THE OAKMARK INTERNATIONAL AND OAKMARK INTERNATIONAL SMALL CAP FUNDS

Fellow Shareholders,

2005 was an acceptable year for both The Oakmark International and International Small Cap Funds on an absolute basis. However, our results were mixed when compared with the respective benchmarks. Please see the individual Fund pages for more specific performance information.

From a relative perspective, both Funds were hurt by being significantly underweight in Japan, which is the largest component in the MSCI EAFE Index¹⁵ and was up over 40% in local terms and over 25% in U.S. dollar terms. Both Funds have not historically had high weightings in Japan. However, the International Fund's weighting in Japan rose to its highest level since inception this quarter, though it was still below the index weight because we could not find, en masse, companies that fit our strict value criteria. This is the case despite the country's strong macro improvement as well as our countless research trips to Japan visiting prospective companies. In short, though things are changing slowly for the positive, it is still not easy to find shareholder-oriented management teams in Japan.

On a positive note, despite being underweight in Japan and in the energy/resource sectors, both Funds finished close to their peers and their respective indices. The decision to hedge some of our foreign currency exposure, though unpopular at the end of 2004, proved to be the right decision and contributed to our return for the year. (See below). Stock picking was also strong as many of our top positions significantly outperformed their local markets.

Be Wary of Year-End Predictions

As mentioned, at the end of 2004 the pundits were tripping over themselves predicting further dollar declines and weakness in the foreign markets. Instead, the dollar rallied strongly in 2005 taking foreign markets higher with it. Typically, a weak home currency bolsters local share prices as many mid-sized and large foreign companies have U.S. dollar revenue and/or they compete against U.S. companies. As a result, European stock markets, in local terms (recall that total return equals local market and currency returns), were up over 20% with the DJ STOXX 600 (European) Index¹⁶ up 23.5%. However, the rising dollar had a negative impact on the currency component of total return, ranging from 10-20% depending on the currency. Our Japanese holdings experienced a similar effect, though absolute impact in U.S. dollars was still strong.

We remain optimistic about future investment returns because we still believe there is good value in the global equity markets. Both portfolios trade at around 10 times cash flows and with yields well over 2%. The global economy continues to do well due to burgeoning recoveries in Japan and Europe, which aid corporate profitability.

Lastly, I'd like to announce two additions to the international research team. Pierre Py and Mike Manelli both started in the second half of 2005. Pierre came from Harvard Business School, and Mike joined us from Morgan Stanley.

Thanks again for your support in 2005!

David G. Herro, CFA Portfolio Manager dherro@oakmark.com