares of Chrysler Corporation generated the biggest single contribution to the June quarter return. When the May 6th announcement came of Daimler-Benz's agreement with Chrysler for a friendly acquisition, I was surprised to discover that your fund's 4.2% position in the stock was the largest percentage holding of Chrysler by any mutual fund. This was particularly unexpected given that your fund was only 59% invested in stocks at that moment and other firms have mutual funds which invest 100% of their assets in equities from the automotive sector. The size of the holding elicited numerous questions from the media as well as fund investors as to what I saw in Chrysler and why I had taken a concentrated position in the Fund. I devote the remainder of this report to our thought process supporting the Chrysler investment.
When I consider an equity investment for your fund, I examine the issue's valuation, financial condition, and fundamental outlook as well as the orientation of the company's management team. Since the Equity and Income Fund has an income orientation, I also pay attention to the stock's dividend yield. Chrysler is a prototypical example of a stock which excelled in every category.
I first purchased Chrysler stock one year ago. The shares then traded for less than 7 times our estimate for 1998 earnings. The condition of the company's balance sheet was extraordinary: cash exceeded $7 billion against total debt of around $2 billion, the once seriously underfunded pension plans were in surplus, and the company had over $1 billion of reserves set aside for the health costs of retired employees. The stock's dividend yield at the time of the initial purchase was 4.3%, making it the third highest yielding stock in your fund. Management was using the com-pany's financial strength to undertake significant and persistent stock repurchases.
Management had obviously demonstrated expertise in financial administration of the company, but what seemed to be less appreciated was their leadership in technology and labor relations. Some readers may have seen commercials for the Dodge Intrepid, one of Chrysler's ''LH'' models. The commercials describe how the company used computers alone to design the car without building scale models. What was not shown was how it took the engineers only 4 minutes to make the body of the first production model fit onto the chassis. When Chrysler developed the previous generation of LH cars, it took the engineers several months to fit the body to the chassis. Change of this sort saves costs, improves quality, and makes it possible to keep the product line fresher.
As I write this letter, General Motors has lost most of its production capacity because of a labor action at one critical parts manufacturing facility. Chrysler has kept labor problems to a minimum in the 1990's largely because the company now outsources approximately 70% of the manufacturing process (the comparable number at GM is roughly 30%). While it is true that this outcome was more a product of Chrysler's historic financial weakness rather than brilliant management foresight, the company has used this advantage effectively to become the low cost producer in most of its product segments.
I initiated a normal sized position in Chrysler in the Fund last July. As sometimes happens, I had the opportunity to add to the position at a lower price in January when Wall Street began to fret about the slow introduction of the LH cars. We noticed that factory production of these cars was rising, the new Dodge Durango sport utility vehicle was selling briskly (I own one myself), and the company had new offerings in the pickup truck market. I made the decision to increase the position to 5% at that point and have not added to the holding since then.
I wrote about diversification in the previous quarterly letter, so I will not repeat myself. The Chrysler experience demonstrates why we should emphasize those holdings which most perfectly fulfill our stock selection criteria of valuation, financial strength, and management.
In closing, I would be quite remiss were I not to thank Jim Benson of our research team for bringing this idea to The Fund.
As always, please e-mail me with your questions or comments.
CLYDE S. McGREGOR
Portfolio Manager
mcgregor@oakmark.com
July 8, 1998
THE OAKMARK EQUITY AND INCOME FUND |
Shares
Market
Equity and Equivalents—62.5%
Office Equipment—2.6%
Lexmark International Group, Inc., Class A (a)
26,000
$1,586,000
Other Consumer Goods & Services—7.4%
H&R Block, Inc.
48,000
$2,022,000
Juno Lighting, Inc.
76,300
1,802,587
National Presto Industries, Inc.
17,000
661,938
4,486,525
Banks—2.2%
Banc One Corporation
23,674
$1,321,305
Insurance—6.9%
PartnerRe Ltd.
32,500
$1,657,500
Old Republic International Corporation
49,500
1,450,969
Aon Corporation
15,000
1,053,750
4,162,219
Other Financial—2.5%
Washington Mutual, Inc.
35,000
$1,520,312
TV Programming—3.4%
Tele-Communications, Liberty Media, Class A (a)
52,800
$2,049,300
Publishing—4.4%
Dun & Bradstreet Corporation
45,000
$1,625,625
Lee Enterprises, Inc.
