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 (12/31/04) AS COMPARED TO THE LIPPER BALANCED FUND INDEX10
	Annual Average Total Returns (as of 12/31/04)
	Total Return Last 3 Months*	1-year	5-year	Since Inception (11/1/95)
Oakmark Equity & Income Fund (Class I)	5.11%	10.36%	13.47%	14.31%
Lipper Balanced Fund Index	6.40%	8.99%	2.95%	8.23%
S&P 5003	9.23%	10.88%	-2.30%	10.10%
Lehman Govt./Corp. Bond11	0.80%	4.19%	8.00%	6.83%
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

"The believer is happy; the doubter is wise." Hungarian Proverb

Our Results
The Oakmark Equity and Income Fund increased 5% for the quarter ended December 31, bringing the calendar year gain to 10%. For the calendar year 2004, the Fund trailed the stock market averages while outperforming our primary benchmark, the Lipper Balanced Fund Index, which gained 9% during the year. We are pleased with this result, as we have consistently said that it is absolute positive returns that preserve and grow your capital. We are even more pleased that, looking back over the past three-year and five-year periods, we have grown and compounded the capital of our long-term investors (ourselves included) at a 10% and 13% rate annualized respectively.

Please do not think for one moment that those returns are going to make us slack off. We started the year 2004 cautiously pessimistic and remained that way during the year. We have ushered in 2005 feeling similarly but without any great convictions, believing as did Nietzsche that "convictions are more dangerous enemies of truth than lies." Instead, we find much to be thoughtful about in the current environment. The domestic savings rate is at an all-time low and, we would argue, at a low that is unsustainable if we want to continue to be masters of our own destiny. Indeed, over the past several years the largest purchasers of our ongoing issues of U.S. Treasury securities have been the central banks of China and Japan. Despite recent corrections, the price of energy remains substantially higher than it was forecast to be two years ago. (And, we believe that many have not adjusted their forecasts from $18 or $24 a barrel to reflect higher prices, which is more realistic when looking out over several years.) In addition, demand from emerging market countries such as China and India is substantially higher than was forecast. Finally, inflation appears to be making a comeback, and if one follows the logic of Mr. William Gross of PIMCO, government reports are understating the rate of inflation by anywhere from one to one and a half per cent. Our experience makes us justly leery of the cheery consensus (as one finds at Bubblehead Financial Business Network), but it also makes us leery of doomsday scenarios. And while there is much to ponder, we refrain from making predictions, which allows us to do what is often best in such circumstances: nothing. Remember: our goal is to position the Fund for a range of potential outcomes so that we may continue to preserve and grow your capital.

Plus ça Change
Particularly strong performers during the quarter were Caremark RX Inc., Diageo PLC, Nestle SA, SAFECO Corporation, and Costco Wholesale Corporation. Over time, we have noted that many

recent strong performers were often among the worst performers of the quarter before. This remained true with both Diageo and Nestle, which transitioned again from worst to best. We reiterate this because it underpins our philosophy of keeping a long-term focus, rather than changing strategy with a "flavor of the day" approach. Short-term perceptions rarely if ever have anything to do with the long-term business value of an enterprise.

One of the worst performers during the quarter was American-Italian Pasta Company, which continued to see its share price decline dramatically (albeit with a slight recovery towards year-end). Pasta consumption in this country fell off a cliff with the low-carb diet craze. In response, pasta companies developed low-carb products that never caught on. While domestic pasta consumption and demand has recovered somewhat, the sector's overcapacity and lack of pricing power continues. In addition, overseas products seem able to compete at the high end on artisan—like quality and the lower end on price, notwithstanding that most U.S. consumers see pasta as a commodity, rather than a premium product. We thought we had an opportunity to buy a business, albeit at the lower end of the quality spectrum for a consumer food business, after a substantial decline brought on by investor fears of the long-term effects of the low carbohydrate diets with regard to American eating habits. In our initial evaluation, however, we did not sufficiently account for the twin impacts of: (1) having a domestic competitor going through a bankruptcy reorganization and (2) overseas competitors' willingness to cut prices and erode their margins to maintain the marketshare footholds they had gained (notwithstanding an additional hit from currency). We have since reevaluated the importance of these factors and have subsequently eliminated American-Italian Pasta from the portfolio.

