The Oakmark International Small Cap Fund

THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK INTERNATIONAL SMALL CAP FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (3/31/99) AS COMPARED TO THE MORGAN STANLEY WORLD EX U.S. INDEX
3/31/99 NAV $10.74	Total Return Last 3 mos.	Average Annual Total Return* Through 3/31/99 From Fund Inception 11/1/95
The Oakmark International Small Cap Fund	24.6%	8.3%
Morgan Stanley World ex U.S. w/inc.**	1.6%	10.6%
Lipper Analytical International Small Cap Fund Average**	5.0%	10.6%
Micropal International Small Co. Fund Index**	5.3%	10.4%
*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 69 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,

We are pleased to report that The Oakmark International Small Cap Fund has produced a return of 24.6% for the first quarter of 1999. This compares very favorably to our peers, which on average returned around 3%. The Morgan Stanley Small Cap World ex-US index returned 2.8%. This performance is a continuation of the strong rebound from a weak period, which ended in the third quarter of 1998.

Since the end of the one-year "drought" in September, 1998, your Fund is up over 59%. Though this rate of appreciation is not sustainable, we remain very enthusiastic about the future of this Fund and the underlying value.

DEATH TO DIVERSIFICATION???

On a recent trip to the west coast of the U.S., we met with investment advisors to discuss the great opportunities we are finding for our international funds. While our remarks were well received, the advisors were not eager to invest. Why? Because, we were told, their clients, now are only interested in what has been hot over the last few years—U.S. big cap, growth and technology stocks. We warn our clients against this type of thinking. Remember, past performance is not always a good indicator of future performance.

A rowboat capsizes when all of its passengers lean in the same direction and we have seen the same happen in investment markets. When the majority of investors flee from emerging markets, foreign markets, U.S. small caps and U.S. value stocks, long-term investors should start investigating opportunities. Do not fall into the trap of investing in an asset class because it has performed well in the recent past or because everyone else is doing it.

As shown by our Fund's recent performance, recovery can happen when it is least expected. We are constantly asked about our short-term market outlook, and our answer is always the same: we gauge our optimism about future prospects solely on the values we are finding in the markets. As value investors, we are convinced that price and value converge in the long run, but it is the timing that is often uncertain. Based on the value of companies in the portfolio today, we are extremely optimistic that long-term investors will do well.

"SCARY" EMERGING MARKETS?

Another theme in the investment world today is that it is the riskiness of investing in emerging markets. This line of thinking completely ignores a factor near and dear to our hearts: PRICE. In the maximum bullishness of 1993, prices told you that market growth was limitless. In the days of extreme pessimism in 1997-98, share prices implied that markets in Asia and Latin America would never grow again. What do current share prices tell us about expectations? Emerging markets went from "dot.com" euphoria status to shunned pariah in five years. Investors must remember that it is the price you pay for a business that is the biggest determinant of the risk you are taking.

As we have written before, the destruction in the emerging markets over the past two years has produced some extremely positive long-term changes, the most important of which is that these markets are now more open than ever and less controlled by political powers. The extremely attractive long-term demographic trends and growth opportunities are still intact—companies can now take advantage of these opportunities from a more solid, sustainable base. And, best of all, we can still buy these companies at fractions of what they were selling for five years ago!

It is important to note, as we have in the past, that the share prices of many emerging market companies (especially in Asia) deserved the beating they took. Poor underlying businesses, bad balance sheets, and weak management are some of the reasons. It is our job as analysts to find the ones that did not deserve it.

One of your Fund's largest holdings, Haw Par, is one such company. It is a holding company that has some leisure businesses but is best known for its analgesic rub, "Tiger Balm" (we encourage you to try it for aches and pains—it works). Its largest asset is a large stake in United Overseas Bank, one of Singapore's best run financial institutions (and a holding of The Oakmark International Fund). Though it appreciated in price over the last 6 months, UOB is still considerably cheaper than most European banks and, in our opinion, is a significantly better bank. It was not hoodwinked by BCCI, Russian government debt, Long-Term Capital Management or any of the other disasters du jour that European banks are so famous for collecting. And, even in a period of strong asset deflation, their loan loss experience has been very manageable. Even better for shareholders of International Small Cap, the large appreciation in UOB's share price has really yet to be recognized by the market in terms of Haw Par's share price.

LOOKING FORWARD

Despite the nice price appreciation the Fund has experienced in the past few quarters, we are still very excited about the values that have yet to be recognized. We appreciate your continued support.

DAVID G. HERRO
Portfolio Manager
72242.772@compuverve.com

MICHAEL J. WELSH
Portfolio Manager
102521.2142@compuserve.com
April 7, 1999

 

THE OAKMARK INTERNATIONAL SMALL CAP FUND International Diversification—March 31, 1999

THE OAKMARK INTERNATIONAL SMALL CAP FUND Schedule of Investments—March 31, 1999 (Unaudited)

(a) Non-income producing security.

(b) Represents an American Depository Receipt.

(c) Includes portfolio and transaction hedges.

(d) See footnote number five in the Notes to Financial Statements regarding transactions in affiliated issuers.

(e) At March 31, 1999, net unrealized appreciation of $3,178,401, for federal income tax purposes consisted of gross unrealized appreciation of $15,167,423 and gross unrealized depreciation of $11,989,022.