<PAGE>
CORPORATE DATA
Transfer and Dividend Disbursing Agent
Harris Trust and Savings Bank
Shareholder Communications Team
P.O. Box A3504
Chicago, Illinois 60690-3504
1-800-394-5187 or 312-360-5198
Custodian
UMB Bank, N.A.
Legal Counsel
Bell, Boyd & Lloyd
Address of Company
200 West Madison Street
Suite 3510
Chicago, Illinois 60606
312-236-9190 or 800-BKF-1891
Baker, Fentress & Company
Report to Shareholders
[ARTWORK]
THIRD QUARTER
SEPTEMBER 30, 1998
[RECYCLING LOGO]
The Company's Report to Shareholders is printed on recycled paper. We encourage
recycling and use of recycled products.
<PAGE>
TO OUR SHAREHOLDERS
The third quarter was characterized by a marked increase in market volatility
and changed investor expectations.
Concerns about problems that have affected the economies and financial
institutions in Asia, Russia, Latin America, and other emerging markets, as well
as the slowing earnings growth rates of U.S. companies, triggered a significant
decline in the S&P 500 Index. For the quarter, the market, as measured by the
total return on the index, was down 10.0%. The net asset value (NAV) total
return of Baker, Fentress & Company decreased 6.9% for the period, and the
market value total return fell 10.9%.
While the sharpest decline began on July 20 and continued through August
31, when the S&P 500 Index fell 19.0% from its all-time high, volatility
continued to characterize trading activity in the month of September, which saw
nine days in which the index moved either up or down by more than 2%. Market
participants were concerned by the problems affecting the global economy and
with continuing reductions in earnings forecasts. Thus, investors were not as
confident about an immediate resumption of the unprecedented rise we experienced
in earlier periods, even with a positive interest rate environment. These
factors probably will lead to continued volatility.
This quarter witnessed the initiation of two new investment strategies: (1)
a program to purchase put options on the S&P 500 Index and (2) an investment in
a partnership that invests in Japanese securities. These strategies are
described below and reflect our belief that the Company's investment approach
should be receptive to new opportunities that fit within our overall philosophy
of seeking total return through capital appreciation and protection.
PUBLIC PORTFOLIO
The value of the public portfolio at September 30, 1998 totaled $488.4 million,
amounting to 64.7% of our total net assets, as compared to $524.6 million, or
64.6%, at June 30, 1998. In a turbulent market environment, an emphasis on the
preservation of capital can play a significant role in the achievement of long-
term results. To that end, on July 22, we began a program of purchasing put
options on the S&P 500 Index. The purpose of this strategy is to provide a
measure of portfolio protection while remaining invested in stocks and
positioned for long-term appreciation. The options are intended to protect the
public portfolio in a market decline, as they can be expected to increase in
value as the S&P 500 Index declines. (In the event of a market rise, the total
purchase price of the puts, and only the purchase price, would be lost.) From
July 22 to September 30, we realized gains on the option strategy of $14.8
million. At the end of the quarter, the portfolio held options valued at $11.4
million with an unrealized loss of approximately $800,000. Although the capital
committed to the options does not constitute a large percentage of the public
portfolio, the
Baker, Fentress & Company | Third Quarter Report 1998 1
<PAGE>
TO OUR SHAREHOLDERS (continued)
options clearly made a positive contribution to the overall return and provided
the intended protection.
While the S&P 500 fell 10.0% during the quarter, the value of our public
portfolio decreased by 6.9%. In August, the put options had a positive effect on
performance, while in September they had a negative impact (See Table I). Aside
from the put option program, we believe that the fund's relative performance
during this recent decline also benefited from the portfolio's significant
position in cash and treasury bills that totaled 14.4% of public portfolio
assets at quarter end, as well as from our stock selections. During this period
we utilized defensive strategies to structure the portfolio to be less volatile
than the market. In future periods we may follow different strategies.
