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 (6/30/99) AS COMPARED TO THE LIPPER BALANCED FUND INDEX |
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| 6/30/99 NAV $16.52
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Total Return Last 3 mos. |
Average Annual Total Return* Through 6/30/99 From Fund Inception 11/1/95 |
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| The Oakmark Equity & Income Fund | 9.9% | 18.2% |
| Lipper Balanced Fund Index** | 4.5% | 16.3% |
| Lehman Govt./Corp. Bond** | -1.1% | 6.2% |
| S&P 500 w/inc** | 7.1% | 28.7% |
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*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. |
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CHANGED FOR THE BETTER!
In my previous letter I wrote about how the stock market's odd character in the March quarter had produced a 0.0% rate of return for the Fund. I am happy to report that the outcome for the June quarter was decidedly more attractive: a gain of 9.9%. Relative results were strong as well.
Improvement in the Fund's returns began in the second week of April. The first three months of 1999 saw 98% of investor cash flow in equity mutual funds go to growth funds oriented to large company stocks, but in April these flows of funds began to spread out more evenly across investing categories. As well, the Wall Street Journal reported in June that managers of growth funds had begun to purchase stocks from a broader universe rather than merely throwing more cash at Microsoft or GE. One consequence of the market's action in this cycle has been that the most popular stocks have developed exceedingly large market capitalizations. This means that a shift of a small percentage of the funds invested in the largest growth stocks can have a significant effect on previously unpopular sectors.
The US stock market in the 1990's has already surprised investors many times by breaking historic patterns. One such rule is that the stock market does not change its internal character without first suffering through a bear market. If in time we know that the market's change in April began a period where value investing and smaller stocks were favored, it would mean that another rule had bitten the dust. No one would be happier than we fund managers for the Oakmark group.
DID YOU KNOW THAT YOU OWN A TECH FUND?
Well, not really, but as of the end of the June quarter 19% of the total portfolio was invested in technology issues. Perhaps more surprisingly, this represented over 30% of the equities alone. At Harris Associates, we have often been asked why we do not own tech stocks. Our answer has always been that we have nothing against technology per se, we just wish to own stocks (in any sector) on our terms. Over the last few quarters our analysts have identified an unusual number of attractively priced names in the tech sector, even while the best known stocks in the group were soaring to unprecedented heights. Each of the companies in which I have invested in this area has its own story and its reasons for having become quite cheaply priced. But, in every case the stock came to our attention after it had experienced a substantial price decline based on reasons which we believe were both transitory and irrelevant to the fundamental intrinsic value of the business.
The first one to enter the portfolio was Imation, a spin-off from 3M. Imation suffered persistent earnings shortfalls after being spun, knocking the stock off of most investors' play lists. I was able to acquire a position for the Fund at a discount to Imation's $18/share book value. Last year, the company sold its medical imaging businesses (25% of total corporate sales) to Eastman Kodak for cash equal to 50% of the company's total enterprise value. This valuation gave us great encouragement because we estimated the value of the remaining businesses to be similar on a price/sales basis. To our surprise, the stock declined on this announcement. In the June quarter, however, Imation became a star performer, enjoying a 50%+ price increase. In June, the company sold its remaining imaging businesses, further intensifying the company's focus on data storage. Imation has repurchased 6% of its shares this year and has an open authorization to repurchase an additional 19%.
Second to join the tech mix was Electronic Data Systems. Once separated from General Motors, EDS had earnings and management issues, which resulted in poor price performance. Since our purchase, the EDS Board has hired a new CEO who has already made a meaningful impact on the company's inefficient cost structure. The combination of EDS's position in the information technology outsourcing business with the company's changing corporate culture make us optimistic.
First Data is the largest merchant processor for credit card transactions and is the owner of Western Union. Again, a short-term earnings shortfall resulted in a dramatic price decline, at which point we pounced. The stock has earned the highest percentage return in the Fund for the calendar year to date.
