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 (9/30/99) AS COMPARED TO THE LIPPER BALANCED FUND INDEX |
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| 9/30/99 NAV $15.68 |
Total Return Last 3 mos. |
Average Annual Total Return* Through 9/30/99 From Fund Inception 11/1/95 |
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| The Oakmark Equity & Income Fund | -5.1% | 15.4% |
| Lipper Balanced Fund Index** | -4.1% | 14.0% |
| Lehman Govt./Corp. Bond** | .5% | 5.9% |
| S&P 500 w/inc** | -6.2% | 24.6% |
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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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FISCAL 1999: IT WAS THE BEST OF TIMES, IT WAS THE WORST OF TIMES
Oakmark Equity and Income's fiscal year ended on September 30. For fiscal 1999 as a whole, the Fund returned 15.3%, a solid absolute level of return and nearly 2% better than the Lipper Balanced Fund Index. The year exhibited a curious pattern, however: strong results in quarters one and three, weak in two and four. In fact, the September quarter was only the second in the Fund's four-year history to register a loss, the previous example being last year's September quarter (whatever happened to the "summer rally?").
As I wrote this letter one-year ago, stock prices were rapidly eroding, culminating in a panic on October 8. Soon thereafter Alan Greenspan and the Federal Reserve restored the equilibrium of the markets with three interest rate cuts. Today the environment is quite different. The overall economic and political situation appears promising, and the distractions originating abroad which have bedeviled the markets have mostly dissipated. Probably the biggest negative for investors is the fact that the Federal Reserve has now taken away two of last year's rate reductions and noisily threatens to increase rates yet again.
Despite the recent quarter's difficulties, I remain optimistic in my outlook for the security markets. The current economic expansion may be one of the longest-lived, but it is also the slowest on record. This means that the kinds of imbalances that develop during periods of growth are less prevalent this cycle. Instead, the imbalances have surfaced in the stock market where some sectors trade at unprecedented multiples while others suffer through a bear market. This "aversion to the mean" runs counter to powerful economic forces; we value investors eagerly await the inevitable trend reversal.
MIGHTY OAKS AWARDS
My tradition at the fiscal year-end is to honor the analysts in our firm whose ideas had the greatest positive impact on the Fund in both equity and fixed income investments. (The name "Mighty Oaks" derives from our firm's splendid athletic teams.) In the first three years of the Fund's existence it was easy to determine the winners. In fiscal 1999, however, price considerations caused me to sell several very successful holdings early in the year, complicating the analysis. Rather than be too arbitrary, I have decided to make four awards for equities.
Greg Jackson, co-manager of the new Oakmark Global Fund, wins an award for his recommendation of First Data (FDC). FDC more than doubled over the fiscal year as investors regained confidence in management. As a processor of transactions which involve the use of credit and debit cards, the company is a beneficiary of changing consumer preferences. Increased immigration lies behind the strength of FDC's Western Union unit.
Following close behind is analyst Kevin Grant with Premark International. In September, Premark announced that it would merge into Illinois Tool Works at a price of $55/share. Back in April, Jim Ringler, Premark CEO, stopped by our office to give us an update. During the meeting he pointed out that the company had been growing earnings at 18% per year yet the investing community did not seem to notice. We commended him and his team on their fine work and averred that eventually their efforts would be rewarded. Now, as it happened, the CEO of Illinois Tool sat on Premark's board of directors. With ITW's stock price much more highly valued than Premark's, he was able to make a deal that should continue to produce shareholder value for many years to come.
One footnote is in order concerning this merger. Most stocks experience some increase in their share price in the period leading up to a deal announcement. Occasionally this price increase is natural, but it often is the result of some sort of information leak. The Premark announcement came after the stock market closed on September 9. On that day the stock price rose a mere 6 cents, and its price had actually declined over the previous week. Congratulations to all involved for their professionalism and integrity!
Jim Benson of our research team receives a sort of group award for his recommendations of Lexmark International, Imation, and Ugly Duckling debentures, all of which I have discussed in detail in previous reports.
I am also granting Ed Studzinski a special award for "best performance by an income-oriented equity in an industry with collapsing stock prices." Ed has worked diligently to develop ideas which would build up the Fund's income generation. His Legacy Hotels not only had a better than 13% dividend yield at the time of my purchase for the Fund but also earned a 30% return over the last nine months. Thanks Ed, Jim, Kevin, and Greg for your contributions.
