The Oakmark Fund

THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK FUND FROM ITS INCEPTION (8/5/91) TO PRESENT (3/31/99) AS COMPARED TO THE STANDARD & POOR'S 500 INDEX
3/31/99 NAV $35.65	Total Return Last 3 mos.	Average Annual Total Return* Through 3/31/99 From Fund Inception 8/5/91
The Oakmark Fund	-0.5%	25.2%
Standard & Poor's 500 Stock Index w/inc**	5.0%	19.8%
Dow Jones Industrial Average w/inc**	7.0%	19.5%
Value Line Composite Index**	-6.4%	7.1%
*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 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 results.

REDEMPTION SONG

The late great Bob Marley sang, "All I ever had ... redemption song."

I can relate.

When we launched The Oakmark Fund in 1991, we pledged to write meaningful quarterly letters and to keep you apprised of significant developments at The Oakmark Fund (and, subsequently, all our funds). An item I want to discuss is the high and steady level of redemption activity we have experienced over the past nine months or so. The total assets in The Oakmark Fund have declined from a high of over $9 billion in April of 1998 to less than $6 billion today, and the vast majority of that decline is due to redemptions.

I want to discuss this phenomenon, how it affects management of the Fund, and how it affects the overall market.

First, the redemptions we have experienced have required selling a lot of our holdings. In general, cash flows in or out, or even the size of the Fund, have little bearing on where I invest our money. For instance, whether our Fund has $1 billion or $10 billion in assets, I would have, say, seven percent invested in Nike and five percent in Eaton. The number of shares and the dollars are merely a residual. While I continue to make "real" trades—be it eliminating a holding, or buying a new one, or altering percentage holdings—in general I have met these redemptions by selling across the board.

Redemptions have affected virtually every fund with a value bias. (Throughout this discussion, be advised that there are no hard and fast rules that make a fund either a "value" or "growth" fund.) According to J.P. Morgan Securities, over 98 percent of new money flowing into equity funds this year has gone to growth funds! It seems that today's mutual fund investor has become very short term in his investment endeavors, and the game seems to be dependent on the assumption that what will be good is what has been good recently. These cash flows—to the growth guys, away from the value guys—tend to create forced selling pressure on the stocks that the "value" guys own and corresponding pressure on the stocks the "growth" guys own. This tends, of course, to create conditions that allow the growth guys to do well and the value guys to do poorly, which sets off the whole cycle again ... and again ... and again ...

A key question is whether fundamentals and economics are driving these cash flows or if they are mindless. A huge amount of anecdotal evidence leads me to conclude that these flows are generally mindlessly following recent past performance and increasingly bizarre theories are concocted to rationalize them. Wall Street firms, competing for underwritings, have always been creative on this score. One theory is that the Return on Invested Capital (ROIC) is so high at the New Age companies that they deserve their stratospheric valuations. Of course, what really matters is whether it can be sustained. In my experience, excess returns attract new entrants and competitors and tend to be competed away. Another theory is that Internet firms in particular should receive lofty valuations because they require little cash investment to operate. Of course, another way to look at this feature is to focus on the very low barriers to entry facing anyone trying to compete with, say, Amazon.com. (Apparently, there is a 16-year-old in Iowa who has replicated virtually their entire system!)

While I understand how frustrating our performance has been to you, and while I appreciate your patience, I actually view this cash flow phenomenon as a positive. The more investors who invest without regard to fundamentals and the more investors adopt an ever-shorter time frame, the more attractive are the opportunities for The Oakmark Fund. In fact, this is another quarter where I will reiterate that I have never been more confident of our prospective performance, particularly relative to the Standard & Poor's 500.

So, while I am now singing "Redemption Song," I expect to soon be singing another song from the Marley oeuvre: "Riding High."

OAKMARK: A GROWTH FUND?

As I indicated above, the distinction between a value fund and a growth fund tends to be arbitrary. We have never been the sort of value investors who simply buy those stocks with the lowest price-earnings- or price-book-ratio. We prefer to buy $1 of economic value for 60 cents. A growth company at a reasonable valuation can be a value to us.

This is a prelude to an assertion I often hear: "The world has changed." Today, this statement is often made by those trying to rationalize the valuations of the market leaders. Many constituents use this argument in an effort to compel me to surrender to the valuations of, say, Internet stocks. As I have written, I will never buy what I believe to be an overvalued stock in the hopes of its becoming even more over-valued.

Nevertheless, while our philosophy and how we frame the investment process never changes and never will, we often change our assessments of value in response to changes in the economic landscape. The most important change in how we view businesses and their valuation versus, say, ten years ago, is how we assess market leaders versus industry also-rans. If we look at our client portfolios of ten years ago, in general they were heavily populated with statistically cheap stocks that were in either horrible businesses or were the third or fourth participant in a given industry.

Now, let's look at The Oakmark Fund's ten largest holdings, which comprise almost 60 percent of the Fund's value. Within their respective industries, eight are dominant competitors (Nike, Philip Morris, Mattel, Black & Decker, Lockheed Martin, Boeing, H&R Block, and Dun & Bradstreet) and the other two (Washington Mutual, Eaton) are strong competitors in their markets. For every stock we own or monitor closely, our analysts assign a rating from 1 (best) to 5 (worst) in assessing the quality of a given company's business. A "1" business would tend to have a strong market share in a decent market, have high barriers to entry, have low technological obsolescence, and provide products and/or services that are differentiated. The average rating assigned to The Oakmark Fund's ten largest holdings is less than 2, meaning that we believe that the average quality of the business structure of our ten largest holdings is above average.

Our analysts also estimate long-term growth rates for every stock. The average long-term earnings growth rate for our ten largest holdings is over 11 percent, slightly above what the market is likely to experience. So, I conclude that the bulk of our Fund, at the current time, is in superior businesses with robust growth rates. Yet, the valuation of these holdings is significantly less than that of the Standard & Poor's 500.

... AND ON A PERSONAL NOTE

This past March, actually on the ides of March, I sent you a letter describing our investment philosophy. This was in response to a lot of e-mails and letters I had received from shareholders that led me to conclude that some of our shareholders were not knowledgeable about our investment philosophy. This concerned me because I believe that shareholders who simply chase returns are bound to be disappointed.

Well, I received an avalanche of letters and e-mails in response to this letter. And, I must admit it has been extremely gratifying that the vast majority of these letters has expressed knowledge and support of our investment approach. Many of you would (rightfully!) move on if we changed our philosophy. Do not worry, we will not.

With the assistance of my colleague Ms. Kathy O'Keefe-Smith, I have tried to respond to all of these communications. I want to thank all who wrote.

ROBERT SANBORN
Portfolio Manager
rsanborn@oakmark.com
April 7, 1999

THE OAKMARK FUND Schedule of Investments—March 31, 1999 (Unaudited)

(a) Non-income producing security.

(b) See footnote number five in the Notes to Financial Statements regarding transactions in affiliated issuers.

(c) At March 31, 1999, net unrealized appreciation of $348,606,400, for federal income tax purposes consisted of gross unrealized appreciation of $965,289,295 and gross unrealized depreciation of $616,682,895.