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 (9/30/99) AS COMPARED TO THE MSCI WORLD EX U.S. INDEX
9/30/99 NAV $12.64	Total Return Last 3 mos.	Average Annual Total Return* Through 9/30/99 From Fund Inception 11/1/95
The Oakmark International Small Cap Fund	0.8%	11.7%
MSCI World ex U.S. w/inc.**	4.3%	11.1%
Lipper International Small Cap Fund Average**	9.1%	15.1%
Micropal Equity International Small Cap Index**	9.7%	15.1%
*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 MSCI World ex U.S. Index includes 21 country sub-indexes. The Lipper International Small Cap Fund Average includes 70 mutual funds that invest in securities whose primary markets are outside the United States. The Micropal Equity International Small Cap Index 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,

Over the last fiscal year, The Oakmark International Small Cap Fund achieved a return of 88.0%, smashing the MSCI World ex U.S. Index which was up 31.3% and the Lipper International Small Cap Average which was up 47.2%. The Fund posted a return of 0.8% for the quarter ending September 30. This compares with returns of 4.3% and 9.1% for the MSCI World ex U.S. Index and the Lipper International Small Cap Average respectively. Since inception, your Fund has averaged 11.7% per annum which compares to 11.1% for the MSCI Index and 15.1% for the Lipper Average.

A QUIET QUARTER

After some volatile price movements over the last few years, this quarter was a quiet one. Our star performers continue to be located in the Pacific Rim. Ichiyoshi Securities, based in Japan, added close to 2.5 percentage points of return. Ichiyoshi is a regional brokerage firm that continues to benefit from the pick-up of stockmarket activity. JCG Holdings, a Hong Kong based consumer credit company added over 1 percentage point to return. It continues to improve its business as the Hong Kong economy lifts out of recession.

On the negative side, a couple of our newer positions have hurt. Reinsurance Australia cost the Fund almost 1.5% as an abundance of natural disasters hit the insurance industry very hard. "ReAC" is a smaller reinsurer with a new, more profit-focused Managing Director; even after losses from increased claims, the current share price is at less than half of book value. We have used the short-term price weakness to add to our position. Dylex, a Canadian retail company, cost the Fund 1.3%. We have sold this company because we have lost faith in the company's management team. Though the stock is cheap on paper, the company was performing differently than expected and we were unable to ascertain why after numerous discussions with management.

The last point above highlights a part of our philosophy that merits expansion. Though we are dogmatic value investors, we will never invest in a company that either has consistently impaired value or starts to do so after we have invested in them. Part of our due diligence is to examine a management's past record. We also continue to monitor them while we own the investment. If things change, like with Dylex, we will not hesitate to sell the stock.

WHY AND WHY NOT TO INVEST IN OAKEX

As many of you may have noticed, The Oakmark International Small Cap Fund (OAKEX) has had a great 1-year run. Though we are heartened by the returns, keep in mind, past performance is no reason to invest in a mutual fund. In fact, we strongly discourage "momentum" traders for this is a fund for long-term investors. As you have noticed, we instituted a redemption fee, payable to the Fund, for those traders who leave the Fund in less than 90 days. The people who frequently trade in and out hurt those who truly invest for the long term by creating volatility in our cash position. We are confident that a 2% redemption fee will solve this problem.

Though the Fund's performance has been strong, we continue to feel quite confident that there is significant long-term investment potential within our portfolio. The Fund is full of high quality, undervalued companies. House of Fraser, for example, is a UK-based department store company that yields 7% and has a normal P/E of 5.5 times earnings. In fact, we love it when the sustainable yield is greater than the normal p/e, as in this case! Fletcher Building is a New Zealand-based building materials company that could be one of the cheapest of its kind in the world. It has high quality assets, huge market positions and its main market is in a cyclical trough. Fletcher has a normal p/e of about 7 times earnings and yields almost 8%. We are happy to say that we have an entire portfolio of good quality, value stocks that should provide us with great returns going forward.

THE WORLD IS LOOKING UP!

Over the history of the Fund, short-term crises have often provided us with the opportunity to invest in quality companies at extremely low prices. Today, though, the world seems to have stabilized. Asia is growing again and even Europe seems to be showing signs of life. This may well mean that though it will be harder to find "fire sales," the operating environment will be more conducive for smaller companies to grow. This invariably means more growth in earnings, cashflow and usually shareholder value. As two of the Fund's largest shareholders, we remain enthusiastic about the prospects of our small companies and look forward to their future performance.

DAVID HERRO
Portfolio Manager
dherro@cs.com

MICHAEL WELSH
Portfolio Manager
102521.2142@compuserve.com
October 8, 1999
 

THE OAKMARK INTERNATIONAL SMALL CAP FUND International Diversification—September 30, 1999