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 OAKMARKEQUITY AND INCOME FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (12/31/06) AS COMPARED TO THE LIPPER BALANCED FUND INDEX9
		Average Annual Total Returns (as of 12/31/06)
	Total Return Last 3 Months*	1-year	5-year	10-year	Since Inception (11/1/95)
Oakmark Equity & Income Fund (Class I)	4.50%	10.82%	9.88%	13.27%	13.48%
Lipper Balanced Fund Index	5.08%	11.60%	6.50%	7.43%	8.22%
S&P 5004	6.70%	15.80%	6.19%	8.42%	10.08%
Lehman Govt./Corp. Bond10	1.04%	3.78%	5.17%	6.26%	6.13%
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

"The two most powerful warriors are patience and time." Lev Nikolayevich Tolstoy

Our Results
The Oakmark Equity and Income Fund increased 5% for the quarter ended December 31, bringing the calendar year gain to 11%. For the calendar year 2006, the Fund lagged behind both the S&P 500 Index and our primary benchmark, the Lipper Balanced Fund Index, which gained respectively 16% and 12% for the year. This represents another period of positive returns for the Fund. We are somewhat pleased with this result because it represents a positive total return that will supplement the income of those investors who rely on the combination of a fixed income plus investments. As we have said, our objective is to assist you in both preserving your capital and protecting your purchasing power from inflation. We are consistently attuned to that objective, given the volatile, yet upward, trends in consumer energy prices, health care insurance costs, prescription drug costs, real estate taxes, and most basic of all, food costs.

Was 2006 a difficult year? To all outward appearances, perhaps not. After all, the Dow Jones Industrial Average⁵ at the end of the year hit new highs. For many who are deeply involved in investing, this is the be-all and end-all summation of 2006. For many other investors, the traditional notion of risk has been relegated to the investment attic or basement, not to emerge ever again. To us, however, there remains much to worry about. The war in Iraq, which was supposed to be short-run and of minimal expense to the U.S. taxpayer, continues with no end in sight. As of mid-summer 2006, it had cost those U.S. taxpayers in excess of $200 billion dollars. Reading through the tea leaves of the many supplemental appropriations, it is reasonably clear that tens of billions of dollars more will be required to replace the military equipment that has worn out or been destroyed far in advance of the originally projected useful life. Energy costs, which many viewed as the result of short-term speculative phenomena, have continued to reflect extreme volatility. At the end of the day, supply and demand rule in the energy area. We continue to wonder where the newly-discovered giant fields are that will ease pricing issues caused by the tightness of supply. We are still waiting to hear. And yes we understand that existing reserves may increase incrementally as a result of new drilling and recovery technologies. Both increasing demand and accelerating depletion of existing fields continues to outstrip supply as reflected in existing fields and new discoveries. The tipping point either has or will be reached at some point.

We are most concerned, however, with the continuing deterioration of credit quality in the marketplace. This is evidenced by the absence of any real spread difference between quality credits (U.S. Treasuries) and junk bond issues. One possibility, which raises more questions than it answers, is that the global marketplace now perceives these two kinds of credit as equal. In any event, we suspect that this situation cannot continue. Most central banks are tending toward a bias of raising rates. As of the end of 2006, the U.S. was not moving in this direction. A foreign central bank faces a double whammy if it is paying out more in interest rates on its own bonds than it is receiving back from U.S. Treasury bonds AND, the U.S. dollar continues to sink against the respective currency. We suspect that this is why our Treasury Secretary and Federal Reserve Chief were in China at the end of last year. We would also like to note a tangential concern: the Iranian Oil Ministry has apparently directed that it wants to be paid for oil in Euros rather than dollars. Stay tuned, as will we, for how all of these issues will play out. As all change occurs at the margin, it is at the margin where the beginnings of change to the inputs involved in shaping our fundamental assessment of business values must necessarily be observed.

Portfolio Adjustments
From our perspective, activity in the Fund during the quarter was quite limited. Although we had hoped that the volatility from earlier in the year might allow us to initiate positions in undervalued securities at very optimal prices, we added only two positions in the quarter. We initiated small positions in Idearc Inc. and Allstate. Idearc is a spin-off of Verizon's yellow pages business. Allstate is the second largest property and casualty operation in the United States, particularly focused on personal lines (private auto and homeowners) insurance. We eliminated no positions during the quarter. At the end of the prior quarter, 54.3% of the Fund was invested in equity and equivalents, compared to58.4%at the end of the current quarter. A merger (of equals) agreement was announced between Caremark RX Inc., one of our holdings, and CVS, Inc., a major drug store chain. A second bid for Caremark has emerged from Express Scripts, another pharmaceutical benefits manager. We look forward to seeing how this plays out, but we believe that our shareholders are in a win-win situation.

