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 (3/31/02) AS COMPARED TO THE LIPPER BALANCED FUND INDEX14 |
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| Average Annual Total
Returns1 (as of 3/31/02) |
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| Total Return Last 3 Months* |
1-year | 5-year | Since Inception (11/1/95) |
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| Oakmark Equity and Income Fund | 4.19% | 18.07% | 17.05% | 16.54% |
| S&P 5005 | 0.27% | 0.24% | 10.17% | 12.92% |
| Lehman Govt./ Corp. Bond15 | -0.47% | 4.64% | 7.45% | 6.60% |
| Lipper Balanced Fund Index | 0.60% | 2.48% | 8.40% | 9.40% |
| 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 Review
After the extreme volatility experienced in the second half of calendar 2001, the March quarter was comparatively calm in the securities markets. This proved to be a favorable environment for The Oakmark Equity and Income Fund. The Fund returned 4% which contrasts with 1% for the Lipper Balanced Fund Index, our primary standard of comparison. The Fund's equities earned virtually all of the return in the quarter as the bond market began to anticipate future tightening actions by the Federal Reserve.
During the quarter we were active, scooping up shares of companies that had lost investor favor for a variety of reasons. Often these issues had been featured in the portfolios of growth-oriented investors. Morningstar, the leading company evaluating mutual funds, observed this development and declared that the fund was now a "blend" fund rather than value. (Blend funds have characteristics of both value and growth.) Some have asked whether this change offends or troubles us. In fact, the whole growth/value dialectic bores us. Famed investor Warren Buffett has commented extensively on this issue, and we agree with him that growth is simply a factor that helps to determine value.
As investors, we look for value wherever we may find it. Two years ago we were primarily able to discover undervalued securities in sectors that had historically been associated with value investors. Today the situation is quite different as we are finding undervalued stocks in many high quality, higher growth businesses. For example, an emerging "theme" in the portfolio is companies from various segments of the health care industry, an industry normally featured in growth funds. Portfolio holdings Apogent Technologies, Caremark, Chiron, Edwards Lifesciences, First Health, Guidant, IMS Health, Omnicare, Techne, Watson Pharmaceuticals, and even CVS, the drug store chain, would seem to indicate that we have targeted the health care sector as an attractive investing opportunity. In fact, we have not made this determination at all - the stocks simply declined to levels where we evaluated them to be selling cheaply. In virtually every case the shares met our price criteria after the companies had disappointed investors counting on steady or accelerating growth. We are perfectly happy to recycle "growth" companies that have lost their former cachet.
As we wrote in last quarter's letter, we believe that investor expectations became excessive in the late 1990's because of the unprecedented returns earned then. The March quarter may be representative of the investing environment for the next few years. If so, we believe that our eclectic value philosophy will serve the Fund well.
Avoiding Mistakes
An unfortunate reality of the investment business is that the range of investing possibilities far exceeds the intellectual grasp of any individual or even any institution. Investors react to this complexity by making various simplifying assumptions. For example, many investors choose only to own stocks from the S&P 500 or the Dow Jones Industrials believing that those who construct the indices have already performed a useful filtering function.
In the March quarter the integrity of corporate accounting became the issue on the front of investors' minds, an outcome of the Enron experience. Shareholders complimented our firm for avoiding Enron while the media repeatedly asked how we knew it would go down. The answer, of course, is that we did not foresee the collapse in Enron's share price. We simply did not have an opinion one way or the other. The simplifying assumption that guided us is this: if we do not understand it, we move on. At any moment in time the market contains thousands of issues that we believe to be overvalued and probably just as many that we do not understand how to value. In the case of Enron, we looked at the stock fairly early in its ascent and could neither understand the nature of the revolution Enron was allegedly initiating nor justify the price investors were paying for the company's activities.
Highlights |
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Our best advice will always be to "do what you understand." This pertains to individual securities and to mutual funds. If our style of value investing makes sense to you, you will probably make sensible decisions about your investment in our funds. If, rather, you have invested in our funds because of recent results or the managers' pictures, you will be less likely to be satisfied with your experience.
Is the Fed Done Reducing Interest Rates?
Actually, the title to this section is merely a hook, as we do not have an investment opinion on the question of what the Fed will do. Investors in the Fund, however, are questioning us regularly about our fixed income holdings in view of the barrage of articles suggesting that interest rate increases are inevitable. Some of the questions appear to reflect some uncertainty as to our Fund's charter and purpose, so some review is first in order.
