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 (6/30/04) AS COMPARED TO THE LIPPER BALANCED FUND INDEX13
	Annual Average Total Returns
	(as of 06/30/04)
	Total Return Last 3 Months*	1-year	5-year	Since Inception (11/1/95)
Oakmark Equity & Income Fund (Class I)	1.87%	18.21%	12.18%	14.68%
Lipper Balanced Fund Index	-0.13%	12.64%	2.18%	7.93%
S&P 5004	1.72%	19.11%	-2.20%	9.83%
Lehman Govt./Corp. Bond14	-3.17%	-0.72%	7.10%	6.71%
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.
The performance data quoted represents past performance. The above performance information for the Fund does not reflect the imposition of a 2% redemption fee on shares held for 90 days or less to deter market timers. If reflected, the fee would reduce the performance quoted. Past performance does not guarantee future results. The investment return and principal value will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. Average annual total return measures annualized change, while total return measures aggregate change. To obtain current month end performance data, call 1-800-OAKMARK or visit www.oakmark.com.
* Not annualized

"History is a set of agreed lies." Napoleon Bonaparte

Our Results

The price of The Oakmark Equity and Income Fund increased 2% for the quarter ended June 30, bringing the calendar year gain to 6%. For the calendar year to date, the Fund outperformed both the market averages as well as our primary benchmark, the Lipper Balanced Fund Index, which gained 2% during the year. We consider this result acceptable, and we are pleased again to have compounded your investment with a positive absolute return. However, we are nevertheless somewhat disappointed that, up until the last day of the quarter, we had been doing even better. We point this out not to engage in self-flagellation so much as to emphasize the value of looking at the long-term history of your investment to get a true picture of its performance. Mr. Market tends not to respect the last day of the quarter or the last day of the year, and so it is important to look at three-year and five-year returns for a better sense of the growth of your capital. We are extremely pleased to report that our three-year and five-year average annual returns of 10% and 12% still handily outstrip the primary benchmark returns of 3% and 2% and the S&P 500 returns of -1% and -2% for the same three and five year periods.

Mr. Market's Focus

Two particular occurrences on the last reporting day of the quarter caused a short-term drag on your portfolio. One, the early transfer of power to a new government in Iraq, somewhat naively convinced Mr. Market that "peace in our time" had been achieved, at least as far as both the supply and cost of energy were concerned. So, all of our energy holdings declined in sympathy with that thesis. Unfortunately, we think this peace will prove as illusory as it did after Neville Chamberlain returned from Munich some sixty-odd years ago. The second event was that Watson Pharmaceuticals pre-announced an earnings shortfall, as well as a major restructuring of its business. Watson was the worst performer in the portfolio during the quarter.

Our long-term investors will recognize that this is the second time Watson has had an impact on your investment, and we think this warrants an explanation. Watson's first disappointment happened for various reasons, including a delay of FDA approval of their Oxytrol product, manufacturing issues at one of Watson's California plants, and a generic pipeline that had dried up relative to the competition. (Watson had been one of the biggest sellers of generics and held one of the most extensive product lines in the generic industry). After this disappointment, a new president/chief operating officer and a new chief financial officer were brought in, Oxytrol was ultimately approved, the manufacturing issues were resolved, and, through a combination of internal work, joint venture agreements, and selective product acquisitions of authorized generics, the generic portfolio and pipeline were restored. So, what do we believe has derailed things? On an operating level, two issues. One, Oxytrol, although it has received tremendous specialist physician interest, has not been anywhere near the success anticipated, primarily because general practitioners and their patients, for whatever reason, have not been receptive to the product vis a vis other, more heavily-promoted alternatives. The second operating issue was that Watson's branded oral contraceptive business, where Watson with a number two market share, has fallen victim to increasing generic competition. Because Watson maintained prices throughout 2003 in this product line, management believed that the pricing declines of 2004 would reverse, or alternatively, would be made up on new oral contraceptive product volume. However, pricing declines have continued, and this, in combination with significant destocking at the wholesale level, has convinced management that oral contraceptives have truly become commodity products. We think that Watson will continue as a strong generic competitor.

