THE OAKMARK SMALL CAP FUND Report from James P. Benson and Clyde S. McGregor, Portfolio Managers

THE VALUE OF A $10,000 INVESTMENT IN THE OAKMARK SMALL CAP FUND FROM ITS INCEPTION (11/1/95) TO PRESENT (9/30/02) AS COMPARED TO THE RUSSELL 2000 INDEX14
	Average Annual Total Returns4
	(as of 9/30/02)
	Total Return Last 3 Months*	1-year	5-year	Since Inception (11/1/95)
Oakmark Small Cap Fund	-22.01%	-3.23%	-3.02%	8.37%
Russell 2000	-21.40%	-9.30%	-3.19%	4.33%
S&P Small Cap 60015	-18.61%	-1.79%	0.82%	8.25%
Lipper Small Cap Value Index16	-18.83%	-0.33%	1.36%	8.49%
The graph and table do not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares.
Past performance is no guarantee of future results. Investment return and principal value vary, and you may have a gain or loss when you sell shares. Average annual total return measures annualized change, while total return measures aggregate change.
* Not annualized

The third calendar quarter of 2002 was the worst quarter for U.S. stocks since the fourth quarter of 1987. It is notable that the fourth quarter of 1987 included the October "Black Monday" stock market crash when the market lost over 20% in one day. Thankfully, the just concluded quarter lacked a major one-day catastrophe, but the cumulative pounding of stock prices over the weeks took a severe toll. We wish we could say we avoided this sharp downdraft, but we cannot. For the just concluded quarter, stocks slumped in value as the S&P 500 Index² fell by over 17% and the Russell 2000 Small Cap Index declined by more than 21%. Year-to-date the Russell 2000 is down by over 25%. Your Fund experienced a loss roughly in-line with the Russell 2000 of 22% during the last three months, bringing the year-to-date return to a loss of 18%. While we can report that our results thus far in 2002 are about 7% better vis-a-vis the Russell 2000, our absolute returns have been disappointing.

The Recent Past

Uncertainty concerning economic activity, terrorism, a possible war and corporate governance has, we believe, had a negative impact on stocks over the past six months. Successful investing, however, has always revolved around seeing opportunities and accessing risks well ahead of the crowd. Examining past periods when equity prices declined sharply provides investors a few key guideposts for the future. In most cases in the post World War II economy, a sharp drop in equity prices was followed in fairly short order by a significant rebound in prices as the economic picture brightened and investor psychology improved. There are only two examples over this time period when stocks entered an extended period of sluggish performance, the mid-1970's to the early 1980's and the past two and one-half years.

The 1973-1982 period was characterized by high inflation, a lack of productivity, high interest rates and stock prices that moved generally sideways for almost a decade. Almost none of these characteristics are present in today's economy, thus we do not believe this historical example is applicable to today's stock market. The other extended period of poor equity performance has been over the past two and one-half years. During this period, the NASDAQ Composite Index³ has declined by over 75% from its peak led by price declines in telecom and technology companies. Most other broad-based indices are also down over this period, although by lesser amounts, as excesses in valuations got squeezed out of stock prices. Despite the strong headwind created by generally declining stock prices since March 2000, your Fund has achieved a total return of approximately 15% from its mid-March 2000 level.

Looking Forward

The ability to exceed the returns posted by the overall stock market over an extended period of time is usually based on sound analytical work in estimating the value of any asset and comparing that asset's expected investment return to other investment choices. While no investment process that we are aware of generates a perfect track record, we work diligently to uncover stocks that are undervalued relative to their private market value. One key measure of comparing stock prices to other classes of investments is a company's earnings yield. Many investors are familiar with price-to-earnings ratios and the earnings yield of a company is simply the inverse of the P/E⁷ ratio. We think the earnings-to-price yield is an especially interesting valuation measure in a low inflation and low interest rate environment.

The earnings yield measure is conceptually easier to think about in the context of owning an entire company. If an investor purchases a company for $100 million and that company generates $12 million in after-tax profits, the investor paid 8.3 times earnings (the P/E) and is enjoying a 12% yield on his/her $100 million investment. This 12% yield looks very attractive in an environment where fixed-income investment alternatives like 10-year Treasury Notes yield less than 4%. Since shares of stock simply represent a percentage ownership in a company, the earnings yield calculation can easily be applied to publicly traded stocks. In addition to looking at earnings, our analysts focus on the ability of the companies we invest in to generate free cash flow which we believe provides us with incremental insight as to what a stock is worth.

In retrospect, in early 2000 the 10-year Treasury Note yielded over 6% while many stocks had earnings yields of less than 3%. Today, many of the stocks in your Fund trade at less than ten times estimated earnings and thus have an expected earnings yield of over 10%. We believe the return expectations for stocks are now very positive based upon the positive earnings yield differential between many stocks and fixed-income Treasury securities. Therefore, we remain optimistic on the long-term future of small cap equities.

Portfolio Update

During the past quarter we deleted two stocks from your Fund's portfolio while we added no new names. The two companies we sold were Covance Inc. and Silverstream Software. Covance had been a strong performer for the Fund for a couple of years and we elected to liquidate this position principally due to its valuation relative to many other stocks in the portfolio. Covance was one of our lowest earnings yield stocks and we wanted to redeploy the capital invested in Covance into other stocks that we believe represent better values. The other stock we exited during the quarter was Silverstream Software. This company was purchased in an all cash transaction that closed during the third quarter of 2002.

Within the portfolio we actively trimmed some positions while adding to others to better position the Fund for the future. We were able to take advantage of the overall decline in equity prices to add to our positions in Insituform Technologies, Surebeam Corp. and Tupperware Corp. Insituform, a leading provider of sewer replacement services to local governments, appears to be well positioned to benefit from a replacement/upgrade cycle in municipal sewer systems. We believe Surebeam, with its patented food irradiation process, is just beginning to see large numbers of customers embrace its solutions to prevent food borne illnesses such as e. coli and salmonella. Lastly, we added to Tupperware based upon its strong consumer brand name, expanding distribution channels, attractive valuation and high dividend yield.

Conclusion

We would like to thank our shareholders for your ongoing interest in and your support of The Oakmark Small Cap Fund. Additionally, we look forward to communicating with you over the next several years.

James P. Benson, CFA Portfolio Manager jbenson@oakmark.com	Clyde S. McGregor, CFA Portfolio Manager mcgregor@oakmark.com

October 1, 2002

Schedule of Investments—September 30, 2002

See accompanying notes to financial statements.