The Oakmark Equity and Income Fund is a balanced fund and is to be the least volatile fund in The Oakmark Funds group. Oakmark E&I will always have at least 25% of its assets invested in US Treasury securities. The Treasurys buffer the volatility of return while enhancing income generation. We choose to take our risks in the equity portion of the portfolio, which is not to exceed 65% of total fund assets. If equities are at 65%, the remaining 35% of the portfolio will be composed of Treasurys, debt of the various government agencies, corporate bonds, preferred stocks, and short term investments. If conditions warrant, the commitment to Treasury securities could far exceed 25%, but we will not fall below that level for any meaningful time period.
With that background, how do we invest the fixed income assets in the Fund as we face the likelihood that the previous cycle of Federal Reserve easing has ended? We first inventory the current conditions. While rates increased modestly in the March quarter, they are still historically low. According to government statistics, inflation is minimal and the economy still has meaningful slack. The futures markets for bonds, however, forecast significant future interest rate increases. Our tactical response has been to keep our overall maturity structure fairly short and to emphasize the Treasury inflation-indexed securities (TIPS). We have written extensively on TIPS in previous shareholder letters, so we will only reiterate that these instruments offer whatwe believeisthe best compromise between our desire to earn income for our shareholders without risking excessive capital loss.
As always, we thank you for your interest in our Fund and welcome your comments and questions.
Clyde S. McGregor, CFA
Portfolio Manager
mcgregor@oakmark.com
Edward A. Studzinski, CFA
Portfolio Manager
estudzinski@oakmark.com
April 1, 2002
| THE OAKMARK EQUITY AND INCOME FUND |
Schedule of Investments—March 31, 2002 (Unaudited)
| Name | Shares Held | Market Value |
| Equity and Equivalents—60.9% | ||
| Food & Beverage—2.9% | ||
| UST Inc. | 1,350,000 | $52,555,500 |
| Retail—4.6% | ||
| CVS Corporation | 1,000,000 | 34,330,000 |
| J.C. Penney Company, Inc. | 1,000,000 | 20,710,000 |
| Office Depot, Inc. (a) | 980,000 | 19,453,000 |
| Albertson's, Inc. | 252,200 | 8,357,908 |
| BJ's Wholesale Club, Inc. (a) | 20,000 | 894,000 |
| 83,744,908 | ||
| Household Products—0.1% | ||
| Energizer Holdings, Inc. (a) | 80,000 | $1,900,000 |
| Electronics—0.6% | ||
| KEMET Corporation (a) | 575,000 | $11,137,750 |
| Bank & Thrifts—0.4% | ||
| U.S. Bancorp | 280,703 | $6,335,467 |
| Insurance—4.1% | ||
| SAFECO Corporation | 1,500,000 | $48,060,000 |
| PartnerRe Ltd. (b) | 485,600 | 26,513,760 |
| 74,573,760 | ||
| Other Financial—1.5% | ||
| GATX Corporation | 846,900 | $26,931,420 |
| Marketing Services—0.9% | ||
| The Interpublic Group of Companies, Inc. | 500,000 | $17,140,000 |
| Information Services—1.7% | ||
| Ceridian Corporation (a) | 1,422,200 | $31,359,510 |
| Computer Software—3.2% | ||
| Novell, Inc. (a) | 8,000,000 | $31,120,000 |
| Synopsys, Inc. (a) | 500,000 | 27,580,000 |
| 58,700,000 | ||
| Computer Systems—1.9% | ||
| The Reynolds and Reynolds Company, Class A | 1,164,000 | $34,920,000 |
| Telecommunications—4.6% | ||
| CenturyTel, Inc. | 1,400,000 | $47,600,000 |
| Citizens Communications Company (a) | 3,362,800 | 36,150,100 |
| 83,750,100 | ||
| Printing—0.9% | ||
| Valassis Communications, Inc. (a) | 399,400 | $15,428,822 |
| Pharmaceuticals—3.7% | ||
| Watson Pharmaceuticals, Inc. (a) | 1,401,400 | $37,963,926 |
| Chiron Corporation (a) | 648,100 | 29,741,309 |
| 67,705,235 | ||
| Managed Care Services—3.2% | ||
| First Health Group Corp. (a) | 2,420,000 | $58,394,600 |
