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 (9/30/06) AS COMPARED TO THE LIPPER BALANCED FUND INDEX10 (UNAUDITED)
	Average Annual Total Returns (as of 9/30/06)
(Unaudited)	Total Return Last 3 Months*	1-year	5-year	10-year	Since Inception (11/1/95)
Oakmark Equity & Income Fund (Class I)	2.36%	6.51%	10.59%	13.46%	13.36%
Lipper Balanced Fund Index	3.87%	8.02%	6.79%	7.49%	7.92%
S&P 5002	5.67%	10.79%	6.97%	8.59%	9.67%
Lehman Govt./ Corp. Bond11	3.91%	3.33%	4.96%	6.47%	6.17%
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 most recent month-end performance data, visit oakmark.com.
* Not annualized

Quarter and Fiscal Year Review

The Equity and Income Fund earned 2% in the quarter ended September 30. This is a solid return, but it nevertheless lags behind the 4% result of the Lipper Balanced Fund Index. The comparison for the fiscal year ended September 30 is 7% for the Fund and 8% for the Lipper Balanced Fund Index. As always, we are pleased to report a positive rate of return for the Fund, even when the comparison with Lipper is uninspiring. It especially pleases us that in the recent quarter the fixed income segment of the portfolio contributed meaningfully. When the quarter began, the Fund's duration (a measure of sensitivity to changes in interest rates) was a very low 1.8 years, meaning that we had positioned that portfolio segment defensively. During the quarter the Federal Reserve broke its string of 17 consecutive hikes in short-term interest rates. Believing that the risk in longer term fixed income securities had diminished, we increased the portfolio's duration to 3.2 years by quarter's end. The extension of maturity produced a significantly favorable effect on the Fund's return in the quarter.

Many of our investors wrote to us earlier in the year expressing concern about the fixed income outlook and the Fund's bond holdings. These correspondents argued that continued upward pressure on short-term rates would inevitably result in deterioration in bond prices. As we noted two letters ago, during the time that the Fed increased short-term rates 17 times, long-term bond prices stayed remarkably stable. Now that the Federal Reserve has either paused or perhaps completed its cycle of increasing rates, longer term bonds have rallied vigorously. Markets often move in a fashion designed to frustrate the maximum amount of investors, and this appears to have happened in the bond market.

Earnings Season

In late July, the writer of this letter was awaiting the arrival of his commuter train when an investing professional from a competitor asked, "How is your earnings season going?" Your letter writer stumbled to construct a response, attempting to hide the fact that he did not know that our industry now designates the period in a quarter when the majority of companies report earnings as "earnings season." As most of our regular readers know (and those who don't can infer from our pictures), your Fund managers have labored long enough in the investment management industry to observe our industry pursue many fads. In the early 1980s, for example, the weekly money supply figures were the data du jour, and many professionals made good livings simply forecasting these numbers. The current obsession with quarterly earnings announcements and mid-quarter "earnings guidance" strikes us as a similar fad, because quarterly earnings reports rarely contain information that changes a business's intrinsic value.

This fad may be losing momentum, however. In July the Business Roundtable Institute for Corporate Ethics and the CFA Institute issued a joint report calling for business leaders to stop issuing quarterly earnings guidance. [The National Investor Relations Institute estimates that just over half of U.S. public companies provide earnings guidance each quarter.] The report argues that regular three-month forecasts distract management from concentrating on their businesses' long-term health. We agree and often share this opinion with the management teams that we meet. We should note, though, that the stock market's focus on short-term earnings benefits our investing style by generating stock price volatility unconnected to long-term fundamental value.

Shortly after the Business Roundtable issued its report, New York Times columnist Joe Nocera wrote a piece titled "A Defense of Short-Termism."¹² He argued that before the investment community forced corporate management teams to focus on quarterly results, managers often avoided making tough decisions and could appear lethargic. He points out that "Having sailed through the post-war era without much in the way of global competition, there were plenty of American industries that desperately needed to be shaken up in a tougher, more competitive era." It may be that Mr. Nocera is correct, that the obsession with short-term earnings has been necessary for reinvigorating the U.S. economy. But we believe that this phase has persisted too long. In any event, you may rest assured that your managers will continue to ignore the noise of the moment and focus on understanding long-term business value.

Passage of Time

Notwithstanding the previous section of this report, we do charge our security analysts with the task of developing annual earnings forecasts for the companies that they cover. Every August we require them to extend their estimates another year into the future. While the analysts may grumble about the difficulty of forecasting so far out, the point is simply to keep their focus very long term.

As the analysts review their earnings projections, they often increase their estimates for intrinsic value because of the "passage of time." This brings to mind an experience we had with a client many years ago who sold his business for cash and hired us to manage some of the proceeds. All too soon he terminated his account. When asked why, he explained his reasons. Before the sale of his business, he had never owned a stock nor paid any attention to the stock market. Once he began to pay attention, however, the daily volatility of stock prices shocked him. He remarked that when he owned his business, he knew that every evening when he left the office the business was worth more than when the day began. The daily price movements in the stock market were not just disconnected from economic reality (as he saw it), they were completely irrational!

As value investors, we simply try to answer two questions about an investment: "What is it worth?" and "What is its current price?" If our former client's understanding of the world—where every security properly reflected its intrinsic value—prevailed, we would have to change careers! As it is, however, the securities markets provide us with enough irrational pricing to continue to employ our value investing approach. Here's to irrationality in the stock market!

As always, we thank you for entrusting us with your assets.

Schedule of Investments—September 30, 2006