THE OAKMARK EQUITY AND
INCOME FUND
Report from Clyde S. McGregor and
Edward A. Studzinski, Portfolio Managers
THE OAKMARK EQUITY AND
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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 (9/30/01) AS COMPARED TO THE LIPPER BALANCED FUND INDEX12 |
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| Average Annual Total Returns1 | ||||
| (as of 9/30/01) | ||||
| Year to Date Total Return* (as of 9/30/01) |
1-year | 5-year | Since Inception (11/1/95) |
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| Oakmark Equity and Income Fund | 9.34% | 14.40% | 16.40% | 15.73% |
| S&P 5004 | -20.39% | -26.62% | 10.22% | 12.08% |
| Lehman Govt./ Corp. Bond13 |
8.44% | 13.17% | 8.00% | 7.25% |
| Lipper Balanced Index | -9.13% | -10.33% | 8.19% | 8.96% |
| Past performance is no guarantee of future results. Investment return and principal value vary, and you may have a gain or loss when you sell shares. Average annual total return measures annualized change, while total return measures aggregate change. | ||||
| * Not annualized | ||||
Quarter and Annual Review
Despite ending at a difficult moment, fiscal 2001 proved to be another profitable period for The Oakmark Equity and Income Fund. The return for the twelve months was 14%, which contrasts with a loss of 10% for the Lipper Balanced Fund Index, our primary standard of comparison. The September quarter itself, however, was not positive as the stock market’s drastic downturn overwhelmed the moderate gains we realized from bonds. For the quarter, the Fund declined 3%, again far better than the 8% loss that the Lipper posted.
Oakmark Equity and Income garnered many new shareholders over the last twelve months, so a brief refresher course on some of our firm’s guiding principles may be appropriate. Our first three rules of investing are "Don’t lose money," "Don’t lose money," "Don’t lose money." The power of negative returns has been amply demonstrated over the last 18 months. Mathematics dictates that a loss of 20% in a period requires a gain of 25% in the subsequent period just to get back to the starting point. Turning to our recent results for the Fund, we are grateful to have bested our standard of comparison in the quarter, but we are unimpressed with the absolute outcome. The quarter was the third to lose money in the Fund’s 23-quarter lifespan. Our goal is to improve upon that record.
Outlook in the Aftermath
Even before September 11th the US economy appeared to be headed for a period of torpor. Given the horrors of that date and the subsequent layoffs, bankruptcies, etc., a recession seems probable. Speaking only about the economy, September 11th not only diminished consumer and investor confidence but also introduced new taxes on business in the guise of security measures.
Since September 11th, economists and clients have suggested many possible paths for the economy. Over the last month our clients have frequently espoused the hypothesis that major acts of terrorism will become a regular feature of our socio-political environment. Another common model has the United States repeating the Japanese experience of the previous decade. In this model American consumers lose their natural ebullience and government fiscal and monetary policy fail to stimulate economic recovery. In either of these economic scenarios, the investing environment would be extremely difficult.
We have no more ability to forecast the economy successfully than we do to predict when (or if) acts of terrorism may hit. We do believe that in our country the process of reversion to the mean is very powerful and that extreme outcomes for the economy or stocks tend to be unsustainable. In this cycle government leadership initiated efforts to head off recession far earlier than is usually the case, and the new spirit of bipartisanship may enable additional stimulus efforts to be enacted quickly. We believe our most appropriate course of action for you, our shareholders, is to continue to invest according to the tenets of our value-based investing style. In this manner we attempt to make sense of a world and investing environment that periodically does not make sense.
What Did We Do?
Historically this quarter’s report has focused on the Fund’s successful holdings of the previous 12 months. Given the unprecedented events in September, we will break with tradition and recount our actions in the last two weeks of that month. This exercise will demonstrate both our inability to forecast the future correctly and the positive attributes of adhering to our investing approach.
