The Oakmark Int'l Small Cap Fund

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

THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK INTERNATIONAL SMALL CAP FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (7/31/97) AS COMPARED TO THE MORGAN STANLEY WORLD EX U.S. INDEX
7/31/97 NAV $12.76	Total Return Last 3 mos.	Average Annual Total Return* Through 7/31/97 From Inception 11/1/95
The Oakmark Int'l Small Cap Fund	9.1%	17.5%
Morgan Stanley World ex U.S. w/inc**	14.4%	15.8%
Lipper Analytical International Fund Average**	14.2%	21.2%
Micropal Int'l Small Co Fund Index**	11.1%	16.9%
* 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 30 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.

FELLOW SHAREHOLDERS:

Since your Fund's inception, The Oakmark International Small Cap Fund has achieved an average annual return of 17.5 percent, compared to 15.8 percent and for the Morgan Stanley World ex US and 16.9% for the Micropal Intl Small Co. Fund indices, respectively. For the third quarter ended July 31, 1997, the Fund achieved a return of 9.1 percent, compared with returns of 14.3 percent for the Morgan Stanley World ex US and 11.1 percent for the Micropal International Small Cap indices.

This year has produced a nice rally for many bourses (stock exchanges) around the world, though small cap companies have not really participated to the same extent as the larger caps. While we think it's nearly impossible to predict the timing of when price and value will converge for these companies, we are confident in the attractiveness of their long-term prospects.

LONG-TERM BULLISH

When we open this letter by saying "Fellow Shareholders", we mean it. We, the portfolio managers, are among the largest shareholders of The Oakmark International Small Cap Fund. We firmly believe that small cap stocks overseas can generate tremendous returns for the patient investor. When we are looking at potential investments for the Fund, we do so on a three to five year time horizon, and ask our fellow shareholders to do the same.

In many markets around the world a wide divergence in valuation has emerged between smaller and larger companies. Currently, Germany is a good example of a market in which large caps have significantly outperformed small caps and where the current valuations of the DAX30 companies look rich relative to their smaller German counterparts.

In past quarterly letters for The Oakmark International Fund we've written about some of the inefficiencies we've found in foreign markets that we feel we can exploit as long-term investors. Some of these inefficiencies are even more apparent in the small cap area. Below are three characteristics of many overseas markets which create short-term inefficiencies.

Lack of Coverage by Sell-Side Analysts - Most brokerage firms limit analyst coverage to those companies in which investors have shown significant interest--usually companies with a large share turnover. This leaves the majority of small-cap companies with spotty, if any coverage. This lack of exposure sometimes allows big gaps between the current share price and underlying value. It is within this group of smaller names which fly under the broker's radar that we spend most of our time looking for attractive investments.

Lack of Information - Investors who rely upon databases and third-party sources for information have a hard time investing in many overseas small caps. Data can be incomplete, untimely, and often inaccurate. This is one reason why we believe it so important for our team to spend 30-40 percent of our time on the road. We don't like to rely on others, so we go directly to the source to get information. Not only do we discuss long-term strategic and financial plans with management but we also spend a good deal of our time talking to managers in order to gain a thorough understanding of the company's financial statements and accounting policies.

Top-Down Turbulence - When macro-oriented investors bail out of foreign markets, they typically sell everything -- good, bad, and indifferent. These investors usually sell because they believe that over the next few quarters the macroeconomic environment will not be conducive to attractive equity returns. They hope to buy back in later when things start looking better. The limited liquidity in some of these markets further exacerbates the selling pressure from these investors. We, on the other hand, are more concerned about the next 3 to 4 years rather than the next 3 to 4 quarters, and we think our patience gives us an edge. When we see good companies being beaten down for short-term macroeconomic reasons, we see potential long-term buying opportunities.

TOP THREE HOLDINGS

The best evidence of the value we are finding around the world is in our top holdings. As you know, we believe in making our most undervalued ideas very substantial portfolio positions. This way they have maximum impact on the Fund's NAV. Here are brief summaries of your Fund's top three holdings as of July 31, 1997:

Lambert-Fenchurch (5.5% of portfolio) - This company is a medium size, specialty insurance broker based in the United Kingdom. The company's dividend yield of 8.2% exceeds its 1997 price-earnings ratio of 7 times. Lambert-Fenchurch should be able to grow both earnings and dividends further as they take advantage of their recent combination of businesses. Further, as in the case of Sedgwick, a holding in The Oakmark International Fund, the insurance brokerage business is near a cyclical bottom.

Enix (4.6% of portfolio) - This Japanese software developer was given a lengthy feature in our last quarterly letter. In sum, it is an extremely cash generative, high return business managed by fellow shareholders. Enix is currently trading in the market at a significant discount to its intrinsic value.

JCG Holding (3.9% of portfolio) - This Hong Kong based consumer finance company is soundly managed and has moderate loan growth, high capital ratios and extremely low default rates (no repo man needed here!). It has recently gotten into the taxi financing business, which should provide additional growth. At 10 times this year's earnings it represents a bargain.

The beauty of all of this is that we believe we have a portfolio full of such undervalued companies and we should be able to find more. Clearly, we expect that the patient investor will prosper!

DAVID G. HERRO
Portfolio Manager
72242.772@compuserve.com

MICHAEL J. WELSH
Co-Portfolio Manager
102521.2142@compuserve.com
August 5, 1997

Notes:

(a) Non-income producing security.

(b) Represents an American Depositary Receipt.

(c) Includes transaction hedges.