In addition to American-Italian Pasta, the portfolio experienced an unusual amount of turnover in stocks during the quarter. Alamo Group, Monsanto, Rockwell Automation, SYBASE, and Triarc were all sold after hitting our valuation targets. The balance of our Cox Communications was tendered in response to a take-over offer from the controlling family shareholders. Del Monte Foods and Kraft Foods were sold after a reassessment of their competitive prospects and, consequently, our valuations of them. We also eliminated positions in Amerisource Bergen and Watson Pharmaceuticals to reduce the risk profile of our health care holdings. We initiated new positions in Alliant Tech-systems, CONOCO Phillips, Echostar Communications, Fox Entertainment Group, MBIA Insurance, UST Corporation, and VIACOM Inc. Last year, we explained our low turnover as a result of our portfolio holdings not reaching their valuation targets and due to a lack of compelling values worth moving into. This year more of our valuation targets have been reached, but at the same time, we are finding a few truly compelling names, especially in the media area. At this point, continuing our baseball analogy of last year, we had a good year in terms of singles and doubles, which allowed us once again to show consistent returns with controlled risk. And while we are not seeing an abundance of compelling ideas, we still are finding the one or two really good ones over a twelve-month period.

Growth—Real or Illusory?
One early lesson for aspiring value investors is to learn through experience (usually bad) what the correct price is for perceived growth, all other things being equal. Investors tend to extend past growth rates into the distant future while ignoring that once a business has matured, growing entails taking on more risk. Since growth in a mature or maturing business often plateaus, a revaluation of both market perceptions and business value usually follows. Studies have shown that only one out of ten companies will actually be able to sustain a growth rate that will lead to an outsized shareholder return over time. Indeed, a study by the Corporate Strategy Board over decades shows that when companies hit the stall point, they often will lose more than 50% of their market capitalization over the next ten years. Thus, an industry's life cycle becomes understandable. A new industry sees substantial growth followed by an influx of entrants. Shortly thereafter comes the shake-out, followed by an exit of competitors and more stable returns for those left. Growth begins a gentle decline, and in a mature industry, this leads to muted growth and returns close to a competitive balance. Data supports the conclusion that it becomes much harder for very large companies to outperform the market over time, simply because they already are, in effect, the market (or a large percentage of it).

Global Tourists?
We are on occasion asked why we invest in foreign companies such as Diageo and Nestle. Aren't there more than enough choices in U.S. companies available? First, Diageo and Nestle are multinationals, with a presence around the world. They also share the fact that they have both strong branded product portfolios and a large presence in some of the fastest growing emerging market countries. This has resulted in both companies having considerably stronger organic (internal) growth than many domestic alternatives. Finally, notwithstanding that faster growth, they have been priced on a valuation basis cheaper than the alternatives we have considered. Does it bother us that they report in non-U.S. currencies (pounds sterling and Swiss francs)? Frankly, we think that issue is a canard. Our focus is upon the true economic effects of what is taking place in the underlying business, reflected in the growth in business value. We are willing to invest in undervalued, well-run global companies within what we define as our circle of competency, when they meet our criteria and are priced accordingly. In both instances we are not paying for their being positioned for future demand. The best example of future demand one can think of is in Guang-dong Province outside of Hong Kong, where there are ninety million middle class consumers waiting to be reached. We can assure you that both Diageo and Nestle are aware of that market's potential.

Consistency
Winston Churchill once said, "The only way a man can remain consistent amid changing circumstances is to change with them while preserving the same dominating purpose." Our purpose, which is to make an absolute positive return for you (and ourselves) as shareholders, has not changed. We have to confess that we are entering into our favorite period of the year—when the winter solstice has just passed, the year-end reporting period for most companies is looming, and the weather allows us to take stock of opportunities with a little less of Wall Street's road shows and conferences that lead to a hyping of stock valuations without any attendant increase in business value. In any event, we look forward to every day in this business, as every day represents a new day in the marketplace, with an ever-changing set of opportunities. We are not going to do anything different this coming year than what we have done in the past, which is searching for business values in the market place with the margin of safety discount to intrinsic value that we like to have. We remain grateful to you, our shareholders and partners, for your patience and confidence in entrusting us with your capital to manage.

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

Schedule of Investments—December 31, 2004 (Unaudited)