THE OAKMARK
EQUITY AND INCOME FUND
Report from Clyde S. McGregor and Edward A. Studzinski, Portfolio Managers
THE OAKMARK
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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 (6/30/00) AS COMPARED TO THE LIPPER BALANCED FUND INDEX | ||
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| 6/30/00 NAV $15.01 |
Total Return Last 3 mos. |
Average Annual Total Return* Through 6/30/00 From Fund Inception 11/1/95 |
| The Oakmark Equity & Income Fund | -0.2% | 14.6% |
| Lipper Balanced Fund Index** | -1.2% | 13.7% |
| Lehman Govt./Corp. Bond** | 1.5% | 5.8% |
| S&P 500 w/inc** | -2.7% | 23.8% |
| *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
The price of the Oakmark Equity and Income Fund was virtually unchanged in the quarter ended June 30, which contrasts with a small loss of -1.2% for the Lipper Balanced Fund Index, our primary standard of comparison. Two equity holdings suffered drastic markdowns late in the quarter, turning an otherwise promising period into one with a dull outcome. We are most pleased with the Fund's fixed income holdings as they provided positive rates of return despite continued upward pressure on interest rates.
Time Periods
But for a particularly bad day on June 30th, we had a pretty good quarter. While this may smack of an apology (like the insurance company that, but for the hurricane that destroyed property it was insuring, would have had a banner underwriting year), it is more by way of leading into a discussion of time periods. What is so magical about the end of a month, end of a quarter, end of a year? Just as corporations (or families) do not wind up their businesses and liquidate at the end of a calendar year (hence the phrase going concern), it should be remembered that investment results should be looked at in the context of the long-term, rather than just interim snapshots. Certainly those snapshots serve as progress reports. However, since the dates on which the snapshots are taken increasingly are subject to market forces other than fundamentals (whether it be the derivative positions of arbitrageurs or major financial institutions), measuring over a rolling long-term period is critical when assessing the true performance of value investors.
One of our more successful investments of 2000 has been the St. Joe Company, the largest private landholder in Florida. Originally a creation of a branch of the DuPont family, St. Joe over time grew to be a collection of a variety of assets, including majority ownership of the Florida East Coast Railway. New management was brought in several years ago in an effort to unlock the inherent value in the company's assets and pristine balance sheet. That management has moved aggressively to exit non-core, capital intensive businesses and focus on the development of St. Joe's land portfolio. To that end, upon receiving IRS approval, St. Joe will spin out tax-free to its shareholders its ownership in the Florida East Coast Railway and become a pure real estate operating company. That company, with more than 1,000,000 acres, will own a substantial portion of the remaining part of coastal Florida that is left open to development, with a cost basis of approximately $100 per acre. Management expects that it will have few capital needs going forward, and will effectively be in long-term liquidation as it undertakes a major shrinkage of its equity base with its free cash flow. Florida East Coast Railway will operate as an independent company and have the opportunity to optimize not just its transportation assets but also its own real estate and telecommunications business. In both instances, we will have the opportunity to participate with smart, shareholder-oriented managements in an area where the demographics for their businesses are favorable for the foreseeable future.
Sell Discipline
Over our many years as investors, the stock market has changed its characteristics in several respects. Perhaps most noticeable has been the amplification of volatility in the prices of individual stocks in response to news. This particular trend seems to be a natural outcome of the fact that the institutionally-managed share of invested assets continues to grow, and an ever larger number of institutions employ investing styles that are news-dependent.
As mentioned in the quarter review section above, our results would have been more pleasant but for two stock blowups late in June. Both Electronic Data Systems (EDS) and Sybron International issued releases to warn investors that their earnings would not meet expectations. The combined effect on the Fund of the price declines in these two issues was more than 1.3%. When situations such as this arise, clients often inquire as to our sell discipline.
