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 (12/31/02) AS COMPARED TO THE LIPPER BALANCED FUND INDEX17
	Average Annual Total Returns5
	(as of 12/31/02)
	Total Return Last 3 Months*	1-year	5-year	Since Inception (11/1/95)
Oakmark Equity and Income Fund	6.12%	-2.14%	10.91%	13.68%
S&P 5002	8.44%	-22.10%	-0.59%	7.63%
Lehman Govt./ Corp. Bond18	1.73%	11.04%	7.61%	7.52%
Lipper Balanced Fund Index	5.47%	-10.69%	2.10%	6.59%
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

"The fixity of a habit is generally in direct proportion to its absurdity." Proust

Our Results

The Oakmark Equity and Income Fund increased 6% for the quarter ended December 31, bringing the calendar year loss to 2%. For the calendar year 2002, the Fund outperformed both the market averages and our primary benchmark, the Lipper Balanced Fund Index, which lost 11% during the year. Suffice it to say that we are not pleased with this result. We appreciate all too well that it is absolute positive returns that preserve and grow your capital. Over time we have achieved that growth and compounding of capital for our long-term investors. Rest assured that it remains our goal and primary focus for both you and ourselves.

Enough Misery To Go Around

Not too long ago, Queen Elizabeth II of Great Britain, in her annual address, spoke about the prior year having been an "annus horribilis" or terrible year. In retrospect, it certainly was that for the markets. Last year was the worst year for stock mutual funds since 1974. If you were looking for a place to hide, they were few and far between. The New York Times fourth quarter Mutual Funds Report cites statistics from Morningstar showing only two fund groups, real estate and gold funds, had positive returns for the year. The New York Times also cites information from Lipper indicating that more than 96% of equity funds finished the year in the red. According to Morgan Stanley research, seventy-five per cent of all stocks in the S&P 500 Index declined in 2002, every single sector in the S&P 500 declined for the year, and style (value or growth) or market capitalization (large or small) made no difference in terms of carnage.

A great deal of time, effort, and newsprint is now being devoted to trying to identify the culprits to blame for this watershed year of investment debacles. The "usual suspects" now include greedy managements fixated on short-term returns, investment bankers and their in-house analysts, the accounting profession, overworked and understaffed regulatory bodies, and governmental leaders in both the legislative and executive branches who were more than willing to accept the largesse flowing into their political action committees from any source when the bulls were running through Main Street U.S.A.

We would like to suggest something radical. In our own way all of us share some culpability for letting unreasonable expectations and an unwillingness to confront the reality of the history of long-term returns from stocks, bonds, and bills in this country blind us to where we were in investment time (or as Pogo would put it, "We have met the enemy and he is us"). Specifically, five consecutive years of returns in the stock market in this country in excess of 19% led people to expect this as the "new" norm, rather than focus on the fact that each successive year was another statistical outlier more than two standard deviations beyond the historic norm. Thus when regression to the mean began, it was first met with disbelief and ultimately shell-shock.

We again refer you to the excellent data compiled by Professor Ibbotson and Ibbotson Associates that describes in detail long-term returns from various asset classes in this country. What we suggest you will find is that long-term returns on stocks, excluding inflation, probably fall in a range of from 7 to 10% on average. A typical balanced fund with a 60% equity/40% fixed-income allocation, again excluding inflation, will probably show an average return of from 6 to 8%. When returns fall outside those bands, the causes of such deviation should be examined.

Will Godot Ever Show Up?

There is a scene in Beckett's "Waiting for Godot" where one of the characters, almost in despair, laments, "Nothing ever changes. Everything is always the same." We have to confess that we worry on occasion that many of you will get bored with a certain sameness in these reports, as we relate what we are doing and what if anything we are doing differently. In some respects it would certainly be easier to write these reports if we paid a great deal of attention to macroeconomic forecasting and grand themes (we don't), for then we could regale you with charts, graphs, interesting bits of gossip, and many of the other everyday facets of what passes for the investment research process at some firms. Well, nothing has changed. We remain focused on selecting individual stocks to invest in which ideally we would like to buy at 60% of our assessment of intrinsic value, where the business value is growing and the managements actually think and act like shareholders and stewards of capital. And if we ever tell you that something has changed in terms of philosophy or implementation, you should question us on it.

In practical terms, during the quarter we initiated positions in Concord EFS Inc., Laboratory Corporation of America, Omnicare, Inc., and Textron when these businesses were available, however briefly, at prices that met our criteria. In particular, one business which met our criteria and which we were able to purchase was Laboratory Corporation of America, the #2 independent medical lab testing company in the country. The quality and competitive position of the business had already begun to intrigue us when it suddenly became available at a very attractive price when the market reacted to an earnings shortfall pre-announcement and the stock sold off more than 40%. The business should benefit over time from continued outsourcing and as consolidation in the industry allow the larger companies to bring to bear the benefits of scale.

Also of benefit, will be the demographics of an aging population—we do tend to be tested more as we get older. And, the number and type of tests will increase as genetic discoveries revolutionize medical science with new non-invasive diagnostic tests replacing or supplementing previously invasive (and with some degree of risk) procedures for detecting diseases such as colon and other types of cancer. Finally, this is a business with certain barriers to entry given the Laboratory Corporation's huge number of contractual managed care relationships in place.

We would also like to discuss briefly the sale of one investment, namely our holding in Legacy Hotel REIT. Legacy is a Canadian hotel real estate investment trust whose primary assets are the former Canadian Pacific urban hotels in Canada. Many of those hotels are unique in both history and setting, and they have been well maintained over time. In many Canadian cities such as Toronto there are effective competitive barriers to entry in the form of taxes, zoning, and a lack of available land. Post-September 11th, we had the opportunity to take a position in the company at an attractive price relative to business value. Since that time both Canada's hotels in general and Legacy's portfolio in particular, had statistically outperformed the American competition in terms of occupancy and REVPAR (revenue per available room) growth. Legacy was also in the position of having first right of refusal to acquire other Canadian Pacific hotel and resort assets if they were to be sold. We were pleased when they exercised those rights, acquiring irreplaceable assets such as The Empress Hotel in Victoria, BC and Le Chateau Frontenac in Quebec City, Quebec. We were also enthusiastic when Legacy indicated it was considering at some point in the future the acquisition of another irreplaceable asset, namely Le Chateau Whistler. While this was a small position relative to the overall portfolio, the competitive position of the properties, the growing business value, and management's apparent shareholder focus all met our investment criteria. All of that changed in the last quarter when management (which is also the management of Fairmont Hotels) announced their first acquisition of a U.S. property in Washington, DC. One, we (and many other shareholders) found the price being paid to be excessive, especially as management seemed to be overly optimistic about the dilution entailed and the competitive potential of the property. Two, it changed the basic nature of the investment. Three, it appeared to us that management was not acting in the best interest of Legacy's shareholders. Accordingly, after considering our options, we exited our position at a small loss. We will do the same thing, whenever our assessment of management's shareholder orientation proves to be incorrect as indicated by both action, explanation, and our independent assessment of same.

The Future

One of Mark Twain's more entertaining essays was about the variability and unpredictability of the weather in New England. We feel the same way about the markets. The good news is that recognizing that neither we (nor anyone else that we know of) have any special skill in this regard, we don't devote any time to it, preferring to continue our search for business values that meet our investment criteria. Rest assured that still is the primary focus of our daily activities (and we also tremendously enjoy doing it). We are grateful to you, our shareholders and partners, for entrusting us with your capital to manage and your patience.

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

January 6, 2003

Schedule of Investments—December 31, 2002 (Unaudited)