"And now for a word ......."
We used to think that investing in the markets was a job with a relatively level playing field: those who did the best fundamental work and had a long-term horizon generally produced superior returns for their investors. We wonder if this will continue to be the case as we look at the different categories of "pseudo-investors," that have come to influence the short-term market scene.

Our first group of pretenders are the hedge funds. We have often wondered why rational investors would flock to a vehicle where the most common fee structure is referred to as the "two and twenty." That is, the management fee is 2% of assets, plus once a threshold return is reached, 20% of the profits above the threshold. What we find even more intriguing is that for much of this year, many of these funds allegedly had returns below their thresholds, meaning that they fell short of that magic return that would generate the higher fee. One should not underestimate the power of leverage (which these funds make use of). The question we would ask is how much leverage, exercised in unison, can move the markets? Put another way, in these unregulated vehicles, what safeguards are in place to ensure that the goal is to generate superior results for the investor rather than superior results for the management company? While you may think us too cynical on this issue, we recently met with the management of one of our long-term holdings. We learned—at least anecdotally—that hedge fund managers and long-term investors, such as ourselves, are often at cross-purposes. Not surprisingly, the hedge fund managers seem to be concerned with generating short-term performance in share price, regardless of the implications to the long-term value of the underlying business. We had suspected as much, but it is somewhat disconcerting to hear this from company managements. We also note that the sell-side firms, ever-mindful of their hedge-fund customers as huge commission payers, are now catering to that group, and giving them office space and support services in return for commissions. The company management we spoke with informed us of a seminar that a major Street firm was going to hold to educate corporate managements about the "special needs" of their hedge fund investors. Our conclusion is that it is our long-term focus and our long-term investing horizon that gives us a distinct competitive advantage relative to most hedge fund vehicles. Rather than starting to worry at some point in a fiscal year about hitting a "bogey" as hedge fund managers and analysts seem inclined to do, we worry about what the business values of our investments might be looking out three to five years. That approach has led to superior long-term returns for our investors. It has also made us a "preferred" investor by many of our companies, given the alignment of interests that our approach creates.

Our second group of pretend investors consists of greedy corporate managements. We confess that at one point we encouragingly accepted the practice of giving options to management, feeling that it facilitated an alignment of shareholders' and managements' interests. Unfortunately, in practice, options became viewed as an expected part of executive compensation and have subsequently been abused. From one-time grants, options soon transformed into a regular way of rewarding executive management teams for coming to work every day. In some cases, the options for top management teams were regularly "reloaded" each year without concern that this would dilute the real shareholders' value. Finally, the "backdating" scandal surrounding options has emerged. Although the press seems to prefer that terminology, we find it disingenuous. The backdating of options, if the requisite intent was present, appears to be simply fraud and theft and should be treated as such.

Last but not least on our list, we come to private equity and managements that are taking their companies private. We do not consider this group per se to be a subset of the "pseudo-investors." However, we have been concerned for some time about the escalating numbers of companies that are going private. In 2006 in the United States, the volume of public to private equity deals far surpassed the volume of initial public offerings. In addition, it seems that increasingly larger companies (as measured by market capitalization) are looking to do the same. What are the implications of that trend? On one level, there is a certain logic to going private as the cost of debt is lower than the free cash flow yield from many of these businesses. Hence the ability for a private equity buyer to make a cash offer for a business. Alternatively, the company may elect to issue debt itself and repurchase its own shares. Well, what kinds of companies go private? Generally, companies that go private have aggressive, entrepreneurial managements, are businesses that tend to throw off a lot of cash and have the potential to throw off a lot more. The companies are often under-leveraged before they go private. In short, many of these companies are "value" investments, the kinds of companies and managements that we like to invest in. Who are the sellers of these equities? Unfortunately they are often our peers, institutional investors in search of higher returns, at least in the short-term, without regard to the real opportunity cost of what they are giving up over the long-term. The problem is that they are often selling the future. They are disposing of high quality businesses with great cash flows, which represent some of the most undervalued equities in the marketplace at present. And to invest in what? Emerging market debt? Russian oil companies? Our concern is that the pool of long-term investors may be shrinking as institutions become increasingly short-term oriented and detached from the concept of risk (and return).

The year ahead......
The New Year is usually a time to reflect upon what went right in the past year, what we expect for the coming year, and what we would do differently. At this particular time we are grateful for the opportunity to do our work and look forward to continuing to do it for some time to come. Are there things that we look back on that we would do differently? Probably. Hindsight is always perfect. We will think about those things a little bit longer, if only from a lessons learned perspective, and then go forward. The important issue is to recognize that we are where we are and focus on where we are going, not where we have been. We continue to search for business values in the market place at that margin of safety discount to intrinsic value that we like. We remain grateful to you, our shareholders and partners, for your patience and confidence in entrusting us with your capital to manage.

Schedule of Investments—December 31, 2006 (Unaudited)