The stock market was closed from September 11th through Friday, the 15th. This gave us time to prepare for a challenging market opening on the following Monday. Our first thought was that shareholders of all mutual funds would become more risk-averse and that redemptions from Equity and Income were likely. We also observed that during the period our markets were closed foreign stock markets sank while the prices of oil and gold rallied. We believed the equity portion of the Fund was favorably positioned with minimal exposure to the most affected industries while the largest industry exposure was in energy. Accordingly, we prepared to react to three possibilities: significant redemptions from the Fund, a strong rally in energy stocks that could be a selling opportunity, and potential buying opportunities in insurance and travel-related issues.
Highlights |
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So how effective did our preparations prove? To our surprise, the Fund received positive cash flow from our investors over the period. Second, energy prices sank like a stone on the morning the stock market reopened, pulling the prices of our energy company holdings down. Our readiness to buy issues with depressed prices, however, did prove fruitful.
We initiated positions in eight stocks and two bonds after the market reopened. PartnerRe, a Bermuda-based reinsurance company and previous holding of the fund, has enjoyed such a vigorous recovery from its post-9/11 bottom that the stock is today the Fund’s largest holding. Other new positions we purchased after drastic price declines include industrial conglomerates (Cooper, Dover, and Textron), a hotel company (Starwood), a retailer (Gap), an advertising agency (Interpublic), and another energy name (Cabot Oil & Gas). We also found timely buys in the fixed income sector as rattled sellers sought liquidity wherever they could find it. We purchased the bonds of Park Place Entertainment and Rite Aid at prices that we estimate to offer the return potential of an equity holding.
The obvious conclusion is that we serve our clients best when we stick to our knitting: constructing a portfolio by the disciplined application of our value-investing style to the opportunities the markets present to us. And, the corollary to this rule is that the best opportunities arise when we are buying from an "informationless" seller, i.e. an investor who is selling because of reasons that have nothing to do with fundamental knowledge of the investment.
In closing, we once again thank you our shareholders for your support and loyalty through this difficult time. Your constancy has made our job easier. We all pray that our next letter will cover a more tranquil time period. In the meantime we welcome your e-mailed questions or comments.
Clyde S. McGregor, CFA
Portfolio Manager
mcgregor@oakmark.com
Edward A. Studzinski, CFA
Portfolio Manager
estudzinski@oakmark.com
October 4, 2001
| THE OAKMARK EQUITY AND INCOME FUND |
Schedule of Investments—September 30, 2001
| Shares Held | Market Value | |
| Equity and Equivalents—57.6% | ||
| Food & Beverage—3.0% | ||
| UST Inc. | 560,000 | $18,592,000 |
| Retail—3.6% | ||
| Office Depot, Inc. (a) | 980,000 | $13,328,000 |
| J. C. Penney Company, Inc. | 350,000 | 7,665,000 |
| The Gap, Inc. | 125,000 | 1,493,750 |
| 22,486,750 | ||
| Household Products—0.2% | ||
| Energizer Holdings, Inc. (a) | 80,000 | $1,329,600 |
| Bank & Thrifts—2.2% | ||
| U.S. Bancorp | 610,703 | $13,545,393 |
| Insurance—6.5% | ||
| PartnerRe Ltd. (b) | 440,600 | $20,752,260 |
