UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT
OF
REGISTERED MANAGEMENT INVESTMENT COMPANIES
Investment Company Act file number: 2-88116
Name of Registrant: VANGUARD SPECIALIZED FUNDS
Address of Registrant: P.O. BOX 2600, VALLEY FORGE, PA 19482
Name and address of agent for service: R. GREGORY BARTON
P.O. BOX 876
VALLEY FORGE, PA 19482
Registrant's telephone number, including area code: (610) 669-1000
Date of fiscal year end: January 31
Date of reporting period: February 1, 2004 - January 31, 2004
ITEM 1: Reports to Shareholders
VANGUARD(R) ENERGY FUND
JANUARY 31, 2004
ANNUAL REPORT
THE VANGUARD GROUP(R)LOGO
HOW TO READ YOUR FUND REPORT
This report contains information that can help you evaluate your investment. It
includes details about your fund's return and presents data and analysis that
provide insight into the fund's performance and investment approach.
By reading the letter from Vanguard's chairman, John J. Brennan, together with
the letter from the managers who select securities for your fund, you'll get an
understanding of how the fund invests and how the market environment affected
its performance. The statistical information that follows can help you
understand how the fund's performance and characteristics stack up against those
of similar funds and market benchmarks.
It's important to keep in mind that the opinions expressed by Vanguard's
investment managers are just that: informed opinions. They should not be
considered promises or advice. The opinions, like the statistics, cover the
period through the date on the cover of this report. As things change--and in
the financial markets you can be certain only of change--an investment manager's
job is to evaluate new information and make adjustments, if necessary. Of
course, the risks of investing in the fund are spelled out in the prospectus.
Frequent updates on the fund's performance and information about some of its
holdings are available on Vanguard.com(R).
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CONTENTS
1 letter from the chairman
7 report from the advisor
9 fund profile
10 glossary of investment terms
11 performance summary
13 your fund's after-tax returns
14 about your fund's expenses
15 financial statements
26 advantages of vanguard.com
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SUMMARY
* The Energy Fund climbed to a 36.5% return for Investor Shares in
fiscal-year 2004. The fund's Admiral Shares returned 36.6%.
* The fund benefited from lofty prices for oil and natural gas, as increasing
demand chased tight supplies.
* Strategic positioning helped the fund to outperform its benchmark index and
the average competitor, although it did not quite match the gain of the
broad stock market.
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LETTER FROM THE CHAIRMAN
FELLOW SHAREHOLDER,
Vanguard Energy Fund's 2004 fiscal year opened with winds of war blowing in the
Middle East and closed with investors focused instead on the expanding economies
at home and abroad.
[PICTURES OF JOHN J. BRENNAN]
- -----------------------------------------------
2004 TOTAL RETURNS FISCAL YEAR ENDED
JANUARY 31
- -----------------------------------------------
VANGUARD ENERGY FUND
Investor Shares 36.5%
Admiral Shares 36.6
S&P Energy Sector Index 30.6
Average Natural Resources Fund* 36.0
Wilshire 5000 Index 38.1
- -----------------------------------------------
*Derived from data provided by Lipper Inc.
The fund benefited in both environments, profiting from the spike in oil prices
before the war with Iraq, then capitalizing on a global surge in demand for oil
in subsequent months. For the year ended January 31, 2004, the Investor Shares
of Vanguard Energy Fund returned 36.5% and the Admiral Shares 36.6%.
The shift in sentiment fueled a heady stock market rally, with the Wilshire 5000
Total Market Index returning 38.1% for the 12 months. Energy stocks as a group
produced a booming 30.6% return, as measured by the Standard & Poor's Energy
Sector Index, your fund's comparative benchmark.
The Energy Fund's return was closer to that of the broad stock market thanks to
the fund's holdings in strongly performing international oil companies and in
emerging markets, such as China and Brazil. Accelerating economic growth in
China, a nation that is consuming an increasing share of the world's energy
supplies, was felt across the sector.
The table above presents the 12-month total returns (capital change plus
reinvested distributions) for the fund and its comparative standards. Details on
changes in net asset value and per-share distributions for each of the fund's
share classes are shown in the table on page 6.
1
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ADMIRAL(TM) SHARES
A lower-cost class of shares available to many longtime shareholders and to
those with significant investments in the fund.
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STOCKS GENERATED OUTSTANDING RETURNS
For the 12 months ended January 31, the broad U.S. stock market rallied
aggressively from a negative return for the prior year. At the start of the
period, investors were apprehensive. War with Iraq was imminent, and the labor
market and manufacturing industries were stagnating, despite the broad economy's
slow-but-steady expansion. Within weeks, however, the United States and its
allies had begun and successfully completed major combat operations in Iraq. And
in the succeeding months, the economic picture also brightened: The unemployment
rate declined, and manufacturing began to stir. In the quarter ended September
30, the U.S. economy grew at an annualized rate of 8.2%; estimates put
fourth-quarter gross domestic product growth at about 4.0%.
With each piece of good news, the market's mood inched from cautious toward
cavalier. For the full 12 months, the stock market's small-capitalization,
somewhat speculative issues, as represented by the Russell 2000 Index, returned
58.0%. That was 22.4 percentage points more than the Russell 1000 Index's
large-cap stocks.
- --------------------------------------------------------------------------------
MARKET BAROMETER AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED JANUARY 31, 2004
--------------------------------------
ONE THREE FIVE
YEAR YEARS YEARS
- --------------------------------------------------------------------------------
STOCKS
Russell 1000 Index (Large-caps) 35.6% -4.2% -0.5%
Russell 2000 Index (Small-caps) 58.0 6.0 7.8
Wilshire 5000 Index (Entire market) 38.1 -3.0 0.1
MSCI All Country World Index
ex USA (International) 48.9 -0.9 1.9
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BONDS
Lehman Aggregate Bond Index 4.9% 7.3% 6.6%
(Broad taxable market)
Lehman Municipal Bond Index 6.2 6.5 5.7
Citigroup 3-Month Treasury Bill Index 1.0 2.1 3.4
================================================================================
CPI
Consumer Price Index 1.9% 1.9% 2.4%
- --------------------------------------------------------------------------------
RISK WAS REWARDED IN THE BOND MARKET
The same behavior was apparent in the fixed income markets. Demand for
default-risk-free U.S. Treasuries was initially extreme, boosting the price of
the 10-year Treasury note while reducing its yield to just above 3% in June. By
the fiscal year-end, however, the mood had changed. The Lehman Brothers High
Yield Bond Index, a benchmark of below-investment-grade
2
bonds, recorded a 12-month return of 27.2%, while investment- grade bonds, as
measured by the Lehman Aggregate Bond Index, returned 4.9%.
Short-term interest rates were the fixed income market's one constant, remaining
low--and lower--throughout the period. The yield of the 3-month Treasury bill, a
proxy for money market rates, ended the fiscal year at 0.91%, 26 basis points
lower than at the start of the period.
THE ENERGY FUND RODE OUT VOLATILITY
Oil prices were generally high, but unusually volatile, during the fiscal year.
Prices skyrocketed as the Iraqi war approached, then declined after it
commenced. In the late spring another rise began, and prices peaked during the
summer holiday travel season; then they trended down again until a
fourth-quarter surge anticipated the winter heating season in North America.
The Energy Fund rode these hills and valleys well, thanks both to its focus on
attractively priced stocks--which helps keep out issues with inflated prices
that can collapse in a volatile market--and to the investment advisor's balance
of faster-growing companies with large integrated oil firms. These companies
boast relatively diversified operations--drilling, refining, selling oil
products--which makes them steadier earners than pure-play exploration and
production companies. Of the fund's top ten holdings on January 31, 2004, eight
were integrated oils, including ChevronTexaco, ExxonMobil, BP, and Total.
High oil prices raised all boats in the sector, with companies that are most
sensitive to oil prices performing best. At the fund's fiscal year-end, crude
oil commanded $33.05 a barrel, significantly above OPEC's informal price band--a
range of $22 to $28 a barrel. Low inventories, tight supply, and increased
demand--driven primarily by economic expansion in the United States and
China--set the stage for high oil prices.
Natural gas prices also benefited from a supply-demand imbalance, closing the
fiscal year at $5.80 per thousand cubic feet, more than twice the ten-year
average. The fund's meaningful position in natural gas companies, two of which
were top-ten holdings on January 31, contributed significantly to the overall
return.
3
For more details on the fund's performance and holdings, see the Report from the
Advisor on page 7.
ADDRESSING AN INCREASINGLY GLOBAL MARKETPLACE
During the fiscal year, the U.S. dollar's decline against other currencies
boosted the Energy Fund's performance by enhancing the returns from its
significant foreign holdings.
The fund's foreign holdings have grown over time to make up a large portion of
its portfolio--44% as of January 31, 2004. Only three of the fund's top ten
holdings at that point were headquartered in the United States. This reflects
the evolution of the fact that the energy market is increasingly dominated by
fewer, larger players around the globe.
A look at the makeup of the Morgan Stanley Capital International World Energy
Index, which tracks the global energy market, illustrates this trend. From the
beginning of 1996 through August 2003, the index's weighting in foreign
integrated oil companies rose from 34% to 47%. Over the same period, the
weighting in U.S. integrated oil firms fell from 46% to 32%. Similarly, the
number of foreign oil stocks in the index grew from 9 to 15, while the number of
U.S. oil stocks fell from 9 to 4.
Accordingly, the fund's board of trustees has voted to eliminate the fund's 50%
limit on investments in foreign stocks. Effective on or about May 24, 2004,
Vanguard Energy Fund will be permitted to invest up to 100% of its assets in
foreign stocks. This change will allow the fund's advisor, Wellington Management
Company, llp, to better adapt to the globalization of the energy industry while
adhering to the fund's investment objective of providing long-term capital
appreciation.
WHY IT MAKES SENSE TO THINK LONG-TERM
Over the past decade, your fund's returns have been commendable in terms of both
absolute and relative measures. As you can see in the table on page 5, a
hypothetical $10,000 investment made in the fund ten years ago would have grown
to $30,951 by January 31, 2004. An investor in the average competing mutual fund
would have accumulated $10,485 less, essentially half the gain enjoyed by your
fund over the decade.
The Energy Fund's outstanding performance over long periods is a testament to
the abilities of Wellington Management, which has advised the
4
fund since its 1984 inception. The fund's record also reflects Vanguard's
running start, from a cost perspective, on its competitors. The Energy Fund's
expense ratio traditionally has been a fraction of the average charged by its
competitors, which means that the fund's investors enjoy a greater share of the
rewards produced by the investment advisor. (See page 14 for details on the
fund's expenses and how these costs measure up against those of similar funds.)
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TOTAL RETURNS TEN YEARS ENDED
JANUARY 31, 2004
- -----------------------------------------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RETURN INITIAL INVESTMENT
- -----------------------------------------------------------------
Energy Fund
Investor Shares 12.0% $30,951
S&P Energy Sector Index 11.5 29,587
Average Natural
Resources Fund 7.4 20,466
Wilshire 5000 Index 10.5 27,107
- -----------------------------------------------------------------
The fund's strong long-term performance is good news only for the long-term
investor. As a sector fund, Vanguard Energy Fund is very volatile, meaning that
it can swing strongly up or down in any given year. It is therefore
inappropriate for an investor who has a short time horizon or whose portfolio is
not fully diversified. The fund is aimed at investors who want to add an
energy-focused holding to a portfolio that is already well diversified among
asset classes and subsectors.
A FINAL NOTE ON RISK
The three-year bear market that ended in 2003 was a reminder to everyone that
trees do not grow to the sky. The stock market can, and often does, take away
what it has given. The energy sector has been generous to investors over the
past ten years--and offers no guarantee of continued favor.
At Vanguard we counsel the importance of developing a diversified investment
plan appropriate to your future needs and to your risk tolerance. That plan
should see you through the markets' ups and downs--without any impulsive
movements in and out of investment styles or sectors.
I want to close by thanking you for entrusting your assets to Vanguard. In light
of reports of late trading and market-timing at some competing investment
management firms, I also want to assure you that Vanguard has long had policies
and procedures in place to identify and deter such behavior. More important,
5
Vanguard shareholders are served by a crew of the highest integrity. Finally,
our client-owned corporate structure is the most effective means I can imagine
of aligning our day-to-day efforts with your long-term financial goals.
Sincerely,
/S/ JOHN J. BRENNAN
John J. Brennan
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
FEBRUARY 12, 2004
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YOUR FUND'S PERFORMANCE AT A GLANCE JANUARY 31, 2003-JANUARY 31, 2004
DISTRIBUTIONS PER SHARE
--------------------------
STARTING ENDING INCOME CAPITAL
SHARE PRICE SHARE PRICE DIVIDENDS GAINS
- ------------------------------------------------------------------------------
Energy Fund
Investor Shares $22.85 $29.99 $0.390 $0.744
Admiral Shares 42.89 56.30 0.760 1.398
- ------------------------------------------------------------------------------
6
REPORT FROM THE ADVISOR
Vanguard Energy Fund rose 36.5% in the fiscal year ended January 31, 2004. The
average natural resources fund rose 36.0% for the period, and the Wilshire 5000
Index rose 38.1%.
THE INVESTMENT ENVIRONMENT
The environment for investing in energy equities has remained very robust. Oil
prices began the fiscal year at more than $30 per barrel as supply issues,
particularly relating to Venezuela, Nigeria, and Iraq, kept inventories low and
anxiety high. Although output from members of the Organization of Petroleum
Exporting Countries (OPEC) increased throughout the period, oil prices remained
in the low $30s per barrel. Inventories stayed low because demand was higher
than expected and non-OPEC supply fell short of expectations. For the full
fiscal year, oil prices were at the highest average levels seen in the last two
decades.
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INVESTMENT PHILOSOPHY
This fund reflects a belief that investors who seek to emphasize a given
economic sector as part of a long-term, balanced investment program are best
served by holding a portfolio of securities well-diversified across that sector.
- --------------------------------------------------------------------------------
Natural gas prices were also strong, with the monthly average ranging from $4.50
to $7.50 per thousand cubic feet. Lately, prices have been in the middle of this
range, which is surprisingly high given that inventories have grown to
above-average levels.
OUR SUCCESSES
The portfolio benefited from generally robust stock returns throughout the
energy sector. Some of the best performers were foreign oil companies, including
Petrol Brasil, Sinopec (China Petroleum and Chemical), and OAO Lukoil Holding.
Refining stocks, including Sunoco and Ashland, were especially strong,
rebounding from relatively poor returns in the previous fiscal year.
OUR SHORTFALLS
Few stocks had negative returns during the year, but there were weaker
performers within some subsectors in the fund. Among them were a
7
number of oil services stocks, including Baker Hughes and Transocean, and
international oils, including Royal Dutch Petroleum and ExxonMobil.
While commodity prices were higher than expected throughout the year, earnings
for most service stocks were lower than expected. As for the international oils,
the nature of these companies--integrated operations with a relatively low-cost
structure--means that their earnings are somewhat insulated from swings in
commodity prices. In the bullish environment of the last 12 months, this was a
drawback to some of the fund's holdings in the subsector.
THE FUND'S POSITIONING
The portfolio continues to emphasize promising long-term total-return
opportunities in the various energy subsectors. Relative to its positioning 12
months ago, the fund has increased its exposure to international oils and
foreign producers, while decreasing its exposure to oil services and refining
stocks. Common characteristics among our holdings are proven management, strong
balance sheets, and an underlying resource that can provide above-average
long-term growth.
KARL E. BANDTEL, SENIOR VICE PRESIDENT AND PORTFOLIO MANAGER
WELLINGTON MANAGEMENT COMPANY, LLP
FEBRUARY 18, 2004
SEE PAGE 15 FOR A COMPLETE
LISTING OF THE FUND'S HOLDINGS.
8
FUND PROFILE AS OF 1/31/2004
This Profile provides a snapshot of the fund's characteristics, compared where
indicated with a broad market index. Key terms are defined on page 10.
ENERGY FUND
- -------------------------------------------------
PORTFOLIO CHARACTERISTICS
BROAD
FUND INDEX*
- -------------------------------------------------
Number of Stocks 57 5,190
Median Market Cap $16.7B $28.0B
Price/Earnings Ratio 13.7x 25.4x
Price/Book Ratio 2.2x 3.1x
Yield 1.5%
Investor Shares 1.4%
Admiral Shares 1.5%
Return on Equity 15.2% 15.8%
Earnings Growth Rate 16.8% 5.2%
Foreign Holdings 47.2% 0.9%
Turnover Rate 26% --
Expense Ratio --
Investor Shares 0.38%
Admiral Shares 0.32%
Short-Term Reserves 9% --
- -------------------------------------------------
- ---------------------------------------------------
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETs)
BP PLC ADR 5.0%
Total SA ADR 4.9
ChevronTexaco Corp. 4.7
ExxonMobil Corp. 4.6
ENI SpA ADR 4.0
BG Group PLC 3.1
ConocoPhillips Co. 2.8
Royal Dutch Petroleum Co. ADR 2.3
Shell Transport & Trading Co. ADR 2.3
EnCana Corp. 2.2
- ---------------------------------------------------
Top Ten 35.9%
- ---------------------------------------------------
The "Ten Largest Holdings" excludes any temporary cash investments and equity
index products.
- ---------------------------------
INVESTMENT FOCUS
STYLE Value
MARKET CAP Medium
- ---------------------------------
- ---------------------------------------------------
VOLATILITY MEASURES
BROAD
FUND INDEX*
- ---------------------------------------------------
R-Squared 0.33 1.00
Beta 0.58 1.00
- ---------------------------------------------------
- ---------------------------------------------------
SECTOR DIVERSIFICATION (% OF PORTFOLIO)
Coal 3%
Energy Miscellaneous 3
International 44
Machinery--Oil Well Equipment & Services 6
Materials & Processing 1
Offshore Drilling 3
Oil--Crude Producers 11
Oil--Integrated Domestic 6
Oil--Integrated International 12
Utilities--Gas Pipelines 2
- ---------------------------------------------------
Short-Term Reserves 9%
- ---------------------------------------------------
*Wilshire 5000 Index.
VISIT OUR WEBSITE AT VANGUARD.COM
FOR REGULARLY UPDATED FUND INFORMATION.
9
GLOSSARY OF INVESTMENT TERMS
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of a given market index. The index is assigned a
beta of 1.00. Compared with a given index, a fund with a beta of 1.20 typically
would have seen its share price rise or fall by 12% when the index rose or fell
by 10%. A fund's beta should be reviewed in conjunction with its R-squared (see
definition below). The lower the R-squared, the less correlation there is
between the fund and the index, and the less reliable beta is as an indicator of
volatility.
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EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
- --------------------------------------------------------------------------------
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
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FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or depositary receipts of companies based outside the United States.
- --------------------------------------------------------------------------------
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
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PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
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PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
- --------------------------------------------------------------------------------
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the market in general, as measured by a given index. If a
fund's total returns were precisely synchronized with an index's returns, its
R-squared would be 1.00. If the fund's returns bore no relationship to the
index's returns, its R-squared would be 0.
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RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
- --------------------------------------------------------------------------------
SHORT-TERM RESERVES. The percentage of a fund invested in highly liquid,
short-term securities that can be readily converted to cash.
- --------------------------------------------------------------------------------
TURNOVER RATE. An indication of the fund's trading activity. Funds with high
turnover rates incur higher transaction costs and may be more likely to
distribute capital gains (which may be taxable to investors).
- --------------------------------------------------------------------------------
YIELD. A snapshot of a fund's income from interest and dividends. The yield,
expressed as a percentage of the fund's net asset value, is based on income
earned over the past 30 days and is annualized, or projected forward for the
coming year. The index yield is based on the current annualized rate of income
provided by securities in the index.
- --------------------------------------------------------------------------------
10
PERFORMANCE SUMMARY As of 1/31/2004
All of the returns in this report represent past performance, which is not a
guarantee of future results that may be achieved by the fund. (For the most
recent performance, which may be higher or lower than that cited, visit our
website at www.vanguard.com.) Note, too, that both investment returns and
principal value can fluctuate widely, so that an investor's shares, when sold,
could be worth more or less than their original cost. The returns shown do not
reflect taxes that a shareholder would pay on fund distributions or on the sale
of fund shares.
