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 (6/30/01) AS COMPARED TO THE LIPPER BALANCED FUND INDEX12 | ||
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| 6/30/01 NAV4 $17.96 | Total Return Last 3 months* |
Average Annual Total Return1 Through 6/30/01 From Fund Inception 11/1/95 |
| The Oakmark Equity & Income Fund | 8.06% | 17.08% |
| Lipper Balanced Fund Index | -3.51% | 10.91% |
| Lehman Govt./Corp. Bond13 | 0.30% | 6.71% |
| S&P 500 w/inc.3 | 5.85% | 15.85% |
| *Not annualized. | ||
"If all economists were laid end to end, they would not reach a conclusion." George Bernard Shaw
Our Results
The Oakmark Equity and Income Fund increased 8% for the quarter ended June 30, bringing the calendar-year gain to 13%. For both the quarter and the calendar year, the Fund continued to outperform both the market averages and our primary benchmark, the Lipper Balanced Fund Index, which has lost 2% for the year. While we continue to be pleased with both our relative and absolute performance this year, we remain extremely vigilant to avoid complacency. This year there have been a number of value traps to avoid, such as assuming that a security now selling for 20% of what it was selling for twelve months ago represents compelling business value. A focus on intrinsic business value rather than market price assists us in both avoiding the traps and seizing the opportunities when presented. Our goal remains to compound your (and our) investment in the Fund through achieving consistent above-average real rates of return over the long-term, while undertaking considerably less risk than the market as a whole. This focus on understanding the relationship that exists between risk and return has stood us in good stead in the past, and we expect it to continue to do so in the future.
Indexing and Closet Indexing
There has been a great deal of commentary about the debacle of both dot.com issues and technology stocks in general. Little has been said about the growth of assets under management utilizing indexing strategies. Likewise ignored is the fact that growth in assets under management at many of the huge mutual fund complexes has effectively made some of the mega-sized ($25B on up) mutual funds, regardless of espoused style, closet index funds. A couple of different phenomena have played out here. Indexing was originally intended as a style of investment management giving an investor a diversified slice of a particular market such as the S&P 500 at lower transaction, tax, and investment management costs. As a result of a period of outperformance relative to active managers, indexing attracted so much in the way of new asset flows that performance of the S&P 500 index began to be driven by the investment of those asset flows into the equities that composed the index. Children will recognize this as a variation on musical chairs—adults have been a little slower off the mark. At a certain point as the flows begin to slow, so does the performance, which causes the flows to stop and even reverse. After all, investors have made it quite clear that they are always looking backwards, chasing performance, causing fund flows to gravitate to that area now outperforming the index.
A by-product of indexing has been closet indexing, a corollary of which is sometimes called capitalization creep. The preconditions for closet indexing are usually found in linking the compensation of investment managers to how much they outperform a relevant index. As the night follows the day it becomes almost a certainty that the composition of the portfolio will take on a remarkable likeness to the index. A tremendous amount of time is then spent on trying to add value RELATIVE TO THE INDEX while concurrently minimizing deviations from that index. You will observe that not much time in this process is spent on whether an idea may be compelling in terms of intrinsic value, only on gaming the index. Closet indexing is a result of the same fund flows attracted into indexing. To avoid significant under performance, especially if you are a $25B megafund, the fund manager is forced into larger and larger capitalization stocks without regard to valuation. As bottom-up fundamental investors who invest when and where we find value, we are able to avoid these pitfalls. Put another way, if we make an investment error, it is not going to be because we were gaming a benchmark index.
As 2001 has progressed, opportunities for value investors have continued to present themselves, albeit of a slightly different character than before. The opportunities to overpay for mediocre or declining businesses (categorized by some as "cigar-butt" businesses) have increased as new moneys have been attracted to the "value" category. This reflects a market that lacks discrimination and presents better than average to very good businesses selling at discounts to intrinsic business value. Two examples of such investments initiated during the quarter are our investments in both C.R. Bard (BCR) and Valassis Communications (VCI).
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Our Research Process—Value Affirmation
It is nice when outside confirmation of our investment process is provided by a takeover bid for one of our portfolio investments. This quarter saw two such bids. Nova Corporation, one of our larger positions where our average cost was under $18 a share, is to be acquired by U.S. Bancorp for $31 a share in stock. C.R. Bard, an investment we had initiated this quarter at an average cost of $44.50 is to be acquired by Tyco for $60 a share in stock. In both instances, attractive businesses were available and ignored in the marketplace notwithstanding good and improving fundamentals. In the case of Bard, improving product lines and a management perhaps looking to cash out served as catalysts in attracting a buyer. Clearly, both value investors in the public equity marketplace and value investors running companies are looking to exploit the gap between market price and intrinsic business value.