Table I
<TABLE>
<CAPTION>
Portfolio
Return S&P 500
<S> <C> <C>
July -2.6% -1.1%
August -6.7 -14.5
September 2.4 6.4
-------------------------------------------
Third Quarter -6.9 -10.0
</TABLE>
On August 1, 1998, the Company made a $5 million dollar investment in Penta
Japan Domestic Partners, L.P., a private investment partnership that invests
primarily in Japanese equities, fixed income instruments and related securities.
The partnership seeks to achieve superior long-term absolute investment returns
by using a research-driven, fundamental investment approach and may take long
and short positions and utilize leverage to achieve its objective.
While the investment in the partnership involves only a very small
percentage of the Company's total net assets, we view it as a long-term
investment with the opportunity for significant appreciation over time. This
commitment allows the Company to expand its investment horizons in a careful,
measured way, while still adhering to a fundamental, research-driven approach.
Through September 30, our investment in the partnership has achieved a return of
approximately 11.1%.
PRIVATE PLACEMENT PORTFOLIO
There was relatively modest activity in the private placement portfolio during
the third quarter. Shares of Citadel Communications Corporation (NASDAQ: CITC)
traded as high as $25 13/16 on September 9 before closing at $20 7/16 on
September 30. On August 20, we invested $500,000 in an affiliate of DuroLite
International to help fund a strategic acquisition in Europe by that portfolio
company. The outlook for completing an orderly liquidation of the portfolio's
remaining assets is unchanged.
LEVCO
Total assets under management as of September 30, 1998 were $7.3 billion
compared to $7.4 billion at the end of 1997. After raising the valuation of
Levco in June, it was reduced in
2 Baker, Fentress & Company | Third Quarter Report 1998
<PAGE>
September to its previous level to reflect the general decline in the valuation
of financial services companies.
CONSOLIDATED-TOMOKA LAND CO. (CTO)
CTO's real estate development activity remains strong. Several new sales
contracts were signed during the third quarter. In its other line of business,
citrus production and sales, the harvest for the new crop year has just begun.
Recent forecasts are for a smaller orange crop in Florida and California which
should lead to higher citrus prices and improved earnings. CTO's operating
results for the full year will depend largely on fourth quarter real estate
closings and on the realization of higher citrus prices.
CTO's dividend for 1998 was $0.70 per share, a 7.7% increase over the 1997
dividend.
PROJECTED 1998 DISTRIBUTIONS
In addition to the midyear distributions paid in May, which totaled $2.00 per
share ($1.75 in capital gain and $0.25 in ordinary income), we expect to pay
both a year-end capital gain distribution and an ordinary income dividend in mid
to late December. We anticipate the 1998 calendar year distributions will
meaningfully exceed 12% of average net assets for the 12 months ending October
31, 1998. The average net assets for the 11 months ended September 30, 1998 is
$782 million, or approximately $20.88 per share. Although we intend to return to
our 8% minimum distribution target in 1999 and beyond, actual distributions will
be dependent upon market conditions.
OTHER BUSINESS
The Company is currently in the process of applying to the Securities and
Exchange Commission (the "SEC") for exemptive relief regarding a compensation
plan that would, among other things, allow for the issuance of restricted stock
and options to key employees. In addition to requiring exemptive relief from the
SEC, this plan will need to be approved by shareholders to become effective. We
hope to be able to hold a special shareholders' meeting to vote on the plan
before the end of the year. You will receive a proxy statement containing a
description of the plan prior to the proposed meeting.