Reynolds & Reynolds (REY) is best known as a business forms company, but REY derives the majority of its profits from selling business information systems to auto dealers. We estimate REY to be worth far more than its current price based on the value of its core operations. REY also owns 50% of Carpoint, a joint venture with Microsoft. This is an Internet business that helps consumers and auto dealers get together. Similar businesses have traded in the public market for prices that impute a $5+/share value to REY for Carpoint. I love getting something like this for free.
Last is Sterling Commerce, perhaps most clearly a tech company. Sterling's electronic data interchange software helps make it possible for companies such as Wal-Mart to keep their inventories as low as possible and thereby increase their returns on invested capital. The company's growth rate has slowed from phenomenal to merely wonderful, resulting in wholesale dumping by aggressive growth managers.
I have often written that I will own value wherever I can find it. The Fund's current tech exposure should make that point clear. Please feel free to e-mail me with your comments, questions, or ideas for quarterly reports.
CLYDE S. MCGREGOR
Portfolio Manager
mcgregor@oakmark.com
July 6, 1999
THE OAKMARK EQUITY AND INCOME FUND |
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Market |
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| Equity and Equivalents—60.9% | ||
| Food & Beverage—2.7% | ||
| UST Inc. | 60,000 | $1,755,000 |
| Banks & Thrifts—4.4% | ||
| Washington Mutual, Inc. | 40,000 | $1,415,000 |
| Bank One Corporation | 23,674 | 1,410,083 |
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| 2,825,083 | ||
| Insurance—2.9% | ||
| IPC Holdings, Ltd. | 50,000 | $1,000,000 |
| PartnerRe Ltd. (b) | 23,000 | 859,625 |
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| 1,859,625 | ||
| Other Financial—2.2% | ||
| Heller Financial, Inc. | 50,000 | $1,390,625 |
| Publishing—2.1% | ||
| Lee Enterprises, Inc. | 43,900 | $1,338,950 |
| Information Services—2.9% | ||
| The Dun & Bradstreet Corporation | 51,500 | $1,825,031 |
| Computer Services—14.1% | ||
| The Reynolds and Reynolds Company, Class A | 110,200 | $2,569,038 |
| First Data Corporation | 50,000 | 2,446,875 |
| Sterling Commerce, Inc. (a) | 60,000 | 2,190,000 |
| Electronic Data Systems Corporation | 32,500 | 1,838,281 |
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| 9,044,194 | ||
| Data Storage—5.4% | ||
| Imation Corp. (a) | 140,000 | $3,473,750 |
| Medical Products—2.9% | ||
| Sybron International Corporation (a) | 68,000 | $1,874,250 |
| Automotive—3.5% | ||
| Lear Corporation (a) | 45,000 | $2,238,750 |
| Agricultural Equipment—1.4% | ||
| Alamo Group Inc. | 100,000 | $875,000 |
| Building Materials & Construction—0.1% | ||
| Juno Lighting, Inc. | 4,720 | $89,680 |
| Other Industrial Goods & Services—3.3% | ||
| Premark International, Inc. | 56,500 | $2,118,750 |
| Real Estate—9.8% | ||
| Amli Residential Properties Trust | 100,000 | $2,237,500 |
| Legacy Hotels Real Estate Investment Trust (b) | 350,000 | 2,056,027 |
| Catellus Development Corporation (a) | 128,728 | 1,995,284 |
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| 6,288,811 | ||
| Diversified Conglomerates—1.3% | ||
| U.S. Industries, Inc. | 50,000 | $850,000 |
| Convertible Preferred Stock—1.9% | ||
| Telecommunications—1.9% | ||
| Metromedia International Group, Inc., Convertible Preferred, 7.25% |
35,000 | $1,220,625 |
