THE OAKMARK INTERNATIONAL FUND

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

Your Fund continues to deliver significant results. Our second quarter return of 6.2% compares favorably to the Morgan Stanley EAFE index return of 2.5%. More importantly, your Fund has achieved an annualized return of 17.8% since inception. This compares to a 10.8% return for EAFE and a 13.3% return for the Lipper average of diversified international funds. We continue to find excellent long-term investment opportunities overseas and believe that the long-term prospects of international markets are extremely attractive.

TO ANSWER A FEW QUESTIONS…

On occasion we like to use this space to directly address recent commonly asked questions about the Fund.

Q. What is the reason for the Fund’s strong performance?

A. We believe we have done well because of our disciplined approach to value investing. Discipline to us means doing thorough research, visiting countless companies, keeping composure in weak markets and buying stocks that are out of favor for short-term reasons.

Q. Why not invest in Russia?

A. Though Russia appears to offer value for long-term holders, at this time there is not the legal or regulatory framework in place to protect foreign investors. While the market’s potential reward could be large, constantly changing laws and taxes, lax (non-existing) corporate governance procedures and the strong influence of organized crime stand in the way of realizing this reward.

Q. What will happen to Hong Kong after June 30th?

A. One can only speculate as to what changes face Hong Kong as its sovereignty changes from British to PRC. However, confidence remains strong and long-term benefits will most likely overpower the short-term transitional strains. The real key is the strength of the Hong Kong people and their ability to adapt to change. They are excellent business people for the most part and we feel they will be able to aptly respond to the change. At the same time, China is a huge investor in Hong Kong, so it is in China’s own financial interest not to rock the boat. Finally, southern China, itself, has also been a capitalist hotbed of economic growth. There is a good possibility that, over time, the rest of China will become more like Hong Kong and the South than the reverse.

Q. How do you come up with stock ideas?

A. We spend the majority of our analytical time searching for companies that meet our value criteria. One recurring place we look for candidates is among companies hitting new lows or that have underperformed their respective stock markets. We also give extra attention to searching for ideas in markets that have been weak. If a company looks interesting from a quantitative standpoint, we then like to meet management and gather other qualitative information about the company. If, after all of this, we decide the company represents good value and is managed by people committed to building value, we will put the stock on our buy list.

Q. Where are your favorite areas to invest?

A. We don’t have any favorite “areas.” We base our investment selection only on companies. It does not matter to us where a company is located or in what industry it does business (although we require proper legal and regulatory protection, as mentioned above with Russia). We seek only companies that are inexpensively priced (the lowest price for the amount of cashflow generation) and that are managed by people who allocate the company’s surplus capital in a way beneficial to owners.

Q. Are you still hedging currency? What impact does the dollar’s rise have on the Fund’s performance?

A. We are still partially hedged, but are slowly unwinding our currency hedges. Our policy has always been to use currency hedging defensively. We hedge only when we believe that a wide divergence between the U.S. dollar and the local currency presents an undue currency risk for the Fund in holding an equity position. With the recent appreciation of the dollar, most of this unsustainable divergence has been erased.

There are two ways the dollar’s rise impacts your Fund’s performance–one short term and one long term. In the short run, as the dollar increases and foreign currencies fall, your Fund’s net asset value drops to reflect this. However, if your Fund is partially hedged, some of this “loss” would be offset through the increased value of the hedges. In the longer term, foreign stocks usually do better in weak home currency environments as many compete against U.S. companies and many have U.S. dollar or dollar-linked revenues that become larger when translated back into their local currency.

In the long term, we generally feel a strong dollar is a net positive for those who invest internationally. It is probably one of the reasons why both the European and Japanese stock markets appear to have awakened.

Q. Still underweight in Japan… why?

A. Remember that we invest in companies only if we see value and managers who care about shareholders’ interests. Though we have found some companies in Japan that fit our criteria, it has been difficult to find them. The big problem is usually a lack of management commitment to building shareholder value.

Things appear to be getting better in terms of greater shareholder orientation in Japan. Driven by deregulation in financial services and widening pension shortfalls, even domestic financial institutions are starting to put pressure on company managements to enhance returns. And surprisingly, a few dozen companies have started share buyback programs (we own one of them in Oakmark International, Amway Japan) as a way of returning surplus capital to the owners. Hopefully, this is the beginning of a trend which will result in victory for the much beleaguered shareholders of Japanese companies.

That’s it for now. Hope this answered some of the questions you had regarding The Oakmark International Fund. And, as always, you can e-mail us at the addresses listed below.

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 Morgan Stanley EAFE Free Index refers to Europe, Asia and the Far East and includes 18 country sub-indexes. 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—April 30, 1997

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THE OAKMARK INTERNATIONAL FUND

Schedule of Investments—April 30, 1997 (Unaudited)

Notes:
(a) Non-income producing security.
(b) Represents an American Depositary Receipt.
(c) Includes portfolio and transaction hedges.
(d) At April 30, 1997, net unrealized appreciation of $143,361,460 for federal income tax purposes consisted of gross unrealized appreciation of $201,449,089 and gross unrealized depreciation of $58,087,629.
(e) See footnote number five to the financial statements regarding transactions in securities of affiliated issuers.

See accompanying notes to financial statements.