THE OAKMARK INTERNATIONAL FUND

Report from David G. Herro and Michael J. Welsh, Portfolio Managers

Your Fund gained 8.7% in the first quarter of our new fiscal year, well ahead of the Lipper international average gain of 5.8% and the Morgan Stanley World ex US index loss of -0.5%.

We are happy to report that your Fund was one of the best performing diversified international funds for the 1996 calendar year. The Oakmark International Fund was up 28% in 1996 versus the 11.8% return for the average international fund. This performance ranked fourth out of the 331 international funds tracked by Lipper Analytical Services. Ranked fifth was The Oakmark International Small Cap Fund (formerly known as The Oakmark Int’l Emerging Value Fund), with a 1996 return of 25%. We are proud of having two of the top five international funds, especially given the lack of overlap in stocks between the two portfolios.

In general, overseas markets had a better than average year in 1996. Many foreign markets, especially in Europe, have hit or are around new highs. Most importantly, we are still finding new ideas which meet our disciplined criteria.

Best of and Worst of Revisited

Many of you have written or spoken to us about how much you enjoyed David Herro’s 1995 quarterly letter entitled “The Best and Worst of ...”. So, we have decided to try it again by adding a few new categories to the ones David mentioned in 1995.

Most Promising Markets for the Year Ahead: Many shareholders ask us which will be the best equity markets in the year ahead. As you know, we don’t try to predict these things based on macroeconomic forecasts—we spend our time trying to find cheap companies. And of course, just because we are finding value in a particular market does not mean it will necessarily be a good performer in the short term. But one constant to our approach is to give extra scrutiny to markets which have underperformed, searching for stocks which meet our criteria. In developed markets in 1996 the underperformers were Japan, Switzerland, and Austria. In developing markets Thailand, Korea, Chile and India were the laggards last year.

Worst Traffic Congestion: When on the road visiting companies we spend a great deal of time in cars and taxis. Much more time than we would like. As countries become more affluent traffic problems seem to grow at a geometric rate. Our opinion of the worst cities for traffic are: 1) Bangkok, Thailand (watch the motorcycles!!); 2) Seoul, Korea; and 3) Mexico City, Mexico (can you actually drive on the grass?). Coming up fast (slow?) on the outside is the German autobahn, where the huge influx of cross-border traffic from the West, the South, and especially the East is prompting the German government to think long and hard about instituting user fees for these important European arteries.

A corollary to the above category is Worst Drivers, with our nominees: the drivers in India where the motto is “honk first, brake second” and Korea where the number of lanes flowing north or south on major streets changes minute-by-minute depending on the aggressiveness of the respective drivers.

Best Subway/Train Systems: A good, reliable train system is a real time saver and a huge help in visiting companies off-the-beaten path. The best: Japan whose system is extraordinarily efficient and very clean. It has amazing coverage and up-to-the-minute service information, but is enormously expensive. Switzerland is second, where its train system is the best and only bargain in the country. Hong Kong comes in third with special mention to the beloved Star Ferry. Fourth is the European ICE/TGV. These are German and French bullet trains which fly you to your next destination without the hassle of an airport. Fifth is the Paris Metro, which is a wonderful system when the workers are not on strike—efficient, cheap, and good coverage.

Best Place to Buy Knockoffs: First, Chinatown in Kuala Lumpur, Malaysia. Second, the tables nestled amidst the gogo bars in Patpong, Bangkok, Thailand. And third, the incredibly mobile carts that line the sidewalks in Iteowon, Seoul, Korea, but take care not to get trampled—they pack up and go hurtling down the sidewalk at the first whiff of trouble.

Most Popular KnockOffs: Based on personal observation, these are fake (“original copies”) Rolex and Breitling watches and brand name casual shirts. For the patient negotiator, the prices can be extraordinarily low.

Best Airports: Efficiency and a place to sit and work are all we ask for in an airport. The best at delivering: 1) Schipol, Amsterdam; 2) Singapore; 3) Kansai Airport, near Osaka, Japan; 4) Hong Kong (landing at night here is one of the world’s greatest amusement park rides).

Worst Airports: Unfortunately there are more candidates for this award than the previous. The winners: 1) Kimpo, Seoul, gives you the feeling upon arrival that you are going through a prison orientation complete with armed guards; 2) Taipei, Taiwan, except for the physically fit who don’t mind standing during a two hour layover; 3) Narita, Tokyo (unless you are flying JAL); 4) Manila, Philippines (do you really NEED your luggage?); and 5) Heathrow, London.

Most Expensive Cities: 1) Zurich, Switzerland (that five-minute cab ride was HOW much?!); 2) Vienna, Austria; 3) Tokyo, Japan; 4) Buenos Aires, Argentina; 5) Brussels, Belgium (that new EU directive will cost European businesses HOW much?!).

Most Reasonably Priced Cities: 1) Budapest, Hungary; 2) Istanbul, Turkey (stunning, exotic beauty, great food); 3) Mexico City, Mexico (not expensive even before the devaluation); 4) Caracas, Venezuela; 5) Kuala Lumpur, Malaysia (the oversupply of new hotel rooms doesn’t hurt).

Best Prediction of 1996: David’s—that the Green Bay Packers would win the Super Bowl.

David G. Herro

Michael J. Welsh
Portfolio Managers
72242.722@compuserv.com
oakix@aol.com
January 31, 1997

*Total return includes change in share prices and in each case includes reinvestment of any dividends, interest and capital gain distributions.

**Each of the three indexes or averages is an unmanaged group of stocks whose composition is different from the Fund. The Morgan Stanley World ex U.S. Index includes 19 country subindexes. The Morgan Stanley EAFE Free Index refers to Europe, Asia and the Far East and includes 18 country subindexes. The Lipper International Fund Average includes 106 mutual funds that invest in securities whose primary markets are outside the United States. Past performance is no guarantee of future results.

THE OAKMARK INTERNATIONAL FUND

International Diversification—January 31, 1997

THE OAKMARK INTERNATIONAL FUND

Schedule of Investments—January 31, 1997 (Unaudited)

Notes: (a) Nonincome producing security.

(b) Represents an American Depositary Receipt.

(c) Includes portfolio and transaction hedges.