On the fixed income side of the ledger, the Ugly Duckling debentures mentioned above clearly take the prize. One other issue is worthy of comment, however. As I have often noted, it is a great advantage for this Fund to be in a group of funds which invest in different market segments. In particular, Steve Reid's Small Cap Fund has been a fertile source of fixed-income ideas. In December of 1997, one of Steve's holdings, Scotsman Industries, acquired a division of another company in which his Fund held an investment. To finance this purchase, Scotsman issued debentures for the first time in its corporate history. I purchased a position in this issue for your Fund, merely expecting to earn a comfortable income return over the 10-year life of the security. In August, 1999, Scotsman itself was acquired. In order to effect this transaction the purchaser tendered for our bonds at a healthy premium to the pre-acquisition price. The result was a 19% return to the issue for the fiscal year, not bad for a bond in a period where the returns to bond indices were close to zero. Thanks to research director John Raitt for this successful idea.
At the close of this rather lumpy fiscal year I would certainly be remiss not to thank the Fund's long-term shareholders for their support. Those who have been with the Fund since inception have enjoyed a 15% rate of return compounded annually which falls in the top 20% of similar funds. Thanks for your interest, questions, and e-mails.
CLYDE S. McGREGOR
Portfolio Manager
mcgregor@oakmark.com
October 8, 1999
THE OAKMARK EQUITY AND INCOME FUND |
| Shares Held | Market Value | |
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| Equity and Equivalents—59.4% | ||
| Food & Beverage—3.0% | ||
| UST Inc. | 60,000 | $1,811,250 |
| Banks & Thrifts—4.3% | ||
| Washington Mutual, Inc. | 67,000 | $1,959,750 |
| Bank One Corporation | 18,724 | 651,829 |
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| 2,611,579 | ||
| Insurance—2.9% | ||
| IPC Holdings, Ltd. (b) | 50,000 | $937,500 |
| PartnerRe Ltd. (b) | 23,000 | 799,250 |
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| 1,736,750 | ||
| Other Financial—2.6% | ||
| Heller Financial, Inc. | 70,000 | $1,575,000 |
| Information Services—3.1% | ||
| The Dun & Bradstreet Corporation | 63,500 | $1,897,062 |
| Computer Services—12.7% | ||
| The Reynolds and Reynolds Company | 110,200 | $2,245,325 |
| First Data Corporation | 50,000 | 2,193,750 |
| Electronic Data Systems Corporation | 32,500 | 1,720,469 |
| Sterling Commerce, Inc. (a) | 80,000 | 1,485,000 |
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| 7,644,544 | ||
| Data Storage—5.4% | ||
| Imation Corp. (a) | 104,300 | $3,233,300 |
| Publishing—2.0% | ||
| Lee Enterprises, Incorporated | 43,900 | $1,201,763 |
| Medical Products—3.0% | ||
| Sybron International Corporation (a) | 68,000 | $1,827,500 |
| Automotive—2.6% | ||
| Lear Corporation (a) | 45,000 | $1,583,438 |
| Agricultural Equipment—1.5% | ||
| Alamo Group Inc. | 100,000 | $925,000 |
| Other Industrial Goods & Services—3.9% | ||
| Premark International, Inc. | 46,500 | $2,348,250 |
| Real Estate—9.1% | ||
| Amli Residential Properties Trust | 100,000 | $2,100,000 |
| Legacy Hotels Real Estate Investment Trust (b) | 350,000 | 1,989,042 |
| Catellus Development Corporation (a) | 116,728 | 1,371,554 |
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| 5,460,596 | ||
| Diversified Conglomerates—0.8% | ||
| U.S. Industries, Inc. | 30,000 | $472,500 |
| Total Equity (Cost: $29,851,840) | 34,328,532 | |
| Convertible Preferred Stock—2.5% | ||
| Telecommunications—2.5% | ||
| Metromedia International Group, Inc., Convertible Preferred, 7.25% | 60,000 | $1,477,500 |
| Total Convertible Preferred Stock (Cost: $1,946,738) | 1,477,500 | |