ENERGY FUND
- --------------------------------------------------------------------------------
CUMULATIVE PERFORMANCE JANUARY 31, 1994-JANUARY 31, 2004
ENERGY FUND WILSHIRE S&P ENERGY AVERAGE NATURAL
INVESTOR SHARES* 5000 INDEX SECTOR INDEX RESOURCES FUND**
199401 10000 10000 10000 10000
199404 9891 9423 9721 9461
199407 10280 9535 10032 9767
199410 10522 9923 10532 9966
199501 9085 9898 10109 8815
199504 10533 10826 11332 10055
199507 10804 12025 11750 10400
199510 10270 12478 11661 9926
199601 11691 13574 12950 11162
199604 13548 14307 14039 12780
199607 12848 13791 13816 12118
199610 14840 15199 15524 13861
199701 16405 16881 17129 14605
199704 15171 16831 17418 13591
199707 18029 20301 20706 15519
199710 19217 20001 20895 16025
199801 17028 21152 19320 13701
199804 19198 24110 22297 15121
199807 16163 23760 20127 11835
199810 15688 22960 20601 11762
199901 13418 26922 19063 10328
199904 17650 28239 24906 13387
199907 18307 28119 24837 13757
199910 17337 28854 23875 13566
200001 16885 30753 24025 13554
200004 19716 31574 24701 14881
200007 19883 31166 26152 14920
200010 21292 31192 28391 16173
200101 22808 29684 28310 17570
200104 25747 27123 30068 18670
200107 23020 26489 27770 16258
200110 22266 23226 25827 15448
200201 22682 25136 25673 15980
200204 25716 24442 27141 17680
200207 22318 20644 23804 14400
200210 21688 20112 22420 14401
200301 22677 19635 22657 15048
200304 23520 21122 23315 14754
200307 25207 23291 24460 15847
200310 26984 25027 25565 17792
200401 30951 27107 29587 20466
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AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED JANUARY 31, 2004
---------------------------------- FINAL VALUE
ONE FIVE TEN OF A $10,000
YEAR YEARS YEARS INVESTMENT
- --------------------------------------------------------------------------------
Energy Fund Investor Shares* 36.49% 18.19% 11.96% $30,951
Wilshire 5000 Index 38.05 0.14 10.49 27,107
S&P Energy Sector Index 30.59 9.19 11.46 29,587
Average Natural Resources Fund** 36.00 14.66 7.42 20,466
- --------------------------------------------------------------------------------
FINAL VALUE
ONE SINCE OF A $250,000
YEAR INCEPTION+ INVESTMENT
- --------------------------------------------------------------------------------
Energy Fund Admiral Shares* 36.58% 15.39% $343,444
Wilshire 5000 Index 38.05 4.84 277,634
S&P Energy Sector Index 30.59 6.02 284,650
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FISCAL-YEAR TOTAL RETURNS (%) JANUARY 31, 1994-JANUARY 31, 2004
ENERGY FUND S&P ENERGY
INVESTOR SHARES* SECTOR INDEX
1995 -9.1 1.1
1996 28.7 28.1
1997 40.3 32.3
1998 3.8 12.8
1999 -21.2 -1.3
2000 25.8 26.0
2001 35.1 17.8
2002 -0.6 -9.3
2003 0.0 -11.7
2004 36.4 30.6
- --------------------------------------------------------------------------------
*Total return figures do not reflect the 1% fee assessed on redemptions of
shares held for less than one year.
**Derived from data provided by Lipper Inc.
+November 12, 2001.
NOTE: See Financial Highlights tables on pages 20 and 21 for dividend and
capital gains information.
11
PERFORMANCE SUMMARY (CONTINUED)
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2003
This table presents average annual total returns through the latest calendar
quarter--rather than through the end of the fiscal period. Securities and
Exchange Commission rules require that we provide this information.
TEN YEARS
ONE FIVE -------------------------
INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------
Energy Fund *
Investor Shares 5/23/1984 33.80% 16.42% 10.78% 1.65% 12.43%
Admiral Shares 11/12/2001 33.89 15.79** -- -- --
- --------------------------------------------------------------------------------
*Total return figures do not reflect the 1% fee assessed on redemptions of
shares held for less than one year.
**Return since inception.
12
YOUR FUND'S AFTER-TAX RETURNS
This table presents returns for your fund both before and after taxes. The
after-tax returns are shown in two ways: (1) assuming that an investor owned the
fund during the entire period and paid taxes on the fund's distributions, and
(2) assuming that an investor paid taxes on the fund's distributions and sold
all shares at the end of each period.
Calculations are based on the highest individual federal income tax and capital
gains tax rates in effect at the times of the distributions and the hypothetical
sales. State and local taxes were not considered. After-tax returns reflect the
reduced tax rates on ordinary income (including qualified dividend income) and
short-term capital gains that became effective as of January 1, 2003, and on
long-term capital gains realized on or after May 6, 2003. To calculate qualified
dividend income, we use actual 2003 figures and estimates for 2004. (In the
example, returns after the sale of fund shares may be higher than those assuming
no sale. This occurs when the sale would have produced a capital loss. The
calculation assumes that the investor received a tax deduction for the loss.)
The table shows returns for Investor Shares only; returns for other share
classes will differ. Please note that your actual after-tax returns will depend
on your tax situation and may differ from those shown. Also note that if you own
the fund in a tax-deferred account, such as an individual retirement account or
a 401(k) plan, this information does not apply to you. Such accounts are not
subject to current taxes.
Finally, keep in mind that a fund's performance--whether before or after
taxes--does not indicate how it will perform in the future.
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2004
ONE YEAR FIVE YEARS TEN YEARS
---------------------------------------------------
ENERGY FUND INVESTOR SHARES*
Returns Before Taxes 36.49% 18.19% 11.96%
Returns After Taxes on Distributions 35.64 16.82 10.58
Returns After Taxes on Distributions
and Sale of Fund Shares 24.62 15.46 9.90
- --------------------------------------------------------------------------------
*Total return figures do not reflect the 1% fee assessed on redemptions of
shares held for less than one year.
13
ABOUT YOUR FUND'S EXPENSES
All mutual funds have operating expenses. These expenses include costs for
portfolio management, administrative services, and shareholder reports (like
this one), among others. Operating expenses, which are deducted from a fund's
gross income, directly reduce the investment return of the fund. A fund's
expenses are expressed as a percentage of its net assets. This figure is known
as the expense ratio.
a hypothetical example
We believe it is important for you to understand the impact of costs on your
investment. The following example illustrates the costs that you would incur
over a 12-month period if you invested $10,000 in the fund, using the fund's
actual return and operating expenses for the fiscal year ended January 31, 2004.
The cost in dollars is calculated by applying the expense ratio to the average
balance in the hypothetical account. For comparative purposes, we also list the
average expense ratio for the fund's peer group, which is derived from data
provided by Lipper Inc.
- --------------------------------------------------------------------------------
COST OF $10,000 FUND PEER GROUP*
INVESTMENT IN FUND EXPENSE RATIO EXPENSE RATIO
- --------------------------------------------------------------------------------
ENERGY FUND
Investor Shares $45 0.38% 1.71%
Admiral Shares 38 0.32 --
- --------------------------------------------------------------------------------
*Average Natural Resources Fund.
The calculation assumes no shares were sold. Your actual costs may have been
higher or lower, depending on the amount of your investment and your holding
period. Peer-group ratio captures data through year-end 2003.
You can find more information about the fund's expenses, including annual
expense ratios for the past five years, in the Financial Statements section of
this report. For additional information on operating expenses and other
shareholder costs, please refer to the fund's prospectus. The prospectus
presents hypothetical shareholder costs over various time periods based upon a
$10,000 investment and a return of 5% a year. This standardized example, which
appears in all mutual fund prospectuses, may be useful to you in comparing the
costs of investing in different funds.
14
FINANCIAL STATEMENTS AS OF 1/31/2004
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.) and by sector
within the fund's designated industry; international securities, if significant,
may be presented in a separate group. Other assets are added to, and liabilities
are subtracted from, the value of Total Investments to calculate the fund's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the fund to
arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying the
composition of the fund's net assets. Because all income and any realized gains
must be distributed to shareholders each year, the bulk of net assets consists
of Paid-in Capital (money invested by shareholders). The amounts shown for
Undistributed Net Investment Income and Accumulated Net Realized Gains usually
approximate the sums the fund had available to distribute to shareholders as
income dividends or capital gains as of the statement date, but may differ
because certain investments or transactions may be treated differently for
financial statement and tax purposes. Any Accumulated Net Realized Losses, and
any cumulative excess of distributions over net income or net realized gains,
will appear as negative balances. Unrealized Appreciation (Depreciation) is the
difference between the market value of the fund's investments and their cost,
and reflects the gains (losses) that would be realized if the fund were to sell
all of its investments at their statement-date values.
- --------------------------------------------------------------------------------
MARKET
VALUE*
ENERGY FUND SHARES (000)
- --------------------------------------------------------------------------------
COMMON STOCKS (93.2%)
- --------------------------------------------------------------------------------
UNITED STATES (49.2%)
- --------------------------------------------------------------------------------
COAL (2.8%)
Peabody Energy Corp. 1,264,000 $ 50,598
** CONSOL Energy Inc. PIPE 1,073,600 22,320
------------
$ 72,918
------------
ENERGY MISCELLANEOUS (3.2%)
Valero Energy Corp. 997,400 52,782
Sunoco, Inc. 598,600 33,192
------------
$ 85,974
------------
MACHINERY--OIL WELL EQUIPMENT & Services (6.5%)
Schlumberger Ltd. 860,700 52,658
Halliburton Co. 1,263,000 38,079
Baker Hughes, Inc. 1,030,200 36,139
* Nabors Industries, Inc. 571,700 25,155
* Weatherford International Ltd. 313,200 12,628
* Rowan Cos., Inc. 300,000 6,864
------------
$ 171,523
------------
MATERIALS & PROCESSING (1.2%)
Ashland, Inc. 671,800 31,111
OFFSHORE DRILLING (3.1%)
GlobalSantaFe Corp. 1,973,900 53,887
* Transocean Inc. 1,067,600 28,761
------------
$ 82,648
------------
OIL--CRUDE PRODUCERS (11.7%)
Burlington Resources, Inc. 841,000 46,036
Anadarko Petroleum Corp. 870,900 43,458
Devon Energy Corp. 616,000 34,779
EOG Resources, Inc. 731,000 33,114
Cabot Oil & Gas Corp. 937,800 28,603
Kerr-McGee Corp. 564,600 27,507
* Westport Resources Corp. 834,900 24,371
* Premcor, Inc. 800,300 24,233
* Newfield Exploration Co. 506,300 23,892
Noble Energy, Inc. 500,000 22,100
------------
$ 308,093
------------
OIL--INTEGRATED DOMESTIC (5.9%)
ConocoPhillips Co. 1,106,780 72,915
Occidental Petroleum Corp. 1,193,700 52,583
Amerada Hess Corp. 544,900 30,727
------------
$ 156,225
------------
OIL--INTEGRATED INTERNATIONAL (12.3%)
ChevronTexaco Corp. 1,437,800 124,154
ExxonMobil Corp. 3,008,900 122,733
Unocal Corp. 1,566,000 57,660
Marathon Oil Corp. 630,200 20,469
------------
$ 325,016
------------
15
- --------------------------------------------------------------------------------
MARKET
VALUE*
ENERGY FUND SHARES (000)
- --------------------------------------------------------------------------------
UTILITIES--GAS PIPELINES (2.5%)
Equitable Resources, Inc. 1,321,300 $ 57,992
El Paso Corp. 896,500 7,620
------------
$ 65,612
------------
- --------------------------------------------------------------------------------
TOTAL UNITED STATES $ 1,299,120
- --------------------------------------------------------------------------------
INTERNATIONAL (44.0%)
- --------------------------------------------------------------------------------
BRAZIL (1.9%)
Petrol Brasil ADR 1,713,800 $ 50,386
CANADA (8.3%)
EnCana Corp. 1,501,750 58,718
Canadian Natural Resources Ltd. 715,600 34,578
Talisman Energy, Inc. 613,262 32,636
Shell Canada Ltd. CLass A 685,200 30,392
Suncor Energy, Inc. 987,800 24,932
Petro Canada 437,100 19,093
* Western Oil Sands Inc. 537,900 11,923
* Paramount Resources Ltd. 998,004 8,057
------------
$ 220,329
------------
CHINA (1.3%)
China Petroleum and Chemical Corp. ADR 860,700 34,127
------------
FRANCE (4.9%)
Total SA ADR 1,462,500 129,139
------------
HONG KONG (0.9%)
CNOOC Ltd. ADR 572,400 22,919
------------
ITALY (4.7%)
ENI SpA ADR 1,141,600 106,420
* Fugro 322,079 17,265
------------
$ 123,685
------------
NETHERLANDS (2.3%)
Royal Dutch Petroleum Co. ADR 1,291,100 61,198
------------
NORWAY (3.9%)
Statoil ASA ADR 4,772,100 52,255
Norsk Hydro AS ADR 796,300 49,450
------------
$ 101,705
------------
RUSSIA (1.6%)
OAO Lukoil Holding Sponsored ADR 401,200 41,484
Surgutneftegaz ADR 67,300 1,994
------------
$ 43,478
------------
SOUTH AFRICA (1.0%)
Sasol Ltd. Sponsored ADR 1,767,700 26,339
SPAIN (1.8%)
Repsol YPF, SA ADR 2,340,500 47,536
UNITED KINGDOM (11.4%)
BP PLC ADR 2,753,900 131,086
BG Group PLC 16,332,000 82,272
Shell Transport & Trading Co. ADR 1,506,300 60,704
National Grid Transco PLC 3,705,700 26,441
------------
$ 300,503
------------
- --------------------------------------------------------------------------------
TOTAL INTERNATIONAL $ 1,161,344
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS (Cost $1,861,109) $ 2,460,464
- --------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (17.7%)
- --------------------------------------------------------------------------------
Repurchase Agreements
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
1.02%, 2/2/2004--Note G $229,399 $ 229,399
1.02%, 2/2/2004 239,356 239,356
- --------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(Cost $468,755) 468,755
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (110.9%)
(Cost $2,329,864) $ 2,929,219
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-10.9%)
- --------------------------------------------------------------------------------
Other Assets--Note C 8,510
Security Lending Collateral
Payable to Brokers--Note G (229,399)
Other Liabilities (66,373)
------------
$ (287,262)
------------
- --------------------------------------------------------------------------------
NET ASSETS (100%) $ 2,641,957
================================================================================
*See Note A in Notes to Financial Statements.
*Non-income-producing security.
**Restricted security represents 0.8% of net assets.
ADR--American Depositary Receipt.
16
- ----------------------------------------------------------------
AMOUNT
(000)
- ----------------------------------------------------------------
AT JANUARY 31, 2004, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------
Paid-in Capital 2,025,664
Undistributed Net Investment Income 73
Accumulated Net Realized Gains 16,865
Unrealized Appreciation 599,355
- ----------------------------------------------------------------
NET ASSETS $ 2,641,957
================================================================
Investor Shares--Net Assets
Applicable to 81,169,952 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $ 2,434,089
- ----------------------------------------------------------------
NET ASSET VALUE PER SHARE-- INVESTOR SHARES $ 29.99
================================================================
Admiral Shares--Net Assets
Applicable to 3,692,085 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $ 207,868
- ----------------------------------------------------------------
NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $ 56.30
================================================================
See Note E in Notes to Financial Statements for the tax-basis components of net
assets.
17
STATEMENT OF OPERATIONS
This Statement shows the types of income earned by the fund during the reporting
period, and details the operating expenses charged to each class of its shares.
These expenses directly reduce the amount of investment income available to pay
to shareholders as income dividends. This Statement also shows any Net Gain
(Loss) realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) of investments during the period.
- --------------------------------------------------------------------------------
ENERGY FUND
YEAR ENDED JANUARY 31, 2004
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends* $ 37,125
Interest 1,405
Security Lending 929
- --------------------------------------------------------------------------------
Total Income $ 39,459
- --------------------------------------------------------------------------------
EXPENSES
Investment Advisory Fees--Note B $ 1,103
The Vanguard Group--Note C
Management and Administrative
Investor Shares 5,138
Admiral Shares 341
Marketing and Distribution
Investor Shares 187
Admiral Shares 12
Custodian Fees 32
Auditing Fees 14
Shareholders' Reports
Investor Shares 75
Admiral Shares --
Trustees' Fees and Expenses 2
- --------------------------------------------------------------------------------
Total Expenses 6,904
Expenses Paid Indirectly--Note D (395)
- --------------------------------------------------------------------------------
Net Expenses 6,509
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 32,950
- --------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Investment Securities Sold 82,569
Foreign Currencies 5
- --------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS) 82,574
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 460,848
Foreign Currencies 1
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 460,849
- --------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ 576,373
================================================================================
*Dividends are net of foreign withholding taxes of $2,126,000.
18
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the net amount shareholders invested in
or redeemed from the fund. Distributions and Capital Share Transactions are
shown separately for each class of shares.
- --------------------------------------------------------------------------------
ENERGY FUND
----------------------------
YEAR ENDED JANUARY 31,
----------------------------
2004 2003
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 32,950 $ 22,328
Realized Net Gain (Loss) 82,574 74,377
Change in Unrealized Appreciation
(Depreciation) 460,849 (113,925)
- --------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets
Resulting from Operations 576,373 (17,220)
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Net Investment Income
Investor Shares (27,313) (19,022)
Admiral Shares (2,358) (1,501)
Realized Capital Gain*
Investor Shares (52,106) (83,735)
Admiral Shares (4,338) (5,973)
- --------------------------------------------------------------------------------
Total Distributions (86,115) (110,231)
- --------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS--NOTE H
Investor Shares 683,309 151,108
Admiral Shares 67,055 61,825
- --------------------------------------------------------------------------------
Net Increase (Decrease) from Capital
Share Transactions 750,364 212,933
- --------------------------------------------------------------------------------
Total Increase (Decrease) 1,240,622 85,482
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 1,401,335 1,315,853
- --------------------------------------------------------------------------------
End of Period $ 2,641,957 $ 1,401,335
================================================================================
*Includes fiscal 2004 and 2003 short-term gain distributions totaling $0 and
$23,192,000, respectively. Short-term gain distributions are treated as ordinary
income dividends for tax purposes.
19
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis for each class of shares. It also presents the
Total Return and shows net investment income and expenses as percentages of
average net assets. These data will help you assess: the variability of the
fund's net income and total returns from year to year; the relative
contributions of net income and capital gains to the fund's total return; how
much it costs to operate the fund; and the extent to which the fund tends to
distribute capital gains. The table also shows the Portfolio Turnover Rate, a
measure of trading activity. A turnover rate of 100% means that the average
security is held in the fund for one year.
ENERGY FUND INVESTOR SHARES
- ----------------------------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
------------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $22.85 $24.76 $26.93 $21.24 $17.16
- ----------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .435 .392 .428 .39 .355
Net Realized and Unrealized Gain (Loss)
on Investments* 7.839 (.349) (.660) 7.04 4.080
- ----------------------------------------------------------------------------------------------------------------
Total from Investment Operations 8.274 .043 (.232) 7.43 4.435
- ----------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.390) (.360) (.400) (.36) (.355)
Distributions from Realized Capital Gains (.744) (1.593) (1.538) (1.38) --
- ----------------------------------------------------------------------------------------------------------------
Total Distributions (1.134) (1.953) (1.938) (1.74) (.355)
- ----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $29.99 $22.85 $24.76 $26.93 $21.24
================================================================================================================
TOTAL RETURN** 36.49% -0.02% -0.55% 35.08% 25.83%
================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $2,434 $1,298 $1,258 $1,281 $973
Ratio of Total Expenses to Average Net Assets 0.38% 0.40% 0.39% 0.41% 0.48%
Ratio of Net Investment Income to Average Net Assets 1.79% 1.56% 1.57% 1.52% 1.63%
Portfolio Turnover Rate 26% 23% 28% 24% 18%
================================================================================================================
*Includes increases from redemption fees of $.00, $.01, $.01, $.02, and $.02.
**Total returns do not reflect the 1% fee assessed on redemptions of shares held
for less than one year.
20
ENERGY FUND ADMIRAL SHARES
- --------------------------------------------------------------------------------
NOV. 12,
YEAR ENDED 2001* TO
JANUARY 31, JAN. 31,
--------------- -----------
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2004 2003 2002
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $42.89 $46.48 $50.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .847 .758 .118
Net Realized and Unrealized Gain (Loss)
on Investments** 14.721 (.658) .010
- --------------------------------------------------------------------------------
Total from Investment Operations 15.568 .100 .128
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.760) (.698) (.760)
Distributions from Realized Capital Gains (1.398) (2.992) (2.888)
- --------------------------------------------------------------------------------
Total Distributions (2.158) (3.690) (3.648)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $56.30 $42.89 $46.48
================================================================================
TOTAL RETURN+ 36.58% 0.02% 0.57%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $208 $103 $58
Ratio of Total Expenses to Average Net Assets 0.32% 0.34% 0.34%++
Ratio of Net Investment Income to
Average Net Assets 1.85% 1.59% 0.53%++
Portfolio Turnover Rate 26% 23% 28%
================================================================================
*Inception.