We reiterate our commitment to seeking out investments with a considerable margin of safety supported by a real rather than illusory valuation gap. This letter is being written in a climate of continued interest rate cuts by the Federal Reserve and a growing concern about the domestic and global economies. Nonetheless we are heartened by the opportunities we see for those with investment time-horizons beyond the next day, week, month, quarter, or year. We believe that assessing business value over the long-term, rather than worrying about macro-economic issues over which we have no control, will always be the best use of our time. We thank you for your continued support of the Fund and we look forward to reporting to you, our partners, at the end of the next quarter.
Clyde S. McGregor, CFA
Portfolio Manager
mcgregor@oakmark.com
Edward A. Studzinski, CFA
Portfolio Manager
estudzinski@oakmark.com
July 9, 2001
| THE OAKMARK EQUITY
AND INCOME FUND Schedule of Investments—June 30, 2001 (Unaudited) |
| Shares Held | Market Value | |
| Equity and Equivalents—61.6% | ||
| Food & Beverage—4.9% | ||
| UST Inc. | 320,000 | $9,235,200 |
| General Mills, Inc. | 195,000 | 8,537,100 |
| 17,772,300 | ||
| Retail—5.3% | ||
| Office Depot, Inc. (a) | 980,000 | $10,172,400 |
| J.C. Penney Company, Inc. | 350,000 | 9,226,000 |
| 19,398,400 | ||
| Household Products—0.5% | ||
| Energizer Holdings, Inc. (a) | 80,000 | $1,836,000 |
| Other Consumer Goods & Services—1.0% | ||
| H&R Block, Inc. | 56,000 | $3,614,800 |
| Bank & Thrifts—0.3% | ||
| Washington Mutual, Inc. | 25,500 | $957,525 |
| Insurance—1.2% | ||
| The PMI Group, Inc. | 60,000 | $4,299,600 |
| Other Financial—2.6% | ||
| GATX Corporation | 235,000 | $9,423,500 |
| Marketing Services—1.5% | ||
| Harte-Hanks Incorporated | 225,000 | $5,571,000 |
| Information Services—6.5% | ||
| Ceridian Corporation | 505,000 | $9,680,850 |
| NOVA Corporation (a) | 300,000 | 9,435,000 |
| Equifax Inc. | 125,000 | 4,585,000 |
| 23,700,850 | ||
| Computer Services—0.3% | ||
| SunGard Data Systems Inc. (a) | 30,000 | $900,300 |
| Electronic Data Systems Corporation | 5,000 | 312,500 |
| 1,212,800 | ||
| Computer Software—1.6% | ||
| The Reynolds and Reynolds Company, Class A | 260,000 | $5,707,000 |
| Telecommunications—2.7% | ||
| Telephone and Data Systems, Inc. | 90,000 | $9,787,500 |
| TV Programming—0.8% | ||
| AT&T Corp. - Liberty Media Group, Class A (a) | 170,000 | $2,973,300 |
| Printing—1.0% | ||
| Valassis Communications, Inc. (a) | 100,000 | $3,580,000 |
| Pharmaceuticals—4.1% | ||
| Chiron Corporation (a) | 200,000 | $10,416,000 |
| Abbott Laboratories | 93,000 | 4,464,930 |
| 14,880,930 | ||
| Medical Products—6.7% | ||
| C. R. Bard, Inc. | 175,000 | $9,966,250 |
| Apogent Technologies Inc. (a) | 200,000 | 4,920,000 |
| Sybron Dental Specialties, Inc. (a) | 236,666 | 4,849,286 |
| Edwards Lifesciences Corporation (a) | 175,000 | 4,613,000 |
| 24,348,536 | ||
| Transportation Services—0.7% | ||
| Florida East Coast Industries, Inc. | 58,500 | $2,065,050 |
| Nordic American Tanker Shipping Limited | 32,500 | 558,350 |
| 2,623,400 | ||
| Aerospace & Defense—0.1% | ||
| Rockwell Collins | 15,000 | $352,650 |
| Agricultural Equipment—0.6% | ||
| Alamo Group Inc. | 141,900 | $2,022,075 |
| Instruments—2.6% | ||
| Rockwell International Corporation | 250,000 | $9,530,000 |
| Oil & Natural Gas—10.0% | ||
| Burlington Resources Inc. | 270,000 | $10,786,500 |
| St. Mary Land & Exploration Company | 500,000 | 10,630,000 |
| Conoco Inc. | 350,000 | 9,870,000 |
| XTO Energy, Inc. | 200,000 | 2,870,000 |
| Berry Petroleum Company | 142,000 | 2,059,000 |