/s/ James P. Gorter
James P. Gorter
Chairman of the Board
/s/ John A. Levin
John A. Levin
President and CEO
Baker, Fentress & Company | Third Quarter Report 1998 3
<PAGE>
STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
September 30, 1998 - Unaudited Shares Value
------- ----------
<S> <C> <C>
INVESTMENTS IN UNAFFILIATED ISSUERS--57.09%
Public--55.43%
Common Stock--50.97%
Basic Materials--2.92%
E.I. du Pont de Nemours and Company.... 90,000 $ 5,062,500
Getchell Gold Corporation (b).......... 232,000 4,886,616
Monsanto Company....................... 166,400 9,360,000
Sealed Air Corporation (b)............. 84,440 2,691,525
-----------
22,000,641
-----------
Capital Goods--5.82%
The Boeing Company..................... 96,436 3,309,008
General Electric Company............... 80,000 6,365,040
Lockheed Martin Corporation............ 86,800 8,750,568
Owens-Illinois, Inc. (b)............... 226,500 5,662,500
Sunstrand Corporation.................. 194,695 9,028,981
United Technologies Corporation........ 141,300 10,800,690
-----------
43,916,787
-----------
Communication Services--3.51%
Bell Atlantic Corporation.............. 191,000 9,251,658
Chancellor Media Corporation (b)....... 178,300 5,950,763
MediaOne Group, Inc. (b)............... 140,000 6,221,320
Loral Space & Communications Ltd. (b).. 340,775 5,026,431
-----------
26,450,172
-----------
Consumer Cyclical--5.07%
The Black & Decker Corporation......... 175,500 7,305,187
J.C. Penney Company, Inc............... 98,200 4,412,912
TRW Inc................................ 218,400 9,691,500
Tribune Company........................ 334,600 16,834,730
-----------
38,244,329
-----------
Consumer Staples--2.68%
PepsiCo, Inc........................... 160,700 4,730,687
Philip Morris Companies Inc............ 157,200 7,270,500
Ralston Purina Company................. 280,800 8,213,400
-----------
20,214,587
-----------
Energy--3.80%
Amerada Hess Corporation............... 46,700 2,694,030
Sempra Energy.......................... 542,843 14,148,117
Unocal Corporation..................... 325,300 11,792,125
-----------
28,634,272
-----------
</TABLE>
See accompanying Notes to Statement of Investments
4 Baker, Fentress & Company | Third Quarter Report 1998
<PAGE>
STATEMENT OF INVESTMENTS
<TABLE>
<CAPTION>
September 30, 1998 - Unaudited Shares Value
------- -----------
<S> <C> <C>
INVESTMENTS IN UNAFFILIATED ISSUERS (continued)
Financials--8.65%
Ace Ltd.................................................. 161,500 $ 4,845,000
Aetna Inc................................................ 82,600 5,740,700
Annuity and Life Re (Holdings), Ltd. (b)................. 2,000 39,500
Aon Corporation.......................................... 104,000 6,708,000
The Bank of New York Company, Inc........................ 278,000 7,610,250
W.R. Berkley Corporation................................. 22,000 657,250
The CIT Group, Inc., Class A............................. 30,000 768,750
The Chase Manhattan Corporation.......................... 12,800 552,000
CRIIMI MAE Inc........................................... 130,000 1,145,690
EXEL Limited, Class A.................................... 129,916 8,184,705
Fairfax Financial Holdings Ltd. (Stock Purchase Rights).. 78,000 29,250
First Investors Financial Services Group, Inc. (b)....... 292,600 1,572,725
First Sierra Financial, Inc. (b)......................... 6,520 59,091
Heller Financial, Inc. (b)............................... 40,000 960,000
Mellon Bank Corporation.................................. 10,800 594,000
Morgan Stanley Dean Witter & Co.......................... 14,000 603,750
NAC Re Corp.............................................. 24,000 1,182,000
NationsBank Corporation.................................. 69,687 3,728,255
Partner Re Ltd........................................... 79,000 3,164,977
Risk Capital Holdings, Inc. (b).......................... 21,000 462,000
SLM Holding Corporation.................................. 20,500 664,979
TIG Holdings, Inc........................................ 283,200 3,982,640
Terra Nova Holdings Ltd., Class A........................ 32,800 885,600
Tokio Marine & Fire Insurance Company, Limited (ADR)..... 125,000 5,562,500
Travelers Group Inc. (b)................................. 23,600 885,000
UICI (b)................................................. 80,900 1,334,850
Unitrin, Inc............................................. 42,000 2,695,895
Vesta Insurance Group, Inc............................... 70,000 603,750
-----------
65,223,107
-----------
Health Care--3.52%
