THE OAKMARK SMALL CAP FUND
Report from James P. Benson and
Clyde S. McGregor, Portfolio Managers
THE OAKMARK SMALL CAP FUNDReport from James P. Benson and
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THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK SMALL CAP FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (9/30/01) AS COMPARED TO THE RUSSELL 2000 INDEX9 |
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Average Annual Total Returns1 |
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(as of 9/30/01) |
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| Year to Date Total Return* (as of 9/30/01) |
1-year | 5-year | Since Inception (11/1/95) |
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| Oakmark Small Cap Fund | 6.43% | 0.07% | 6.35% | 10.46% |
| Russell 2000 | -15.36% | -21.21% | 4.54% | 6.83% |
| S&P Small Cap 60010 | -11.72% | -10.62% | 7.76% | 10.05% |
| Lipper Small Cap Value Index11 | -1.14% | 2.33% | 8.69% | 10.05% |
| 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 | ||||
The third calendar quarter of 2001 was difficult as nervousness concerning the slowing economy, combined with September’s tragic events, caused a steep decline in the prices of U.S. equities. Additionally, the flight to quality that typically accompanies periods of national crisis resulted in small cap stocks underperforming their larger cap peers. The Russell 2000 small cap index declined 21% for the just ended quarter and on a year-to-date basis this index of small company stocks was down 15%. We feel fortunate to report that your Fund, while down by 15% in the most recent quarter, still is in positive territory for 2001 with a gain of 6%. Despite last quarter’s challenges, your Fund widened its year-to-date performance relative to the Russell 2000 from 18% at the end of June to 21% at the close of September. We believe the current jumbled investment environment has created incremental potential for our group of analysts to find fundamentally undervalued small cap stocks and we are working diligently to identify stocks with excellent expected future returns.
Uncertain Times
Little did we realize three months ago, when we wrote to our shareholders about preparing the Fund’s portfolio for uncertain times, that the uncertainty would reach such unprecedented levels so soon. As we wrote to you last quarter: "During the past few quarters we have actively migrated the investments within the portfolio toward companies that have an above average probability of thriving during sluggish economic times. If you were to view the Fund’s portfolio as a single entity you would notice that we have been upgrading the portfolio’s financial dynamics. We have been buying stocks in companies that have strong balance sheets, good levels of cash flow per dollar invested, growth potential over time and bright managements that are committed to enhancing shareholder value. Our goal is to not only own companies that are well positioned to benefit when economic growth resumes, but also own those firms that can handle a period of economic contraction. By positioning your Fund’s investments in this fashion we hope to realize above average investment returns regardless of the economic environment."
The aforementioned comments not only remain pertinent, but by positioning the portfolio’s investments in this fashion, we have entered this period of great economic uncertainty with only modest concern about the financial viability of most of the companies in which we have invested. That is not to say several of our companies will not suffer short-term hits to their operations, but rather these firms have the financial staying power to emerge from this period of uncertainty as strong and vibrant competitors in their respective businesses. As we search for new investments for the Fund, we anticipate our bias for financially robust firms will continue to be key in selecting stocks that are added to the Fund’s portfolio.
Managing Investments During Turmoil
The events of recent weeks have been emotionally unsettling, but for long-term optimists like us we see numerous opportunities. After the markets reopened on September17th, we were able to add to many of our positions at good prices as we utilized some of the cash that the Fund had been holding awaiting lower stock prices. As the markets regained some stability we undertook some trades that not only upgraded the portfolio but also brought our estimated distribution down to zero as of September 30 with one month to go in the Fund’s tax year. It is our intention to try and keep the potential distribution at zero, but in a volatile stock market no firm promises can be made. The Fund’s portfolio grew by four positions to stand at fifty stocks at the end of the third calendar quarter. We added six new stocks and sold two stocks. We sold Heidrick & Struggles and Spherion Corp. due to deteriorating outlooks. We initiated positions in Cabot Oil & Gas, Grey Global Group, MCSi Inc., Measurement Specialties, Mentor Graphics and Optimal Robotics.
Highlights |
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All of our new purchases are companies with well above average balance sheet strength. Cabot Oil & Gas is an asset rich petroleum company with a stock that trades at a significant discount to our estimate of what their reserves are worth. Grey Global is an advertising agency with an underappreciated ability to generate future cash flow. MCSi Inc. is the leading firm that installs and services video conferencing equipment while Measurement Specialties is a growing provider of sensors to industrial and retail consumers. Mentor Graphics, a maker of software design tools for the semiconductor industry, reentered the portfolio. We originally bought this stock at prices under $15 in March 2000 and sold those shares in December at prices above $25. We have been able to reacquire Mentor shares in the mid-teens. Finally, we purchased a small position in Optimal Robotics, a rapidly growing, cash rich manufacturer of self-service checkout systems for grocery and general merchandise retailers. We believe that these new investments in financially strong companies in diverse industries should aid the Fund’s future performance.