| SAFECO Corporation | 650,000 | 19,714,500 |
| 40,466,760 | ||
| Other Financial—2.7% | ||
| GATX Corporation | 500,000 | $16,820,000 |
| Hotels & Motels—0.7% | ||
| Starwood Hotels & Resorts Worldwide, Inc. | 200,000 | $4,400,000 |
| Marketing Services—0.3% | ||
| The Interpublic Group of Companies, Inc. | 100,000 | $2,040,000 |
| Information Services—1.6% | ||
| Ceridian Corporation (a) | 705,000 | $10,222,500 |
| Computer Software—5.4% | ||
| Novell, Inc. (a) | 3,500,000 | $12,810,000 |
| Synopsys, Inc. (a) | 275,000 | 11,030,222 |
| The Reynolds and Reynolds Company, Class A | 414,000 | 9,646,200 |
| 33,486,422 | ||
| Printing—1.5% | ||
| Valassis Communications, Inc. (a) | 289,400 | $9,234,754 |
| Pharmaceuticals—4.9% | ||
| Watson Pharmaceuticals, Inc. (a) | 336,000 | $18,382,560 |
| Chiron Corporation (a) | 270,000 | 11,979,900 |
| 30,362,460 | ||
| Medical Products—3.4% | ||
| Sybron Dental Specialties, Inc. (a) | 341,666 | $6,354,988 |
| Edwards Lifesciences Corporation (a) | 275,000 | 6,160,000 |
| Guidant Corporation (a) | 125,000 | 4,812,500 |
| Apogent Technologies Inc. (a) | 150,000 | 3,585,000 |
| 20,912,488 | ||
| Transportation Services—0.2% | ||
| Nordic American Tanker Shipping Limited (b) | 96,900 | $1,452,531 |
| Aerospace & Defense—1.9% | ||
| Rockwell Collins | 823,600 | $11,695,120 |
| Agricultural Equipment—0.3% | ||
| Alamo Group Inc. | 141,900 | $1,827,672 |
| Instruments—0.7% | ||
| Varian Inc. (a) | 177,900 | $4,532,892 |
| Machinery & Industrial Processing—3.9% | ||
| Cooper Industries, Inc. | 300,000 | $12,441,000 |
| Rockwell International Corporation | 811,000 | 11,905,480 |
| 24,346,480 | ||
| Forestry Products—2.3% | ||
| Georgia-Pacific Corporation (Timber Group) | 401,200 | $14,531,464 |
| Oil & Natural Gas—8.4% | ||
| XTO Energy, Inc. | 1,328,000 | $18,525,600 |
| Conoco Inc. | 675,000 | 17,165,250 |
| St. Mary Land & Exploration Company | 780,000 | 12,425,400 |
| Berry Petroleum Company | 148,100 | 2,288,145 |
| Cabot Oil & Gas Corporation | 85,500 | 1,705,725 |
| 52,110,120 | ||
| Real Estate—1.9% | ||
| Catellus Development Corporation (a) | 695,900 | $12,164,332 |
| Diversified Conglomerates—2.0% | ||
| Textron, Inc. | 286,100 | $9,615,821 |
| Dover Corporation | 100,000 | 3,011,000 |
| 12,626,821 | ||
| Total Equity and Equivalents (Cost: $362,269,593) | 359,186,559 |
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| Fixed Income—29.3% | ||
| Preferred Stock—0.5% | ||
| Bank & Thrifts—0.3% | ||
| BBC Capital Trust I, Preferred, 9.50% | 48,000 | $1,183,200 |
| Pennfed Capital Trust, Preferred, 8.90% | 27,500 | 694,375 |
| Fidelity Capital Trust I, Preferred, 8.375% | 43,500 | 426,300 |
| 2,303,875 | ||
| Telecommunications—0.1% | ||
| MediaOne Finance Trust III, Preferred, 9.04% | 20,000 | $510,000 |
| Real Estate—0.1% | ||
| Host Marriott Corporation, Preferred Class B,10.00% | 21,000 | $483,000 |
| Host Marriott Corporation, Preferred Class A,10.00% | 5,000 | 113,600 |
| 596,600 | ||
| Total Preferred Stock (Cost: $3,350,448) | 3,410,475 |
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| Corporate Bonds—1.5% | ||
| Retail—0.4% | ||
| Rite Aid Corporation, 7.625% due 4/15/2005, Senior Notes | $2,000,000 | $1,760,000 |
| Ugly Duckling Corporation, 12.00% due 10/15/2003, | ||
| Subordinated Debenture | 650,000 | 520,000 |
| 2,280,000 | ||
| Office Equipment—0.1% | ||
| Xerox Capital Europe Plc, 5.75% due 5/15/2002 | $500,000 | $474,830 |
| Hotels & Motels—0.5% | ||
| Park Place Entertainment, 7.00% due 7/15/2004, Senior Notes | $2,700,000 | $2,679,658 |