**Includes increases from redemption fees of $.01, $.02, and $.03.
+Total returns do not reflect the 1% fee assessed on redemptions of shares held
for less than one year.
++Annualized.
SEE ACCOMPANYING NOTES, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
21
NOTES TO FINANCIAL STATEMENTS
Vanguard Energy Fund is registered under the Investment Company Act of 1940 as
an open-end investment company, or mutual fund. The fund may invest in
securities of foreign issuers, which may subject it to investment risks not
normally associated with investing in securities of United States corporations.
The fund offers two classes of shares, Investor Shares and Admiral Shares.
Investor Shares are available to any investor who meets the fund's minimum
purchase requirements. Admiral Shares are designed for investors who meet
certain administrative, servicing, tenure, and account-size criteria.
A. The following significant accounting policies conform to generally accepted
accounting principles for U.S. mutual funds. The fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Securities are valued as of the close of trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation
date. Equity securities are valued at the latest quoted sales prices or official
closing prices taken from the primary market in which each security trades; such
securities not traded on the valuation date are valued at the mean of the latest
quoted bid and asked prices. Securities for which market quotations are not
readily available, or whose values have been materially affected by events
occurring before the fund's pricing time but after the close of the securities'
primary markets, are valued by methods deemed by the board of trustees to
represent fair value. Temporary cash investments acquired over 60 days to
maturity are valued using the latest bid prices or using valuations based on a
matrix system (which considers such factors as security prices, yields,
maturities, and ratings), both as furnished by independent pricing services.
Other temporary cash investments are valued at amortized cost, which
approximates market value.
2. FOREIGN CURRENCY: Securities and other assets and liabilities
denominated in foreign currencies are translated into U.S. dollars at the
exchange rates on the valuation date as employed by Morgan Stanley Capital
International in the calculation of its indexes.
Realized gains (losses) and unrealized appreciation (depreciation) on
investment securities include the effects of changes in exchange rates since the
securities were purchased, combined with the effects of changes in security
prices. Fluctuations in the value of other assets and liabilities resulting from
changes in exchange rates are recorded as unrealized foreign currency gains
(losses) until the asset or liability is settled in cash, when they are recorded
as realized foreign currency gains (losses).
3. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a pooled cash account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
4. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold. Fees assessed on redemptions of
capital shares are credited to paid-in capital.
Each class of shares has equal rights as to assets and earnings, except that
each class separately bears certain class-specific expenses related to
maintenance of shareholder accounts (included in
22
Management and Administrative expenses) and shareholder reporting. Marketing and
distribution expenses are allocated to each class of shares based on a method
approved by the board of trustees. Income, other non-class-specific expenses,
and gains and losses on investments are allocated to each class of shares based
on its relative net assets.
B. Wellington Management Company, llp, provides investment advisory services to
the fund for a fee calculated at an annual percentage rate of average net
assets. For the year ended January 31, 2004, the advisory fee represented an
effective annual rate of 0.06% of the fund's average net assets.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the board of trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At January 31, 2004, the fund had contributed capital of $370,000 to
Vanguard (included in Other Assets), representing 0.01% of the fund's net assets
and 0.37% of Vanguard's capitalization. The fund's trustees and officers are
also directors and officers of Vanguard.
D. The fund has asked its investment advisor to direct certain security trades,
subject to obtaining the best price and execution, to brokers who have agreed to
rebate to the fund part of the commissions generated. Such rebates are used
solely to reduce the fund's management and administrative expenses. For the year
ended January 31, 2004, these arrangements reduced expenses by $395,000 (an
annual rate of 0.02% of average net assets).
E. Distributions are determined on a tax basis and may differ from net
investment income and realized capital gains for financial reporting purposes.
Differences may be permanent or temporary. Permanent differences are
reclassified among capital accounts in the financial statements to reflect their
tax character. Temporary differences arise when certain items of income,
expense, gain, or loss are recognized in different periods for financial
statement and tax purposes; these differences will reverse at some time in the
future. Differences in classification may also result from the treatment of
short-term gains as ordinary income for tax purposes.
During the year ended January 31, 2004, the fund realized net foreign currency
gains of $5,000, which increased distributable net income for tax purposes;
accordingly, such gains have been reclassified from accumulated net realized
gains to undistributed net investment income. The fund used a tax accounting
practice to treat a portion of the price of capital shares redeemed during the
year as distributions from net investment income and realized capital gains.
Accordingly, the fund has reclassified $1,548,000 from undistributed net
investment income, and $3,534,000 from accumulated net realized gains, to
paid-in capital.
For tax purposes, at January 31, 2004, the fund had $5,316,000 of ordinary
income and $13,980,000 of long-term capital gains available for distribution.
At January 31, 2004, net unrealized appreciation of investment securities for
tax purposes was $599,355,000, consisting of unrealized gains of $606,670,000 on
securities that had risen in value since their purchase and $7,315,000 in
unrealized losses on securities that had fallen in value since their purchase.
F. During the year ended January 31, 2004, the fund purchased $1,035,579,000 of
investment securities and sold $449,693,000 of investment securities other than
temporary cash investments.
G. The market value of securities on loan to broker/dealers at January 31, 2004,
was $220,172,000, for which the fund held cash collateral of $229,399,000. The
fund invests cash collateral received in repurchase agreements, and records a
liability for the return of the collateral, during the period the securities are
on loan.
23
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
H. Capital share transactions for each class of shares were:
- -------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
-------------------------------------------
2004 2003
--------------------- -------------------
AMOUNT SHARES AMOUNT SHARES
(000) (000) (000) (000)
- -------------------------------------------------------------------------------------------
INVESTOR SHARES
Issued $859,161 31,335 $307,206 11,969
Issued in Lieu of Cash Distributions 75,835 2,669 97,538 4,124
Redeemed* (251,687) (9,640) (253,636) (10,106)
---------------------------------------------
Net Increase (Decrease)--Investor Shares 683,309 24,364 151,108 5,987
---------------------------------------------
ADMIRAL SHARES
Issued 79,170 1,534 76,563 1,529
Issued in Lieu of Cash Distributions 5,919 111 6,556 149
Redeemed* (18,034) (364) (21,294) (504)
---------------------------------------------
Net Increase (Decrease)--Admiral Shares 67,055 1,281 61,825 1,174
- -------------------------------------------------------------------------------------------
*Net of redemption fees of $413,000 and $630,000, respectively (fund totals).
24
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Trustees of Vanguard Energy Fund:
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Energy Fund (the "Fund") at January 31, 2004, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended and the financial highlights for each of
the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the Fund's management; our responsibility
is to express an opinion on these financial statements based on our audits. We
conducted our audits of these financial statements in accordance with auditing
standards generally accepted in the United States of America, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits, which included confirmation
of securities at January 31, 2004 by correspondence with the custodian, provide
a reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
PHILADELPHIA, PENNSYLVANIA
MARCH 8, 2004
- --------------------------------------------------------------------------------
SPECIAL 2003 TAX INFORMATION
(UNAUDITED) FOR VANGUARD ENERGY FUND
This information for the fiscal year ended January 31, 2004, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $59,838,000 as capital gain dividends (from net long-term
capital gains) to shareholders during the fiscal year, all of which is
designated as a 20% rate gain distribution.
For corporate shareholders, 51.1% of investment income (dividend income plus
short-term gains, if any) qualifies for the dividends-received deduction.
The fund intends to distribute the maximum amount of qualified dividend income
allowable. The amount of qualified dividend income distributed by the fund is
provided to individual shareholders on their Form 1099-DIV.
- --------------------------------------------------------------------------------
25
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26
CAPITALIZE ON YOUR IRA
Are you taking full advantage of your individual retirement account? You really
should be. The contribution limits on IRAs were recently raised, making these
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Here's how you can exploit your IRA--and improve your chances of having the
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CONTRIBUTE THE MAXIMUM AMOUNT EACH YEAR
It may be an obvious point, but if you invest as much in your IRA as the law
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"Max out" every year you can.
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THE PEOPLE WHO GOVERN YOUR FUND
The trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are a part owner of
the fund. Your fund trustees also serve on the board of directors of The
Vanguard Group, Inc., which is owned by the Vanguard(R) funds and provides
services to them on an at-cost basis.
A majority of Vanguard's board members are independent, meaning that they have
no affiliation with Vanguard or the funds they oversee, apart from the sizable
personal investments they have made as private individuals.
Our independent board members bring distinguished backgrounds in business,
academia, and public service to their task of working with Vanguard officers to
establish the policies and oversee the activities of
- ------------------------------------------------------------------------------------------------------------
POSITION(S) HELD WITH
NAME FUND (NUMBER OF
(YEAR OF BIRTH) VANGUARD FUNDS
TRUSTEE/OFFICER OVERSEEN BY
SINCE TRUSTEE/OFFICER) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
- ------------------------------------------------------------------------------------------------------------
JOHN J. BRENNAN* Chairman of the Chairman of the Board, Chief Executive Officer, and Director/Trustee
(1954) Board, Chief of The Vanguard Group, Inc., and of each of the investment companies
May 1987 Executive Officer, served by The Vanguard Group.
and Trustee
(118)
- ------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
CHARLES D. ELLIS Trustee The Partners of '63 (pro bono ventures in education); Senior Advisor
(1937) (118) to Greenwich Associates (international business strategy consulting);
January 2001 Successor Trustee of Yale University; Overseer of the Stern School of
Business at New York University; Trustee of the Whitehead Institute
for Biomedical Research.
- ------------------------------------------------------------------------------------------------------------
RAJIV L. GUPTA Trustee Chairman and Chief Executive Officer (since October 1999), Vice
(1945) (118) Chairman (January-September 1999), and Vice President (prior to
December 2001 September 1999) of Rohm and Haas Co. (chemicals); Director of
Technitrol, Inc. (electronic components), and Agere Systems
(communications components); Board Member of the American Chemistry
Council; and Trustee of Drexel University.
- ------------------------------------------------------------------------------------------------------------
JOANN HEFFERNAN Trustee Vice President, Chief Information Officer, and Member of the
HEISEN (118) Executive Committee of Johnson & Johnson (pharmaceuticals/consumer
(1950) products); Director of the Medical Center at Princeton and Women's
July 1998 Research and Education Institute.
- ------------------------------------------------------------------------------------------------------------
BURTON G. MALKIEL TRUSTEE Chemical Bank Chairman's Professor of Economics,Princeton University;
(1932) (116) Director of Vanguard Investment Series plc (Irish invest-ment fund)
May 1977 (since November 2001), Vanguard Group (Ireland)Limited (Irish
investment management firm)(since November 2001),Prudential Insurance
Co. of America, BKF Capital (investment management), The Jeffrey Co.
(holding company), and NeuVis, Inc.(software company).
- ------------------------------------------------------------------------------------------------------------
the funds. Among board members' responsibilities are selecting investment
advisors for the funds; monitoring fund operations, performance, and costs;
reviewing contracts; nominating and selecting new trustees/directors; and
electing Vanguard officers.
Each trustee serves a fund until its termination; or until the trustee's
retirement, resignation, or death; or otherwise as specified in the fund's
organizational documents. Any trustee may be removed at a shareholders' meeting
by a vote representing two-thirds of the net asset value of all shares of the
fund together with shares of other Vanguard funds organized within the same
trust. The table on these two pages shows information for each trustee and
executive officer of the fund. The mailing address of the trustees and officers
is P.O. Box 876, Valley Forge, PA 19482.
POSITION(S) HELD WITH
NAME FUND (NUMBER OF
(YEAR OF BIRTH) VANGUARD FUNDS
TRUSTEE/OFFICER OVERSEEN BY
SINCE TRUSTEE/OFFICER) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
- ------------------------------------------------------------------------------------------------------------
Alfred M. Rankin, Jr. Trustee Chairman, President, Chief Executive Officer, and Director of NACCO
(1941) (118) Industries, Inc. (forklift trucks/housewares/lignite); Director of
January 1993 Goodrich Corporation (industrial products/aircraft systems and
services); Director of Standard Products Company (supplier for
the automotive industry) until 1998.
- ------------------------------------------------------------------------------------------------------------
J. Lawrence Wilson Trustee Retired Chairman and Chief Executive Officer of Rohm and Haas Co.
(1936) (118) (chemicals); Director of Cummins Inc. (diesel engines), The Mead
April 1985 Corp. (paper products), and AmerisourceBergen Corp. (pharmaceuti-cal
distribution); Trustee of Vanderbilt University.
- ------------------------------------------------------------------------------------------------------------
EXECUTIVE OFFICERS*
R. Gregory Barton Secretary Managing Director and General Counsel of The Vanguard Group, Inc.;
(1951) (118) Secretary of The Vanguard Group and of each of the investment
June 2001 companies served by The Vanguard Group.
- ------------------------------------------------------------------------------------------------------------
Thomas J. Higgins Treasurer Principal of The Vanguard Group, Inc.; Treasurer of each of the
(1957) (118) investment companies served by The Vanguard Group.
July 1998
- ------------------------------------------------------------------------------------------------------------
*Officers of the funds are "interested persons" as defined in the Investment
Company Act of 1940.
More information about the trustees is in the Statement of Additional
Information, available from The Vanguard Group.
- ------------------------------------------------------------------------------------------------------------
VANGUARD SENIOR MANAGEMENT TEAM
MORTIMER J. BUCKLEY, Information Technology. MICHAEL S. MILLER, Planning and Development.
JAMES H. GATELY, Investment Programs and Services. RALPH K. PACKARD, Finance.
KATHLEEN C. GUBANICH, Human Resources. GEORGE U. SAUTER, Chief Investment Officer.
F. WILLIAM MCNABB, III, Client Relationship Group.
- ------------------------------------------------------------------------------------------------------------
JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996.
- ------------------------------------------------------------------------------------------------------------
[VANGUARD SHIP LOGO]
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ABOUT OUR COVER
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FOR MORE INFORMATION
This report is intended for the fund's shareholders. It may not be distributed
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(C) 2004 THE VANGUARD GROUP, INC.
ALL RIGHTS RESERVED.
VANGUARD MARKETING
CORPORATION, DISTRIBUTOR.
Q510 032004
VANGUARD(R) PRECIOUS METALS FUND
JANUARY 31, 2004
{GRAPHIC}
ANNUAL REPORT
THE VANGUARD GROUP (R) [LOGO]
HOW TO READ YOUR FUND REPORT
This report contains information that can help you evaluate your investment. It
includes details about your fund's return and presents data and analysis that
provide insight into the fund's performance and investment approach.
By reading the letter from Vanguard's chairman, John J. Brennan, together with
the letter from the managers who select securities for your fund, you'll get an
understanding of how the fund invests and how the market environment affected
its performance. The statistical information that follows can help you
understand how the fund's performance and characteristics stack up against those
of similar funds and market benchmarks.
It's important to keep in mind that the opinions expressed by Vanguard's
investment managers are just that: informed opinions. They should not be
considered promises or advice. The opinions, like the statistics, cover the
period through the date on the cover of this report. As things change--and in
the financial markets you can be certain only of change--an investment manager's
job is to evaluate new information and make adjustments, if necessary. Of
course, the risks of investing in the fund are spelled out in the prospectus.
Frequent updates on the fund's performance and information about some of its
holdings are available on Vanguard.com(R).
- --------------------------------------------------------------------------------
CONTENTS
1 LETTER FROM THE CHAIRMAN
6 REPORT FROM THE ADVISOR
9 FUND PROFILE
10 GLOSSARY OF INVESTMENT TERMS
11 PERFORMANCE SUMMARY
12 YOUR FUND'S AFTER-TAX RETURNS
13 ABOUT YOUR FUND'S EXPENSES
14 FINANCIAL STATEMENTS
23 ADVANTAGES OF VANGUARD.COM
SUMMARY
- - Vanguard Precious Metals Fund posted a 2004 fiscal-year return of 44.1%,
outperforming its comparative measures and the broad U.S. stock market.
- - The fund's strategy of diversifying through non-gold-related holdings
helped its relative performance in fiscal 2004.
- - The fund's board of trustees recently approved an expansion of the fund's
investment mandate to include stocks of companies that deal with
non-precious metals or minerals. The expansion will take effect later this
year; at that time, the fund will reopen to new investments.
Want less clutter in your mailbox? Just register with VANGUARD.COM and opt to
get fund reports online.
- --------------------------------------------------------------------------------
LETTER FROM THE CHAIRMAN
- --------------------------------------------------------------------------------
Dear Shareholder,
Inflation fears, a weaker U.S. dollar, and rising prices for bullion and other
metals helped Vanguard Precious Metals Fund to achieve its third straight fiscal
year with a double-digit gain.
[PICTURES OF JOHN J. BRENNAN]
For the 12 months ended January 31, 2004, your fund returned 44.1%, topping the
results of both its benchmark index and the average gold- oriented mutual fund.
The adjacent table shows total returns (capital change plus reinvested
distributions) for your fund and its comparative measures, as well as for the
Wilshire 5000 Total Market Index, a proxy for the broad U.S. stock market. The
table on page 5 presents the fund's share price at the beginning and end of the
12 months and its per-share distributions during the period.
- --------------------------------------------------------------------------------
2004 TOTAL RETURNS FISCAL YEAR ENDED
JANUARY 31
- --------------------------------------------------------------------------------
VANGUARD PRECIOUS METALS FUND 44.1%
S&P/Citigroup World Equity Gold Index 34.2
Average Gold-Oriented Fund* 40.5
Wilshire 5000 Index 38.1
- --------------------------------------------------------------------------------
*Derived from data provided by Lipper Inc.
I should note that a significant change to your fund will take effect in late
May. The fund's board of trustees has broadened the fund's mandate to permit
investments in companies that focus on non- precious metals such as nickel,
copper, and zinc. The majority of the fund's assets will continue to be invested
in companies that focus on precious and rare metals or minerals.
The change is a response to the increasing concentration of the metal and
minerals industries, which has made it difficult to keep the portfolio fully
invested while maintaining the overall quality and diversity of its holdings.
When regulators complete their review of our change, the fund will be renamed to
reflect the expanded investment mandate, and the freeze on new investments will
be lifted.
1
STOCKS GENERATED OUTSTANDING RETURNS
For the 12 months ended January 31, the Wilshire 5000 Index returned 38.1%,
reflecting a dramatic resurgence in stocks across the board. At the start of the
period, investors were apprehensive. War with Iraq was imminent, and the labor
market and manufacturing industries were stagnating, despite the broad economy's
slow-but-steady expansion. Within weeks, however, the United States and its
allies had begun and successfully completed major combat operations in Iraq. And
in the succeeding months, the economic picture also brightened: The unemployment
rate declined, and manufacturing began to stir. In the quarter ended September
30, the U.S. economy grew at an annualized rate of 8.2%; estimates put
fourth-quarter gross domestic product growth at about 4.0%.
With each piece of good news, the market's mood inched from cautious toward
cavalier. For the full 12 months, the stock market's small-capitalization
issues, as represented by the Russell 2000 Index, returned 58.0%. That was 22.4
percentage points more than the Russell 1000 Index's large-cap stocks.
RISK WAS REWARDED IN THE BOND MARKET
The same tone was apparent in the fixed income market. Demand for
default-risk-free U.S. Treasuries was initially extreme, boosting the price of
the 10-year Treasury note while reducing its yield to just above 3% in June. By
year-end, however, the mood had changed. The Lehman Brothers High Yield Bond
Index, a benchmark of below-investment-grade bonds, recorded a 12-month return
of 27.2%, while investment-grade bonds, as measured by the Lehman Aggregate Bond
Index, returned 4.9%.
- --------------------------------------------------------------------------------
MARKET BAROMETER AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED JANUARY 31, 2004
------------------------------
ONE THREE FIVE
YEAR YEARS YEARS
- --------------------------------------------------------------------------------
STOCKS
Russell 1000 Index (Large-caps) 35.6% -4.2% -0.5%
Russell 2000 Index (Small-caps) 58.0 6.0 7.8
Wilshire 5000 Index (Entire market) 38.1 -3.0 0.1
MSCI All Country World Index
ex USA (International) 48.9 -0.9 1.9
- --------------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 4.9% 7.3% 6.6%
(Broad taxable market)
Lehman Municipal Bond Index 6.2 6.5 5.7
Citigroup 3-Month Treasury Bill Index 1.0 2.1 3.4
================================================================================
CPI
Consumer Price Index 1.9% 1.9% 2.4%
- --------------------------------------------------------------------------------
Short-term interest rates fell to even lower levels during the period. The yield
of the 3-month Treasury bill, a proxy for money market rates, ended the fiscal
year at 0.91%, 26 basis points lower than at the start of the period.