Opportunities In Technology Stocks
In general, technology stocks have been a difficult sector in which to achieve positive investment returns over the past couple of years. While we are not known for our technology investments since they typically comprise less than 15% of the Fund’s total assets, we have invested in and will in the future invest in technology companies. Firms that meet our investment criteria usually have either very solid business models in non-commodity niches and/or undervalued assets on their balance sheets. This disciplined approach has only yielded ten technology related investments for your Fund since January 1, 1999. However, these ten investments have resulted in net realized and unrealized gains of over $43 million for your Fund through September 30, 2001. By being selective our technology investments have resulted in six stocks achieving significant gains, two were approximately breakeven performers and two suffered losses.
Mentor Graphics fits our investment parameters. First, Mentor has a rock solid balance sheet with minimal debt and over $2 per share in net cash. Second, Mentor has a strong and growing market share with its customers, and the company’s research & development efforts continue to yield exciting new products. Finally, Mentor trades at less than eight times our estimate of 2002 cash flow which is a modest valuation based upon both Mentor’s expected growth rate and the current low level of interest rates. Therefore, based upon these favorable factors, we have recently reestablished a position in Mentor for your Fund.
The Future
Many small cap stocks are selling at very compelling valuations. Therefore, we continue to expect the rebound in small cap value stocks that began in 2000 will, despite the recent volatility, likely persist for the next few years.
We sincerely thank our shareholders for your steadfast support of The Oakmark Small Cap Fund.
James P. Benson, CFA
Portfolio Manager
jbenson@oakmark.com
Clyde S. McGregor, CFA
Portfolio Manager
mcgregor@oakmark.com
October 5, 2001
| THE OAKMARK SMALL CAP FUND |
Schedule of Investments—September 30, 2001
| Name | Shares Held | Market Value |
| Common Stocks—93.8% | ||
| Food & Beverage—7.2% | ||
| Ralcorp Holdings, Inc. (a) | 579,000 | $11,267,340 |
| Del Monte Foods Company (a) | 1,020,000 | 7,854,000 |
| 19,121,340 | ||
| Apparel—1.4% | ||
| R.G. Barry Corporation (a)(d) | 907,000 | $3,664,280 |
| Retail—3.3% | ||
| ShopKo Stores, Inc. (a) | 936,000 | $7,759,440 |
| Ugly Duckling Corporation (a) | 370,000 | 1,024,900 |
| 8,784,340 | ||
| Office Equipment—2.2% | ||
| InFocus Corporation (a) | 357,500 | $4,665,375 |
| MCSi, Inc. (a) | 75,000 | 1,208,250 |
| 5,873,625 | ||
| Other Consumer Goods & Services—3.5% | ||
| Department 56, Inc. (a) | 600,000 | $3,810,000 |
| Central Parking Corporation | 250,000 | 3,497,500 |
| American Greetings Corporation, Class A | 150,000 | 1,986,000 |
| 9,293,500 | ||
| Bank & Thrifts—10.1% | ||
| BankAtlantic Bancorp, Inc., Class A | 1,023,700 | $10,339,370 |
| People's Bank of Bridgeport, Connecticut | 325,000 | 7,215,000 |
| Golden State Bancorp Inc. | 190,000 | 5,776,000 |
| PennFed Financial Services, Inc. | 150,000 | 3,372,000 |
| 26,702,370 | ||
| Insurance—4.7% | ||
| The PMI Group, Inc. | 200,000 | $12,478,000 |
| Other Financial—2.3% | ||
| NCO Group, Inc. (a) | 450,000 | $6,156,000 |
| Hotels & Motels—2.9% | ||
| Prime Hospitality Corp. (a) | 860,000 | $7,568,000 |
| Educational Services—4.2% | ||
| ITT Educational Services, Inc. (a) | 349,800 | $11,193,600 |
| Marketing Services—0.2% | ||
| Grey Global Group Inc. | 1,000 | $553,000 |
| Data Storage—1.6% | ||
| Imation Corp. (a) | 200,000 | $4,180,000 |
| Computer Services—2.7% | ||
| CIBER, Inc. (a) | 960,000 | $6,048,000 |
| Interland, Inc. (a) | 1,050,000 | 1,102,500 |