33,900
1,038,187
2,663,812
Computer Services—3.3%
Electronic Data Systems Corporation
50,000
$2,000,000
Data Storage—3.3%
Imation Corp. (a)
120,200
$1,990,813
Medical Products—1.6%
Sybron International Corporation a
40,000
$1,010,000
Automotive—7.7%
Chrysler Corporation
56,000
$3,157,000
Lear Corporation (a)
15,000
769,687
Borg-Warner Automotive, Inc.
15,000
720,938
4,647,625
Aerospace & Defense—1.9%
The Boeing Company
25,800
$1,149,713
Mining—2.9%
DeBeers Centenary AG (b)
100,000
$1,750,000
Other Industrial Goods & Services—2.2%
Premark International, Inc.
41,500
$1,338,375
Commercial Real Estate—6.4%
Catellus Development Corporation (a)
142,728
$2,524,501
Amli Residential Properties Trust
65,000
1,393,438
3,917,939
Diversified Conglomerates—3.8%
U.S. Industries, Inc.
92,250
$2,283,187
Total Equity and Equivalents (Cost: $30,828,605)
37,877,125
Shares Held/
Market Value
Fixed Income—35.9%
Preferred Stock—4.9%
Banks—4.2%
BBC Capital Trust 1, Preferred, 9.50%
28,000
$717,500
PennFirst Capital Trust 1, Preferred, 8.625%
70,000
700,000
Pennfed Capital Trust, Preferred, 8.90%
27,500
697,812
RBI Capital Trust I, Preferred, 9.10%
42,500
432,969
2,548,281
Other Financial—0.7%
Fidelity Capital Trust I, Preferred, 8.375%
43,500
$429,563
Total Preferred Stock (Cost: $2,970,737)
2,977,844
Corporate Bonds—2.4%
Aerospace & Automotive—0.3%
Coltec Industries, Inc., 9.75% due 4/1/2000
$150,000
$159,187
Coltec Industries, Inc., 9.75% due 11/1/1999
25,000
26,375
185,562
Building Materials & Construction—0.3%
USG Corporation, 9.25% due 9/15/2001, Senior Notes Series B
150,000
$162,750
Utilities—0.3%
Midland Funding Corporation, 11.75% due 7/23/2005
150,000
$177,750
Other Industrial Goods & Services—1.5%
Scotsman Industries, Inc., 8.625% due 12/15/2007, Senior Subordinated Note
$565,000
$575,594
UCAR Global Enterprises Inc., 12.00% due 1/15/2005, Senior
Subordinated Note
300,000
336,375
911,969
Total Corporate Bonds (Cost: $1,397,505)
1,438,031
Government and Agency Securities—28.6%
U.S. Government Bonds—28.1%
United States Treasury Notes, 7.875% due 11/15/2004
6,000,000
$6,735,780
United States Treasury Notes, 7.50% due 5/15/2002
6,000,000
6,399,900
United States Treasury Notes, 7.125% due 9/30/1999
3,800,000
3,872,542
17,008,222
U.S. Government Agencies—0.5%
Federal Home Loan Bank, 6.405% due 4/10/2001, Consolidated Bond
300,000
$305,400
Total Government and Agency Securities (Cost: $17,059,955)
17,313,622
Total Fixed Income (Cost: $21,428,197)
21,729,497
Short Term Investments—4.4%
Commercial Paper—3.3%
American Express Credit Corp., 5.51% due 7/6/1998
$500,000
$500,000
Ford Motor Credit Corp., 5.53%–5.55% due 7/7/1998–7/9/1998
1,000,000
1,000,000
General Electric Capital Corporation, 5.57% due 7/8/1998
500,000
500,000
Total Commercial Paper (Cost: $2,000,000)
2,000,000
Repurchase Agreements—1.1%
State Street Repurchase Agreement, 5.65% due 7/1/1998
$644,000
$644,000
Total Repurchase Agreements (Cost: $644,000)
644,000
Total Short Term Investments (Cost: $2,644,000)
2,644,000
Total Investments (Cost $54,900,802)—102.8%
$62,250,622
Other Liabilities In Excess Of Other Assets—(2.8)%
(1,695,938)
Total Net Assets—100%
$60,554,684
(a) Non-income producing security.
(b) Represents an American Depositary Receipt.
Held
Value
Principal Value
