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 (3/31/03) AS COMPARED TO THE LIPPER BALANCED FUND INDEX19
	Average Annual Total Returns1
	(as of 3/31/03)
	Total Return Last 3 Months*	1-year	5-year	Since Inception (11/1/95)
Oakmark Equity and Income Fund	-2.28%	-8.21%	8.59%	12.85%
S&P 5004	-3.15%	-24.76%	-3.77%	6.90%
Lehman Govt./Corp. Bond20	1.65%	13.40%	7.64%	7.49%
Lipper Balanced Fund Index	-1.84%	-12.85%	0.19%	6.10%
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 Review

Results for the quarter ended March 31 disappointed your management team. Not only did the fund's value decline by 2% but our results lagged behind the Lipper Balanced Fund Index by nearly 1/2%. The last time that the Fund trailed the Lipper Index was in the fourth calendar quarter of 1999, near the end of the bull market boom period. We can tolerate lagging when investors are ebullient. We have no tolerance, however, for lagging in a bear market. The explanation for the relative shortfall in the recently ended quarter was the poor performance of small and mid-cap companies, sectors where the fund is heavily represented. Large caps did somewhat better, particularly the large capitalization technology companies that dominate the NASDAQ²¹. In times of world crisis, investors often retreat to the most liquid issues, and that seems to have happened recently.

The outbreak of war made the March quarter another in what has been a series of highly unusual time periods. It is our opinion that much of the stock market's volatility was the result of poorly informed reactions to political events rather than the result of careful analysis and long term thinking. We do not bring much insight as to what may develop in the very near future, but we firmly believe that the Fund is favorably positioned for the long term.

Fixed Income Strategy and Tactics

Since the Fund's earliest days we have welcomed your e-mailed questions and comments. When times are good, our e-mail flow tends to be sporadic. In challenging times like the present the flow picks up. Generally these communications cover a wide range of topics. The last few months, however, have been a time when our correspondents have converged on one issue. To our surprise, that issue has not been related to the extremely difficult conditions in the stock market or even the political environment. Instead, the authors have focused on our Fund's fixed income strategy, in particular, "what are we doing to protect the Fund's value against the inevitable increase in interest rates?" Given this level of interest, we are devoting this report to a review of our fixed income strategy and our current tactics. Those of you who have been with the Fund since the beginning can skip to the next report.

At Harris Associates, we base all of our investing activities on the idea of fundamental or intrinsic value. The concept of value is somewhat clearer for stocks as standards usually exist to help define what a business might be worth. And, opportunities to purchase equities that are materially mis-priced arise often. In the fixed income arena we observe that pricing inefficiencies do develop, but rarely to the degree commonly found in equities. This drives us to the conclusion that when we take on risk in the Fund, we should take it in equities because the reward for insightful analysis is far greater. Our objectives for the fixed income segment of the Fund are to preserve capital, enhance portfolio income, and reduce the volatility of the total portfolio return stream.

We typically invest between 30% and 40% of The Equity and Income Fund's assets in fixed income securities. We invest at least one-quarter of the total portfolio in US Treasury notes in order to provide safety, liquidity, and income. We periodically find opportunities to purchase attractively priced securities that government agencies such as the Federal Home Loan Bank Board issue. On rare occasions we add bonds that foreign governments have issued. The remainder of the fixed income segment is composed of corporate bonds and preferred stocks that we estimate to have total return prospects that are competitive with the stock market.

As fixed income investors we manage two factors: duration, a measure of sensitivity to changes in interest rates, and credit risk, the possibility that a holding will default. Since the great majority of the Fund's fixed income holdings are Treasury notes, the issue of credit risk applies only to the small allocation to corporate debt securities. For corporate issues, our analysts perform the same kind of fundamental analysis that they employ when evaluating equities. In fact, when looking at companies, our analysts are charged to look across the entire capitalization to seek out opportunity.

We are less active in our management of duration. We typically maintain the duration for the entire fixed income portfolio between 3 and 4. This means that a general shift in interest rates of 1% would cause a change in the value of the fixed income segment of 3-4%. We do very little investing based on anticipating changes in interest rates. Instead, we simply try to construct a fixed income position that dampens portfolio volatility while providing income. As rates have declined in recent years, we have shortened the maturity structure because we perceived the risk/reward ratio in longer term bonds to be less favorable. To understand this better, we study hypothetical scenarios and their effect on returns. For example, we analyzed the return profile of today's 10-year Treasury notes and found that it was almost impossible for these notes to generate returns of 6% or better over a longer term time horizon.

So, what are we doing to protect the portfolio against significant increases in interest rates? We are keeping our maturity structure quite short. The duration for the portfolio is currently only 2.7, probably a record low. This means that should interest rates instantaneously increase by 2%, the value of the fixed income segment of the Fund would decline by approximately 5.4%. But remember that the Fund is invested in both bonds and stocks. Given the current 36% allocation to fixed income securities, the effect on the Fund as a whole would be approximately 2% (in the unlikely event that the interest rate increase did not also affect stock prices).

Because we have previously written so much about our investment in Treasury Inflation-Protected Securities, we will simply note that they also speak to the problem of rising interest rates. For those who feel that we write too much about fixed income, the solution is simple: send us more e-mails about stocks!

In closing, we would like to express our hope for a speedy resolution to the Iraqi conflict. We recognize that anything we write about the Fund is of little significance when contrasted with current world events. We hope that our next quarterly report will find a world at peace.

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

Schedule of Investments—March 31, 2003 (Unaudited)

See accompanying notes to financial statements.