THE OAKMARK INT'L SMALL CAP FUND

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

We are pleased to announce that Michael Welsh, co-portfolio manager of The Oakmark International Fund, has succeeded Adam Schor as the co-manager of this Fund. This coincides with Adam’s leaving Harris Associates to pursue new opportunities. We want to thank Adam for his valuable contribution to The Oakmark Family of Funds.

Since your Fund’s inception, it has returned on an annualized basis 13.9%. This quarter, your Fund was up 0.1% as compared to 2.2% for the Morgan Stanley World ex U.S. and 2.8% for the Lipper Analytical International Fund Index.

We’re happy with the record of this Fund. But, this year, some shareholders have asked us why it is lagging The Oakmark International Fund.

There is no one answer. Each Fund invests in different types of stocks. This Fund focuses on small companies while Oakmark International tends to buy medium and large-sized firms. Recently, larger international companies have performed better than the smaller names. This happens from time to time, and we don’t get concerned about any short-term deviation in performance. The season is young and both Funds have good stocks. (We introduce a new one below.)

As we have said before, our portfolio of small companies consists of well managed businesses at unbelievable prices. As more capital goes overseas and stock investing becomes more global, these values will not remain undiscovered.

Small companies in general can be great opportunities. Being small makes growth easier. Sometimes it takes just one new contract for a small company to dramatically increase sales and profits. Small firms are often more flexible and so can act more quickly than their larger counterparts. They can be more innovative and nimble and can take advantage of niches. They can be more responsive to changing customer needs or market conditions. Sometimes the best industry for a small firm is one with a few large established players. These behemoths are often predictable, slow to react and too fixed in tradition to recognize a new competitor.

We believe in the fundamentals of our firms and certainly the values. Over time, that’s all that matters. We are confident that our portfolio of stocks will produce the returns they should.

LET'S LOOK AT A NEW ADDITION TO OUR PORTFOLIO.

One of our largest positions is Enix, a major developer of game software in Japan. Enix offers everything we like to see before investing in a company. We often mention our difficulty in finding appropriate investment opportunities in Japan. Here’s an exception and an example of how we focus on companies, not countries.

Management runs the business well.

Enix is one of Nintendo’s most important software suppliers, giving Enix the chance for good profitability on titles. The company recently increased its revenue potential by developing software for Sony PlayStation, the game platform with the largest installed base in Japan. Enix’s entertainment publishing business also provides high returns and diminishes somewhat the cyclical nature of the game software business.

Management focuses on increasing the equity value of the firm.

Enix’s management spends money wisely and focuses on return on capital. Part of the reason for this focus is that company president and founder Yasuhiro Fukushima and his family own more than 60% of the firm. After Japanese regulations changed, Enix was one of the first companies to announce a buy back program.

The underlying business is highly cash generative.

Software development and publishing produce excellent free cash flow. The revenues of the game business are cyclical because of the delays between new game introductions, yet Enix’s flexible cost structure (and its other publishing businesses) allows it to generate excess cash even in the tough years.

Enix’s stock is cheap.

We calculate that we’re paying less than five times normal operating profit and less than one times revenue for a high return business whose managers are on our side. A cheap price. Despite using some cash to buy back six percent of its shares, Enix still has one-third of its market capitalization as cash in the bank.

DAVID G. HERRO
Portfolio Manager
72242.772@compuserve.com

MICHAEL J. WELSH
Co-Portfolio Manager
102521.2142@compuserve.com

*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 or funds whose composition is different from the Fund. The Morgan Stanley World ex U.S. Index includes 19 country sub-indexes. The Lipper International Fund Average includes 106 mutual funds that invest in securities whose primary markets are outside the United States. The Micropal Int'l Small Co Fund Index sector average is an unweighted index comprised of all funds within the International Small Company Fund sector. Past performance is no guarantee of future results.

THE OAKMARK INT'L SMALL CAP FUND

International Diversification—April 30, 1997

THE OAKMARK INT'L SMALL CAP FUND

Schedule of Investments—April 30, 1997 (Unaudited)