THE OAKMARK EQUITY AND INCOME FUND
Report from Clyde S. McGregor and Edward A. Studzinski,
Portfolio Managers
THE OAKMARK EQUITY AND INCOME FUNDReport from Clyde S. McGregor and Edward A. Studzinski,
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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 (3/31/00) AS COMPARED TO THE LIPPER BALANCED FUND INDEX | ||
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| 3/31/00 NAV $15.04
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Total Return Last 3 mos. |
Average Annual Total Return* Through 3/31/00 From Fund Inception 11/1/95 |
| The Oakmark Equity & Income Fund | 4.4% | 15.5% |
| Lipper Balanced Fund Index** | 3.0% | 14.8% |
| Lehman Govt./Corp. Bond** | 2.7% | 5.8% |
| S&P 500 w/inc.** | 2.3% | 26.0% |
| *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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Quarter Review
Frankly, it is impossible to give a thorough review of the recent quarter within the confines of this report. The March quarter was my 91st in this business, and it stands out as one of the most unusual. The emotional state of investors cycled between elation and despair frequently. The NASDAQ marketplace experienced both robust gains and the fastest correction in history not associated with a crash. The Equity and Income Fund was not immune to this turbulence but did succeed in dampening the volatility. At the nadir in returns for the quarter (January 28) the Fund had declined 3%. Over the next two months the Fund rebounded, closing March 31 at an all-time high and producing a total return of 4.4%.
While the recovery in fund returns in March is pleasing, it does not yet reflect a definitive change in the investing environment. Flows to and from mutual funds dominate investing activity today in a manner never previously observed, and to date these flows continue to favor funds employing a momentum style, especially those concentrating on issues in the technology sector. Over the last decade technology has grown in importance within the stock market at an incredible pace—by one measure from 7% of market value to about 40% today. The contribution to gross domestic product, however, has not grown commensurately.
As I noted in my June, 1999, report, the Equity and Income Fund has not ignored this development—currently 40% of the fund's equities are in the technology "space" and this is true even after losing Sterling Commerce in March to a takeover offer. As you would expect from an Oakmark Group offering, our thrust in this sector has been to identify issues with strong business franchises and attractive valuations. It has been frustrating, however, to observe the market favoring concerns with little more than an idea.
Imagine that in 1980 two knowledgeable investors (I'll call them Rip van Winkle 1 and 2) had gone to sleep and were awakened today. If we now give Rip 1 information about the prevailing market environment except for the 250 or so most expensive stocks and Rip 2 information only concerning those 250 issues, imagine how their analysis would differ. The first Rip would no doubt wax eloquent about the improved conditions in the overall picture—reduced world tensions, low inflation and interest rates, no federal deficit, etc. He would also note that valuations of the stocks he had reviewed were not too much in excess of 1980 levels. He would probably conclude that this is a wonderful time to be an investor. In contrast, Rip 2 would no doubt come back in shock. The high valuation periods within his previous experience would seem tame in comparison to present conditions. He would also admit that the world seems like a far safer and more prosperous place, but he would counsel fleeing the stock market.
I cannot predict when the current trend will change. I am convinced, however, that it sows the seeds of its own destruction. The vast amounts of money both public and private flowing into so-called "new economy" ventures will eventually ensure that profitability in this sector melts away. In the meantime, our focus is on issues which benefit from these trends and managements which fully understand how to propel their companies' evolution.
Fixed Income Management in a Time of Federal Reserve Tightening
One of the best known and most successful rules for investors is "don't fight the Fed." In the March quarter investors in both stocks and long term Treasury notes chose to ignore this axiom. In the Treasury market the promise of shrinking supply induced a buying panic in issues with the longest maturities. This has resulted in an "inversion" in the Treasury yield curve where short term issues yield more than long. The corporate debt market does not have a similar future scarcity issue, and longer term issues continue to yield more than short.
Our strategy for the fixed income segment of the Equity and Income Fund has not changed with the peculiar conditions in the fixed income market. We continue to seek corporate debt and preferred issues which offer the possibility of equity-like returns while managing the riskiness of the entire portfolio with a significant commitment to short and intermediate term Treasury and Agency notes.
Heller vs. GE Scorecard
Last quarter I wrote at length concerning the amazing divergence in valuation statistics between Heller Financial and General Electric. Each company experienced wide swings in stock price in the March quarter, but by March 31 the score was Heller +14.6%, GE +0.4%. Of course, this barely begins to bridge the valuation gap, but it is noteworthy that rising interest rates did not prove to be a problem to either stock in the quarter.
New to the Fund
In March, Edward Studzinski joined me as portfolio manager of the Equity and Income Fund. Ed has been invaluable to me in the management of The Fund since his arrival here nearly four years ago, and I have regularly mentioned his efforts in these pages. Ed has a wide range of experience and his incisive insights have often helped me to see flaws in my logic. Because his appointment as portfolio manager was so recent, I did not think it fair to ask Ed to contribute his thoughts to this report. Future editions will bear his unmistakable imprint.
Both Ed and I welcome e-mailed questions or comments.