Our sell discipline is a logical outcome of our investing process. To buy a security, we must find it to be selling at a significant discount to its intrinsic value, project a satisfactory growth rate for that intrinsic value, and evaluate the management team to be one which treats company shareholders as partners. Obviously, the sell discipline is based on an investment failing to satisfy one or more of these conditions.
We establish buy and sell targets for each company that we approve for purchase based on our understanding of the intrinsic value per share. Next, our analysts devise a list of "reasons to own" which help provide the conceptual framework for holding a security. Stocks are sold when they attain their sell target. In some cases, however, we sell without reaching the sell target when the reasons to own begin to erode away.
Now how does this relate to EDS and Sybron? In both cases the share price has yet to attain our sell target and the respective reasons to own have not been compromised. In fact, our respect for each management team has only increased with time. Before June, share prices for both companies had risen significantly this year, and we reduced our holdings on the way up. This reflects our perception that risk increases as a stock price closes in on its sell target. With the precipitous and, in our opinion, unwarranted declines in stock price, we have been rebuilding these positions. In both cases we are confident that the disappointment in earnings does not reflect a secular deterioration in the company's prospects. It is our firmly held belief that at some point in the future we will be able to report back to our shareholders concerning the successful conclusion of our ownership of each of these stocks.
Clyde S. McGregor, CFA
Portfolio Manager
mcgregor@oakmark.com
Edward A. Studzinski, CFA
Portfolio Manager
estudzinski@oakmark.com
July 3, 2000
| THE OAKMARK EQUITY
AND INCOME FUND Schedule of Investments—June 30, 2000 (Unaudited) |
| Shares Held | Market Value | |
| Equity and Equivalents—56.2% | ||
| Household Products—2.9% | ||
| Energizer Holdings, Inc. (a) | 80,000 | $1,460,000 |
| Banks & Thrifts—3.7% | ||
| Washington Mutual, Inc. | 64,000 | $1,848,000 |
| Other Financial—3.0% | ||
| Heller Financial, Inc. | 74,000 | $1,517,000 |
| Information Services—3.8% | ||
| Ceridian Corporation | 80,000 | $1,925,000 |
| Data Storage—0.1% | ||
| StorageNetworks, Inc. (a) | 600 | $54,150 |
| Computer Services—3.5% | ||
| Electronic Data Systems Corporation | 25,000 | $1,031,250 |
| First Data Corporation | 15,000 | 744,375 |
| 1,775,625 | ||
| Computer Software—4.2% | ||
| The Reynolds and Reynolds Company | 117,500 | $2,144,375 |
| Telecommunications—4.3% | ||
| Citizens Communications Company | 125,000 | $2,156,250 |
| Medical Products—5.7% | ||
| Sybron International Corporation (a) | 89,500 | $1,773,219 |
| Edwards Lifesciences Corporation (a) | 60,000 | 1,110,000 |
| 2,883,219 | ||
| Automotive—2.7% | ||
| Lear Corporation (a) | 67,700 | $1,354,000 |
| Transportation Services—1.2% | ||
| GATX Corporation | 18,500 | $629,000 |
| Agricultural Equipment—4.8% | ||
| Alamo Group Inc. | 192,350 | $2,404,375 |
| Chemicals—0.9% | ||
| The Geon Company | 25,000 | $462,500 |
| Real Estate—13.5% | ||
| Catellus Development Corporation (a) | 136,728 | $2,050,920 |