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| Total Convertible Preferred Stock (Cost: $1,206,487) | 1,220,625 | |
| Total Equity and Equivalents (Cost: $30,984,962) | 39,068,124 | |
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| Fixed Income—35.0% | ||
| Preferred Stock—5.3% | ||
| Banks & Thrifts—4.5% | ||
| Pennfed Capital Trust, Preferred, 8.90% | 27,500 | $680,625 |
| BBC Capital Trust I, Preferred, 9.50% | 28,000 | 679,000 |
| PennFirst Capital Trust I, Preferred, 8.625% | 70,000 | 673,750 |
| RBI Capital Trust I, Preferred, 9.10% | 42,500 | 414,375 |
| Fidelity Capital Trust I, Preferred, 8.375% | 43,500 | 413,250 |
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| 2,861,000 | ||
| Telecommunications—0.8% | ||
| MediaOne Finance Trust III, Preferred, 9.04% | 20,000 | $535,000 |
| Total Preferred Stock (Cost: $3,470,738) | 3,396,000 | |
| Corporate Bonds—4.5% | ||
| Retail—1.0% | ||
| Ugly Duckling Corporation, 12.00% due 10/15/2003, Subordinated Debenture | 650,000 | $617,500 |
| Aerospace & Automotive—0.3% | ||
| Coltec Industries, Inc., 9.75% due 4/1/2000 | 150,000 | $153,188 |
| Coltec Industries, Inc., 9.75% due 11/1/1999 | 25,000 | 25,531 |
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| 178,719 | ||
| Building Materials & Construction—1.4% | ||
| Juno Lighting Inc., 11.875% due 7/1/2009, Senior Subordinated Note (c) | 750,000 | $755,625 |
| USG Corporation, 9.25% due 9/15/2001, Senior Notes Series B |
150,000 | 158,625 |
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| 914,250 | ||
| Utilities—0.3% | ||
| Midland Funding Corporation, 11.75% due 7/23/2005 |
200,000 | $221,500 |
| Other Industrial Goods & Services—1.5% | ||
| Scotsman Industries, Inc., 8.625% due 12/15/2007, Senior Subordinated Note | 615,000 | $614,231 |
| UCAR Global Enterprises Inc., 12.00% due 1/15/2005, Senior Subordinated Note | 300,000 | 316,875 |
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| 931,106 | ||
| Total Corporate Bonds (Cost: $2,743,755) | 2,863,075 | |
| Government and Agency Securities—25.2% | ||
| U.S. Government Bonds—24.7% | ||
| United States Treasury Notes, 7.50% due 5/15/2002 | 6,500,000 | $6,807,060 |
| United States Treasury Notes, 7.875% due 11/15/2004 | 4,750,000 | 5,177,642 |
| United States Treasury Notes, 6.25% due 2/15/2007 | 2,000,000 | 2,037,380 |
| United States Treasury Notes, 6.875% due 5/15/2006 | 1,750,000 | 1,841,963 |
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| 15,864,045 | ||
| U.S. Government Agencies—0.5% | ||
| Federal Home Loan Bank, 6.405% due 4/10/2001, Consolidated Bond | 300,000 | $302,937 |
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| Total Government and Agency Securities (Cost: $16,327,588) | 16,166,982 | |
| Total Fixed Income (Cost: $22,542,081) | 22,426,057 | |
| Short Term Investments—0.3% | ||
| Repurchase Agreements—0.3% | ||
| State Street Repurchase Agreement, 4.75% due 7/1/1999 | 184,000 | $184,000 |
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| Total Repurchase Agreements (Cost: $184,000) | 184,000 | |
| Total Short Term Investments (Cost: $184,000) | 184,000 | |
| Total Investments (Cost $53,711,043)—96.2% | $61,678,181 | |
| Other Assets In Excess Of Other Liabilities—3.8% | 2,407,222 | |
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| Total Net Assets—100% | $64,085,403 | |
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(a) Non-income producing security.
(b) Represents foreign domiciled corporation.
(c) Restricted security.