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 (12/31/97) AS COMPARED TO THE MORGAN STANLEY WORLD EX U.S. INDEX
12/31/97 NAV $8.09	Total Return Last 3 mos.	Average Annual Total Return* Through 12/31/97 From Fund Inception 11/1/95
The Oakmark International Small Cap Fund	-23.9%	-1.7%
Morgan Stanley World ex U.S. w/inc.**	-7.7%	7.4%
Lipper Analytical International Small Cap Fund Average**	-9.1%	7.0%
Micropal International Small Co. Fund Index**	-10.0%	7.2%
*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 indexes 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 Small Cap Fund Average includes 48 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:

December 31, 1997 marked the end of a trying year for international mutual funds, particularly international small-cap funds. In general, European large cap stocks outperformed small caps while the world witnessed the Asian markets tumble. Keeping in mind these factors, coupled with the fact that Asian holdings comprise 37 percent of The Small Cap Fund's portfolio, The Oakmark International Small Cap Fund, was down 19.9 percent for the calendar year 1997.

ASIAN TURBULENCE

The collapse of confidence in Asia was the big story of 1997. Given our weighting in the region, performance of the Fund suffered accordingly. While Australia and New Zealand held up relatively well, currency and equity markets of emerging Asia plunged. The declines in the second half of the year in some of these markets were unprecedented: Indonesia, -75 percent, Thailand, -63 percent, the Philippines, -55 percent, and Korea, -72 percent, all in U.S. dollars terms.

The developed markets of Asia were also big global underperformers. Japanese small caps, one of the Fund's biggest weightings, were down 40 percent for the year, as measured by the JASDAQ and Nikkei OTC markets, significantly underperforming Japanese large caps which were down 20 percent. Hong Kong, another large weighting in the Fund, was down 28 percent for the period.

Asia will continue to be volatile in 1998, but now that markets have collapsed, the real question investors should be asking is: Are all the negatives factored into current share prices? For the companies your Fund owns, we believe the answer is a resounding "YES''.

We want to review 1997 by detailing the specific investment ideas which had the biggest impact on the performance of the Fund—The year's biggest winners and losers.

THE WINNERS . . .

Our discipline and long-term orientation paid off with our investment in Grupo Herdez, up over 150% for the Fund. We purchased shares of Grupo Herdez as low as 1.8 Mexican Pesos in mid-1995 while Mexico was still out of favor with most investors. The Fund's position was sold earlier in the year at around 6.0 Mexican Pesos after having hit our sell price target.

The success of Grupo Herdez two years after Mexico's devaluation is a good lesson to remember in light of the current disarray in Asian markets. In 1995 Wall Street strategists were uniformly bearish about the medium and long-term prospects for Mexico (and Argentina as well); both markets have come roaring back. It is important to remember that the pendulum of sentiment swings too far from reality on both the positive and the negative extremes—this is a phenomenon that helps create undervalued opportunities for long-term investors.

Another winner was Tower Semiconductor of Israel, which rebounded strongly from a poor 1996. The investment returned over 30% for the Fund before reaching its sell target earlier in the year.

The share price of Taittinger surged 100% in 1997. The market awakened to the undervaluation of this French holding company with interests in hotels, real estate, and champagne. For the past few years the lack of sell-side analyst coverage contributed to a wide gap between underlying asset value and market value. This gap was largely closed during the year.

Techtronic Industries performed well, returning over 40% for the Fund in a difficult Hong Kong market. The shares have reached their price target and have been sold.

In the UK, Vardon did well both operationally and from a share price perspective in 1997, up 45% for the Fund.

Surprisingly, a Korean company provided the Fund's largest positive price movement, Daehan Flour Mills. Up 150% before being sold, Daehan is a perfect example of the potential in overseas small cap markets to exploit inefficiencies using independent research and due diligence.

AND THE LOSERS . . .

A number of stocks cut into the Fund's performance this year, all of them located in Asia. Two of the worst were from Korea, Woon Jin Publishing and Chosun Brewery, down 70% and 80%, respectively, including the 50% decline in the value of the Korean Won. Woon Jin, a publisher of mainly educational materials, remains one of our favorite ideas for its strong free cash flow, modern management and extremely cheap valuation. Chosun Brewery has a dominant market position and brand-new production facilities, and would make an ideal partner for any foreigner wanting to enter the newly-opened Korean market.

In Japan, discount liquor retailer Daimon was a very poor performer, dropping over 60% for the Fund in US dollar terms. Trading as high as 6,000 Yen last year, we started to buy around 650 Yen when its market value was at a slight premium to the net cash on the Company's balance sheet. As it sometimes happens when buying out-of-favor shares, we were early. Daimon currently trades at a discount to its net cash, has attractive long-term growth potential and remains extremely undervalued by any measure. We have continued to add to our position.

Hong Kong consumer financier JCG Holdings was down 55%, punished along with the entire financial sector on fears of a devaluation of the HK Dollar, followed by fears of emerging credit problems due to higher than historical interest rates. The Company is extremely well-placed to weather any short-term economic slowdown due to its overcapitalized balance sheet and proactive, shareholder-oriented management.

We met with a great number of Thai companies this year on three separate trips. To date, because of heavy debt loads and still too high share prices, we have not found many companies that we think give us a proper return in light of the risk. The one exception is Matichon, the dominant Thai language newspaper group, which was down 60 percent from our first purchases in January. We continued to purchase this stock throughout the year. With a sound balance sheet, conservative management, and an excellent franchise, we remain enthusiastic that the company will be a rewarding investment over the medium- to long-term.

PROSPECTS FOR 1998

Looking at the geographic allocation of the Fund as we enter 1998, Europe remains a large regional weighting with a number of undervalued situations, especially in the United Kingdom. Even though German large caps have had an excellent two year run, we still find value in the smaller caps in our portfolio.

The Pacific Rim makes up most of the rest of the Fund's assets, with large weightings in Australia, New Zealand, Japan, Hong Kong and Korea. We will continue in 1998 to devote analytical resources to finding undervalued companies in these depressed markets.

DAVID G. HERRO
Portfolio Manager
72242.772@compuserve.com

MICHAEL J. WELSH
Co-Portfolio Manager
102521.2142@compuserve.com
January 8, 1998

% of Fund Net Assets				% of Fund Net Assets
	Pacific Rim	46.2%			Europe	44.2%
	Japan	12.7%			Great Britain	18.3%
	New Zealand	9.0%			Germany	5.3%
	Hong Kong	7.6%			Italy	4.7%
	Australia	6.8%			Turkey	4.4%
	Korea	5.5%			Netherlands	4.1%
	Thailand	2.7%			France	3.8%
	Philippines	1.9%			Ireland	3.6%
	Latin America	4.6%			Other	2.8%
	Brazil	4.6%			Canada	2.8%

(a) Non-income producing security.