The Oakmark International
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 (9/30/97) AS COMPARED TO THE MORGAN STANLEY WORLD EX U.S. INDEX
9/30/97 NAV $12.20	Total Return Last 2 mos.	Average Annual Total Return* Through 9/30/97 From Fund Inception 11/1/95
The Oakmark International Small Cap Fund	-4.4%	13.1%
Morgan Stanley World ex U.S. w/inc**	-2.2%	13.1%
Lipper Analytical International Fund Average**	-1.3%	18.4%
Micropal International Small Co. Fund Index**	-1.7%	14.2%
*Total return includes change in share prices and in each case includes reinvestment of any dividends 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 inception, The Oakmark International Small Cap Fund has achieved an average annual return of 13.1%, compared to 13.1% and 14.2% for the Morgan Stanley World ex US and Micropal Intl Small Co. Fund indices, respectively. For the eleven-month fiscal year ended September 30, 1997, the Fund achieved a return of 11.1%, compared with returns of 13.8% and 13.8% for the Morgan Stanley World ex US and Micropal International Small Cap indices.

SMALL CAPS CONTINUE TO UNDERPERFORM THE BIG GUYS

While The Oakmark International Small Cap Fund has performed in line with similar international small cap funds this year, it has underperformed the Oakmark International Fund and the EAFE index. The primary reason is that share prices of large capitalization companies have continued to outperform those of small caps around the world. As a result we continue to see tremendous value in this sector.

One stark example of divergent performance is in the Japanese market. The Nikkei 225 index, the proxy for large cap stocks in Japan, is basically flat in local currency terms over the past five years. In contrast the smaller market indicies, the JASDAQ and the OTC, are both down around 30%. Most of this underperformance has taken place over the last twelve months: the Nikkei 225 is down 15% in local terms, while the JASDAQ and OTC indicies are down 40%.

We are seeing this divergence as a common pattern around the globe. As value investors with a long-term time horizon we can take advantage of the tremendous opportunities we see in some of these markets.

Our investment process and criteria are the same for The Small Cap Fund as in Oakmark International; it is simply a different investment universe. The vast majority of our holdings in The Oakmark International Small Cap Fund have a market cap below $500 million). And as we've frequently mentioned, the geographic allocation of the portfolio is simply a function of stock selection, not a top-down macroeconomic "bet". A good illustration of this point is the difference in the portfolio weightings of Japanese companies between Oakmark International with 4.0% of its portfolio in Japanese stocks and Oakmark International Small Cap with 9.5%. We have found more companies which meet our criteria in the small cap area than in the large cap area.

EXCELLENT LONG-TERM OPPORTUNITIES

The size of The Oakmark International Small Cap Fund is significantly smaller than that of The Oakmark International Fund. One of the advantages of the current asset size is the concentration we are able to achieve in our favorite ideas without incurring large trading costs (especially moving the share price when buying and selling). We are convinced that over a reasonable time horizon the prices of these companies will converge with their underlying value. We continue to believe that this fund has great potential to earn excess returns for shareholders.

ASIA WILL BE FINE...

Your fund has been adversely impacted by the instability which hit the Asian markets this summer and fall resulting in weaker Asian currencies and sharply lower share prices. Profligate credit expansion over the past few years helped fuel a property glut which has put tremendous strain on the financial sector of many East Asian markets. Also, the strength of the US dollar hurt the competitiveness of many countries which try to maintain a stable exchange rate.

Finally, some ill-timed comments made by Dr. Mahathir, leader of Malaysia, have shaken the confidence of foreign investors in the region. While these comments are very serious and shocking, his actions to date have been far less reactionary and have demonstrated an understanding of the importance in treating foreign investors properly.

From an investment perspective, many opportunities have surfaced in Asia. Any company that does not have foreign currency debt or foreign costs will be better able to compete and will eventually have higher profits. More reasonably priced currencies will benefit those Asian companies that are net exporters and also will benefit the tourist industry. These industries should then lead Asia to stronger macroeconomic growth. The "grass-roots" of the Asian economies are still strong and no major rehabilitation is needed. We believe that over the medium term there will be a strong recovery which will be reflected in share prices. Don't forget what happened in Latin America!!!

DAVID G. HERRO

Portfolio Manager
72242.772@compuserve.com

MICHAEL J. WELSH

Co-Portfolio Manager
102521.2142@compuserve.com

October 16, 1997

International Diversification—September 30, 1997

Schedule of Investments—September 30, 1997

See accompanying notes to financial statements.