| Park Place Entertainment, 7.375% due 6/1/2002, Senior Notes | 320,000 | 322,112 |
| 3,001,770 | ||
| TV Programming—0.3% | ||
| Liberty Media Corporation, 8.25% due 2/1/2030, Debenture | $2,500,000 | $2,224,510 |
| Building Materials & Construction—0.1% | ||
| Juno Lighting, Inc., 11.875% due 7/1/2009, Senior | ||
| Subordinated Note | $750,000 | $690,000 |
| Utilities—0.1% | ||
| Midland Funding Corporation, 11.75% due 7/23/2005 | $500,000 | $559,375 |
| Total Corporate Bonds (Cost: $9,369,855) | 9,230,485 |
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| Government and Agency Securities—27.3% | ||
| U.S. Government Notes—26.4% | ||
| United States Treasury Notes, 3.375% due 1/15/2007, | ||
| Inflation Indexed | $42,576,720 | $43,800,801 |
| United States Treasury Notes, 10.75% due 8/15/2005 | 20,000,000 | 25,040,620 |
| United States Treasury Notes, 7.00% due 7/15/2006 | 20,000,000 | 22,655,460 |
| United StatesTreasury Notes, 6.625% due 5/15/2007 | 20,000,000 | 22,512,500 |
| United States Treasury Notes, 11.875% due 11/15/2003 | 15,000,000 | 17,728,710 |
| United States Treasury Notes, 7.875% due 11/15/2004 | 15,000,000 | 16,958,790 |
| United States Treasury Notes, 7.25% due 8/15/2004 | 5,000,000 | 5,541,600 |
| United States Treasury Notes, 5.25% due 5/15/2004 | 5,000,000 | 5,267,190 |
| United States Treasury Notes, 5.25% due 8/15/2003 | 5,000,000 | 5,220,655 |
| 164,726,326 | ||
| U.S. Government Agencies—0.9% | ||
| Federal Home Loan Bank, 6.75% due 5/1/2002 | $2,000,000 | $2,049,550 |
| Federal Home Loan Bank, 7.85% due 6/7/2004, | ||
| Consolidated Bond | 1,250,000 | 1,295,501 |
| Federal Home Loan Bank, 6.50% due 10/19/2001 | 1,000,000 | 1,016,071 |
| Federal Home Loan Mortgage Corporation, 7.00% | ||
| due 2/23/2016 | 1,000,000 | 1,004,236 |
| 5,365,358 | ||
| Total Government and Agency Securities (Cost: $165,122,927) | 170,091,684 |
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| Total Fixed Income (Cost: $177,843,230) | 182,732,644 |
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Par Value |
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| Short Term Investments—14.3% | ||
| Government and Agency Securities—3.2% | ||
| U.S. Government Agencies—3.2% | ||
| Federal Home Loan Bank, 2.75% due 10/9/2001, Discount Note | $20,000,000 | $19,987,778 |
| Total Government and Agency Securities (Cost: $19,987,778) | 19,987,778 |
|
| Commercial Paper—8.0% | ||
| Citicorp, 3.20% due 10/2/2001 | $10,000,000 | $10,000,000 |
| American Express Credit Corporation, 3.35% due 10/1/2001 | 20,000,000 | 20,000,000 |
| General Electric Capital Corporation, 3.25% due 10/1/2001 | 20,000,000 | 20,000,000 |
| Total Commercial Paper (Cost: $50,000,000) | 50,000,000 |
|
| Repurchase Agreements—3.1% | ||
| State Street Repurchase Agreement, 3.05% due 10/1/2001, | ||
| repurchase price $18,844,789, collateralized by | ||
| U.S. Treasury Bonds. | $18,840,000 | $18,840,000 |
| Total Repurchase Agreements (Cost: $18,840,000) | 18,840,000 |
|
| Total Short Term Investments (Cost: $88,827,778) | 88,827,778 |
|
| Total Investments (Cost $628,940,601) - 101.2% (c) | $630,746,981 | |
| Other Liabilities In Excess Of Other Assets - (1.2)% | (7,390,585) | |
| Total Net Assets—100% | $623,356,396 | |
| (a) | Non-income producing security. |
| (b) | Represents foreign domiciled security. |
| (c) | At September 30, 2001, net unrealized appreciation of $1,806,380, for federal income tax purposes, consisted of gross unrealized appreciation of $29,993,999 and gross unrealized depreciation of $28,187,619. |
See accompanying notes to financial statements.