2
THE FUND POSTED ITS BEST FISCAL-YEAR RETURN IN A DECADE
More than four-fifths of your fund's 44.1% total return came from an increase in
share price, with the balance from dividend income. Several factors contributed
to this remarkable return.
Although inflation has been tame for more than a decade, the strengthening
economy raised the possibility that prices would once again begin to climb. The
result was renewed interest in precious metals, a traditional haven for
investors concerned about inflation. During the fiscal year, prices for these
commodities--and for stocks in the companies that mine or process them--rose.
The decline of the U.S. dollar also played a role in your fund's stellar return.
For U.S.-based investors, a weaker dollar bolsters returns from foreign
securities because of the favorable currency exchange rates. Relative to the
U.S. dollar, the Canadian dollar rose about 15%, the South African rand rose
22%, and the Australian dollar rose 29% during the 12 months. I mention those
currencies because companies in the three countries constituted about 60% of the
fund's assets at our fiscal year-end. Because most precious metals companies are
based outside the United States, virtually all of your fund's assets are
invested in stocks of foreign companies. The advantage of stronger foreign
currencies abroad, however, was partly offset by lower revenue from exports, as
was the case for some of our stocks with operations in South Africa.
As the table on page 1 shows, the fund's return was almost 10 percentage points
higher than the result of its benchmark index. The fund also bested the average
return of its fund peer group by 3.6 percentage points. In both cases, much
credit goes to the investment advisor's superior stock selection. Another
factor, however, is that the index and the average peer are almost exclusively
gold-oriented, while your fund invests a fair proportion of its assets in
companies devoted entirely or in part to other metals and minerals. Silver and
platinum prices rose more than gold prices in fiscal 2004, and some of the best
performers during the period were companies that mine or process diamonds,
platinum, silver, copper, and nickel. For example, Russian-based Norilsk Nickel
rose 201%, and it alone contributed more than 6 percentage points to the fund's
total return.
For further details on the fund's individual holdings and performance, see the
Report from the Advisor on page 6.
3
YOUR FUND OUTPERFORMED ITS BENCHMARKS OVER TEN YEARS
Your fund's diversification within its sector helped it stay somewhat less
volatile than its benchmark index or the average peer fund during the decade
ended January 31, and the advisor achieved this without sacrificing relative
performance. The table at left shows annualized returns for your fund and its
comparative measures during the decade. Also shown are the final results of a
hypothetical $10,000 investment made in each. Your fund would have generated
almost $3,400 more than the average peer fund--the difference is more than
one-third of the initial investment.
- --------------------------------------------------------------------------------
TOTAL RETURNS TEN YEARS ENDED
JANUARY 31, 2004
---------------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RETURN INITIAL INVESTMENT
- --------------------------------------------------------------------------------
Precious Metals Fund 4.1% $14,972
S&P/Citigroup World
Equity Gold Index 2.5 12,802
Average Gold-Oriented Fund 1.5 11,574
Wilshire 5000 Index 10.5 27,107
- --------------------------------------------------------------------------------
Again, much of the credit goes to the fund's advisor, M&G Investment Management,
which focuses on the fundamentals of a company and generally avoids smaller,
speculative businesses that can be prone to implosion. Vanguard's low costs give
us another edge. Your fund's expense ratio has traditionally been a fraction of
the average for its peer group. That means that competitors have to generate a
higher gross return than ours to match our net return--a difficult hurdle to
overcome year after year.
THE LONG-TERM RECORD ALSO ARGUES FOR DIVERSIFICATION
Although your fund's long-term performance relative to its average peer and
benchmark index has been solid, its 4.1% annualized return over the last decade
significantly lagged the result of the broad stock market. And while the fund
has been less volatile than its average peer, it certainly is not for the faint
of heart. Over that same ten-year period, for example, the fund had five years
of double-digit gains and four years of double-digit declines.
High volatility shouldn't be a surprise in any fund that holds a concentrated
portfolio or focuses on just one sector; that's why such a fund should never
represent the bulk of a personal portfolio. However, during the past decade your
fund has also illustrated another aspect of sector investments. Some of the
fund's best returns came during the 2000-2002 bear market for stocks, while some
of its worst came during the bull
4
market of the late 1990s. This low correlation between the performance of the
fund and that of the broader market illustrates the proper role of certain
sector funds--as a potential counterweight to the fluctuations of other assets.
- --------------------------------------------------------------------------------
If you own the fund in a taxable account, you may wish to read the report on the
fund's after-tax returns on page 12.
- --------------------------------------------------------------------------------
In other words, as a small portion of a broader portfolio made up of stocks,
bonds, and short-term investments, a sector fund can serve to reduce the overall
volatility of the whole portfolio. As part of such a balanced plan, a fund like
ours, which focuses on precious metals and mining stocks, can play a useful
role.
I want to close by thanking you for entrusting your assets to Vanguard. In light
of reports of late trading and market-timing at other investment management
firms, I can assure you that Vanguard has long had policies and procedures in
place to identify and deter such behavior. More important, Vanguard shareholders
are served by a crew of the highest integrity working within a client-owned
corporate structure that aligns our day-to-day efforts with our clients'
long-term financial goals.
Sincerely,
/S/ JOHN J. BRENNAN
JOHN J. BRENNAN
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
FEBRUARY 12, 2004
- --------------------------------------------------------------------------------
YOUR FUND'S PERFORMANCE AT A GLANCE JANUARY 31, 2003-JANUARY 31, 2004
DISTRIBUTIONS PER SHARE
STARTING ENDING INCOME CAPITAL
SHARE PRICE SHARE PRICE DIVIDENDS GAINS
- --------------------------------------------------------------------------------
Precious Metals Fund $11.25 $15.29 $0.934 $0.000
- --------------------------------------------------------------------------------
5
- --------------------------------------------------------------------------------
REPORT FROM THE ADVISOR
- --------------------------------------------------------------------------------
Vanguard Precious Metals Fund returned 44.1% during the 12 months ended January
31, 2004. This was significantly ahead of the 34.2% return of the Standard &
Poor's/Citigroup World Equity Gold Index for the period, and it also exceeded
the 40.5% return of our average mutual fund peer. Over the longer term, the fund
has had excellent returns, with its 22.9% annualized five-year return comparing
very favorably with those of the average peer (+19.4%) and the benchmark
(+20.6%).
THE INVESTMENT ENVIRONMENT
The price of gold was heavily influenced by geopolitical events during the past
12 months. At the start of our fiscal year, gold prices were pushed higher by
investors worrying about the looming war in Iraq, global terrorism, and the
continued weakness of the world's equity markets. Although suspense abated about
many of these factors during the fiscal year, the price of gold remained at a
surprisingly high level. This level is now increasingly sustained by investors'
concerns about the weakness of the U.S. dollar, as well as by the ongoing
consolidation in the precious metals industry.
THE FUND'S SUCCESSES
The fund benefited greatly from the bid for Ashanti Goldfields by AngloGold,
with our very large position in the former gaining impressively. This was the
latest in a number of takeovers and mergers to benefit companies held by the
fund over the past few years. Another holding, Compania de Minas Buenaventura,
performed well based on its good production figures and the increased
attractiveness to investors of emerging markets such as Peru, where the company
is based. We also saw strong performances from the fund's limited positions at
the smaller end of the market-capitalization spectrum. Examples are Tanami Gold,
Equinox Resources, and First Quantum Minerals, all of which had healthy gains.
By far the most significant driver of the fund's performance, however, was its
exposure to diversified mining companies, which registered excellent gains due
to strong global demand for their products. China's demand for metals to fuel
the country's explosive economic growth was
6
a particularly influential factor. Looking forward, we continue to see
compelling investment opportunities in this asset class, as illustrated by the
very strong fiscal 2004 returns of Norilsk Nickel (a Russian producer of nickel
and platinum), Aber Diamond (a Canadian diamond producer), Lonmin (a U.K.-based
producer of South African platinum), and First Quantum Minerals (a Canadian
miner of copper, cobalt, and gold in Africa).
THE FUND'S SHORTFALLS
Gold companies that lagged during the period--and detracted from the fund's
performance--were generally based outside North America. Of particular note was
South Africa-based AngloGold, which underperformed significantly because of the
negative impact of the strong rand on the company's earnings. Our holdings in
South African platinum-mining companies, such as Impala Platinum, were also hurt
by the appreciation of the rand, despite a healthy rise in the price of platinum
and the metal's robust fundamentals.
The fund's relative underexposure in the U.S. gold heavyweight Newmont Mining
during the fiscal year continued to be a drawback to our performance compared
with the benchmark index. Following the company's merger with Franco-Nevada and
Normandy Mining in early 2002, Newmont became the world's largest gold-mining
company, making up a considerable proportion of the index. As in fiscal 2003,
Newmont's shares made strong gains during the past 12 months, but we think that
the company's valuation is increasingly stretched.
THE FUND'S POSITIONING
Throughout the fiscal year the fund remained true to its investment philosophy
and style, concentrating on the blue-chip end of the market. This area has
become increasingly consolidated due to merger-and-acquisition activity, leading
to the concentration of a relatively small number of companies in the fund. This
was a factor in the fund's shift into more diversified mining companies in
fiscal 2004, a move that benefited the fund's shareholders. Given our upbeat
view of the global economy and our concerns about the stretched valuations of
gold stocks, we expect this part of the portfolio to continue to support the
fund's performance going forward.
7
Portfolio activity was limited during the fiscal year. We established a new
position in First Quantum Minerals and bought the Canadian platinum producer
SouthernEra Resources. We reduced the fund's holdings in several North American
companies, such as Newmont Mining (which we eliminated), Barrick Gold, and
Placer Dome, because merger activity had made these companies very significant
positions in the fund.
We continue to run the portfolio in line with our clearly defined investment
approach, which is to invest in attractively valued companies with good assets,
strong managements, and reliable cash flows. We will maintain the fund's
underweighting in the small, speculative end of the market, as well as in the
very large North American producers. Finally, we remain confident that the
macroeconomic environment is right for commodity shares to fare competitively.
GRAHAM E. FRENCH, PORTFOLIO MANAGER
M&G INVESTMENT MANAGEMENT LTD.
FEBRUARY 17, 2004
8
- --------------------------------------------------------------------------------
FUND PROFILE AS OF 1/31/2004
This Profile provides a snapshot of the fund's characteristics, compared where
indicated with a broad market index. Key terms are defined on page 10.
- --------------------------------------------------------------------------------
PRECIOUS METALS FUND
- --------------------------------------------------------------------------------
PORTFOLIO CHARACTERISTICS
BROAD
FUND INDEX*
- --------------------------------------------------------------------------------
Number of Stocks 21 5,190
Median Market Cap $1.9B $28.0B
Price/Earnings Ratio 34.7x 25.4x
Price/Book Ratio 3.1x 3.1x
Return on Equity 9.4% 15.8%
Earnings Growth Rate 12.8% 5.2%
Foreign Holdings 100% 0.9%
Turnover Rate 15% --
Expense Ratio 0.55% --
Short-Term Reserves 3% --
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
VOLATILITY MEASURES
BROAD
FUND INDEX*
- --------------------------------------------------------------------------------
R-Squared 0.14 1.00
Beta 0.56 1.00
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
COUNTRY DIVERSIFICATION (% OF PORTFOLIO)
Canada 28%
South Africa 22
Australia 11
Peru 9
Ghana 9
Russia 8
United Kingdom 7
Papua New Guinea 3
- --------------------------------------------------------------------------------
Subtotal 97%
- --------------------------------------------------------------------------------
Short-Term Reserves 3%
- --------------------------------------------------------------------------------
Total 100%
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
Impala Platinum Holdings Ltd. ADR 10.3%
Placer Dome Inc. 9.6
Compania de Minas Buenaventura S.A.u. ADR 9.4
Ashanti Goldfields Co., Ltd. GDR 9.0
Mining and Metallurgical Company Norilsk Nickel ADR 7.6
Lonmin PLC 7.1
Aber Diamond Corp. 6.4
WMC Resources Ltd. 6.0
Anglo American Platinum Corp. Ltd. ADR 5.7
AngloGold Ltd. ADR 5.3
- --------------------------------------------------------------------------------
Top Ten 76.4%
- --------------------------------------------------------------------------------
The "Ten Largest Holdings" excludes any temporary cash investments and equity
index products.
*Wilshire 5000 Index.
Visit our website at VANGUARD.COM for regularly updated fund information.
9
- --------------------------------------------------------------------------------
GLOSSARY OF INVESTMENT TERMS
- --------------------------------------------------------------------------------
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of a given market index. The index is assigned a
beta of 1.00. Compared with a given index, a fund with a beta of 1.20 typically
would have seen its share price rise or fall by 12% when the index rose or fell
by 10%. A fund's beta should be reviewed in conjunction with its R-squared (see
definition below). The lower the R-squared, the less correlation there is
between the fund and the index, and the less reliable beta is as an indicator of
volatility.
- --------------------------------------------------------------------------------
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
- --------------------------------------------------------------------------------
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
- --------------------------------------------------------------------------------
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or depositary receipts of companies based outside the United States.
- --------------------------------------------------------------------------------
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
- --------------------------------------------------------------------------------
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
- --------------------------------------------------------------------------------
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
- --------------------------------------------------------------------------------
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the market in general, as measured by a given index. If a
fund's total returns were precisely synchronized with an index's returns, its
R-squared would be 1.00. If the fund's returns bore no relationship to the
index's returns, its R-squared would be 0.
- --------------------------------------------------------------------------------
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
- --------------------------------------------------------------------------------
SHORT-TERM RESERVES. The percentage of a fund invested in highly liquid,
short-term securities that can be readily converted to cash.
- --------------------------------------------------------------------------------
TURNOVER RATE. An indication of the fund's trading activity. Funds with high
turnover rates incur higher transaction costs and may be more likely to
distribute capital gains (which may be taxable to investors).
- --------------------------------------------------------------------------------
10
- --------------------------------------------------------------------------------
PERFORMANCE SUMMARY AS OF 1/31/2004
ALL OF THE RETURNS IN THIS REPORT REPRESENT PAST PERFORMANCE, WHICH IS NOT A
GUARANTEE OF FUTURE RESULTS THAT MAY BE ACHIEVED BY THE FUND. (FOR THE MOST
RECENT PERFORMANCE, WHICH MAY BE HIGHER OR LOWER THAN THAT CITED, VISIT OUR
WEBSITE AT WWW.VANGUARD.COM.) NOTE, TOO, THAT BOTH INVESTMENT RETURNS AND
PRINCIPAL VALUE CAN FLUCTUATE WIDELY, SO THAT AN INVESTOR'S SHARES, WHEN SOLD,
COULD BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST. The returns shown do not
reflect taxes that a shareholder would pay on fund distributions or on the sale
of fund shares.
- --------------------------------------------------------------------------------
PRECIOUS METALS FUND
- --------------------------------------------------------------------------------
CUMULATIVE PERFORMANCE JANUARY 31, 1994-JANUARY 31, 2004
- --------------------------------------------------------------------------------
S&P/CITIGROUP AVERAGE
PRECIOUS WILSHIRE WORLD EQUITY GOLD-ORIENTED
METALS FUND 5000 INDEX GOLD INDEX FUND
- --------------------------------------------------------------------------------
199401 10000 10000 10000 10000
199404 9254 9423 8919 8961
199407 9616 9535 9248 8989
199410 10503 9923 10216 9609
199501 8080 9898 7888 7580
199504 8979 10826 8744 8705
199507 9477 12025 8833 9157
199510 8586 12478 8358 8312
199601 10766 13574 10626 10483
199604 10758 14307 10752 11368
199607 9507 13791 9447 10130
199610 9577 15199 9581 10111
199701 8559 16881 9042 9019
199704 8049 16831 8589 8277
199707 7595 20301 8377 7532
199710 6546 20001 7091 6757
199801 6004 21152 6217 5746
199804 6739 24110 7208 6590
199807 5012 23760 5021 4737
199810 5684 22960 5593 5293
199901 5340 26922 5009 4764
199904 6222 28239 6190 5450
199907 5882 28119 5624 4523
199910 6368 28854 6307 5205
200001 6274 30753 5720 4547
200004 5103 31574 5085 4210
200007 5496 31166 5100 4066
200010 5480 31192 4916 3759
200101 6316 29684 5751 4194
200104 6688 27123 6327 4770
200107 6534 26489 5998 4594
200110 7089 23226 6364 4897
200201 8214 25136 7443 5561
200204 9891 24442 9380 7493
200207 8229 20644 7600 6253
200210 8851 20112 8037 6737
200301 10392 19635 9538 8238
200304 9182 21122 8230 7418
200307 10946 23291 10170 8768
200310 14327 25027 12846 11949
200401 14972 27107 12802 11574
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED JANUARY 31, 2004
------------------------------ FINAL VALUE
ONE FIVE TEN OF A $10,000
YEAR YEARS YEARS INVESTMENT
- --------------------------------------------------------------------------------
Precious Metals Fund* 44.07% 22.90% 4.12% $14,972
Wilshire 5000 Index 38.05 0.14 10.49 27,107
S&P/Citigroup World Equity Gold Index** 34.22 20.65 2.50 12,802
Average Gold-Oriented Fund+ 40.50 19.43 1.47 11,574
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FISCAL-YEAR TOTAL RETURNS (%) JANUARY 31, 1994-JANUARY 31, 2004
S&P/CITIGROUP
PRECIOUS WORLD EQUITY
METALS FUND GOLD INDEX
- --------------------------------------------------------------------------------
1995 -19.2 -21.1
1996 33.2 34.7
1997 -20.5 -14.9
1998 -29.8 -31.2
1999 -11.1 -19.4
2000 17.5 14.2
2001 0.7 0.5
2002 30.1 29.4
2003 26.5 28.1
2004 44.1 34.2
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2003
This table presents average annual total returns through the latest calendar
quarter--rather than through the end of the fiscal period. Securities and
Exchange Commission rules require that we provide this information.
TEN YEARS
ONE FIVE -----------------------
INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------
Precious Metals Fund* 05/23/1984 59.45% 24.60% 1.79% 2.90% 4.69%
- --------------------------------------------------------------------------------
*Total return figures do not reflect the 1% fee assessed on redemptions of
shares held for less than one year.
**MSCI Gold Mines Index through December 31,1994; S&P/Citigroup World Equity
Gold Index thereafter.
+Derived from data provided by Lipper Inc.
Note: See Financial Highlights table on page 18 for dividend and capital gains
information.
11
- --------------------------------------------------------------------------------
YOUR FUND'S AFTER-TAX RETURNS
- --------------------------------------------------------------------------------
This table presents returns for your fund both before and after taxes. The
after-tax returns are shown in two ways: (1) assuming that an investor owned the
fund during the entire period and paid taxes on the fund's distributions, and
(2) assuming that an investor paid taxes on the fund's distributions and sold
all shares at the end of each period.
Calculations are based on the highest individual federal income tax and capital
gains tax rates in effect at the times of the distributions and the hypothetical
sales. State and local taxes were not considered. After-tax returns reflect the
reduced tax rates on ordinary income (including qualified dividend income) and
short-term capital gains that became effective as of January 1, 2003, and on
long-term capital gains realized on or after May 6, 2003. To calculate qualified
dividend income, we use actual 2003 figures and estimates for 2004. (In the
example, returns after the sale of fund shares may be higher than those assuming
no sale. This occurs when the sale would have produced a capital loss. The
calculation assumes that the investor received a tax deduction for the loss.)
Please note that your actual after-tax returns will depend on your tax situation
and may differ from those shown. Also note that if you own the fund in a
tax-deferred account, such as an individual retirement account or a 401(k) plan,
this information does not apply to you. Such accounts are not subject to current
taxes.
Finally, keep in mind that a fund's performance--whether before or after
taxes--does not guarantee future results.
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2004
ONE YEAR FIVE YEARS TEN YEARS
----------------------------------------
PRECIOUS METALS FUND*
Return Before Taxes 44.07% 22.90% 4.12%
Return After Taxes on
Distributions 41.62 21.23 3.08
Return After Taxes on
Distributions and Sale of Fund Shares 29.08 19.22 2.86
- --------------------------------------------------------------------------------
*Total return figures do not reflect the 1% fee assessed on redemptions of
shares held for less than one year.
12
- --------------------------------------------------------------------------------
ABOUT YOUR FUND'S EXPENSES
- --------------------------------------------------------------------------------
All mutual funds have operating expenses. These expenses include costs for
portfolio management, administrative services, and shareholder reports (like
this one), among others. Operating expenses, which are deducted from a fund's
gross income, directly reduce the investment return of the fund. A fund's
expenses are expressed as a percentage of its net assets. This figure is known
as the expense ratio.