Eli Lilly and Company.................................... 101,500 7,948,770
Genentech, Inc. (b)...................................... 185,700 13,347,187
Pfizer Inc............................................... 50,000 5,287,500
-----------
26,583,457
-----------
Technology--5.90%
First Data Corporation................................... 435,600 10,236,600
International Business Machines Corporation.............. 111,500 14,327,750
Philips Electronics N.V.................................. 149,600 7,984,900
Texas Instruments Incorporated........................... 226,200 11,988,600
-----------
44,537,850
-----------
</TABLE>
See accompanying Notes to Statement of Investments
Baker, Fentress & Company | Third Quarter Report 1998 5
<PAGE>
<TABLE>
<CAPTION>
STATEMENT OF INVESTMENTS
September 30, 1998 - Unaudited
Shares or
Principal Amount Value
---------------- ------------
<S> <C> <C>
INVESTMENTS IN UNAFFILIATED ISSUERS (continued)
Utilities - 9.10%
Consolidated Edison Company of New York, Inc. ................... 65,700 $ 3,416,400
Duke Energy Corporation.......................................... 365,540 24,194,361
KeySpan Energy Corporation....................................... 780,620 22,394,427
Potomac Electric Power Company................................... 455,100 12,060,150
Texas Utilities Company.......................................... 141,100 6,569,969
------------
68,635,307
------------
Total common stock (Cost $335,864,891)......................... 384,440,509
------------
Preferred Stock - 0.61%
Owens-Illinois, Inc., 4.75%...................................... 85,400 3,053,050
Sealed Air Corporation, $2.00 Series A........................... 42,750 1,544,344
------------
Total preferred stock (Cost $5,580,677)........................ 4,597,394
------------
Convertible Bonds - 1.60%
Hewlett-Packard Company, Zero Coupon Bond
due 10/14/2017 (h).............................................. $22,785,000 12,047,569
------------
Total convertible bonds (Cost $12,472,767)..................... 12,047,569
------------
Limited Partnerships - 0.74%
Penta Japan Domestic Partners, L.P............................... $ 5,000,000 5,556,466
------------
Total limited partnerships (Cost $5,000,000)................... 5,556,466
------------
Purchased Put Options - 1.51%
Expiration
Date/
Strike Price
------------
S&P 500 Index....................................... Oct 98/1050 55 247,500
S&P 500 Index....................................... Oct 98/1075 540 3,375,000
S&P 500 Index....................................... Dec 98/1050 20 149,750
S&P 500 Index....................................... Dec 98/1075 702 6,107,400
S&P 500 Index....................................... Dec 98/1100 25 252,187
S&P 500 Index....................................... Dec 98/1150 96 1,296,000
------------
Total purchased put options (Cost $12,232,899).... 11,427,837
------------
Total public portfolio (Cost $371,151,234)........ 418,069,775
------------
Private Placement - 1.66%
Paracelsus Healthcare Corporation - hospital management company
Common Stock (b)(c)(e).......................................... 535,443 910,253
Security Capital U.S. Realty - real estate investment trust
Common Stock (b)................................................ 983,528 10,523,745
Golder, Thoma, Cressey Fund II Limited Partnership (c)(d)........ $ 158,258 1,135,691
Phillips-Smith Specialty Retail Group Limited Partnership (c)(d). $ 61,060 27,492
------------
Total private placement portfolio (Cost $14,288,302)........... 12,597,181
------------
Total investments in unaffiliated issuers (Cost $385,439,536).... 430,666,956
------------
</TABLE>
See accompanying Notes to Statement of Investments
6 Baker, Fentress & Company | Third Quarter Report 1998
<PAGE>
STATEMENT OF INVESTMENTS
September 30, 1998 - Unaudited
<TABLE>
<CAPTION>
Shares or
Principal Amount Value
---------------- ------------
<S> <C> <C>
INVESTMENTS IN CONTROLLED AFFILIATES -- 27.52%
Publicly-Traded -- 8.62%
Consolidated-Tomoka Land Co., Common Stock
(majority-owned) - development of Florida real estate;
production and sale of citrus fruit (Cost $5,030,627)...................... 5,000,000 $ 65,000,000
------------
Private Placement -- 1.52%
DuroLite International, Inc. - manufacturer and distributor of
specialized lighting products
Convertible Preferred Stock (b)(c)(d)...................................... 2,500 2,627,250
12% Subordinated Note due 11/03/2004 (c)(d)................................ $ 8,000,000 7,872,750
DuroLite Europe Holdings, Inc. - subsidiary of DuroLite International, Inc.