| 7,150,500 | ||
| Computer Software—7.8% | ||
| MSC.Software Corp. (a) | 625,000 | $10,062,500 |
| Mentor Graphics Corporation (a) | 520,000 | 7,165,600 |
| SilverStream Software, Inc. (a) | 700,000 | 2,604,000 |
| Symantec Corporation (a) | 20,000 | 693,400 |
| 20,525,500 | ||
| Computer Systems—0.5% | ||
| Optimal Robotics Corp., Class A (a) | 50,000 | $1,225,000 |
| Security Systems—3.8% | ||
| Checkpoint Systems, Inc. (a) | 910,000 | $9,946,300 |
| Pharmaceuticals—2.1% | ||
| Elan Corporation plc (a)(b) | 115,000 | $5,571,750 |
| Medical Research—1.0% | ||
| Covance Inc. (a) | 155,000 | $2,776,050 |
| Medical Products—5.9% | ||
| CONMED Corporation (a) | 322,500 | $5,708,250 |
| Sybron Dental Specialties, Inc. (a) | 250,000 | 4,650,000 |
| Hanger Orthopedic Group, Inc. (a)(d) | 960,000 | 3,552,000 |
| ORATEC Interventions, Inc. (a) | 250,000 | 1,730,000 |
| 15,640,250 | ||
| Automotive—0.5% | ||
| Standard Motor Products, Inc. | 120,000 | $1,404,000 |
| Automobile Rentals—1.2% | ||
| Dollar Thrifty Automotive Group, Inc. (a) | 310,000 | $3,084,500 |
| Transportation Services—3.2% | ||
| Teekay Shipping Corporation (c) | 250,000 | $7,795,000 |
| Frontline Limited (c) | 75,000 | 682,500 |
| 8,477,500 | ||
| Instruments—4.4% | ||
| IDEXX Laboratories, Inc. (a) | 400,000 | $9,348,000 |
| Measurement Specialties, Inc. (a) | 225,000 | 2,225,250 |
| 11,573,250 | ||
| Machinery & Industrial Processing—2.1% | ||
| Columbus McKinnon Corporation | 525,000 | $5,460,000 |
| Chemicals—2.1% | ||
| H.B. Fuller Company | 70,000 | $3,206,000 |
| Georgia Gulf Corporation | 150,000 | 2,410,500 |
| 5,616,500 | ||
| Oil & Natural Gas—4.8% | ||
| St. Mary Land & Exploration Company | 300,000 | $4,779,000 |
| Cabot Oil & Gas Corporation, Class A | 200,000 | 3,990,000 |
| Berry Petroleum Company, Class A | 250,000 | 3,862,500 |
| 12,631,500 | ||
| Other Industrial Goods & Services—1.3% | ||
| Intergrated Electrical Services, Inc. (a) | 360,000 | $1,980,000 |
| Gardner Denver Inc. (a) | 65,000 | 1,443,000 |
| 3,423,000 | ||
| Real Estate—6.8% | ||
| Catellus Development Corporation (a) | 750,000 | $13,110,000 |
| Trammell Crow Company (a) | 500,000 | 5,000,000 |
| 18,110,000 | ||
| Total Common Stocks (Cost: $255,152,479) | 248,183,655 |
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Par Value |
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| Short Term Investments—3.6% | ||
| Commercial Paper—1.9% | ||
| General Electric Capital Corporation, 3.25% due 10/1/2001 | $5,000,000 | $5,000,000 |
| Total Commercial Paper (Cost: $5,000,000) | 5,000,000 |
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| Repurchase Agreements—1.7% | ||
| State Street Repurchase Agreement, 3.05% due 10/1/2001, | ||
| repurchase price $4,565,160, collateralizedby | ||
| U.S. Treasury Bonds | $4,564,000 | $4,564,000 |
| Total Repurchase Agreements (Cost: $4,564,000) | 4,564,000 |
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| Total Short Term Investments (Cost: $9,564,000) | 9,564,000 |
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| Total Investments (Cost $264,716,479)—97.4% (e) | $257,747,655 | |
| Other Assets In Excess Of Other Liabilities—2.6% | 6,864,550 | |
| Total Net Assets—100% | $264,612,205 |
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| (a) | Non-income producing security. |
| (b) | Represents an American Depository Receipt. |
| (c) | Represents foreign domiciled corporation. |
| (d) | See footnote number five in the Notes to Financial Statements regarding transactions in affiliated issuers. |
| (e) | At September 30, 2001, net unrealized depreciation of $6,968,824, for federal income tax purposes, consisted of gross unrealized appreciation of $43,469,101 and gross unrealized depreciation of $50,437,925. |
See accompanying notes to financial statements.
