Fellow Shareholders:

Both The Oakmark International and International Small Cap Funds had positive performance, up 8%, and 14% for the quarter ending September 30th; versus the MSCI World ex-US Index²¹ which returned 8% for the same period. Both Funds are up significantly from recent market lows in March. Given the availability of value in overseas markets, we continue to remain enthusiastic about prospects in global equity markets.

"I want it now, daddy!"

Those telltale words from young Veruca Salt's mouth in "Willy Wonka and the Chocolate Factory" are instructive on how not to behave in the investment world. We think impatience is almost always a bad thing and it is particularly so in investing. Financial markets have been extremely volatile in the last 5 years: a stock market bubble build-up, a stock market bubble implosion, a bond market bubble build up, an implosion, etc. Certainly, in the short term, the price of any particular stock will react or, in many cases, overreact to "macro" factors, i.e., events in the company's environment that exist but do not have a long-term impact on the economic value of the firm.

Now more than ever, given the threat of terrorist attacks, war in the Mid-East and Africa, a nuclear threat in North Korea, we try to harness the volatility these events precipitate for the good of our shareholders. We are keenly aware that all of these threats/risks exist but believe they often times have little long-term bearing on the worth of most businesses. Therefore, with discipline and our long-term orientation, we attempt to take advantage of the impatience of others.

In sum, we believe our patience and discipline is a source of investment advantage and we will continue to use it. As an example, today, beside the macro threats listed above, there is a great deal of worry surrounding pharmaceutical companies. The news is filled with talk of regulatory issues, patent expiries, generic competition, meager pipelines, and other threats. The stock prices of these companies have collapsed, while in many cases business value per share has increased. We think this has materially increased the value proposition for many of these businesses and have therefore made significant investments. While we think there is validity to a few of the market concerns, pharmaceutical companies remain terrific economic enterprises, with high returns on capital, high barriers to entry, tremendous free cash flow, and above average long-term secular growth.

Our three largest pharmaceutical holdings are GlaxoSmithKline (UK), Aventis (France), and Takeda (Japan). Glaxo trades for 15.0x earnings and 11.0x operating income. It throws off 7% of its market capitalization every year in free cash flow and uses this cash to buyback inexpensive stock and payout a healthy dividend equating to a current yield of 3.1%. Aventis' valuation is even more compelling, although the underlying business is not as high quality as Glaxo's. Aventis trades for 11.0x earnings and 8.0x operating income. It throws off 7% of its market capitalization every year in free cash flow as well. It is using this cash to pay a 1.7% dividend plus fund unique in-licensing arrangements. Takeda trades at 15x earnings, a very reasonable price given that it is run by one of the best management teams in Japan and cash represents over one-third of the market capitalization.

Long-Term Investing

We would be remiss in not mentioning the recent news regarding the issue of market timers in mutual funds. Harris Associates L.P. and The Oakmark Funds have remained focused on building wealth from a long-term perspective. The very idea of short-term opportunists picking off incremental pieces of our core shareholders' return has always made our blood boil.

These timers primarily prey upon funds investing in non-US markets. They attempt to take advantage of time lags in market closes and the perceived short-term correlation in global equity prices.

For most of the 1990's our fund operations group spent a portion of every day tracking new subscriptions into the Oakmark International and International Small Cap Funds and vetting the ones that looked suspicious. We were searching for potential traders (or, as they are not so affectionately known around here, "flippers"). This was a tedious and time-consuming process.

In 1999 we were very relieved to put in place a 90-day 2% redemption fee on Oakmark International and Oakmark International Small Cap. This fee, which short-term traders pay directly into the Fund that they are selling, for all intents and purposes destroys the flipper's ability to profit from our Funds at the expense of our long-term shareholders. We believe that if a potential shareholder cannot commit to a minimum of a 90-day investment horizon, we're probably not the right fit for him or her.

We take our responsibilities to our shareholders very seriously. This includes frequent and open correspondence (like this quarterly), clear disclosure, closing Funds to new investors (when appropriate), and a disciplined adherence to our investment philosophy and process. Both of us have always had and continue to maintain a substantial personal investment in The Oakmark Funds. We mean it when we start each letter with "Fellow Shareholders".

Thank you for your continued confidence and support.

David G. Herro, CFA Portfolio Manager dherro@oakmark.com	Michael J. Welsh, CFA, CPA Portfolio Manager mwelsh@oakmark.com