A HYPOTHETICAL EXAMPLE
We believe it is important for you to understand the impact of costs on your
investment. The following example illustrates the costs that you would incur
over a 12-month period if you invested $10,000 in the fund, using the fund's
actual return and operating expenses for the fiscal year ended January 31, 2004.
The cost in dollars is calculated by applying the expense ratio to the average
balance in the hypothetical account. For comparative purposes, we also list the
average expense ratio for the fund's peer group, which is derived from data
provided by Lipper Inc.
- --------------------------------------------------------------------------------
COST OF $10,000 FUND PEER GROUP*
INVESTMENT IN FUND EXPENSE RATIO EXPENSE RATIO
- --------------------------------------------------------------------------------
PRECIOUS METALS FUND $67 0.55% 1.84%
- --------------------------------------------------------------------------------
*Average Gold-Oriented Fund.
The calculation assumes no shares were sold. Your actual costs may have been
higher or lower, depending on the amount of your investment and your holding
period. Peer-group ratio captures data through year-end 2003.
You can find more information about the fund's expenses, including annual
expense ratios for the past five years, in the Financial Statements section of
this report. For additional information on operating expenses and other
shareholder costs, please refer to the fund's prospectus. The prospectus
presents hypothetical shareholder costs over various time periods based upon a
$10,000 investment and a return of 5% a year. This standardized example, which
appears in all mutual fund prospectuses, may be useful to you in comparing the
costs of investing in different funds.
13
- --------------------------------------------------------------------------------
AS OF 1/31/2004 FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.) and by
country. Other assets are added to, and liabilities are subtracted from, the
value of Total Investments to calculate the fund's Net Assets. Finally, Net
Assets are divided by the outstanding shares of the fund to arrive at its share
price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying the
composition of the fund's net assets. Because all income and any realized gains
must be distributed to shareholders each year, the bulk of net assets consists
of Paid-in Capital (money invested by shareholders). The amounts shown for
Undistributed Net Investment Income and Accumulated Net Realized Gains usually
approximate the sums the fund had available to distribute to shareholders as
income dividends or capital gains as of the statement date, but may differ
because certain investments or transactions may be treated differently for
financial statement and tax purposes. Any Accumulated Net Realized Losses, and
any cumulative excess of distributions over net income or net realized gains,
will appear as negative balances. Unrealized Appreciation (Depreciation) is the
difference between the market value of the fund's investments and their cost,
and reflects the gains (losses) that would be realized if the fund were to sell
all of its investments at their statement-date values.
- --------------------------------------------------------------------------------
MARKET
VALUE*
PRECIOUS METALS FUND SHARES (000)
- --------------------------------------------------------------------------------
COMMON STOCKS (96.3%)
- --------------------------------------------------------------------------------
AUSTRALIA (10.7%)
* WMC Resources Ltd. 9,250,000 $ 36,747
Rio Tinto Ltd. 900,000 24,391
*(1) Tanami Gold NL 17,170,000 3,005
* Equinox Resources Ltd. 3,000,000 890
---------
65,033
---------
CANADA (27.7%)
Placer Dome Inc.--
(Australia Shares) 3,150,000 48,785
Aber Diamond Corp. 1,125,000 39,143
Barrick Gold Corp. 1,550,000 30,571
* Meridian Gold Inc. 1,700,000 22,100
* First Quantum Minerals Ltd. 990,000 11,423
Placer Dome Inc. 600,000 9,430
* SouthernEra Resources Ltd. 1,670,400 7,220
---------
168,672
---------
GHANA (9.0%)
* Ashanti Goldfields Co., Ltd. GDR 4,800,000 54,576
---------
PAPUA NEW GUINEA (3.3%)
Lihir Gold Ltd. 20,000,000 19,787
* Bougainville Copper Ltd. 2,000,000 411
---------
20,198
---------
PERU (9.4%)
Compania de Minas
Buenaventura S.A.u. ADR 2,446,200 57,241
---------
RUSSIA (7.6%)
Mining and Metallurgical
Company Norilsk Nickel ADR 650,000 46,351
---------
SOUTH AFRICA (21.5%)
Impala Platinum Holdings
Ltd. ADR 1,550,000 62,691
Anglo American
Platinum Corp. Ltd. ADR 750,000 34,789
AngloGold Ltd. ADR 800,000 32,264
Harmony Gold Mining Co.
Ltd. ADR 50,000 764
---------
130,508
---------
UNITED KINGDOM (7.1%)
Lonmin PLC 2,125,000 43,360
---------
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS (Cost $333,711) 585,939
- --------------------------------------------------------------------------------
PRECIOUS METALS (0.3%)
- --------------------------------------------------------------------------------
* Platinum Bullion (2,009 ounces)
(Cost $1,213) 1,678
---------
- --------------------------------------------------------------------------------
14
- --------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
PRECIOUS METALS FUND (000) (000)
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (8.9%)
- --------------------------------------------------------------------------------
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
1.02%, 2/2/2004 $17,013 17,013
1.02%, 2/2/2004--Note F 37,071 37,071
- --------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(Cost $54,084) 54,084
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (105.5%)
(Cost $389,008) 641,701
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-5.5%)
- --------------------------------------------------------------------------------
Other Assets--Note C 5,680
Security Lending Collateral
Payable to Brokers--Note F (37,071)
Other Liabilities (2,000)
---------
(33,391)
---------
- --------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------
Applicable to 39,793,762 outstanding
$.001 par value shares of beneficial interest
(unlimited authorization) $608,310
================================================================================
NET ASSET VALUE PER SHARE $15.29
================================================================================
*See Note A in Notes to Financial Statements.
*Non-income-producing security.
(1)Considered an affiliated company of the fund, as the fund owns more than 5%
of the outstanding voting securities of such company. The total market value of
investments in affiliated companies was $3,005,000.
ADR--American Depositary Receipt.
GDR--Global Depositary Receipt.
- --------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------------------
AT JANUARY 31, 2004, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
Paid-in Capital $448,232 $11.27
Overdistributed Net
Investment Income (31,007) (.78)
Accumulated Net Realized Losses (61,606) (1.55)
Unrealized Appreciation (Depreciation)
Investment Securities 252,693 6.35
Foreign Currencies (2) --
- --------------------------------------------------------------------------------
NET ASSETS $608,310 $15.29
================================================================================
See Note D in Notes to Financial Statements for the tax-basis components of net
assets.
15
STATEMENT OF OPERATIONS
This Statement shows the types of income earned by the fund during the reporting
period, and details the operating expenses charged to the fund. These expenses
directly reduce the amount of investment income available to pay to shareholders
as income dividends. This Statement also shows any Net Gain (Loss) realized on
the sale of investments, and the increase or decrease in the Unrealized
Appreciation (Depreciation) of investments during the period.
- --------------------------------------------------------------------------------
PRECIOUS METALS FUND
YEAR ENDED JANUARY 31, 2004
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends*+ $ 11,258
Interest 314
Security Lending 272
- --------------------------------------------------------------------------------
Total Income 11,844
- --------------------------------------------------------------------------------
EXPENSES
Investment Advisory Fees--Note B 1,025
The Vanguard Group--Note C
Management and Administrative 1,808
Marketing and Distribution 62
Custodian Fees 72
Auditing Fees 15
Shareholders' Reports 30
Trustees' Fees and Expenses 1
- --------------------------------------------------------------------------------
Total Expenses 3,013
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 8,831
- --------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Investment Securities Sold+ 22,332
Foreign Currencies (221)
- --------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS) 22,111
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 169,888
Foreign Currencies (16)
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 169,872
- --------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $200,814
================================================================================
*Dividends are net of foreign withholding taxes of $450,000.
+There was no dividend income or realized net gain (loss) from affiliated
companies of the fund.
16
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
fund, either by purchasing shares or by reinvesting distributions, as well as
the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
- --------------------------------------------------------------------------------
PRECIOUS METALS FUND
----------------------
YEAR ENDED JANUARY 31,
----------------------
2004 2003
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 8,831 $ 11,254
Realized Net Gain (Loss) 22,111 51,335
Change in Unrealized Appreciation (Depreciation) 169,872 37,834
- --------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets
Resulting from Operations 200,814 100,423
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Net Investment Income (36,332) (23,081)
Realized Capital Gain -- --
- --------------------------------------------------------------------------------
Total Distributions (36,332) (23,081)
- --------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS1
Issued -- 234,068
Issued in Lieu of Cash Distributions 33,737 21,343
Redeemed* (126,783) (206,374)
- --------------------------------------------------------------------------------
Net Increase (Decrease) from
Capital Share Transactions (93,046) 49,037
- --------------------------------------------------------------------------------
Total Increase (Decrease) 71,436 126,379
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 536,874 410,495
- --------------------------------------------------------------------------------
End of Period $608,310 $536,874
================================================================================
1Shares Issued (Redeemed)
Issued -- 20,762
Issued in Lieu of Cash Distributions 2,170 2,033
Redeemed (10,108) (19,166)
- --------------------------------------------------------------------------------
Net Increase (Decrease) in Shares Outstanding (7,938) 3,629
================================================================================
*Net of redemption fees of $81,000 and $933,000, respectively.
17
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis for each class of shares. It also presents the
Total Return and shows net investment income and expenses as percentages of
average net assets. These data will help you assess: the variability of the
fund's net income and total returns from year to year; the relative
contributions of net income and capital gains to the fund's total return; how
much it costs to operate the fund; and the extent to which the fund tends to
distribute capital gains. The table also shows the Portfolio Turnover Rate, a
measure of trading activity. A turnover rate of 100% means that the average
security is held in the fund for one year.
PRECIOUS METALS FUND
- ----------------------------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
---------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $11.25 $9.31 $7.51 $7.67 $6.61
- ----------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .194 .25 .28 .22 .11
Net Realized and Unrealized Gain (Loss) on Investments* 4.780 2.18 1.91 (.18) 1.05
- ----------------------------------------------------------------------------------------------------------------
Total from Investment Operations 4.974 2.43 2.19 .04 1.16
- ----------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.934) (.49) (.39) (.20) (.10)
Distributions from Realized Capital Gains -- -- -- -- --
- ----------------------------------------------------------------------------------------------------------------
Total Distributions (.934) (.49) (.39) (.20) (.10)
- ----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $15.29 $11.25 $9.31 $7.51 $7.67
- ----------------------------------------------------------------------------------------------------------------
TOTAL RETURN** 44.07% 26.51% 30.05% 0.67% 17.49%
================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $608 $537 $410 $307 $341
Ratio of Total Expenses to Average Net Assets 0.55% 0.60% 0.63% 0.65% 0.77%
Ratio of Net Investment Income to Average Net Assets 1.61% 2.14% 3.45% 2.94% 1.42%
Portfolio Turnover Rate 15% 43% 52% 17% 28%
================================================================================================================
*Includes increases from redemption fees of $0, $.02, $0, $0, and $.01.
**Total returns do not reflect the 1% fee assessed on redemptions of shares held
for less than one year.
SEE ACCOMPANYING NOTES, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
18
NOTES TO FINANCIAL STATEMENTS
Vanguard Precious Metals Fund is registered under the Investment Company Act of
1940 as an open-end investment company, or mutual fund. The fund invests in
securities of foreign issuers, which may subject it to investment risks not
normally associated with investing in securities of United States corporations.
A. The following significant accounting policies conform to generally accepted
accounting principles for U.S. mutual funds. The fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Securities are valued as of the close of trading on the
New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation
date. Equity securities are valued at the latest quoted sales prices or
official closing prices taken from the primary market in which each
security trades; such securities not traded on the valuation date are
valued at the mean of the latest quoted bid and asked prices. Securities
for which market quotations are not readily available, or whose values have
been materially affected by events occurring before the fund's pricing time
but after the close of the securities' primary markets, are valued by
methods deemed by the board of trustees to represent fair value. Precious
metals are valued at the mean of the latest quoted bid and asked prices.
Temporary cash investments acquired over 60 days to maturity are valued
using the latest bid prices or using valuations based on a matrix system
(which considers such factors as security prices, yields, maturities, and
ratings), both as furnished by independent pricing services. Other
temporary cash investments are valued at amortized cost, which approximates
market value.
2. FOREIGN CURRENCY: Securities and other assets and liabilities denominated
in foreign currencies are translated into U.S. dollars at the exchange
rates on the valuation date as employed by Morgan Stanley Capital
International in the calculation of its indexes.
Realized gains (losses) and unrealized appreciation (depreciation) on
investment securities include the effects of changes in exchange rates
since the securities were purchased, combined with the effects of changes
in security prices. Fluctuations in the value of other assets and
liabilities resulting from changes in exchange rates are recorded as
unrealized foreign currency gains (losses) until the asset or liability is
settled in cash, when they are recorded as realized foreign currency gains
(losses).
3. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard
Group, transfers uninvested cash balances to a pooled cash account, which
is invested in repurchase agreements secured by U.S. government securities.
Securities pledged as collateral for repurchase agreements are held by a
custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of
interest and principal; however, in the event of default or bankruptcy by
the other party to the agreement, retention of the collateral may be
subject to legal proceedings.
4. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the
financial statements.
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold.
Costs used to determine realized gains (losses) on the sale of investment
securities are those of the specific securities sold. Fees assessed on
redemptions of capital shares are credited to paid-in capital.
B. M&G Investment Management Ltd. provides investment advisory services to the
fund for a fee calculated at an annual percentage rate of average net assets.
For the year ended January 31, 2004, the investment advisory fee represented an
effective annual rate of 0.19% of the fund's average net assets.
19
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the board of trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At January 31, 2004, the fund had contributed capital of $103,000 to
Vanguard (included in Other Assets), representing 0.02% of the fund's net assets
and 0.10% of Vanguard's capitalization. The fund's trustees and officers are
also directors and officers of Vanguard.
D. Distributions are determined on a tax basis and may differ from net
investment income and realized capital gains for financial reporting purposes.
Differences may be permanent or temporary. Permanent differences are
reclassified among capital accounts in the financial statements to reflect their
tax character. Temporary differences arise when certain items of income,
expense, gain, or loss are recognized in different periods for financial
statement and tax purposes; these differences will reverse at some time in the
future. Differences in classification may also result from the treatment of
short-term gains as ordinary income for tax purposes.
During the year ended January 31, 2004, the fund realized net foreign currency
losses of $221,000, which permanently decreased distributable net income for tax
purposes; accordingly, such losses have been reclassified from accumulated net
realized losses to overdistributed net investment income.
Certain of the fund's investments are in securities considered to be "passive
foreign investment companies," for which any unrealized appreciation and/or
realized gains are required to be included in distributable net income for tax
purposes. During the year ended January 31, 2004, the fund realized gains on the
sale of passive foreign investment companies of $7,817,000, which were included
in current and prior years' taxable income; accordingly, such gains have been
reclassified from accumulated net realized gains to undistributed net investment
income. Unrealized appreciation on passive foreign investment company holdings
at January 31, 2004, was $29,843,000, including $30,636,000 that has been
distributed and is reflected in the balance of overdistributed net investment
income, less a reduction of $793,000 that will reduce taxable income and
distributions for fiscal 2005.
During 2001, the fund elected to use a provision of the Taxpayer Relief Act of
1997 to mark-to-market certain appreciated securities held on January 1, 2001;
such securities were treated as sold and repurchased, with unrealized gains of
$46,006,000 becoming realized, for tax purposes. The mark-to-market created a
difference between the cost of investments for financial statement and tax
purposes, which will reverse when the securities are sold. Through January 31,
2004, the fund realized gains on the sale of these securities of $1,494,000 for
financial statement purposes, which were included in prior year mark-to-market
gains for tax purposes. The remaining difference of $44,512,000 is reflected in
the balance of accumulated net realized losses; the corresponding difference
between the securities' cost for financial statement and tax purposes is
reflected in unrealized appreciation.
For tax purposes, at January 31, 2004, the fund had no ordinary income available
for distribution. The fund had available realized losses of $17,094,000 to
offset future net capital gains of $2,611,000 through January 31, 2007,
$13,354,000 through January 31, 2008, and $1,129,000 through January 31, 2010.
At January 31, 2004, net unrealized appreciation of investment securities for
tax purposes was $178,338,000, consisting of unrealized gains of $184,383,000 on
securities that had risen in value since their purchase and $6,045,000 in
unrealized losses on securities that had fallen in value since their purchase or
since being marked-to-market for tax purposes.
The fund had net unrealized foreign currency losses of $2,000 resulting from the
translation of other assets and liabilities at January 31, 2004.
20
E. During the year ended January 31, 2004, the fund purchased $76,891,000 of
investment securities and sold $212,589,000 of investment securities other than
temporary cash investments.
F. The market value of securities on loan to broker/dealers at January 31, 2004,
was $36,275,000, for which the fund held cash collateral of $37,071,000. The
fund invests cash collateral received in repurchase agreements, and records a
liability for the return of the collateral, during the period the securities are
on loan.
21
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Trustees of Vanguard Precious Metals Fund:
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Precious Metals Fund (the "Fund") at January 31, 2004, the results of
its operations for the year then ended, the changes in its net assets for each
of the two years in the period then ended and the financial highlights for each
of the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the Fund's management; our responsibility
is to express an opinion on these financial statements based on our audits. We
conducted our audits of these financial statements in accordance with auditing
standards generally accepted in the United States of America, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits, which included confirmation
of securities at January 31, 2004 by correspondence with the custodian, provide
a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
March 8, 2004
22
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23
THE PEOPLE WHO GOVERN YOUR FUND
- --------------------------------------------------------------------------------
The trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are a part owner of
the fund. Your fund trustees also serve on the board of directors of The
Vanguard Group, Inc., which is owned by the Vanguard(R) funds and provides
services to them on an at-cost basis.
A majority of Vanguard's board members are independent, meaning that they have
no affiliation with Vanguard or the funds they oversee, apart from the sizable
personal investments they have made as private individuals.
Our independent board members bring distinguished backgrounds in business,
academia, and public service to their task of working with Vanguard officers to
establish the policies and oversee the activities of
- --------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------
POSITION(S) HELD WITH
NAME FUND (NUMBER OF
(YEAR OF BIRTH) VANGUARD FUNDS
TRUSTEE/OFFICER OVERSEEN BY
SINCE TRUSTEE/OFFICER) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
- ------------------------------------------------------------------------------------------------------------
JOHN J. BRENNAN* Chairman of the Chairman of the Board, Chief Executive Officer, and Director/Trustee
(1954) Board, Chief of The Vanguard Group, Inc., and of each of the investment companies
May 1987 Executive Officer, served by The Vanguard Group.
and Trustee
(129)
- ------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
CHARLES D. ELLIS Trustee The Partners of '63 (pro bono ventures in education); Senior Advisor
(1937) (129) to Greenwich Associates (international business strategy consulting);
January 2001 Successor Trustee of Yale University; Overseer of the Stern School of
Business at New York University; Trustee of the Whitehead Institute
for Biomedical Research.
- ------------------------------------------------------------------------------------------------------------
RAJIV L. GUPTA Trustee Chairman and Chief Executive Officer (since October 1999), Vice
(1945) (129) Chairman (January-September 1999), and Vice President (prior to
December 2001 September 1999) of Rohm and Haas Co. (chemicals); Director of
Technitrol, Inc. (electronic components), and Agere Systems
(communications components); Board Member of the American Chemistry
Council; and Trustee of Drexel University.
- ------------------------------------------------------------------------------------------------------------
JOANN HEFFERNAN Trustee Vice President, Chief Information Officer, and Member of the
HEISEN (129) Executive Committee of Johnson & Johnson (pharmaceuticals/consumer
(1950) products); Director of the Medical Center at Princeton and Women's
July 1998 Research and Education Institute.
- ------------------------------------------------------------------------------------------------------------
BURTON G. MALKIEL TRUSTEE Chemical Bank Chairman's Professor of Economics,Princeton University;
(1932) (127) Director of Vanguard Investment Series plc (Irish invest-ment fund)
May 1977 (since November 2001), Vanguard Group (Ireland)Limited (Irish
investment management firm)(since November 2001),Prudential Insurance
Co. of America, BKF Capital (investment management), The Jeffrey Co.
(holding company), and NeuVis, Inc.(software company).
- ------------------------------------------------------------------------------------------------------------
24
- --------------------------------------------------------------------------------
the funds. Among board members' responsibilities are selecting investment
advisors for the funds; monitoring fund operations, performance, and costs;
reviewing contracts; nominating and selecting new trustees/directors; and
electing Vanguard officers.
Each trustee serves a fund until its termination; or until the trustee's
retirement, resignation, or death; or otherwise as specified in the fund's
organizational documents. Any trustee may be removed at a shareholders' meeting
by a vote representing two-thirds of the net asset value of all shares of the
fund together with shares of other Vanguard funds organized within the same
trust. The table on these two pages shows information for each trustee and
executive officer of the fund. The mailing address of the trustees and officers
is P.O. Box 876, Valley Forge, PA 19482.