Clyde S. McGregor
Portfolio Manager
mcgregor@oakmark.com
Edward A. Studzinski
Portfolio Manager
estudzinski@oakmark.com
April 5, 2000
| THE OAKMARK EQUITY
AND INCOME FUND Schedule of Investments—March 31, 2000 (Unaudited) |
| Shares Held | Market Value | |
| Equity and Equivalents—61.6% | ||
| Banks & Thrifts—2.9% | ||
| Washington Mutual, Inc. | 57,000 | $1,510,500 |
| Other Financial—3.3% | ||
| Heller Financial, Inc. | 75,000 | $1,734,375 |
| Information Services—4.4% | ||
| Ceridian Corporation | 120,000 | $2,302,500 |
| Data Storage—3.1% | ||
| Imation Corp. (a) | 61,500 | $1,641,281 |
| Computer Services—5.7% | ||
| First Data Corporation | 35,000 | $1,548,750 |
| Electronic Data Systems Corporation | 22,000 | 1,412,125 |
| 2,960,875 | ||
| Computer Software—6.1% | ||
| The Reynolds and Reynolds Company | 117,500 | $3,172,500 |
| Publishing—2.2% | ||
| Lee Enterprises, Incorporated | 43,900 | $1,146,888 |
| Medical Products—3.2% | ||
| Sybron International Corporation (a) | 58,500 | $1,696,500 |
| Automotive—3.2% | ||
| Lear Corporation (a) | 60,000 | $1,687,500 |
| Agricultural Equipment—4.4% | ||
| Alamo Group Inc. | 196,350 | $2,282,569 |
| Building Materials & Construction—3.1% | ||
| Vulcan Materials Company | 35,000 | $1,603,437 |
| Chemicals—1.0% | ||
| The Geon Company | 25,000 | $537,500 |
| Utilities—3.1% | ||
| Citizens Utilities Company | 100,000 | $1,637,500 |
| Real Estate—12.8% | ||
| Legacy Hotels Real Estate Investment Trust (b) | 350,000 | $1,999,312 |
| Catellus Development Corporation (a) | 136,728 | 1,897,101 |
| Amli Residential Properties Trust | 80,000 | 1,640,000 |
| The St. Joe Company | 40,000 | 1,157,500 |
| 6,693,913 | ||
| Total Equity (Cost: $25,237,495) | 30,607,838 | |
| Convertible Preferred Stock—3.1% | ||
| Telecommunications—3.1% | ||
| Metromedia International Group, Inc., Convertible Preferred, 7.25% | 50,000 | $1,600,000 |
| Total Convertible Preferred Stock (Cost: $1,543,788) | 1,600,000 | |
| Total Equity and Equivalents (Cost: $26,781,283) | 32,207,838 | |
| Par Value | Market Value | |
| Fixed Income—34.3% | ||
| Preferred Stock—5.4% | ||
| Banks & Thrifts—4.2% | ||
| Pennfed Capital Trust, Preferred, 8.90% | 27,500 | $605,000 |
| BBC Capital Trust I, Preferred, 9.50% | 28,000 | 507,500 |
| PennFirst Capital Trust I, Preferred, 8.625% | 70,000 | 507,500 |
| Fidelity Capital Trust I, Preferred, 8.375% | 43,500 | 326,250 |
| RBI Capital Trust I, Preferred, 9.10% | 35,700 | 272,212 |
| 2,218,462 | ||
| Telecommunications—1.0% | ||
| MediaOne Finance Trust III, Preferred, 9.04% | 20,000 | $500,000 |
| Real Estate—0.2% | ||
| Host Marriott Corporation, Preferred Class B, 10.00% | 6,000 | $120,750 |
| Total Preferred Stock (Cost: $3,518,598) | 2,839,212 | |
| Corporate Bonds—3.9% | ||
| Retail—1.1% | ||
| Ugly Duckling Corporation, 12.00% due 10/15/2003, Subordinated Debenture | 650,000 | $573,625 |
| Aerospace & Automotive—0.3% | ||
| Coltec Industries, Inc., 9.75% due 4/1/2000 | 150,000 | $150,000 |
| Building Materials & Construction—1.5% | ||
| Juno Lighting, Inc., 11.875% due 7/1/2009, Senior Subordinated Note | 750,000 | $631,875 |
| USG Corporation, 9.25% due 9/15/2001, Senior Notes Series B | 150,000 | 152,625 |
| 784,500 | ||
| Utilities—1.0% | ||
| Midland Funding Corporation, 11.75% due 7/23/2005 | 500,000 | $534,375 |
| Total Corporate Bonds (Cost: $2,084,983) | 2,042,500 | |
| Government and Agency Securities—25.0% | ||
| U.S. Government Bonds—24.4% | ||
| United States Treasury Notes, 6.25% due 6/30/2002 | 4,000,000 | $3,980,589 |
| United States Treasury Notes, 4.75% due 2/15/2004 | 4,000,000 | 3,781,919 |
| United States Treasury Notes, 6.50% due 10/15/2006 | 3,000,000 | 3,026,556 |
| United States Treasury Notes, 6.00% due 8/15/2009 | 2,000,000 | 1,974,644 |
| 12,763,708 | ||
| U.S. Government Agencies—0.6% | ||
| Federal Home Loan Bank, 6.405% due 4/10/2001, Consolidated Bond | 300,000 | $299,009 |
| Total Government and Agency Securities (Cost: $13,219,341) | 13,062,717 | |
| Total Fixed Income (Cost: $18,822,922) | 17,944,429 | |
| Short Term Investments—3.0% | ||
| Repurchase Agreements—3.0% | ||
| State Street Repurchase Agreement, 6.03% due 4/3/2000 | 1,575,000 | $1,575,000 |
| Total Repurchase Agreements (Cost: $1,575,000) | 1,575,000 | |
| Total Short Term Investments (Cost: $1,575,000) | 1,575,000 | |
| Total Investments (Cost $47,179,205)—98.9% (c) | $51,727,267 | |
| Other Assets In Excess Of Other Liabilities—1.1% | 588,612 | |
| Total Net Assets—100% | $52,315,879 | |
| (a) | Non-income producing security. |
| (b) | Represents foreign domiciled corporation. |
| (c) | At March 31, 2000, net unrealized appreciation of $4,548,062, for federal income tax purposes, consisted of gross unrealized appreciation of $5,810,766 and gross unrealized depreciation of $1,262,704. |