| Health Care Services—5.6% | ||
| IMS Health Incorporated | 2,300,000 | $51,635,000 |
| Omnicare, Inc. | 1,025,000 | 26,537,250 |
| Caremark Rx, Inc. (a) | 1,239,200 | 24,164,400 |
| 102,336,650 | ||
| Medical Products—2.3% | ||
| Guidant Corporation (a) | 457,500 | $19,818,900 |
| Techne Corporation (a) | 400,000 | 11,028,000 |
| Edwards Lifesciences Corporation (a) | 275,000 | 7,686,250 |
| Apogent Technologies Inc. (a) | 150,000 | 3,702,000 |
| 42,235,150 | ||
| Transportation Services—0.1% | ||
| Nordic American Tanker Shipping Limited | 154,900 | $2,365,323 |
| Aerospace & Defense—2.3% | ||
| Rockwell Collins | 1,649,200 | $41,592,824 |
| Agricultural Equipment—0.1% | ||
| Alamo Group Inc. | 141,900 | $2,305,875 |
| Instruments—1.4% | ||
| Varian Inc. (a) | 673,200 | $25,541,208 |
| Machinery & Industrial Processing—3.2% | ||
| Cooper Industries, Inc. | 849,000 | $35,615,550 |
| Rockwell International Corporation | 1,150,000 | 23,069,000 |
| 58,684,550 | ||
| Forestry Products—1.7% | ||
| Plum Creek Timber Company, Inc. | 1,059,644 | $31,482,023 |
| Oil & Natural Gas—5.9% | ||
| Burlington Resources Inc. | 1,125,000 | $45,101,250 |
| XTO Energy, Inc. | 1,378,000 | 27,628,900 |
| St. Mary Land & Exploration Company | 1,030,000 | 22,361,300 |
| Cabot Oil & Gas Corporation | 500,000 | 12,380,000 |
| Berry Petroleum Company | 43,000 | 664,350 |
| 108,135,800 | ||
| Real Estate—2.8% | ||
| Catellus Development Corporation (a) | 1,881,500 | $37,009,105 |
| Hospitality Properties Trust | 200,000 | 6,866,000 |
| Legacy Hotels Real Estate Investment Trust (b) | 1,125,000 | 6,142,911 |
| 50,018,016 | ||
| Recreation & Entertainment—1.2% | ||
| International Game Technology (a) | 345,000 | $21,500,400 |
| Total Equity and Equivalents (Cost: $976,411,768) | 1,110,774,891 | |
Par Value |
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| Fixed Income—33.7% | ||
| Preferred Stock—0.2% | ||
| Bank & Thrifts—0.1% | ||
| BBC Capital Trust I, Preferred, 9.50% | 48,000 | $1,200,000 |
| Pennfed Capital Trust, Preferred, 8.90% | 27,500 | 690,250 |
| Fidelity Capital Trust I, Preferred, 8.375% | 43,500 | 430,215 |
| 2,320,465 | ||
| Telecommunications—0.1% | ||
| MediaOne Finance Trust III, Preferred, 9.04% | 20,000 | $503,600 |
| Total Preferred Stock (Cost: $2,715,763) | 2,824,065 | |
| Corporate Bonds—1.6% | ||
| Retail—0.7% | ||
| The Gap, Inc., 6.90% due 9/15/2007 | 9,187,000 | $8,035,134 |
| Rite Aid Corporation, 7.625% due 4/15/2005, Senior Notes | 4,900,000 | 3,883,250 |
| Ugly Duckling Corporation, 12.00% due 10/15/2003, | ||
| Subordinated Debenture | 650,000 | 552,500 |
| 12,470,884 | ||
| Office Equipment—0.1% | ||
| Xerox Capital Europe Plc, 5.75% due 5/15/2002 | 1,500,000 | $1,492,455 |
| Hotels & Motels—0.4% | ||
| HMH Properties, 7.875% due 8/1/2005, | ||
| Senior Note Series A | 3,450,000 | $3,432,750 |
| Park Place Entertainment, 7.00% due 7/15/2004, | ||
| Senior Notes | 2,750,000 | 2,749,785 |
| Prime Hospitality Corporation, 9.25% due 1/15/2006, | ||
2006 1st Mortgage Note |
413,000 | 425,906 |
| Park Place Entertainment, 7.375% due 6/1/2002, | ||
| Senior Notes | 320,000 | 321,041 |
| 6,929,482 | ||
| TV Programming—0.4% | ||
| Liberty Media Corporation, 8.25% due 2/1/2030, | ||
| Debenture | 7,225,000 | $6,767,867 |
| Machinery & Industrial Processing—0.0% | ||
| Columbus McKinnon Corporation New York, | ||
8.50% due 4/1/2008 |
1,000,000 | $970,000 |
| Building Materials & Construction—0.0% | ||
| Juno Lighting, Inc.,11.875% due 7/1/2009, | ||
| Senior Subordinated Note | 750,000 | $780,000 |
| Utilities—0.0% | ||
| Midland Funding Corporation, 11.75% due 7/23/2005 | 500,000 | $541,697 |
| Total Corporate Bonds (Cost: $29,876,387) | 29,952,385 | |
| Government and Agency Securities—31.9% | ||
