THE OAKMARK EQUITY AND INCOME FUND Report from Clyde S. McGregor and Edward A. Studzinski, Portfolio Managers

THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK EQUITY AND INCOME FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (9/30/02) AS COMPARED TO THE LIPPER BALANCED FUND INDEX17
	Average Annual Total Returns4
	(as of 9/30/02)
	Total Return Last 3 Months*	1-year	5-year	Since Inception (11/1/95)
Oakmark Equity and Income Fund	-8.57%	-0.47%	9.80%	13.24%
S&P 5002	-17.28%	-20.49%	-1.63%	6.66%
Lehman Govt./ Corp. Bond18	5.70%	9.21%	7.92%	7.53%
Lipper Balanced Fund Index	-9.87%	-9.83%	1.34%	6.02%
The graph and table do not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares.
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

What is it about summer, anyway? In the entire 27-quarter history of The Oakmark Equity and Income Fund only six quarters have suffered negative results. Four of those six were summer quarters. The recently completed quarter saw the Fund's price decrease by 9%, which contrasts with a loss of 10% for the Lipper Balanced Fund Index. For the fiscal 9/30 year the comparative results are stronger though still negative: -1% for the Fund, -10% for the Lipper. The Lipper Balanced Fund Index may be our standard of comparison, but it is not our benchmark. Our true focus is on how much money the Fund has earned for its shareholders. Others may be in the business of besting an index. We are in the business of earning positive returns for our clients. Period. We know that our clients can live off positive returns that may be uninteresting when times are good. We also know that they cannot live off negative returns even when those returns are relatively superior.

Issues du jour

Hopefully the summer quarter's pains will produce some positive, if unintended, consequences. For example, we fervently hope that the word "visibility" has been expunged from the lexicon of Wall Street analysts. We regularly come across analyst reports expressing wariness towards a particular company because of insufficient visibility concerning future earnings. If the last two years have not discredited the idea that future corporate outcomes may be precisely forecasted, we do not know what will. This explains why our focus on valuation is so important. While any valuation of a business implicitly assumes that there will, in fact, be a future, our valuation methodologies attempt to minimize the importance of positive future developments. We often speak of "obtaining the future for free." Catellus Development, the real estate company, is a good example of this way of seeing. When we purchased Catellus, we knew that management was in the process of obtaining permits to develop Mission Bay, the first significant new real estate project in the city of San Francisco in over fifty years. We were able to pay a price for the company that did not reflect any positive impact from Mission Bay.

We would also like to reframe the debate over incentive stock options by moving the focus from accounting to aligning. At Harris Associates we have always articulated a belief that corporate management teams should have their interests aligned with their shareholders. In the 1980's we saw options programs as one means to that end. Some of the excesses that we observed in the 1990's changed our minds.

In the last few years management teams have come to regard their options program as an extension of their annual compensation. "Evergreen" options programs are a particularly troublesome illustration of this tendency. When options vest in this system, management exercises the options and sells the new shares immediately. The company's board of directors then "reloads" management with new options so that the incentive element is reestablished.

Today the weakened condition of the stock market and the renewed focus on corporate governance combine to make it possible to return options to their proper role. In our opinion, cash should be the dominant form of compensation. For the purpose of aligning interests, boards should require management to own meaningful equity in their company. Options may be a means to that end if they have long-term vesting and long term holding periods. This would have the effect of reducing management's attention to short term outcomes and focusing efforts on productive deployment of capital. We do not expect to see changes of this sort anytime soon, but we will be studying options programs ever more carefully. Management teams of companies in which we invest have been given control over capital that you, our shareholders, have worked hard to accumulate. It is their responsibility to treat this capital with respect.

Profitless Prosperity

By now it is generally accepted that many sectors of the US economy experienced growth in the late 1990's that was both far above trend and unsustainable. Unfortunately, boom/bust cycles are a recurring feature in our economy. The basic pattern is that new technology promotes optimism, draws inordinate capital investment to the favored sector, and finally collapses that sector under the weight of excessive competition. For example, in early 1983 extreme optimism enabled more than 60 manufacturers of computer storage devices to go public. The flood of capital into this industry quickly resulted in destructive competition and the rapid evaporation of business values. A similar cycle ensued in the early 1990's for manufacturers of personal computers.

More recently, the puncturing of the late 1990's bubble had obvious first level effects such as the disappearance of the "dotcoms." Next to suffer was the telecommunications industry. It is now clear, however, that the boom's impact was much more widespread than first thought. Industries as diverse as retailing and electric utilities now labor under excess capacity conditions. An example more relevant to The Equity and Income Fund has been the effect on portfolio holding GATX. Improved computer systems have helped the railroad industry reduce the time it takes to move a carload across the country. This greater efficiency in the management of the rail fleet means that GATX, a leasing company, has more railroad equipment than it can profitably employ at present. This pattern has spread throughout much of the economy: excess supply leads to lower pricing and then decreased return on investment.

Imagine one year ago we had known that the government would be reporting solid economic growth for 2002 together with low inflation and very low interest rates. With that knowledge we would probably have forecast that the stock market would be enjoying a strong year. But as it has turned out, this apparent prosperity has been without profit and replete with corporate distress. Our tactical response to this environment has been to orient The Equity and Income Fund portfolio to issues with the strongest balance sheets. In particular, we have searched for undervalued issues with no debt and substantial cash positions. In deflationary times, debt is economically disadvantageous. Because we do not know whether the future will bring inflation or deflation, we have built a portfolio that has the potential to succeed in either environment.

In closing, we once again thank you, our shareholders, for entrusting us with the management of your capital.

Clyde S. McGregor, CFA Portfolio Manager mcgregor@oakmark.com	Edward A. Studzinski, CFA Portfolio Manager estudzinski@oakmark.com

October 1, 2002

Schedule of Investments—September 30, 2002

See accompanying notes to financial statements.