| The St. Joe Company | 55,000 | 1,650,000 |
| Amli Residential Properties Trust | 67,500 | 1,590,469 |
| Legacy Hotels Real Estate Investment Trust (b) | 250,000 | 1,494,932 |
| 6,786,321 | ||
| Total Equity (Cost: $24,047,908) | 27,399,815 | |
| Convertible Preferred Stock—1.9% | ||
| Telecommunications—1.9% | ||
| Metromedia International Group, Inc., Convertible Preferred, 7.25% | 34,000 | $952,000 |
| Total Convertible Preferred Stock (Cost: $993,260) | 952,000 | |
| Total Equity and Equivalents (Cost: $25,041,168) | 28,351,815 | |
| Par Value | Market Value | |
| Fixed Income—38.8% | ||
| Preferred Stock—5.4% | ||
| Banks & Thrifts—4.1% | ||
| BBC Capital Trust I, Preferred, 9.50% | 34,000 | $597,125 |
| Pennfed Capital Trust, Preferred, 8.90% | 27,500 | 594,687 |
| PennFirst Capital Trust I, Preferred, 8.625% | 70,000 | 511,875 |
| Fidelity Capital Trust I, Preferred, 8.375% | 43,500 | 353,438 |
| 2,057,125 | ||
| Telecommunications—1.0% | ||
| MediaOne Finance Trust III, Preferred, 9.04% | 20,000 | $501,250 |
| Real Estate—0.3% | ||
| Host Marriott Corporation, Preferred Class B, 10.00% | 6,000 | $132,000 |
| Total Preferred Stock (Cost: $3,270,348) | 2,690,375 | |
| Corporate Bonds—3.7% | ||
| Retail—1.1% | ||
| Ugly Duckling Corporation, 12.00% due 10/15/2003, Subordinated Debenture | 650,000 | $573,625 |
| Building Materials & Construction—1.5% | ||
| Juno Lighting, Inc., 11.875% due 7/1/2009, Senior Subordinated Note | 750,000 | $622,500 |
| USG Corporation, 9.25% due 9/15/2001, Senior Notes SeriesB | 150,000 | 152,625 |
| 775,125 | ||
| Utilities—1.1% | ||
| Midland Funding Corporation, 11.75% due 7/23/2005 | 500,000 | $532,500 |
| Total Corporate Bonds (Cost: $1,933,362) | 1,881,250 | |
| Government and Agency Securities—29.7% | ||
| U.S. Government Notes—25.7% | ||
| United States Treasury Notes, 6.50% due 10/15/2006 | 3,000,000 | $3,031,579 |
| United States Treasury Notes, 6.50% due 2/28/2002 | 2,000,000 | 2,000,000 |
| United States Treasury Notes, 6.00% due 8/15/2009 | 2,000,000 | 1,983,750 |
| United States Treasury Notes, 5.25% due 8/15/2003 | 2,000,000 | 1,939,376 |
| United States Treasury Notes, 5.25% due 5/15/2004 | 2,000,000 | 1,929,376 |
| United States Treasury Notes, 9.125% due 5/15/2009 | 1,000,000 | 1,088,125 |
| United States Treasury Notes, 7.875% due 8/15/2001 | 1,000,000 | 1,014,688 |
| 12,986,894 | ||
| U.S. Government Agencies—4.0% | ||
| Federal Home Loan Bank, 6.75% due 5/1/2002 | 2,000,000 | $1,994,456 |
| Total Government and Agency Securities (Cost: $14,950,646) | 14,981,350 | |
| Total Fixed Income (Cost: $20,154,356) | 19,552,975 | |
| Short Term Investments—4.4% | ||
| Commercial Paper—3.0% | ||
| Ford Motor Credit Corp., 6.72% due 7/3/2000 | 1,500,000 | $1,500,000 |
| Total Commercial Paper (Cost: $1,500,000) | 1,500,000 | |
| Repurchase Agreements—1.4% | ||
| State Street Repurchase Agreement, 6.25% due 7/3/2000 | 731,000 | $731,000 |
| Total Repurchase Agreements (Cost: $731,000) | 731,000 | |
| Total Short Term Investments (Cost: $2,231,000) | 2,231,000 | |
| Total Investments (Cost $47,426,524)—99.4% | $50,135,790 | |
| Other Assets In Excess Of Other Liabilities—0.6% | 313,354 | |
| Total Net Assets—100% | $50,449,144 | |
(a) Non-income producing security.
(b) Represents foreign domiciled corporation.