| 36,215,500 | ||
| Real Estate—2.4% | ||
| Catellus Development Corporation (a) | 490,728 | $8,563,204 |
| Diversified Conglomerates—4.2% | ||
| Textron, Inc. | 155,000 | $8,531,200 |
| Viad Corp. | 260,000 | 6,864,000 |
| 15,395,200 | ||
| Total Equity and Equivalents (Cost: $198,290,941) | 223,766,070 | |
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| Fixed Income—27.7% | ||
| Preferred Stock—0.9% | ||
| Bank & Thrifts—0.6% | ||
| BBC Capital Trust I, Preferred, 9.50% | 47,000 | $1,132,700 |
| Pennfed Capital Trust, Preferred, 8.90% | 27,500 | 715,000 |
| Fidelity Capital Trust I, Preferred, 8.375% | 43,500 | 430,650 |
| 2,278,350 | ||
| Telecommunications—0.1% | ||
| MediaOne Finance Trust III, Preferred, 9.04% | 20,000 | $507,000 |
| Real Estate—0.2% | ||
| Host Marriott Corporation, Preferred Class B, 10.00% | 21,000 | $548,100 |
| Total Preferred Stock (Cost: $3,211,923) | 3,333,450 | |
| Corporate Bonds—0.6% | ||
| Retail—0.1% | ||
| Ugly Duckling Corporation, 12.00% due 10/15/2003, Subordinated Debenture | 650,000 | $520,000 |
| Office Equipment—0.1% | ||
| Xerox Capital Europe Plc, 5.75% due 5/15/2002 | 500,000 | $469,920 |
| Building Materials & Construction—0.2% | ||
| Juno Lighting, Inc., 11.875% due 7/1/2009, Senior Subordinated Note | 750,000 | $720,000 |
| Utilities—0.2% | ||
| Midland Funding Corporation, 11.75% due 7/23/2005 | 500,000 | $548,750 |
| Total Corporate Bonds (Cost: $2,250,093) | 2,258,670 | |
| Par Value | Market Value | |
| Government and Agency Securities—26.2% | ||
| U.S. Government Notes—25.1% | ||
| United States Treasury Notes, 3.375% due 1/15/2007, Inflation Indexed | $20,092,500 | $20,337,388 |
| United States Treasury Notes, 3.50% due 1/15/2011, Inflation Indexed | 15,241,950 | 15,299,107 |
| United States Treasury Notes, 10.75% due 8/15/2005 | 10,000,000 | 12,126,200 |
| United States Treasury Notes, 11.875% due 11/15/2003 | 10,000,000 | 11,640,480 |
| United States Treasury Notes, 7.00% due 7/15/2006 | 10,000,000 | 10,849,360 |
| United States Treasury Notes, 7.25% due 8/15/2004 | 5,000,000 | 5,369,110 |
| United States Treasury Notes, 6.125% due 8/15/2007 | 5,000,000 | 5,249,525 |
| United States Treasury Notes, 5.25% due 8/15/2003 | 5,000,000 | 5,089,760 |
| United States Treasury Notes, 5.25% due 5/15/2004 | 5,000,000 | 5,087,890 |
| 91,048,820 | ||
| U.S. Government Agencies—1.1% | ||
| Federal Home Loan Bank, 6.75% due 5/1/2002 | $ 2,000,000 | $2,045,410 |
| Federal Home Loan Bank, 6.50% due 10/19/2001 | 1,000,000 | 1,008,246 |
| Federal Home Loan Mortgage Corporation, 7.00% due 2/23/2016 | 1,000,000 | 979,494 |
| 4,033,150 | ||
| Total Government and Agency Securities (Cost: $94,919,706) | 95,081,970 | |
| Total Fixed Income (Cost: $100,381,722) | 100,674,090 | |
| Short Term Investments—10.4% | ||
| Commercial Paper—7.5% | ||
| American Express Credit Corporation, 3.83% due 7/9/200 | $ 6,000,000 | $6,000,000 |
| Ford Motor Credit Corp., 3.78% - 3.83% due 7/2/2001 - 7/3/2001 | 11,000,000 | 11,000,000 |
| General Electric Capital Corporation, 4.08% due 7/2/2001 | 10,000,000 | 10,000,000 |
| Total Commercial Paper (Cost: $27,000,000) | 27,000,000 | |
| Repurchase Agreements—2.9% | ||
| State Street Repurchase Agreement, 3.85% due 7/2/2001 | $10,648,000 | $10,648,000 |
| Total Repurchase Agreements (Cost: $10,648,000) | 10,648,000 | |
| Total Short Term Investments (Cost: $37,648,000) | 37,648,000 | |
| Total Investments (Cost $336,320,663)—99.7% | $362,088,160 | |
| Other Assets In Excess Of Other Liabilities—0.3% | 1,215,979 | |
| Total Net Assets—100% | $363,304,139 | |
| (a) | Non-income producing security. |