THE OAKMARK INTERNATIONAL AND OAKMARK INTERNATIONAL SMALL CAP FUNDS

Fellow Shareholders,
Both the Oakmark International and International Small Cap Funds had a strong calendar year 2006 in both relative and absolute terms. Please see individual Fund letters for more specific performance information. I would like to remind my fellow shareholders that, although we work hard to continue to outperform, these levels of absolute performance are not sustainable over time.

Looking Backwards and Forward
The results we achieved were made possible both by a somewhat favorable equity investment environment as well as fairly successful investment selection. Looking at the bigger picture, despite concerns about war and terrorism, the global economy continued to grow at a strong rate without experiencing any substantial price inflation. Even the world's largest economy, the U.S., continued to perform well, although the economy was faced with negatives forces, such as rising interest rates and a weakening housing market. Meanwhile, Japan and Germany showed signs of life after years of slumber, and the emerging world continued to surge ahead.

For investors of international stocks, this means favorable operating environments for our businesses. At the same time, valuations of many high quality, financially strong international companies remain subdued, especially in large caps. Though we are not so positive about Japan's long-term prospects (unless more reforms occur and corporations recognize the importance of shareholder value creation), our weighting in Japan is relatively high because of certain pockets of value within that market. We remain unable to find any value in any of the BRICs (Brazil, Russia, India and China) because of poor valuation and/or terrible corporate governance. Again, I must remind my fellow shareholders that the presence of economic growth and vibrancy does not necessarily coincide with undervalued securities that meet our rigorous criteria.

Looking forward, we are cautiously optimistic. Though it is getting harder to find solid value in the small cap arena, we are having a fair amount of success with larger cap securities. I believe the emerging market growth spurt, though subject to volatility, will continue to add to global economic growth and will also provide good competition for some of the sleepier developed markets.

The Top of Carbon-based Energy Prices?
One external shock that has affected the global economic environment has been the rising price of carbon-based energy inputs, such as oil, gas, and coal. While the upward shift in prices appears permanent to many observers, I predict that all three of these commodities will trend towards weaker prices over the longer term (5-10 years). These prices are determined by supply and demand, and important factors will mitigate the demand that is currently driven by emerging markets. Today, whether it is motor vehicle propulsion or the generation of electricity, we have the technology to substantially lower energy consumption. In engines, we have alternative energies including diesel, hybrid, electric, biofuel, and hydrogen. In power generation wind, nuclear, and solar are being developed. Given today's high level of fossil fuel prices and the billions of dollars going into commercialization, one can imagine a far more efficient and greener future. Besides the availability of technology and financial resources, political and individual desires seem pushing for change. We are happy to be invested in companies like BMW, Gurit, and DaimlerChrysler that are aggressively working for improved energy efficiency. So, the future will prove that the forces of supply and demand are still crucial to price determination. Technology will convert energy inputs more efficiently into useable power, which will lower demand for traditional fossil fuels, and new technology will add supply from clean, high tech energy sources.

Thanks for your continued support and confidence!

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