- --------------------------------------------------------------------------------
POSITION(S) HELD WITH
NAME FUND (NUMBER OF
(YEAR OF BIRTH) VANGUARD FUNDS
TRUSTEE/OFFICER OVERSEEN BY
SINCE TRUSTEE/OFFICER) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
- ------------------------------------------------------------------------------------------------------------
Alfred M. Rankin, Jr. Trustee Chairman, President, Chief Executive Officer, and Director of NACCO
(1941) (129) Industries, Inc. (forklift trucks/housewares/lignite); Director of
January 1993 Goodrich Corporation (industrial products/aircraft systems and
services); Director of Standard Products Company (supplier for
the automotive industry) until 1998.
- ------------------------------------------------------------------------------------------------------------
J. Lawrence Wilson Trustee Retired Chairman and Chief Executive Officer of Rohm and Haas Co.
(1936) (129) (chemicals); Director of Cummins Inc. (diesel engines), The Mead
April 1985 Corp. (paper products), and AmerisourceBergen Corp. (pharmaceuti-cal
distribution); Trustee of Vanderbilt University.
- ------------------------------------------------------------------------------------------------------------
EXECUTIVE OFFICERS*
R. Gregory Barton Secretary Managing Director and General Counsel of The Vanguard Group, Inc.;
(1951) (129) Secretary of The Vanguard Group and of each of the investment
June 2001 companies served by The Vanguard Group.
- ------------------------------------------------------------------------------------------------------------
Thomas J. Higgins Treasurer Principal of The Vanguard Group, Inc.; Treasurer of each of the
(1957) (129) investment companies served by The Vanguard Group.
July 1998
- ------------------------------------------------------------------------------------------------------------
*Officers of the funds are "interested persons" as defined in the Investment
Company Act of 1940.
More information about the trustees is in the Statement of Additional
Information, available from The Vanguard Group.
- ------------------------------------------------------------------------------------------------------------
VANGUARD SENIOR MANAGEMENT TEAM
MORTIMER J. BUCKLEY, Information Technology. MICHAEL S. MILLER, Planning and Development.
JAMES H. GATELY, Investment Programs and Services. RALPH K. PACKARD, Finance.
KATHLEEN C. GUBANICH, Human Resources. GEORGE U. SAUTER, Chief Investment Officer.
F. WILLIAM MCNABB, III, Client Relationship Group.
- ------------------------------------------------------------------------------------------------------------
JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996.
- ------------------------------------------------------------------------------------------------------------
25
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All other marks are the exclusive property of their respective owners.
ABOUT OUR COVER
The photographs that appear on the cover of this report are copyrighted by
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FOR MORE INFORMATION
This report is intended for the fund's shareholders. It may not be distributed
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To receive a free copy of the prospectus or the Statement of Additional
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All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc.,
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(C) 2004 THE VANGUARD GROUP, INC.
ALL RIGHTS RESERVED.
VANGUARD MARKETING
CORPORATION, DISTRIBUTOR.
Q530 032004
VANGUARD(R) HEALTH CARE FUND
JANUARY 31, 2004
ANNUAL REPORT
THE VANGUARD GROUP(R) LOGO
HOW TO READ YOUR FUND REPORT
This report contains information that can help you evaluate your investment. It
includes details about your fund's return and presents data and analysis that
provide insight into the fund's performance and investment approach.
By reading the letter from Vanguard's chairman, John J. Brennan, together with
the letter from the managers who select securities for your fund, you'll get an
understanding of how the fund invests and how the market environment affected
its performance. The statistical information that follows can help you
understand how the fund's performance and characteristics stack up against those
of similar funds and market benchmarks.
It's important to keep in mind that the opinions expressed by Vanguard's
investment managers are just that: informed opinions. They should not be
considered promises or advice. The opinions, like the statistics, cover the
period through the date on the cover of this report. As things change--and in
the financial markets you can be certain only of change--an investment manager's
job is to evaluate new information and make adjustments, if necessary. Of
course, the risks of investing in the fund are spelled out in the prospectus.
Frequent updates on the fund's performance and information about some of its
holdings are available on Vanguard.com(R).
- --------------------------------------------------------------------------------
CONTENTS
1 letter from the chairman
6 report from the advisor
8 fund profile
9 glossary of investment terms
10 performance summary
12 your fund's after-tax returns
13 about your fund's expenses
14 financial statements
26 advantages of vanguard.com
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SUMMARY
* The Investor Shares of Vanguard Health Care Fund returned 33.0% during the
fiscal year ended January 31, 2004.
* The fund's returns were much better than the result of its benchmark (+18.7%),
but fell short of the gains of its average mutual fund peer (+37.5%) and the
broad U.S. stock market (+38.1%).
* Outstanding performances from a number of the fund's pharmaceutical and
biotechnology holdings helped bolster returns.
- --------------------------------------------------------------------------------
Want less clutter in your mailbox? Just register with VANGUARD.COM and opt to
get fund reports online.
LETTER FROM THE CHAIRMAN
FELLOW SHAREHOLDER,
For the fiscal year ended January 31, 2004, the Investor Shares of Vanguard
Health Care Fund recorded a total return of 33.0%. The fund's performance was
significantly better than that of its unmanaged benchmark, but lagged the
results of its average mutual fund peer and the broad-based Wilshire 5000 Total
Market Index.
[PICTURES OF JOHN J. BRENNAN]
- -----------------------------------------------
2004 TOTAL RETURNS FISCAL YEAR ENDED
JANUARY 31
- -----------------------------------------------
VANGUARD HEALTH CARE FUND
Investor Shares 33.0%
Admiral Shares 33.1
S&P Health Sector Index 18.7
Average Health/Biotechnology Fund* 37.5
Wilshire 5000 Index 38.1
- -----------------------------------------------
*Derived from data provided by Lipper Inc.
The table at left presents the 12-month total returns (capital change plus
reinvested distributions) for the fund's two share classes, as well as results
for its comparative standards. Details on changes in net asset value and
per-share distributions for each of the fund's share classes are shown in the
table on page 5. If you hold the Health Care Fund in a taxable account, you may
wish to see page 12 for a report on the fund's after-tax returns.
STOCKS GENERATED OUTSTANDING RETURNS
For the 12 months ended January 31, the broad U.S. stock market, as represented
by the Wilshire 5000 Index, returned a remarkable 38.1%.
At the start of the period, investors were apprehensive. War with Iraq was
imminent, and the labor market and manufacturing industries were stagnating,
despite the broad economy's slow-but-steady expansion. Within weeks, however,
the United States and its allies had successfully completed major combat
operations in Iraq. And in the succeeding months, the economic picture also
brightened: The unemployment rate
1
- --------------------------------------------------------------------------------
ADMIRAL(TM) SHARES
A lower-cost class of shares available to many longtime shareholders and to
those with significant investments in the fund.
- --------------------------------------------------------------------------------
declined, and manufacturing began to stir. In the quarter ended September 30,
the U.S. economy grew at an annualized rate of 8.2%; estimates put
fourth-quarter gross domestic product growth at about 4.0%.
With each piece of good news, the market's mood inched from cautious toward
cavalier. For the full 12 months, the stock market's small-capitalization
issues, as represented by the Russell 2000 Index, returned 58.0%--22.4
percentage points more than the Russell 1000 Index's large-cap stocks.
RISK WAS REWARDED IN THE BOND MARKET
The same behavior was apparent in the fixed income market. Demand for
default-risk-free U.S. Treasuries was initially extreme, boosting the price of
the 10-year Treasury note while reducing its yield to just above 3% in June. By
the fiscal year-end, however, the mood had changed. The Lehman Brothers High
Yield Bond Index, a benchmark of below-investment-grade bonds, recorded a
12-month return of 27.2%, while investment-grade bonds, as measured by the
Lehman Aggregate Bond Index, returned 4.9%.
Short-term interest rates were the fixed income market's one constant, remaining
low--and lower--throughout the period. The yield of the 3-month Treasury bill, a
proxy for money market rates, ended the fiscal year at 0.91%, 26 basis points
lower than at the start of the period.
- --------------------------------------------------------------------------------
MARKET BAROMETER AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED JANUARY 31, 2004
-------------------------------------
ONE THREE FIVE
YEAR YEARS YEARS
- --------------------------------------------------------------------------------
STOCKS
Russell 1000 Index (Large-caps) 35.6% -4.2% -0.5%
Russell 2000 Index (Small-caps) 58.0 6.0 7.8
Wilshire 5000 Index (Entire market) 38.1 -3.0 0.1
MSCI All Country World Index
ex USA (International) 48.9 -0.9 1.9
- --------------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 4.9% 7.3% 6.6%
(Broad taxable market)
Lehman Municipal Bond Index 6.2 6.5 5.7
Citigroup 3-Month Treasury Bill Index 1.0 2.1 3.4
================================================================================
CPI
Consumer Price Index 1.9% 1.9% 2.4%
- --------------------------------------------------------------------------------
DESPITE SOME SHORTFALLS, IT WAS A YEAR OF SOLID GAINS FOR THE FUND
In a welcome reversal from the disappointing results of the past two fiscal
years, the Health Care Fund's Investor Shares earned 33.0%--
2
an excellent result on an absolute basis. However, the fund's performance lagged
the average return for its peers. As you know, the Health Care Fund maintains a
broadly diversified portfolio of attractively valued health-related stocks that
seem poised for earnings growth. During the past fiscal year, this focus on
value kept the fund somewhat out of step with investors' preference for riskier
stocks, particularly smaller biotechnology stocks.
Major pharmaceutical companies in the United States and overseas (which
accounted for roughly 60% of the fund's holdings) produced impressive gains as a
group, making the largest contribution to the portfolio's return. Despite
difficulties such as the expiration of numerous patents and a slowdown in the
pipeline of new drugs, both foreign and domestic drugmakers posted excellent
results. The depreciation of the U.S. dollar lifted returns from drugmakers in
international markets, where the advisor found attractive values and added to
holdings. Several of the leading companies, including Pfizer, Aventis, and
Bayer, saw their stock prices driven higher by strong sales, successful clinical
trials, and federal approval of new products. The enactment of a $400 billion
Medicare prescription plan also helped, fostering rallies in many pharmaceutical
stocks during the fourth quarter.
Other groups that contributed substantially to the fund's return were
manufacturers of medical equipment and providers of health insurance. The
advisor's stock selections in these groups appreciated handsomely as a result of
the success of newly developed products and favorable business conditions in the
insurance arena.
- --------------------------------------------------------------------------------
In a welcome rebound that followed two fiscal years of poor returns, the fund's
Investor Shares posted an excellent total return of 33.0%. Outstanding
performances from several holdings in pharmaceuticals, biotechnology, medical
supplies, and insurance providers contributed significantly to the fund's
success.
- --------------------------------------------------------------------------------
Relative to competitors, the fund's limited commitment to biotechnology stocks
was its primary weakness during the period. When speculative biotech stocks are
leading the pack, your fund is apt to fall short of its peers. Although the
portfolio held several major biotech players, such as Amgen, Genentech, and
Genzyme--all of which yielded outstanding returns--the advisor stayed away from
smaller, more volatile companies. The fund's peers typically have a much greater
concentration in biotech stocks, and therefore profit when such risk-taking is
rewarded.
3
THE FUND HAS ESTABLISHED AN EXCEPTIONAL LONG-TERM RECORD
The Health Care Fund's conservative approach to investing in its potentially
volatile sector has served its shareholders well over the years. Over the past
decade, the fund has returned a stellar 20.0% a year, on average--3.3 percentage
points more than its benchmark index and 6.3 percentage points more than its
average peer. The table at left shows that a hypothetical investment of $25,000
made in your fund on January 31, 1994, would have grown to $155,289 over the
subsequent ten years. That is $65,257--or nearly 73%--more than the ending value
of a comparable investment in the average peer fund. In other words, the Health
Care Fund's superiority over its peer-group average amounted to more than twice
the original investment. Remarkable!
- -----------------------------------------------------------------
TOTAL RETURNS TEN YEARS ENDED
JANUARY 31, 2004
- -----------------------------------------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $25,000
RETURN INITIAL INVESTMENT
- -----------------------------------------------------------------
Vanguard Health Care Fund
Investor Shares 20.0% $155,289
S&P Health Sector Index 16.7 117,273
Average Health/ Biotechnology Fund 13.7 90,032
Wilshire 5000 Index 10.5 67,767
- -----------------------------------------------------------------
Although the fund's cost advantage relative to peers hasn't been a major factor
in its long-term outperformance--the primary contributor has been the skill of
the advisor, Wellington Management Company--our low costs have nevertheless
benefited shareholders. All things equal, lower costs equate to higher returns.
For a comparison of your fund's costs with the average cost of its competitors,
see page 13.
ALWAYS HAVE PATIENCE AND A PLAN
After two "down" years for the fund, I am pleased to be writing about an "up"
year again. Whether the fund's performance--or that of the financial markets,
for that matter--is up or down, though, the message we offer to investors
remains the same: The keys to successful long-term investing are balance,
diversification, and low costs. If you make these principles the foundation of
your investment plan, you'll be positioned to survive--and ultimately
thrive--whatever may occur. For investors who are patient and comfortable with
the added risks involved, a small commitment of assets to a sector-specific
fund, such as Vanguard Health Care Fund, can be useful.
Unfortunately, although the past year brought financial rewards to many
investors, it also brought disappointment and a sense of disbelief.
4
The reports of late trading and market-timing at some competing investment
management firms have been as disturbing to us as they no doubt have been to
you. I want to close this letter with an assurance that Vanguard has long had
policies and procedures in place to identify and deter such behavior. More
important, Vanguard shareholders are served by a crew of the highest integrity
working within a client-owned corporate structure that aligns our day-to-day
efforts with your long-term financial goals.
Thank you for investing your assets with Vanguard.
Sincerely,
/S/JOHN J. BRENNAN
John J. Brennan
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
FEBRUARY 10, 2004
- --------------------------------------------------------------------------------
YOUR FUND'S PERFORMANCE AT A GLANCE JANUARY 31, 2003-JANUARY 31, 2004
DISTRIBUTIONS PER SHARE
------------------------------
STARTING ENDING INCOME CAPITAL
SHARE PRICE SHARE PRICE DIVIDENDS GAINS
- --------------------------------------------------------------------------------
Health Care Fund
Investor Shares $94.35 $124.29 $0.995 $0.103
Admiral Shares 39.80 52.44 0.460 0.043
- --------------------------------------------------------------------------------
5
REPORT FROM THE ADVISOR
The Investor Shares of Vanguard Health Care Fund advanced 33.0% for the fiscal
year ended January 31, 2004. This compared favorably with the 18.7% return of
the Standard & Poor's Health Sector Index but trailed the result of the average
health/biotechnology fund, up 37.5%.
THE INVESTMENT ENVIRONMENT
The fiscal year was marked by substantially better market performance in
small-capitalization stocks than in large-caps. Our results relative to
benchmarks reflected this situation. The Health Care Fund, which holds both
large-cap and mid-cap stocks, did dramatically better than the S&P Health Sector
Index, which consists predominantly of large-caps. At the same time, we trailed
the average return of the health/biotechnology peer group, which includes many
funds that concentrate on small-cap biotechnology companies.
A second major influence on performance during the period was the weakness in
the U.S. dollar. This boosted the returns from many of our international stocks.
- --------------------------------------------------------------------------------
INVESTMENT PHILOSOPHY
The fund reflects the belief that investors who seek to emphasize health care
stocks as part of a long-term, balanced investment program are best served by
holding a portfolio of securities well diversified across the sector.
- --------------------------------------------------------------------------------
OUR SUCCESSES
Three of the fund's leading contributors in fiscal 2004 were international:
Aventis, AstraZeneca, and Roche. Among industry sectors, the biggest boost came
from biotechnology, where Genentech, Genzyme, and Gilead were major
contributors.
OUR SHORTFALLS
The major pharmaceutical companies were weak as a group, largely because of
patent issues that affected some companies' results in the fiscal year.
Schering-Plough and Merck were disappointments for us. And, although
international stocks were strong overall, our Japanese stocks generally
underperformed.
6
THE FUND'S POSITIONING
Our basic strategy is to remain diversified across all health care subsectors,
gradually buying into weakness and selling into strength. During the past 12
months, we added considerably to our holdings in the drug distribution group and
in large-cap companies that have lagged the market.
We believe that the health care sector is fairly valued at present and that no
obvious extremes exist in its subsectors. We expect modest growth this year, and
we continue to believe that the health care sector is very positively positioned
for the long-term investor.
EDWARD P. OWENS, SENIOR VICE PRESIDENT AND PORTFOLIO MANAGER
WELLINGTON MANAGEMENT COMPANY, LLP
FEBRUARY 17, 2004
- --------------------------------------------------------------------------------
PORTFOLIO CHANGES FISCAL YEAR ENDED JANUARY 31, 2004
ADDITIONS COMMENTS
- --------------------------------------------------------------------------------
AmerisourceBergen Drug distributors are cheap.
- --------------------------------------------------------------------------------
Cardinal Health Drug distributors are cheap.
- --------------------------------------------------------------------------------
Medtronic Valuation has improved notably.
- --------------------------------------------------------------------------------
Novartis Excellent fundamentals.
================================================================================
REDUCTIONS
Amersham Acquired by General Electric.
- --------------------------------------------------------------------------------
Pfizer Still the largest fund holding.
- --------------------------------------------------------------------------------
Schering-Plough Disappointment in market for its hepatitis treatment.
- --------------------------------------------------------------------------------
St. Jude Medical Trimmed as a result of strong performance.
- --------------------------------------------------------------------------------
SEE PAGE 14 FOR A COMPLETE
LISTING OF THE FUND'S HOLDINGS.
7
FUND PROFILE As of 1/31/2004
This Profile provides a snapshot of the fund's characteristics, compared where
indicated with a broad market index. Key terms are defined on page 9.
HEALTH CARE FUND
- ------------------------------------------------
PORTFOLIO CHARACTERISTICS
BROAD
FUND INDEX*
- ------------------------------------------------
Number of Stocks 103 5,190
Median Market Cap $27.0B $28.0B
Price/Earnings Ratio 26.0x 25.4x
Price/Book Ratio 3.6x 3.1x
Yield 1.5%
Investor Shares 0.8%
Admiral Shares 0.9%
Return on Equity 20.3% 15.8%
Earnings Growth Rate 12.7% 5.2%
Foreign Holdings 28.5% 0.9%
Turnover Rate 13% --
Expense Ratio --
Investor Shares 0.28%
Admiral Shares 0.19%
Short-Term Reserves 7% --
- ------------------------------------------------
- ------------------------------------------------
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
Pfizer Inc. 7.0%
Aventis SA 4.9
Eli Lilly & Co. 3.2
Roche Holdings AG 3.0
Forest Laboratories, Inc. 2.9
Cardinal Health, Inc. 2.9
Amgen, Inc. 2.8
Novartis AG (Registered) 2.7
Schering-Plough Corp. 2.5
Abbott Laboratories 2.2
- ------------------------------------------------
Top Ten 34.1%
- ------------------------------------------------
The "Ten Largest Holdings" excludes any temporary cash investments and equity
index products.
- -------------------------------
INVESTMENT FOCUS
STYLE Growth
MARKET CAP Large
- -------------------------------
- -----------------------------------------------------
VOLATILITY MEASURES
BROAD
FUND INDEX*
- -----------------------------------------------------
R-Squared 0.62 1.00
Beta 0.49 1.00
- -----------------------------------------------------
- ----------------------------------------------
SECTOR DIVERSIFICATION (% OF PORTFOLIO)
Biotech Research & Production 9%
Consumer Discretionary 0
Consumer Staples 2
Drugs & Pharmaceuticals 32
Electronics--Medical Systems 2
Financial Services 0
Health & Personal Care 3
Health Care Facilities 3
Health Care Management Services 5
International 28
Materials & Processing 1
Medical & Dental Instruments & Supplies 6
Medical Services 1
Producer Durables 1
Technology 0
- ----------------------------------------------
Short-Term Reserves 7%
- ----------------------------------------------
*Wilshire 5000 Index.
VISIT OUR WEBSITE AT VANGUARD.COM
FOR REGULARLY UPDATED FUND INFORMATION.
8
GLOSSARY OF INVESTMENT TERMS
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of a given market index. The index is assigned a
beta of 1.00. Compared with a given index, a fund with a beta of 1.20 typically
would have seen its share price rise or fall by 12% when the index rose or fell
by 10%. A fund's beta should be reviewed in conjunction with its R-squared (see
definition below). The lower the R-squared, the less correlation there is
between the fund and the index, and the less reliable beta is as an indicator of
volatility.
