THE OAKMARK INTERNATIONAL AND OAKMARK INTERNATIONAL SMALL CAP FUNDS

Fellow shareholders,

Both Oakmark International and International Small Cap Funds performed poorly in 2007. We repeatedly advise shareholders to think as investors and not as traders. This means considering the long term and not making investment decisions based on the aberrant results of a one-year period. In fact, both Funds have quite strong five-year performance records in absolute returns, and we have more than doubled our shareholders’ money during this period. Also, both Funds have performed very well on an absolute and relative basis over the past 10 years.

Why the Off Year?

Being under-exposed in the “hot areas” was costly in 2007. Last year’s volatile investment climate generated almost a 40% spread in the MSCI World Index¹² between one of the top performing industry sectors, energy (+30%), and the weakest sector, financials (-8%). (Please see the individual Fund letters for more information.) We had very little, if any, capital invested in the top-performing sectors, like resources, utilities and materials, or in the most robust regions, including China, India and Brazil. While these areas might look attractive from a macro perspective, we believe that they are not at all attractive from a valuation perspective because their inflated, high prices present an unadvisable level of risk for long-term investors.

On the other hand, we were overweight in financials, pharmaceuticals and consumer stocks-areas, which all performed quite weakly in 2007. We are invested in these areas for a reason: we have been able to find quality businesses selling at very attractive prices. Especially in the financial sector, which has been decimated due to credit market issues, we have been able to invest in institutions with strong franchises and adequate balance sheet protection at very low prices. Though we acknowledge the short-term uncertainty, we believe that in the medium-and long-term, the value of these businesses will become evident and that their prices will increase accordingly.

Focusing on the financial sector, as it is on everyone’s mind and was the weakest sector in 2007, we strongly believe that almost all financials were painted with the same brush despite unique circumstances at each company. We have always believed that buying good quality businesses at low prices requires a short-term shock that knocks good companies’ stocks into “discount territory.” As we look at companies like UBS, Credit Suisse, Bank of Ireland, and Lloyds, we believe that this has clearly happened. Yes, these companies have experienced some business or balance sheet deterioration. But the huge magnitude of price declines has more than made up for the short-term declines in business value.

As active value managers, we believe that the extremes in today’s market provide exploitable opportunities, and that is exactly what we are doing. Though it was an off year for the Funds, we remain enthusiastic about future prospects, and we believe that both portfolios are invested in extremely good businesses that have been hit for short-term reasons.

A great 2008 to all of our valued shareholders!

David G. Herro, CFA
Portfolio Manager
oakix@oakmark.com
oakex@oakmark.com

December 31, 2007