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 (9/30/04) AS COMPARED TO THE LIPPER BALANCED FUND INDEX10
	Annual Average Total Returns
	(as of 09/30/04)
	Total Return Last 3 Months*	1-year	5-year	Since Inception (8/5/91)
Oakmark Equity & Income Fund (Class I)	-1.07%	14.64%	13.11%	14.10%
Lipper Balanced Fund Index	0.18%	10.58%	3.08%	7.72%
S&P 5004	-1.87%	13.87%	-1.31%	9.31%
Lehman Govt./Corp. Bond11	3.56%	3.33%	7.73%	6.94%
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

Quarter and Annual Review

Fiscal 2004 was a successful year for The Oakmark Equity and Income Fund, though the fourth quarter proved disappointing. The quarterly result for the Fund was -1%, which lagged behind the breakeven outcome of the Lipper Balanced Fund Index. Yearly returns were more favorable, as the Fund earned 15% contrasted to the Lipper Balanced Fund Index's 11%. In an odd coincidence, the Fund's return for the year is essentially equal to the annualized return of the Fund since inception.

The loss for the quarter derived from unexpectedly bad earnings announcements from an amazing 22% of the equity holdings in the portfolio at the start of the quarter. Offenders included companies from a variety of sectors, especially consumer products (Nestle, Dean Foods, Cool Brands, Diageo), technology (Synopsys, Mentor Graphics, Imation), and distribution (Office Depot, Cardinal Health). It is a surprising development that at this point—in what has been a broad-based economic expansion—so many companies are experiencing earnings difficulty. Clearly, managers have had trouble offsetting the cost increases of raw materials and employee health care.

We do not center our investment process on our ability to correctly forecast future earnings. Earnings outcomes can have a depressingly large impact on Fund returns in any given quarter, but in the long run, our ability to identify mispriced securities is what we believe will determine our success.

Change in Duration

The word "duration" in the title above refers to a mathematical term used to measure sensitivity to changes in interest rates. It is primarily used to describe risk in a fixed income portfolio. Two years ago we began to shorten the maturity structure of the Fund's fixed income holdings. Shortening maturities reduces the price sensitivity (i.e. duration) of a bond to changes in the investing environment. Over this time we (and many of you, given the extraordinary flow of e-mail to us on this subject) judged that economic recovery and fiscal deficits would lead to higher rates of inflation, higher interest rates, and lower bond prices.

Generally, we choose to take on risk in the equity portion of the portfolio because potential return of equities is unbounded. With an equity security, if events play out better than expected, the stock price goes up. With bonds, good fundamental outcomes simply increase the likelihood that you will receive that which already is contractually owed to you. In other words, bonds typically do not reward successful analysis with any excess return. Accordingly, our fixed income approach is always risk averse. Given our perception of abnormal risk in the bond market, by June 30 of this year we had reduced the average maturity and duration of the Fund's fixed income portfolio by half of what it had been in early 2002. This was not cost-free, however, as the lower duration also meant lower interest income to the Fund.

In the quarter just ended we reversed course and extended the duration from 1.7 to 2.8 years. Many factors influenced our thinking. Inflation has remained quiescent, economic growth is moderate, and foreign governments appear to have a limitless appetite for our country's securities. Most important was our observation we had become part of a very narrow consensus that believed long term bonds were unattractive. To our knowledge a consensus has never correctly anticipated a bear market in anything. Accordingly, we have moved back to a more neutral position in our fixed income holdings. We have also modestly increased the proportion of the fixed income portfolio invested in sovereign debt (foreign government issued securities) both to increase our interest income and to provide some hedge against possible weakness in the dollar.

Low Volatility?

Statisticians can demonstrate that almost all types of investments exhibit considerable volatility in their record of annual returns. For example, stocks are often described as having an expected return of approximately 10%, but the standard deviation (a measure of probability) around that 10% is more than 20%! Simply put, equity returns are very volatile from one year to the next and even within individual years. This calendar year has been an exception, however, as indices of stock prices have stayed confined within a narrow band. Beneath this placid surface, prices of individual stocks continue to be volatile, and this has been true for some of your Fund's most successful holdings. Given that this report closes our fiscal year, we will briefly take note of the year's exceptional contributors.

The Fund's four energy stocks (Burlington Resources, Cabot Oil & Gas, Saint Mary Land & Exploration, and XTO Energy) were large contributors to total return in fiscal 2004. While we could wax eloquent as to the individual attributes of each of these enterprises, the fact of the matter is that rising prices for oil and natural gas lifted the share prices of virtually every company in this area. Aerospace (General Dynamics, Raytheon, Rockwell Collins, and Textron) turned in a strong performance as did a potpourri of industrial names (Honeywell, Monsanto, Plum Creek Timber, and Rockwell Automation). In contrast to other successful years, fiscal 2004 saw the Fund benefit from only one takeover, Apogent Technologies. During the year we sold the Fund's positions in four issues that had contributed substantially to the overall return: Edwards Lifesciences, JC Penney, Laboratory Corporation of America, and Novell.

Many investors currently profess a belief that returns to equities for the next three to five years will be positive but dull—say, between 5 and 8%. Calendar 2004 may well produce a return to stock market indices that falls within that range. While we would prefer to have a differing point of view, we have no argument with this emerging consensus. Realize, however, that three strong up years and two down years could easily produce a 5-year return of 5-8%. We believe that the low volatility of 2004 is more likely to be the exception than the norm.

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

Schedule of Investments—September 30, 2004

See accompanying notes to financial statements.