| U.S. Government Notes—30.2% | ||
| United States Treasury Notes, 3.375% due 1/15/2007, | ||
| Inflation Indexed | 143,037,440 | $145,965,273 |
| United States Treasury Notes, 3.375% due 1/15/2012, | ||
| Inflation Indexed | 139,592,600 | 140,094,296 |
| United States Treasury Notes, 8.75% due 11/15/2008 | 50,000,000 | 54,035,150 |
| United States Treasury Notes, 5.75% due 11/15/2005 | 50,000,000 | 51,966,800 |
| United States Treasury Notes, 3.00% due 11/30/2003 | 50,000,000 | 49,628,900 |
| United States Treasury Notes, 7.875% due 11/15/2004 | 25,000,000 | 27,315,425 |
| United States Treasury Notes, 5.25% due 5/15/2004 | 25,000,000 | 25,750,975 |
| United States Treasury Notes, 3.00% due 1/31/2004 | 25,000,000 | 24,738,275 |
| United States Treasury Notes, 3.00% due 2/29/2004 | 25,000,000 | 24,698,250 |
| United States Treasury Notes, 7.25% due 8/15/2004 | 5,000,000 | 5,370,310 |
| 549,563,654 | ||
| U.S. Government Agencies—1.7% | ||
| Fannie Mae, 7.25% due 4/12/2005 | 6,500,000 | $6,509,997 |
| Federal Home Loan Mortgage Corporation, | ||
4.75% due 8/23/2004 |
5,000,000 | 5,038,815 |
| Federal Home Loan Bank, 5.03% due 6/21/2006 | 5,000,000 | 4,966,565 |
| Fannie Mae, 3.875% due 9/7/2004 | 5,000,000 | 4,952,110 |
| Federal Home Loan Bank, 5.10% due 12/26/2006 | 2,035,000 | 2,014,638 |
| Federal Home Loan Bank, 7.85% due 6/7/2004, | ||
| Consolidated Bond | 1,250,000 | 1,263,024 |
| Federal Home Loan Bank, 4.50% due 12/26/2008 | 1,135,000 | 1,094,891 |
| Fannie Mae, Principal Only, Zero Coupon, due 10/3/2011 | 1,065,000 | 1,010,962 |
| Federal Home Loan Bank, 5.77% due 4/12/2004 | 1,000,000 | 1,001,090 |
| Federal Farm Credit Bank, 6.00% due 6/27/2008 | 1,000,000 | 998,558 |
| Federal Home Loan Bank, 3.875% due 12/15/2004 | 1,000,000 | 987,781 |
| Federal Home Loan Bank, 4.10% due 12/7/2004 | 600,000 | 594,748 |
| Federal Home Loan Bank, 5.125% due 8/6/2002 | 500,000 | 493,061 |
| Federal Farm Credit Bank, 6.24% due 12/29/2008 | 175,000 | 175,011 |
| 31,101,251 | ||
| Total Government and Agency Securities (Cost: $580,454,081) | 580,664,905 | |
| Total Fixed Income (Cost: $613,046,231) | 613,441,355 | |
| Short Term Investments—4.2% | ||
| U.S. Government Bills—1.1% | ||
| United States Treasury Bills, 1.75% - 1.76% | ||
| due 4/4/2002 - 4/18/2002 | 20,000,000 | $19,990,420 |
| Total U.S. Government Bills (Cost: $19,990,432) | 19,990,420 | |
| Commercial Paper—1.6% | ||
| Citicorp, 1.77% due 4/8/2002 | 10,000,000 | $10,000,000 |
| American Express Credit Corporation, 1.79% - 1.80% | ||
| due 4/4/2002 - 4/11/2002 | 20,000,000 | 20,000,000 |
| Total Commercial Paper (Cost: $30,000,000) | 30,000,000 | |
| Repurchase Agreements—1.5% | ||
| State Street Repurchase Agreement, 1.75% due 4/1/2002, | ||
| repurchase price $26,693,189 collateralized by U.S. | ||
| Treasury Bonds | 26,688,000 | $26,688,000 |
| Total Repurchase Agreements (Cost: $26,688,000) | 26,688,000 | |
| Total Short Term Investments (Cost: $76,678,432) | 76,678,420 | |
| Total Investments (Cost $1,666,136,431)—98.8% (c) | 1,800,894,666 | |
| Shares Subject to Call | ||
| Call Options Written—0.0% | ||
| Marketing Services—0.0% | ||
| The Interpublic Group of Companies, Inc., July 35 Calls | (351,000) | $(631,800) |
| Total Call Options Written (Premiums Received: $(683,457))—(0.0%) | (631,800) | |
| Other Assets In Excess Of Other Liabilities—1.2% | $21,923,353 | |
| Total Net Assets—100% | $1,822,186,219 | |
| (a) | Non-income producing security. |
| (b) | Represents foreign domiciled security. |
| (c) | At March 31, 2002, net unrealized appreciation of $134,809,891, for federal income tax purposes, consisted of gross unrealized appreciation of $154,250,593 and gross unrealized depreciation of $19,440,702. |
See accompanying notes to financial statements.