| Total Equity and Equivalents (Cost: $31,798,578) | 35,806,032 | |
| Fixed Income—35.8% | ||
| Preferred Stock—5.4% | ||
| Telecommunications—0.8% | ||
| MediaOne Finance Trust III, Preferred, 9.04% | 20,000 | $505,000 |
| Banks & Thrifts—4.6% | ||
| Pennfed Capital Trust, Preferred, 8.90% | 27,500 | $677,187 |
| BBC Capital Trust I, Preferred, 9.50% | 28,000 | 661,500 |
| PennFirst Capital Trust I, Preferred, 8.625% | 70,000 | 630,000 |
| RBI Capital Trust I, Preferred, 9.10% | 42,500 | 401,094 |
| Fidelity Capital Trust I, Preferred, 8.375% | 43,500 | 396,938 |
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| 2,766,719 | ||
| Total Preferred Stock (Cost: $3,470,738) | 3,271,719 | |
| Par Value | Market Value | |
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| Corporate Bonds—4.5% | ||
| Retail—1.0% | ||
| Ugly Duckling Corporation, 12.00% due 10/23/2003, Subordinated Debenture | $650,000 | $604,500 |
| Aerospace & Automotive—0.3% | ||
| Coltec Industries, Inc., 9.75% due 4/1/2000 | $150,000 | $150,750 |
| Coltec Industries, Inc., 9.75% due 11/1/1999 | 25,000 | 25,063 |
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| 175,813 | ||
| Machinery & Industrial Processing—0.8% | ||
| Tokheim Corporation, 11.375% due 8/1/2008, Senior Subordinated Note (c) | 500,000 | $491,250 |
| Building Materials & Construction—1.5% | ||
| Juno Lighting Inc., 11.875% due 7/1/2009, Senior Subordinated Note (c) | 750,000 | $742,500 |
| USG Corporation, 9.25% due 9/15/2001, Senior Notes Series B | 150,000 | 158,062 |
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| 900,562 | ||
| Utilities—0.4% | ||
| Midland Funding Corporation, 11.75% due 7/23/2005 | 200,000 | $220,750 |
| Other Industrial Goods & Services—0.5% | ||
| UCAR Global Enterprises Inc., 12.00% due 1/15/2005, Senior Subordinated Note | 300,000 | $316,875 |
| Total Corporate Bonds (Cost: $2,613,725) | 2,709,750 | |
| Government and Agency Securities—25.9% | ||
| U.S. Government Bonds—25.4% | ||
| United States Treasury Notes, 6.625% due 5/15/2007 | 5,250,000 | $5,412,242 |
| United States Treasury Notes, 6.25% due 6/30/2002 | 4,000,000 | 4,052,757 |
| United States Treasury Notes, 4.75% due 2/15/2004 | 4,000,000 | 3,835,563 |
| United States Treasury Notes, 6.00% due 8/15/2009 | 2,000,000 | 2,014,868 |
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| 15,315,430 | ||
| U.S. Government Agencies—0.5% | ||
| Federal Home Loan Bank, 6.405% due 4/10/2001, Consolidated Bond | 300,000 | $301,695 |
| Total Government and Agency Securities (Cost: $15,699,118) | 15,617,125 | |
| Total Fixed Income (Cost: $21,783,581) | 21,598,594 | |
| Short Term Investments—5.0% | ||
| Commercial Paper—2.5% | ||
| General Electric Capital Corporation, 5.53% due 10/1/1999 | $1,500,000 | $1,500,000 |
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| Total Commercial Paper (Cost: $1,500,000) | 1,500,000 | |
| Repurchase Agreements—2.5% | ||
| State Street Repurchase Agreement, 5.20% due 10/1/1999 | $1,507,000 | $1,507,000 |
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| Total Repurchase Agreements (Cost: $1,507,000) | 1,507,000 | |
| Total Short Term Investments (Cost: $3,007,000) | 3,007,000 | |
| Total Investments (Cost $56,589,159)—100.2% (d) | $60,411,626 | |
| Other Liabilities In Excess Of Other Assets—(0.2)% | (94,035) | |
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| Total Net Assets—100% | $60,317,591 | |
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(a) Non-income producing security.
(b) Represents foreign domiciled corporation.
(c) Restricted security.
(d) At September 30, 1999, net unrealized appreciation of $3,822,467, for federal income tax purposes, consisted of gross unrealized appreciation of $6,404,058 and gross unrealized depreciation of $2,581,591.