We recognize that Oxytrol joins a long list of pharmaceutical products that physicians and consumers rejected for reasons that have nothing to do with efficacy or safety. We have to confess, however, that we are troubled by management's misreading of trends in the oral contraceptive business. While some of the issues are not unique to Watson (as competitor Barr Labs discovered), we expected that Watson, whose founder was involved with the beginnings of oral contraceptives at G. D. Searle, would have seen the handwriting on the wall. Indeed, while there was weakness in the branded oral contraceptive line in the first quarter of the year, management assured us and other investors throughout May and most of June that the Q1 shortfall was a result of a manufacturing and shipping issue and would be reversed in Q2. Management also expressed confidence that it would still make its numbers for the year. Rest assured, that we will continue to monitor Watson in order to determine whether it continues to represent value.

We sold three fully valued positions during the quarter: Apogent, J.C. Penney, and Hospitality Properties Trust, resulting in gains for the portfolio. We added three new securities during the quarter. We took a position in Hospira, a spin-off from Abbott, that is a major player in the hospital supply business as well as a manufacturer of injectable pharmaceuticals. We also started small positions in two smaller cap food businesses, CoolBrands International and American Italian Pasta. Our turnover continues to be relatively light, again reflecting our comfort level with most of our holdings. Our asset allocation—with only a 55% commitment to equities—is moving towards the lower limits allowable. As we have discussed on prior occasions, this reflects the absence of compelling absolute value investments. At the same time, most of our holdings stay under the valuation levels that require liquidation. Although we are not averse to liquidating positions should that situation occur, we are very selectively finding issues that intrigue us. Experience has taught us that sometimes doing nothing, or relatively little, is the best thing to do. Forcing opportunities in this business has historically been a road to the destruction of capital. Besides, sooner or later, Mr. Market will inevitably overreact to an individual security or an entire industry, which presents us with the investment equivalent of money lying on the ground. In the interim, all we really need is one or two really good ideas a year.

A Few More Words About Bonds

During the quarter we have continued to reduce the duration of the fixed income portfolio. At the end of the quarter it was 1.68 years. Some have wondered if, with the Federal Reserve finally beginning to raise rates in reality (rather than in expectation), it is time to lengthen the portfolio. We confess to spending a lot of time pondering that question. High-yield securities generally continue to be overvalued, as do most corporate bonds. In governments, one is not yet being well-compensated for extending maturities. So, we continue to think that the risk of substantial capital loss from lengthening both duration and maturity outweighs the potential returns, although we are prepared to concede that change may finally be starting to take place on the edges. How will we know the time has come to lengthen? We do not expect to see the return of the early 1980's, when long-term governments were yielding close to 12% and certificates of deposit for IRAs could be obtained yielding 18%. We did not make such investments then because we believed that rates could and would go so much higher. It is our sense that the time to lengthen will be when there is more fear in the bond market than at present.

The Absence of Predictions

We continue not to make predictions, so long-term investors should find no surprises in our fund. We are somewhat puzzled by the fact that many of those in the prediction business are having trouble making predictions at the moment. We freely admit that we appear to be living in unusual times, when much of the macroeconomic data seems to conflict. Since we choose not to pay attention to such macro-economic data when managing your money, building the portfolio from the bottom up, one security at a time, these conflicts are of academic interest to us, if that.

We continue to meander along, searching for the occasional compelling investment opportunity, which could be a spin-off, a company on the new low list, or something else that twitches our valuation antennae. We also try to avoid overreacting to short-term events, because they often cause investment disaster for those who allow themselves to be driven by them (though they often create moments of opportunity for those who stand back and read them correctly). In any event, we are doing our best to not do anything different than what we have done in the past, which is searching for business values in the market place at that margin of safety discount to intrinsic value that we like. We thank you, our shareholders and partners, for your patience and confidence in investing with us.

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

Schedule of Investments—June 30, 2004 (Unaudited)