20% and 23% Promissory Notes due 08/20/99 (c)(d)........................... $ 500,00 500,000
E-Sales, Inc. - diversified environmental services marketing organization
Convertible Preferred Stock (b)(c)(d)...................................... 500,000 500,000
------------
Total private placement portfolio (Cost $11,500,000)...................... 11,500,000
------------
Wholly-Owned Subsidiary -- 17.38%
Levin Management Co., Inc. - investment management
Common Stock (b)(c)(d).................................................... 1,000 66,155,368
9.75% Notes due 06/28/1999 (c)(d).......................................... $65,000,000 65,000,000
------------
Total wholly-owned subsidiary (Cost $120,645,890)......................... 131,155,368
------------
Total investments in controlled affiliates (Cost $137,176,517)............... 207,655,368
------------
INVESTMENTS IN NON-CONTROLLED AFFILIATES -- 5.52%
Private Placement -- 5.52%
Citadel Communications Corporation - radio broadcasting
Common Stock (b)(c)(f).................................................... 2,239,236 41,187,929
TBN Holdings Inc. - hazardous waste recycler
12% Subordinated Note Due 12/31/2002 (b)(c)(d)(g)......................... $ 8,000,000 500,000
Series C-3 Convertible Preferred Stock (b)(c)(d).......................... 1,511,628 --
Stock Purchase Warrants Expiring 12/31/2002 (b)(c)(d)..................... 1,100,000 --
------------
Total investments in non-controlled affiliates (Cost $13,110,996)............ 41,687,929
------------
MONEY MARKET SECURITIES -- 8.57%
U.S. Treasury bills - 4.59% due 10/01/98..................................... $20,000,000 19,997,450
U.S. Treasury bills - 4.72% due 11/27/98..................................... $45,000,000 44,657,800
------------
Total investments in money market securities (Cost $64,655,250).............. 64,655,250
------------
TOTAL INVESTMENTS -- 98.70% (Cost $600,382,299)............................... 744,665,503
------------
Cash and Other Assets, Less Liabilities -- 1.30%.............................. 9,777,368
------------
NET ASSETS -- 100.00% $754,442,871
============
</TABLE>
See accompanying Notes to Statement of Investments
Baker, Fentress & Company | Third Quarter Report 1998 7
<PAGE>
NOTES TO STATEMENT OF INVESTMENTS
----------------
(a) Based on the cost of investments of $549,477,616, for federal income
tax purposes at September 30, 1998, net unrealized appreciation was
$195,187,887, which consisted of gross unrealized appreciation of
$232,006,313 and gross unrealized depreciation of $36,818,426.
(b) Non-income producing security.
(c) Securities subject to legal or contractual restrictions on sale are
valued at cost on the dates of acquisition and at a fair value
determined in good faith by the board of directors of the Company as
of September 30, 1998, based upon all factors deemed relevant by the
board. The quantitative and qualitative factors considered by the
board of directors may include, but are not limited to, type of
securities, nature of business, marketability, restrictions on
disposition, market price of unrestricted securities of the same issue
(if any), comparative valuation of securities of publicly-traded
companies in the same or similar industries, valuation of recent
mergers and acquisitions of similar companies, current financial
condition and operating results, sales and earnings growth, operating
revenues, competitive conditions, and current and prospective
conditions in the overall stock market.
The values determined by the board of directors may not reflect
amounts that could be realized upon immediate sale, nor amounts that
ultimately may be realized. Accordingly, the fair values included in
the statement of investments may differ from the values that would
have been used had a ready market existed for these securities, and
such differences could be significant. The aggregate value of
restricted securities was $186,416,732 or 24.7% of net assets, at
September 30, 1998.
(d) There were no unrestricted securities of the same issue outstanding on
September 30, 1998 or the dates of acquisition.
