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 (12/31/02) AS COMPARED TO THE RUSSELL 2000 INDEX14
	Average Annual Total Returns5
	(as of 12/31/02)
	Total Return Last 3 Months*	1-year	5-year	Since Inception (11/1/95)
Oakmark Small Cap Fund	6.60%	-13.07%	-1.73%	9.03%
Russell 2000	6.16%	-20.48%	-1.36%	5.05%
S&P Small Cap 60015	4.91%	-14.63%	2.44%	8.67%
Lipper Small Cap Value Index16	5.62%	-11.20%	2.81%	9.00%
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

During the fourth calendar quarter of 2002 stocks generally rose and this trimmed full year losses. For the fourth quarter, stocks rebounded in value as the S&P 500² Index rose by over 8% and the Russell 2000 Index climbed by more than 6%. For the full year, however, the Russell 2000 was down by over 20%. Your Fund gained approximately 7% during the past three months, bringing the full calendar year return to a decline of 13%. While we are pleased we can report that our 2002 results were over 7% better than the Russell 2000, our absolute returns were disappointing.

The Benefit of Thinking Long Term

Many commentators have recently discussed the sad state of the stock market and they often leave the impression that investors should perhaps look to other asset classes for their investment dollars. They point out that this is the first time in 61 years that the Dow Jones Industrial Average¹ has declined for three consecutive years or that the NASDAQ Index⁴ is down over 67% since January 1, 2000. During the past three years, the Russell 2000 Index added to investors' misery by declining by about 21%. This clearly outperformed the NASDAQ, but an absolute decline of this magnitude is still painful.

Despite the headwind of generally declining stock prices, your Fund was able to achieve a 15% increase over the past three years as our analysts identified above average investments for your Fund. The collective goal of our analytical team is to find attractive investments that we believe are undervalued. While we employ several different modeling techniques to estimate a company's private market value, perhaps our biggest advantage is that we think in terms of several years—not weeks or months—for our anticipated holding period for an investment. The currently depressed environment for stock valuations is being met with glee, not despair, by our analysts since investing is always a forward looking exercise. We believe the combination of lower stock prices, a growing gross domestic product, rising productivity and accommodative fiscal and monetary policy bodes well for stocks over the next several years. Our future outlook, while tempered by global political problems, is generally upbeat and we view the current environment as a good entry point to invest for the long term.

Can Patience Improve Investment Performance?

The ability to see the future clearly is obviously impossible, yet that is our daily goal. If we can correctly discern a future trend or event before most other investors, then we have the potential to enjoy a significant gain or perhaps avoid a large loss. However, correctly identifying a future event is only part of the process—the second critical step in this process is to determine which companies will be aided and which companies may be hurt by the event. Lastly, once the aforementioned items have been identified, the timing of any investment action needs to be considered.

An example of our thought process is our investment in Surebeam. This company is a leader in food processing safety. Their patented electron beam technology eliminates many food borne pathogens such as E. coli, Listeria Monocytogenes and Salmonella from meats, fruits, vegetables and spices. We believe this technology, which only costs a few cents per pound, has the possibility of becoming an industry standard much like pasteurization became a standard for milk several decades ago. We believe the value of Surebeam's technology more than covers the current stock price even if Surebeam is unable to grow beyond a niche provider. However, if their process becomes a de facto standard, Surebeam has the potential to grow into a very large company and we would expect its stock to do very well as a result. Exactly when this will happen is uncertain, as the food processing industry has historically been slow to adopt new technologies. This is where our patient, long term view comes into play since we are not looking for just one good quarter, but rather a management team that can successfully grow a business for many years. Surebeam's technology is approved for use by the U.S. government for many types of food, thus regulatory approval is one large hurdle that has already been overcome. Adoption of Surebeam meat products (especially ground beef) by grocery stores began to grow rapidly in the fourth quarter of 2002 and we believe this growth will continue into 2003. While we do not know exactly when the stock market will begin to reflect our estimated value of Surebeam, we do expect that patience is likely to be a profitable virtue.

Portfolio Update

During the past quarter we sold four stocks from your Fund's portfolio while we added two new companies. The stocks sold were IDEXX Laboratories, Sensient Technologies, Teekay Shipping and Pathmark Stores. IDEXX, Sensient and Teekay had been good performers for the Fund and we elected to sell these positions so that we could reinvest the proceeds into stocks that we believe sell at a larger discount to value. We sold Pathmark as we became concerned about the deteriorating fundamental outlook for this regional grocery store chain.

During the fourth quarter we initiated positions in DoubleClick Inc. and Triarc Companies. We believe both of these companies are robust financially since they possess large amounts of net cash on their balance sheets. In Triarc's case, net cash per share exceeded our purchase price, thus we effectively bought their operations (consisting principally of the Arby's restaurant chain) for nothing. While we remain somewhat surprised that we can occasionally buy companies with decent operations for less than the net cash on their balance sheet, we intend to continue investing in situations such as these until the stock market takes away these opportunities.

DoubleClick is a provider of software tools to online advertisers that help these companies plan, execute and analyze online advertising, email marketing and database marketing. DoubleClick's stock trades at only a modest premium to the firm's almost $4 per share in net cash, yet DoubleClick has built a leading online advertising software business that generates approximately $300 million in annual revenues. While revenues at DoubleClick have been under pressure in recent quarters reflecting the soft economy, we believe customized online marketing is a very cost effective way for companies to reach their target audience. Therefore, we believe DoubleClick is likely to be successful over time and their strong cash position should help them weather the economic slowdown in good shape.

Conclusion

We would like to thank all of our shareholders for your ongoing interest in and your support of The Oakmark Small Cap Fund. We wish everyone a happy, healthy and prosperous New Year!

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

January 2, 2003

Schedule of Investments—December 31, 2002 (Unaudited)