- --------------------------------------------------------------------------------
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
- --------------------------------------------------------------------------------
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
- --------------------------------------------------------------------------------
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or depositary receipts of companies based outside the United States.
- --------------------------------------------------------------------------------
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
- --------------------------------------------------------------------------------
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
- --------------------------------------------------------------------------------
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
- --------------------------------------------------------------------------------
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the market in general, as measured by a given index. If a
fund's total returns were precisely synchronized with an index's returns, its
R-squared would be 1.00. If the fund's returns bore no relationship to the
index's returns, its R-squared would be 0.
- --------------------------------------------------------------------------------
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
- --------------------------------------------------------------------------------
SHORT-TERM RESERVES. The percentage of a fund invested in highly liquid,
short-term securities that can be readily converted to cash.
- --------------------------------------------------------------------------------
TURNOVER RATE. An indication of the fund's trading activity. Funds with high
turnover rates incur higher transaction costs and may be more likely to
distribute capital gains (which may be taxable to investors).
- --------------------------------------------------------------------------------
YIELD. A snapshot of a fund's income from interest and dividends. The yield,
expressed as a percentage of the fund's net asset value, is based on income
earned over the past 30 days and is annualized, or projected forward for the
coming year. The index yield is based on the current annualized rate of income
provided by securities in the index.
- --------------------------------------------------------------------------------
9
PERFORMANCE SUMMARY As of 1/31/2004
All of the returns in this report represent past performance, which is not a
guarantee of future results that may be achieved by the fund. (For the most
recent performance, which may be higher or lower than that cited, visit our
website at www.vanguard.com.) Note, too, that both investment returns and
principal value can fluctuate widely, so an investor's shares, when sold, could
be worth more or less than their original cost. The returns shown do not reflect
taxes that a shareholder would pay on fund distributions or on the sale of fund
shares.
HEALTH CARE FUND
- --------------------------------------------------------------------------------
CUMULATIVE PERFORMANCE JANUARY 31, 1994-JANUARY 31, 2004
HEALTH CARE FUND WILSHIRE S&P HEALTH AVERAGE HEALTH/
INVESTOR SHARES* 5000 INDEX SECTOR INDEX BIOTECHNOLOGY FUND
199401 25000 25000 25000 25000
199404 23008 23557 23064 22647
199407 23565 23838 24154 22098
199410 26481 24807 27842 24995
199501 27447 24744 30242 25615
199504 29249 27064 32422 26735
199507 32453 30062 36041 29713
199510 34847 31196 40055 32434
199601 39928 33934 46633 38097
199604 42297 35768 45092 39605
199607 40999 34477 45801 35338
199610 43255 37999 51896 38635
199701 48171 42204 59737 42856
199704 49381 42077 61056 39953
199707 58347 50751 72387 47215
199710 57977 50003 71107 49337
199801 61357 52880 82774 50051
199804 69941 60276 92600 55783
199807 71810 59399 97975 52754
199810 75961 57399 100820 51992
199901 84301 67304 112138 59020
199904 85102 70597 109283 56731
199907 86524 70297 104812 58805
199910 86853 72135 112133 59270
200001 93212 76882 108936 76112
200004 105431 78935 111056 83231
200007 118975 77915 119199 95769
200010 133291 77979 130049 107416
200101 133641 74211 127756 99121
200104 130513 67806 121539 92161
200107 135504 66222 123190 91622
200110 131251 58066 120232 88500
200201 132163 62840 121053 87286
200204 136058 61105 114242 81646
200207 121151 51610 99687 67352
200210 118890 50279 100100 66242
200301 116769 49088 98820 65473
200304 122315 52804 103884 71399
200307 134832 58227 108821 80445
200310 137955 62566 106026 80279
200401 155289 67767 117273 90032
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED JANUARY 31, 2004
------------------------------------- FINAL VALUE
ONE FIVE TEN OF A $25,000
YEAR YEARS YEARS INVESTMENT
- --------------------------------------------------------------------------------
Health Care Fund
Investor Shares* 31.67% 13.00% 20.04% $155,289
Wilshire 5000 Index 38.05 0.14 10.49 67,767
S&P Health Sector Index 18.67 0.90 16.71 117,273
Average Health/
Biotechnology Fund** 37.51 8.81 13.67 90,032
- --------------------------------------------------------------------------------
FINAL VALUE
ONE SINCE OF A $250,000
YEAR INCEPTION+ INVESTMENT
- --------------------------------------------------------------------------------
Health Care Fund Admiral Shares* 31.80% 7.79% $295,247
Wilshire 5000 Index 38.05 4.84 277,634
S&P Health Sector Index 18.67 -1.81 240,096
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FISCAL-YEAR TOTAL RETURNS (%) JANUARY 31, 1994-JANUARY 31, 2004
HEALTH CARE FUND S&P HEALTH
INVESTOR SHARES* SECTOR INDEX
1995 9.8 21.0
1996 45.5 54.2
1997 20.6 28.1
1998 27.4 38.6
1999 37.4 35.5
2000 10.6 -2.9
2001 43.4 17.3
2002 -1.1 -5.2
2003 -11.6 -18.4
2004 33.0 18.7
- --------------------------------------------------------------------------------
*Reflective of the 1% fee assessed on redemptions of shares purchased on or
after April 19, 1999, and held for less than five years.
**Derived from data provided by Lipper Inc.
+November 12, 2001.
NOTE: See Financial Highlights tables on pages 20 and 21 for dividend and
capital gains information.
10
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2003
This table presents average annual total returns through the latest calendar
quarter--rather than through the end of the fiscal period. Securities and
Exchange Commission rules require that we provide this information.
TEN YEARS
ONE FIVE ----------------------
INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------
Health Care Fund
Investor Shares 5/23/1984 26.58% 12.42% 18.91% 1.25% 20.16%
Fee-Adjusted Returns* 25.33 12.42 18.91 1.25 20.16
Admiral Shares 11/12/2001 26.69 7.02** -- -- --
Fee-Adjusted Returns* 25.43 6.58** -- -- --
- --------------------------------------------------------------------------------
*Reflective of the 1% fee assessed on redemptions of shares purchased on or
after April 19, 1999, and held for less than five years.
**Return since inception.
11
YOUR FUND'S AFTER-TAX RETURNS
This table presents returns for your fund both before and after taxes. The
after-tax returns are shown in two ways: (1) assuming that an investor owned the
fund during the entire period and paid taxes on the fund's distributions, and
(2) assuming that an investor paid taxes on the fund's distributions and sold
all shares at the end of each period.
Calculations are based on the highest individual federal income tax and capital
gains tax rates in effect at the times of the distributions and the hypothetical
sales. State and local taxes were not considered. After-tax returns reflect the
reduced tax rates on ordinary income (including qualified dividend income) and
short-term capital gains that became effective as of January 1, 2003, and on
long-term capital gains realized on or after May 6, 2003. To calculate qualified
dividend income, we used actual 2003 figures and estimates for 2004. (In the
example, returns after the sale of fund shares may be higher than those assuming
no sale. This occurs when the sale would have produced a capital loss. The
calculation assumes that the investor received a tax deduction for the loss.)
The table shows returns for Investor Shares only; returns for other share
classes will differ. Please note that your actual after-tax returns will depend
on your tax situation and may differ from those shown. Also note that if you own
the fund in a tax-deferred account, such as an individual retirement account or
a 401(k) plan, this information does not apply to you. Such accounts are not
subject to current taxes.
Finally, keep in mind that a fund's performance--whether before or after
taxes--does not indicate how it will perform in the future.
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2004
ONE YEAR FIVE YEARS TEN YEARS
--------------------------------------------
HEALTH CARE FUND INVESTOR SHARES*
Returns Before Taxes 31.67% 13.00% 20.04%
Returns After Taxes on Distributions 31.49 11.15 18.20
Returns After Taxes on Distributions
and Sale of Fund Shares 20.82 10.48 17.19
- --------------------------------------------------------------------------------
*Reflective of the 1% fee assessed on redemptions of shares purchased on or
after April 19, 1999, and held for less than five years.
12
ABOUT YOUR FUND'S EXPENSES
All mutual funds have operating expenses. These expenses include costs for
portfolio management, administrative services, and shareholder reports (like
this one), among others. Operating expenses, which are deducted from a fund's
gross income, directly reduce the investment return of the fund. A fund's
expenses are expressed as a percentage of its net assets. This figure is known
as the expense ratio.
A HYPOTHETICAL EXAMPLE
We believe it is important for you to understand the impact of costs on your
investment. The following example illustrates the costs that you would incur
over a 12-month period if you invested $10,000 in the fund, using the fund's
actual return and operating expenses for the fiscal year ended January 31, 2004.
The cost in dollars is calculated by applying the expense ratio to the average
balance in the hypothetical account. For comparative purposes, we also list the
average expense ratio for the fund's peer group, which is derived from data
provided by Lipper Inc.
- --------------------------------------------------------------------------------
COST OF $10,000 FUND PEER GROUP*
INVESTMENT IN FUND EXPENSE RATIO EXPENSE RATIO
- --------------------------------------------------------------------------------
HEALTH CARE FUND
Investor Shares $33 0.28% 1.96%
Admiral Shares 22 0.19 --
- --------------------------------------------------------------------------------
*Average Health/Biotechnology Fund.
The calculation assumes no shares were sold. Your actual costs may have been
higher or lower, depending on the amount of your investment and your holding
period. Peer-group ratio captures data through year-end 2003.
You can find more information about the fund's expenses, including annual
expense ratios for the past five years, in the Financial Statements section of
this report. For additional information on operating expenses and other
shareholder costs, please refer to the fund's prospectus. The prospectus
presents hypothetical shareholder costs over various time periods based upon a
$10,000 investment and a return of 5% a year. This standardized example, which
appears in all mutual fund prospectuses, may be useful to you in comparing the
costs of investing in different funds.
13
FINANCIAL STATEMENTS AS OF 1/31/2004
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.) and by sector
within the fund's designated industry; international securities, if significant,
may be presented in a separate group. Other assets are added to, and liabilities
are subtracted from, the value of Total Investments to calculate the fund's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the fund to
arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying the
composition of the fund's net assets. Because all income and any realized gains
must be distributed to shareholders each year, the bulk of net assets consists
of Paid-in Capital (money invested by shareholders). The amounts shown for
Undistributed Net Investment Income and Accumulated Net Realized Gains usually
approximate the sums the fund had available to distribute to shareholders as
income dividends or capital gains as of the statement date, but may differ
because certain investments or transactions may be treated differently for
financial statement and tax purposes. Any Accumulated Net Realized Losses, and
any cumulative excess of distributions over net income or net realized gains,
will appear as negative balances. Unrealized Appreciation (Depreciation) is the
difference between the market value of the fund's investments and their cost,
and reflects the gains (losses) that would be realized if the fund were to sell
all of its investments at their statement-date values.
- --------------------------------------------------------------------------------
MARKET
VALUE*
HEALTH CARE FUND SHARES (000)
- --------------------------------------------------------------------------------
COMMON STOCKS (91.7%)
- --------------------------------------------------------------------------------
UNITED STATES (63.2%)
- --------------------------------------------------------------------------------
BIOTECH RESEARCH & Production (9.2%)
* Amgen, Inc. 8,923,828 $ 575,498
* Genzyme Corp.- General Division 7,401,240 405,958
* Genentech, Inc. 3,400,000 324,700
* Biogen Idec Inc. 4,778,600 204,476
*(1)Cephalon, Inc. 3,430,800 188,076
Baxter International, Inc. 5,000,000 145,750
* Millennium Pharmaceuticals, Inc. 3,000,000 52,920
* Human Genome Sciences, Inc. 1,938,500 26,732
------------
$ 1,924,110
------------
CONSUMER DISCRETIONARY (0.2%)
Kimberly-Clark Corp. 676,300 39,942
------------
CONSUMER STAPLES (2.1%)
CVS Corp. 11,500,900 410,812
Colgate-Palmolive Co. 421,000 21,585
------------
$ 432,397
------------
DRUGS & PHARMACEUTICALS (30.7%)
Pfizer Inc. 39,780,070 1,457,144
Eli Lilly & Co. 9,716,600 661,117
* Forest Laboratories, Inc. 8,202,000 610,967
Cardinal Health, Inc. 9,501,408 609,135
Schering-Plough Corp. 30,000,000 526,200
Abbott Laboratories 10,780,700 464,433
Wyeth 10,684,900 437,547
* Gilead Sciences, Inc. 6,149,924 337,446
Merck & Co., Inc. 6,290,000 299,404
AmerisourceBergen Corp. 5,191,880 285,813
Allergan, Inc. 3,044,100 252,204
* King Pharmaceuticals, Inc. 6,517,400 108,710
Johnson & Johnson 2,000,000 106,840
(1) Perrigo Co. 5,322,320 88,723
* Watson Pharmaceuticals, Inc. 1,289,200 59,961
* Vertex Pharmaceuticals, Inc. 3,755,400 37,216
Bristol-Myers Squibb Co. 1,075,800 30,176
Alpharma, Inc. Class A 748,313 16,253
Mylan Laboratories, Inc. 500,000 12,195
------------
$ 6,401,484
------------
ELECTRONICS--MEDICAL SYSTEMS (1.9%)
Medtronic, Inc. 6,500,000 319,930
*(1)Haemonetics Corp. 1,883,900 53,691
Datascope Corp. 342,100 11,922
(1) E-Z-EM, Inc. 523,602 7,859
------------
$ 393,402
------------
FINANCIAL SERVICES (0.5%)
CIGNA Corp. 1,600,700 99,275
NDCHealth Corp. 181,800 5,130
------------
$ 104,405
------------
14
- --------------------------------------------------------------------------------
MARKET
VALUE*
HEALTH CARE FUND SHARES (000)
- --------------------------------------------------------------------------------
HEALTH & PERSONAL CARE (3.1%)
(1) McKesson Corp. 15,612,550 $ 458,697
* Medco Health Solutions, Inc. 2,258,574 83,228
* Anthem, Inc. 905,500 74,052
* IDX Systems Corp. 909,200 26,630
------------
$ 642,607
------------
HEALTH CARE FACILITIES (3.0%)
HCA Inc. 6,767,620 303,866
Quest Diagnostics, Inc. 2,150,000 182,750
* Laboratory Corp. of America Holdings 2,967,360 126,706
* LifePoint Hospitals, Inc. 460,715 15,899
------------
$ 629,221
------------
HEALTH CARE MANAGEMENT SERVICES (4.6%)
Aetna Inc. 4,350,200 304,514
*(1)Humana Inc. 9,995,000 233,183
IMS Health, Inc. 8,547,400 219,925
*(1)Cerner Corp. 2,680,100 105,060
Universal Health Services Class B 900,000 49,428
* Pediatrix Medical Group, Inc. 348,100 20,468
* Health Net Inc. 500,000 16,650
* American Medical Security Group, Inc. 300,000 7,215
------------
$ 956,443
------------
MATERIALS & PROCESSING (0.8%)
Sigma-Aldrich Corp. 2,750,000 161,123
MEDICAL & DENTAL INSTRUMENTS & SUPPLIES (5.5%)
Becton, Dickinson & Co. 8,451,800 380,838
Beckman Coulter, Inc. 2,776,600 151,352
(1) Bausch & Lomb, Inc. 2,700,000 145,125
* St. Jude Medical, Inc. 1,700,000 122,145
Biomet, Inc. 2,651,925 102,523
Guidant Corp. 1,000,000 63,880
DENTSPLY International Inc. 1,442,700 60,593
(1) Owens & Minor, Inc. Holding Co. 2,260,000 51,867
* Ventana Medical Systems, Inc. 614,400 27,120
* STERIS Corp. 850,000 21,505
* Advanced Medical Optics, Inc. 676,466 15,484
* Viasys Healthcare Inc. 482,130 11,455
------------
$ 1,153,887
------------
MEDICAL SERVICES (0.9%)
* Coventry Health Care Inc. 2,450,000 162,435
*(1)PAREXEL International Corp. 1,570,200 27,086
------------
$ 189,521
------------
PRODUCER DURABLES (0.7%)
* Thermo Electron Corp. 3,000,000 83,610
Pall Corp. 2,154,600 56,020
------------
$ 139,630
------------
TECHNOLOGY
* Varian, Inc. 253,000 $ 10,120
------------
- --------------------------------------------------------------------------------
TOTAL UNITED STATES 13,178,292
- --------------------------------------------------------------------------------
INTERNATIONAL (28.5%)
- --------------------------------------------------------------------------------
BELGIUM (0.4%)
UCB SA 1,933,593 $ 76,891
CANADA (0.2%)
Axcan Pharma Inc. 1,356,900 24,244
* Biovail Corp. 1,015,600 22,516
------------
$ 46,760
------------
DENMARK (0.1%)
Novo Nordisk A/S B Shares 700,000 $ 27,841
------------
FRANCE (6.3%)
Aventis SA 11,675,168 910,128
Sanofi-Synthelabo SA 4,199,623 298,423
Aventis SA ADR 1,317,815 102,921
------------
$ 1,311,472
------------
GERMANY (1.8%)
Bayer AG 7,944,656 240,622
Schering AG 1,440,410 75,496
Bayer AG ADR 1,771,500 54,013
Fresenius Medical
Care Pfd. ADR 645,400 9,649
------------
$ 379,780
------------
JAPAN (6.3%)
Fujisawa Pharmaceutical Co., Ltd. 13,501,000 288,897
Eisai Co., Ltd. 8,306,000 218,930
Chugai Pharmaceutical Co., Ltd. 8,834,500 139,299
Yamanouchi Pharmaceuticals Co., Ltd. 4,380,000 139,035
Shionogi & Co., Ltd. 7,231,000 124,604
Takeda Chemical Industries Ltd. 2,900,000 120,548
Sankyo Co., Ltd. 5,950,000 119,731
Daiichi Pharmaceutical Co., Ltd. 3,300,000 58,081
Tanabe Seiyaku Co., Ltd. 6,850,000 55,460
Ono Pharmaceutical Co., Ltd. 963,000 38,211
------------
$ 1,302,796
------------
NETHERLANS (0.5%)
Akzo Nobel NV 2,400,000 98,092
SWEDEN (0.6%)
Gambro AB A Shares 7,531,120 66,559
Gambro AB B Shares 7,314,580 64,645
------------
$ 131,204
------------
15
- --------------------------------------------------------------------------------
MARKET
VALUE*
HEALTH CARE FUND SHARES (000)
- --------------------------------------------------------------------------------
SWITZERLAND (6.7%)
Roche Holdings AG 6,123,977 $ 619,492
Novartis AG (Registered) 12,619,880 567,214
Alcon, Inc. 1,659,600 106,231
Serono SA Class B 125,198 96,054
------------
$ 1,388,991
------------
UNITED KINGDOM (5.6%)
AstraZeneca Group PLC 8,431,500 399,337
AstraZeneca Group PLC ADR 7,581,772 365,972
GlaxoSmithKline PLC ADR 6,068,881 267,031
Amersham PLC 7,865,820 113,252
* Shire Pharmaceuticals Group PLC 2,700,000 26,048
------------
$ 1,171,640
------------
- --------------------------------------------------------------------------------
TOTAL INTERNATIONAL $ 5,935,467
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS (Cost $12,556,661) $ 19,113,759
- --------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (8.7%)
- --------------------------------------------------------------------------------
U.S. GOVERNMENT AND AGENCY OBLIGATIONS (0.5%)
Federal National Mortgage Assn.**
1.08%, 2/25/2004 $ 75,000 $ 74,952
1.05%, 3/10/2004 21,200 21,178
------------
$ 96,130
------------
COMMERCIAL PAPER (2.0%)
General Electric Capital CP
1.09%, 2/12/2004 210,000 209,942
1.03%, 3/26/2004 210,000 209,689
------------
$ 419,631
------------
REPURCHASE AGREEMENTS (6.2%)
ABN AMRO, Inc.
1.03%, 2/2/2004
(Dated 1/30/2004,
Repurchase Value $25,002,000,
collateralized by Federal Home
Loan Mortgage Corporation,
0.00%, 2/12/2004) 25,000 25,000
DEUTSCHE BANK SECURITIES INC.
1.03%, 2/2/2004
(Dated 1/30/2004,
Repurchase Value $444,938,000,
collateralized by Federal Home
Loan Mortgage Corporation,
0.00%-4.875%, 2/26/2004-
3/15/2007) 444,900 444,900
GOLDMAN SACHS & Co.