(e) Represents 80% of the current market price of unrestricted common
stock of Paracelsus Healthcare Corporation.
(f) Represents 90% of the current market price of unrestricted common
stock of Citadel Communications Corporation.
(g) Security not current as to payment of interest.
(h) Security exempt from registration requirements under Rule 144A of the
Securities Act of 1933 which permits resales of eligible securities
issued in private placements and other transactions to "Qualified
Institutional Investors."
8 Baker, Fentress & Company | Third Quarter Report 1998
<PAGE>
PORTFOLIO CHANGES EXCEEDING $2.5 MILLION
Quarter Ended September 30, 1998 - Unaudited
<TABLE>
<CAPTION>
Purchases Cost
- --------- -----------
<S> <C>
S&P 500 Index Put Option Dec98/1050........... $ 6,378,779
Texas Instruments Incorporated................ 5,887,735
Tribune Company............................... 5,579,465
Chancellor Media Corporation.................. 4,977,589
PepsiCo, Inc.................................. 4,876,418
Loral Space & Communications Ltd.............. 4,393,227
S&P 500 Index Put Option Oct98/1075........... 4,367,869
Ralston Purina Company........................ 3,619,843
International Business Machines
Corporation................................. 3,463,904
United Technologies Corporation............... 3,164,359
Genentech, Inc................................ 3,130,758
Phillips Electronics N.V...................... 2,831,785
TRW Inc....................................... 2,699,050
-----------
$55,370,781
===========
</TABLE>
<TABLE>
<CAPTION>
Sales Proceeds
- ----- -----------
<S> <C>
S&P 500 Index Put Option Dec98/1175........... $13,971,770
S&P 500 Index Put Option Dec98/1150........... 8,150,531
Aetna Inc..................................... 5,900,762
Minnesota Mining and Manufacturing
Corporation................................. 3,514,264
General Mills, Inc............................ 2,797,595
Fortune Brands, Inc........................... 2,783,065
Harnischfeger Industries, Inc................. 2,699,067
-----------
$39,817,054
===========
</TABLE>
BAKER FENTRESS AT A GLANCE
Baker, Fentress & Company, a domestic equity closed-end fund listed on the New
York Stock Exchange (Symbol: BKF), invests for total return with an emphasis on
capital appreciation. The Company's portfolio of publicly-traded securities is
managed by John A. Levin & Co., Inc., a wholly-owned subsidiary. The balance of
the portfolio is internally managed by the Company's officers under the
supervision of its board of directors. The business of the Company was started
in 1891.
The Company's portfolio includes:
. Publicly-traded companies with focus on long-term appreciation and capital
protection.
. Illiquid private placements and controlled affiliates with higher risk but
greater potential for growth.
. Long-term investments with significant unrealized appreciation.
SELECTED DATA
As of September 30, 1998
<TABLE>
<CAPTION>
<S> <C>
Total net assets................. $754,442,871
Net investment income (YTD)...... $ 13,433,498
Net realized capital gain (YTD).. $ 89,113,551
Unrealized appreciation.......... $144,283,204
Shares outstanding............... 37,450,610
Per Share
Net asset value................ $ 20.15
Market price................... $ 16.3125
</TABLE>
Baker, Fentress & Company | Third Quarter Report 1998 9
<PAGE>
DIRECTORS AND OFFICERS
BOARD OF DIRECTORS
Frederick S. Addy
Bob D. Allen
Jessica M. Bibliowicz
Eugene V. Fife
J. Barton Goodwin
James P. Gorter
David D. Grumhaus
Jeffrey A. Kigner
John A. Levin
Burton G. Malkiel
David D. Peterson
William H. Springer
Dean J. Takahashi
OFFICERS
James P. Gorter Chairman of the Board
John A. Levin President and Chief Executive Officer
James P. Koeneman Executive Vice President and Secretary
Scott E. Smith Executive Vice President
Julie A. Heironimus Treasurer and Assistant Secretary
10 Baker, Fentress & Company | Third Quarter Report 1998
<PAGE>
Baker, Fentress & Company | Third Quarter Report 1998 11
