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 (6/30/03) AS COMPARED TO THE RUSSELL 2000 INDEX11
	Average Annual Total Returns1
	(as of 6/30/03)
	Total Return Last 3 Months*	1-year	5-year	Since Inception (11/1/95)
Oakmark Small Cap Fund	16.92%	-10.18%	-0.37%	9.53%
Russell 200011	23.42%	-1.64%	0.96%	6.99%
S&P Small Cap 60012	19.87%	-3.58%	3.72%	9.82%
Lipper Small Cap Value Index13	22.81%	-0.78%	4.99%	10.48%
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 second calendar quarter of 2003 was a period of generally rising stock prices and your Fund experienced its best absolute quarterly return since the fourth calendar quarter of 2001. Interestingly, both of these quarters followed major geopolitical events. In the fourth quarter of 2001, our country was recovering from the World Trade Center and Pentagon attacks while stock prices in the second quarter of 2003 were, we believe, positively impacted by the end of the war in Iraq and some favorable developments in the Mideast peace process. We hope the upcoming quarters provide less political and more economic reasons for stock prices to move higher. In summary, during the just concluded quarter the S&P 500 Index⁴ rose by 15% and the Russell 2000 Index climbed by 23%. Your Fund recorded a gain of 17% during the last three months, which places its performance above the S&P 500 Index, but below the Russell 2000 Index.

We Are Optimistic About The Future

Based upon the recently enacted Federal income tax cuts and interest rates that are hovering near forty-year lows, we believe stocks are an attractive investment class at this time. In cogitating about whether or not stocks are an attractive asset class in which to invest, we believe examining alternatives to stock ownership can give investors some insight as to which asset class is attractive. As an example, suppose a stock is selling for ten times cash flow and the company is expected to grow on average seven percent annually for the next five years. Under these assumptions, a dollar invested in this company would earn a theoretical cash yield over five years of approximately 57 cents. A dollar invested in a money market fund yielding 2% over the next five years (this is significantly above the 1% or lower rate on many money funds at present) compounds out to a return of about 10.4 cents. While we kept this example very simple by excluding many variables such as taxes, transaction costs and the time value of money, we believe this simple exercise illustrates that the projected returns from stocks are likely to exceed asset classes such as cash. Despite the likelihood of some future periods of stock market volatility that cause the investment returns from stocks to widen or narrow relative to cash, we believe over a period of several years stocks are likely to provide a superior return vis-à-vis cash.

Positioning Your Fund's Investments

In our last quarterly letter, we highlighted our investments in Checkpoint Systems and eFunds Corporation so our shareholders could more fully understand our investment thought process. This quarter we would like to repeat this exercise with two more of our larger investments, CIBER, Inc. and Hanger Orthopedic Group Inc. In general, when thinking about investing in smaller companies we attempt to identify corporate strengths or attributes that are not easily copied by other firms. Examples of strengths we look for would include: patented or proprietary products, strong market shares, low costs and innovative management. As long-term investors, we want to generally avoid those companies with large unfunded liabilities (such as pensions), poor market positions, overly leveraged balance sheets and uncompetitive costs (this is why we own very few small, U.S. based manufacturers since manufacturers in Asia seem to have a significant cost advantage relative to domestic manufacturers in a wide array of industries).

CIBER is an example of a company that has developed strong practices in several information technology niches and delivers its services to its customers in a cost effective manner. CIBER provides information technology (IT) services such as systems integration and staffing in both custom and enterprise resource planning (ERP) package environments. CIBER experienced a steep decline in their business post-Y2K and they have been rebuilding the business for about three years. We became interested in CIBER a couple of years ago based upon our belief that the company possessed a solid balance sheet, a lower cost of delivery than many of their competitors and a fundamental expectation that spending on technology by their customers could not be deferred indefinitely. Over the past few years, we have been impressed with management's ability to control costs, make small acquisitions at prices we believe are accretive to shareholder value and allocate capital via share repurchases during periods when their stock appeared to be unduly depressed. The result of management's diligence in positioning CIBER as a cost effective provider of IT services is a company that not only remained consistently profitable during the past five years, but a company that we believe is well positioned to benefit when spending on IT services recovers.

Hanger Orthopedic is a good example of a small cap company with a strong number one market share in a business that is essential to their patients. Hanger, founded by necessity during the Civil War, custom designs, fabricates and fits artificial limbs to its patients as well as providing custom fitted braces for those patients with musculoskeletal conditions. Hanger became the clear leader in the orthotics and prosthetics (O&P) business in 1999 via a merger with NovaCare. Conceptually, by combining the two largest O&P companies to form a dominant market share leader, we believe Hanger was positioning itself to be a strong, long-term player in healthcare. However, the merger integration was messier than expected and Hanger reported losses in 2000 and 2001 as they worked through the merger issues. The long-term promise of this company began to be realized as Hanger returned to profitability in 2002 and we believe this firm has a bright future. Hanger combines many of the attributes that we look for in a successful small company—a strong market position, high barriers to entry since their products and services cannot be easily moved offshore and good free cash flow generation. These two companies are examples of stocks we believe are trading at significant discounts to their private market values. As long as we can find values such as these, we believe the long-term future of small cap equities remains bright.

Portfolio Update

During the second quarter we sold five stocks from your Fund's portfolio. The companies we sold were Catellus Development Corp., DoubleClick Inc., MCSI Inc., Pharmaceutical Resources and Sybron Dental Specialties. Catellus had been a good performer for the Fund for a couple of years and we elected to liquidate this position principally due to the company's decision to become a real estate investment trust (REIT). DoubleClick, Pharmaceutical Resources and Sybron were shorter term holdings that we elected to sell as these stocks reached our estimation of their fair value. MCSI was sold due to deteriorating financial performance.

We did not purchase any new stocks in the just ended quarter and we finished the quarter with a cash balance equal to approximately 9% of the total portfolio. This cash level is about double the amount of cash we view as normal and we are working on several new stocks for your portfolio. We anticipate adding several new names to the portfolio over the next few months and we will discuss these investments in our next quarterly letter.

Finally

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 again next quarter.

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

Schedule of Investments—June 30, 2003 (Unaudited)