1.04%, 2/2/2004
(Dated 1/30/2004,
Repurchase Value $454,739,000,
collateralized by Federal National
Mortgage Association,
4.50%-10.50%, 8/1/2008-
2/1/2034, Federal Home Loan
Mortgage Corporation, 3.50%-
9.50%, 3/1/2007-8/1/2033) $454,700 454,700
J.P. MORGAN SECURITIES INC.
1.04%, 2/2/2004
(Dated 1/30/2004,
Repurchase Value $88,008,000,
collateralized by Federal National
Mortgage Association, 4.00%-
9.00%, 5/1/2004-2/1/2034) 88,000 88,000
BNP PARIBAS SECURITIES CORP.
1.03%, 2/2/2004
(Dated 1/30/2004,
Repurchase Value $14,101,000,
collateralized by Federal Home
Loan Mortgage Corporation,
5.375%, 5/15/2006) 14,100 14,100
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
1.02%, 2/2/2004--Note G 267,624 267,624
------------
$ 1,294,324
------------
- --------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS (Cost $1,810,053) $ 1,810,085
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.4%) (Cost $14,366,714) $ 20,923,844
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES--NET (-0.4%) (92,270)
- --------------------------------------------------------------------------------
NET ASSETS (100%) $ 20,831,574
================================================================================
*See Note A in Notes to Financial Statements.
*Non-income-producing securities.
**The issuer operates under a congressional charter; its securities are neither
issued nor guaranteed by the U.S. government. If needed, access to additional
funding from the U.S. Treasury (beyond the issuer's line of credit), would
require congressional action.
(1)Considered an affiliated company as the fund owns more than 5% of the
outstanding voting securities of such company. The total market value of
investments in affiliated companies was $1,359,367,000.
ADR--American Depositary Receipt.
16
- --------------------------------------------------------------------------------
STATEMENT OF ASSETS AND LIABILITIES
- --------------------------------------------------------------------------------
ASSETS
Investments in Securities, at Value $ 20,923,844
Receivables for Investment Securities Sold 194,925
Other Assets--Note C 28,385
------------
Total Assets $ 21,147,154
------------
LIABILITIES
Security Lending Collateral
Payable to Brokers--Note G 267,624
Other Liabilities 47,956
------------
Total Liabilities $ 315,580
------------
- --------------------------------------------------------------------------------
NET ASSETS (100%) $20,831,574
================================================================================
- --------------------------------------------------------------------------------
AMOUNT
(000)
- --------------------------------------------------------------------------------
AT JANUARY 31, 2004, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
Paid-in Capital $14,160,810
Overdistributed Net Investment Income (21,737)
Accumulated Net Realized Gains 135,113
Unrealized Appreciation
Investment Securities 6,557,130
Foreign Currencies 258
- --------------------------------------------------------------------------------
NET ASSETS $20,831,574
================================================================================
Investor Shares--Net Assets
Applicable to 147,556,675 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $18,339,646
- --------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE-- INVESTOR SHARES $ 124.29
================================================================================
Admiral Shares--Net Assets
Applicable to 47,515,753 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $ 2,491,928
- --------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $ 52.44
================================================================================
See Note E in Notes to Financial Statements for the tax-basis components of net
assets.
17
STATEMENT OF OPERATIONS
This Statement shows the types of income earned by the fund during the reporting
period, and details the operating expenses charged to each class of its shares.
These expenses directly reduce the amount of investment income available to pay
to shareholders as income dividends. This Statement also shows any Net Gain
(Loss) realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) of investments during the period.
- --------------------------------------------------------------------------------
HEALTH CARE FUND
YEAR ENDED JANUARY 31, 2004
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends*+ $ 186,806
Interest 15,699
Security Lending 2,088
- --------------------------------------------------------------------------------
Total Income $ 204,593
- --------------------------------------------------------------------------------
Expenses
Investment Advisory Fees--Note B 10,298
The Vanguard Group--Note C
Management and Administrative
Investor Shares 30,962
Admiral Shares 2,229
Marketing and Distribution
Investor Shares 1,621
Admiral Shares 173
Custodian Fees 1,390
Auditing Fees 14
Shareholders' Reports
Investor Shares 390
Admiral Shares 7
Trustees' Fees and Expenses 20
- --------------------------------------------------------------------------------
Total Expenses 47,104
Expenses Paid Indirectly--Note D (1,431)
- --------------------------------------------------------------------------------
Net Expenses $ 45,673
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 158,920
- --------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Investment Securities Sold+ 144,384
Foreign Currencies 1,127
- --------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS) 145,511
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 4,740,080
Foreign Currencies 159
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 4,740,239
- --------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ 5,044,670
================================================================================
*Dividends are net of foreign withholding taxes of $7,819,000.
+Dividend income and realized net gain (loss) from affiliated companies were
$15,071,000 and $63,073,000, respectively.
18
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the net amount shareholders invested in
or redeemed from the fund. Distributions and Capital Share Transactions are
shown separately for each class of shares.
- --------------------------------------------------------------------------------
HEALTH CARE FUND
------------------------
YEAR ENDED JANUARY 31,
- --------------------------------------------------------------------------------
2004 2003
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 158,920 $ 143,405
Realized Net Gain (Loss) 145,511 982,753
Change in Unrealized Appreciation (Depreciation) 4,740,239 (3,242,938)
- --------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets
Resulting from Operations 5,044,670 (2,116,780)
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Net Investment Income
Investor Shares (144,322) (128,208)
Admiral Shares (20,948) (16,453)
Realized Capital Gain*
Investor Shares (14,623) (876,717)
Admiral Shares (1,758) (103,443)
- --------------------------------------------------------------------------------
Total Distributions (181,651) (1,124,821)
- --------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS--NOTE H
Investor Shares 521,871 421,156
Admiral Shares 320,310 335,369
- --------------------------------------------------------------------------------
Net Increase (Decrease) from Capital
Share Transactions 842,181 756,525
- --------------------------------------------------------------------------------
Total Increase (Decrease) 5,705,200 (2,485,076)
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 15,126,374 17,611,450
- --------------------------------------------------------------------------------
End of Period $20,831,574 $15,126,374
================================================================================
*Includes short-term gain distributions totaling $0 and $618,000, respectively.
Short-term gain distributions are treated as ordinary income dividends for tax
purposes.
19
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis for each class of shares. It also presents the
Total Return and shows net investment income and expenses as percentages of
average net assets. These data will help you assess: the variability of the
fund's net income and total returns from year to year; the relative
contributions of net income and capital gains to the fund's total return; how
much it costs to operate the fund; and the extent to which the fund tends to
distribute capital gains. The table also shows the Portfolio Turnover Rate, a
measure of trading activity. A turnover rate of 100% means that the average
security is held in the fund for one year.
HEALTH CARE FUND INVESTOR SHARES
- ----------------------------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
------------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 94.35 $115.01 $123.04 $ 98.83 $97.32
- ----------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .960 .947 .980 1.16 .92
Net Realized and Unrealized Gain (Loss)
on Investments* 30.078 (14.124) (2.516) 40.05 8.70
- ----------------------------------------------------------------------------------------------------------------
Total from Investment Operations 31.038 (13.177) (1.536) 41.21 9.62
- ----------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.995) (.955) (1.030) (1.07) (.97)
Distributions from Realized Capital Gains (.103) (6.528) (5.464) (15.93) (7.14)
- ----------------------------------------------------------------------------------------------------------------
Total Distributions (1.098) (7.483) (6.494) (17.00) (8.11)
- ----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $124.29 $ 94.35 $115.01 $ 123.04 $98.83
================================================================================================================
TOTAL RETURN** 32.99% -11.65% -1.11% 43.37% 10.57%
================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $ 18,340 $ 13,506 $ 15,981 $ 17,242 $ 10,726
Ratio of Total Expenses to Average Net Assets 0.28% 0.29% 0.31% 0.34% 0.41%
Ratio of Net Investment Income to Average Net Assets 0.91% 0.86% 0.84% 1.03% 0.92%
Portfolio Turnover Rate 13% 25% 13% 21% 27%
================================================================================================================
*Includes increases from redemption fees of $.02, $.04, $.03, $.01, and $.03.
**Total returns do not reflect the 1% fee assessed on redemptions of shares held
for less than five years (or less than one year in the case of shares purchased
prior to April 19, 1999).
20
HEALTH CARE FUND ADMIRAL SHARES
- --------------------------------------------------------------------------------
NOV. 12,
YEAR ENDED 2001* TO
JANUARY 31, JAN. 31,
--------------- -----------
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2004 2003 2002
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 39.80 $48.52 $50.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .447 .436 .066
Net Realized and Unrealized Gain (Loss)
on Investments** 12.696 (5.963) .542
- --------------------------------------------------------------------------------
Total from Investment Operations 13.143 (5.527) .608
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.460) (.438) (.390)
Distributions from Realized Capital Gains (.043) (2.755) (1.698)
- --------------------------------------------------------------------------------
Total Distributions (.503) (3.193) (2.088)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $ 52.44 $ 39.80 $ 48.52
================================================================================
TOTAL RETURN+ 33.12% -11.58% 1.23%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $ 2,492 $ 1,620 $ 1,631
Ratio of Total Expenses to Average Net Assets 0.19% 0.22% 0.23%++
Ratio of Net Investment Income
to Average Net Assets 0.98% 0.93% 0.50%++
Portfolio Turnover Rate 13% 25% 13%
================================================================================
*Inception.
**Includes increases from redemption fees of $.01, $.02, and $.01.
+Total returns do not reflect the 1% fee assessed on redemptions of shares held
for less than five years.
++Annualized.
SEE ACCOMPANYING NOTES, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
21
NOTES TO FINANCIAL STATEMENTS
Vanguard Health Care Fund is registered under the Investment Company Act of 1940
as an open-end investment company, or mutual fund. The fund may invest in
securities of foreign issuers, which may subject it to investment risks not
normally associated with investing in securities of United States corporations.
The fund offers two classes of shares, Investor Shares and Admiral Shares.
Investor Shares are available to any investor who meets the fund's minimum
purchase requirements. Admiral Shares are designed for investors who meet
certain administrative, servicing, tenure, and account-size criteria.
A. The following significant accounting policies conform to generally accepted
accounting principles for U.S. mutual funds. The fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Securities are valued as of the close of trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation
date. Equity securities are valued at the latest quoted sales prices or official
closing prices taken from the primary market in which each security trades; such
securities not traded on the valuation date are valued at the mean of the latest
quoted bid and asked prices. Securities for which market quotations are not
readily available, or whose values have been materially affected by events
occurring before the fund's pricing time but after the close of the securities'
primary markets, are valued by methods deemed by the board of trustees to
represent fair value. Temporary cash investments acquired over 60 days to
maturity are valued using the latest bid prices or using valuations based on a
matrix system (which considers such factors as security prices, yields,
maturities, and ratings), both as furnished by independent pricing services.
Other temporary cash investments are valued at amortized cost, which
approximates market value.
2. FOREIGN CURRENCY: Securities and other assets and liabilities
denominated in foreign currencies are translated into U.S. dollars at the
exchange rates on the valuation date as employed by Morgan Stanley Capital
International in the calculation of its indexes.
Realized gains (losses) and unrealized appreciation (depreciation) on
investment securities include the effects of changes in exchange rates since the
securities were purchased, combined with the effects of changes in security
prices. Fluctuations in the value of other assets and liabilities resulting from
changes in exchange rates are recorded as unrealized foreign currency gains
(losses) until the asset or liability is settled in cash, when they are recorded
as realized foreign currency gains (losses).
3. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a pooled cash account,
which is invested in repurchase agreements secured by U.S. government
securities. The fund may also invest directly in repurchase agreements.
Securities pledged as collateral for repurchase agreements are held by a
custodian bank until the agreements mature. Each agreement requires that the
market value of the collateral be sufficient to cover payments of interest and
principal; however, in the event of default or bankruptcy by the other party to
the agreement, retention of the collateral may be subject to legal proceedings.
4. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold. Fees assessed on redemptions of
capital shares are credited to paid-in capital.
Each class of shares has equal rights as to assets and earnings, except
that each class separately bears certain class-specific expenses related to
maintenance of shareholder accounts (included in
22
Management and Administrative expenses) and shareholder reporting. Marketing and
distribution expenses are allocated to each class of shares based on a method
approved by the board of trustees. Income, other non-class-specific expenses,
and gains and losses on investments are allocated to each class of shares based
on its relative net assets.
B. Wellington Management Company, LLP, provides investment advisory services to
the fund for a fee calculated at an annual percentage rate of average net
assets. For the year ended January 31, 2004, the investment advisory fee
represented an effective annual rate of 0.06% of the fund's average net assets.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the board of trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At January 31, 2004, the fund had contributed capital of $3,079,000 to
Vanguard (included in Other Assets), representing 0.01% of the fund's net assets
and 3.08% of Vanguard's capitalization. The fund's trustees and officers are
also directors and officers of Vanguard.
D. The fund has asked its investment advisor to direct certain security trades,
subject to obtaining the best price and execution, to brokers who have agreed to
rebate to the fund part of the commissions generated. Such rebates are used
solely to reduce the fund's management and administrative expenses. The fund's
custodian bank has also agreed to reduce its fees when the fund maintains cash
on deposit in the non-interest-bearing custody account. For the year ended
January 31, 2004, directed brokerage and custodian fee offset arrangements
reduced expenses by $1,419,000 and $12,000, respectively. The total expense
reduction represented an effective annual rate of 0.01% of the fund's average
net assets.
E. Distributions are determined on a tax basis and may differ from net
investment income and realized capital gains for financial reporting purposes.
Differences may be permanent or temporary. Permanent differences are
reclassified among capital accounts in the financial statements to reflect their
tax character. Temporary differences arise when certain items of income,
expense, gain, or loss are recognized in different periods for financial
statement and tax purposes; these differences will reverse at some time in the
future. Differences in classification may also result from the treatment of
short-term gains as ordinary income for tax purposes.
During the year ended January 31, 2004, the fund realized net foreign currency
gains of $1,127,000, which increased distributable net income for tax purposes;
accordingly such gains have been reclassified from accumulated net realized
gains to undistributed net investment income. The fund used a tax accounting
practice to treat a portion of the price of capital shares redeemed during the
year as distributions from net investment income and realized capital gains.
Accordingly, the fund has reclassified $2,554,000 from undistributed net
investment income, and $2,129,000 from accumulated net realized gains, to
paid-in capital.
For tax purposes, at January 31, 2004, the fund had $44,806,000 of ordinary
income and $90,902,000 of long-term capital gains available for distribution.
At January 31, 2004, net unrealized appreciation of investment securities for
tax purposes was $6,557,130,000, consisting of unrealized gains of
$6,761,974,000 on securities that had risen in value since their purchase and
$204,844,000 in unrealized losses on securities that had fallen in value since
their purchase.
The fund had net unrealized foreign currency gains of $258,000 resulting from
the translation of other assets and liabilities at January 31, 2004.
F. During the year ended January 31, 2004, the fund purchased $2,643,332,000 of
investment securities and sold $2,080,837,000 of investment securities other
than temporary cash investments.
23
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
G. The market value of securities on loan to broker/dealers at January 31, 2004,
was $260,234,000, for which the fund held cash collateral of $267,624,000. The
fund invests cash collateral received in repurchase agreements, and records a
liability for the return of the collateral, during the period the securities are
on loan.
H. Capital share transactions for each class of shares were:
- -------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
-------------------------------------------
2004 2003
--------------------- -------------------
AMOUNT SHARES AMOUNT SHARES
(000) (000) (000) (000)
- -------------------------------------------------------------------------------------------
Investor Shares
Issued $1,962,989 18,046 $1,629,094 14,967
Issued In Lieu of Cash Distributions 151,019 1,309 959,018 9,823
Redeemed* (1,592,137) (14,955)(2,166,956) (20,587)
---------------------------------------------
Net Increase (Decrease)--Investor Shares 521,871 4,400 421,156 4,203
---------------------------------------------
Admiral Shares
Issued 482,596 10,475 454,490 9,715
Issued In Lieu of Cash
Distributions 19,979 410 107,102 2,604
Redeemed* (182,265) (4,075) (226,223) (5,222)
---------------------------------------------
Net Increase (Decrease)--Admiral Shares 320,310 6,810 335,369 7,097
- -------------------------------------------------------------------------------------------
*Net of redemption fees of $3,825,000 and $5,809,000, respectively (fund
totals).
24
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Trustees of Vanguard Health Care Fund:
In our opinion, the accompanying statement of net assets (and the statement of
assets and liabilities) and the related statements of operations and of changes
in net assets and the financial highlights present fairly, in all material
respects, the financial position of Vanguard Health Care Fund (the "Fund") at
January 31, 2004, the results of its operations for the year then ended, the
changes in its net assets for each of the two years in the period then ended and
the financial highlights for each of the five years in the period then ended, in
conformity with accounting principles generally accepted in the United States of
America. These financial statements and financial highlights (hereafter referred
to as "financial statements") are the responsibility of the Fund's management;
our responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these financial statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of securities at January 31, 2004 by
correspondence with the custodian, provide a reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
PHILADELPHIA, PENNSYLVANIA
MARCH 1, 2004
- --------------------------------------------------------------------------------
SPECIAL 2003 TAX INFORMATION
(UNAUDITED) FOR VANGUARD HEALTH CARE FUND
This information for the fiscal year ended January 31, 2004, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $17,813,000 as capital gain dividends (from net long-term
capital gains) to shareholders during the fiscal year, all of which is
designated as a 20% rate gain distribution.
For corporate shareholders, 55.7% of investment income (dividend income plus
short-term gains, if any) qualifies for the dividends-received deduction.
The fund intends to distribute the maximum amount of qualified dividend income
allowable. The amount of qualified dividend income distributed by the fund is
provided to individual shareholders on their Form 1099-DIV.
- --------------------------------------------------------------------------------
25
INVESTING IS FAST, EASY, AND SECURE ON VANGUARD.COM
If you're like many Vanguard investors, you believe in planning and taking
control of your own investments. Vanguard.com was built for you--and it keeps
getting better.
RESEARCH AND PLAN YOUR INVESTMENTS WITH CONFIDENCE
Use our PLANNING & ADVICE and RESEARCH FUNDS & STOCKS sections to:
* Determine what asset allocation might best suit your needs--by taking our
Investor Questionnaire.
* Find out how much to save for retirement and your children's college
education-- by using our planning tools.
* Learn how to achieve your goals--by reading our PlainTalk(R) investment
guides.
* Find your next fund--by using the Compare Funds, Compare Costs, and Narrow
Your Fund Choices tools.
* Look up fund price, performance history, and distribution information--in a
snap.
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Find out what Vanguard.com can do for you. Log on today!
26
CAPITALIZE ON YOUR IRA
Are you taking full advantage of your individual retirement account? You really
should be. The contribution limits on IRAs were recently raised, making these
tax-deferred accounts more powerful options for retirement savers.
Here's how you can exploit your IRA--and improve your chances of having the
retirement of your dreams.
CONTRIBUTE THE MAXIMUM AMOUNT EACH YEAR
It may be an obvious point, but if you invest as much in your IRA as the law
allows--currently $3,000 per tax year if you are under age 50 and $3,500 if you
are age 50 or over--you will increase the odds of meeting your retirement goals.
"Max out" every year you can.
MAKE IT AUTOMATIC
Put your IRA on autopilot by taking advantage of Vanguard's Automatic Investment
Plan. Your IRA contributions will be deducted from your bank account on a
schedule of your choosing, making retirement investing a healthy habit.
CONSIDER COST
The owners of low-cost investments keep a larger portion of their gross returns
than the owners of high-cost investments. Over the long term, avoiding costlier
mutual funds and brokerage commissions could significantly boost your retirement
savings. Our low costs are one reason a Vanguard IRA(R) is such a smart choice.
REQUEST A DIRECT ROLLOVER WHEN YOU CHANGE JOBS
Don't spend your retirement assets before you've retired. When you change jobs,
roll your 401(k) or other employer-sponsored retirement plan assets directly
into your IRA.
If you have questions about your IRA, want to transfer an IRA from another
institution to Vanguard, or need help with any other IRA transaction, call our
Retirement Resource Center at 1-800-205-6189 or visit VANGUARD.COM. You can open
or fund your IRA on our website and have a confirmation in your hand within
minutes.
THE PEOPLE WHO GOVERN YOUR FUND
The trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are a part owner of
the fund. Your fund trustees also serve on the board of directors of The
Vanguard Group, Inc., which is owned by the Vanguard(R) funds and provides
services to them on an at-cost basis.
A majority of Vanguard's board members are independent, meaning that they have
no affiliation with Vanguard or the funds they oversee, apart from the sizable
personal investments they have made as private individuals.
Our independent board members bring distinguished backgrounds in business,
academia, and public service to their task of working with Vanguard officers to
establish the policies and oversee the activities of
- ------------------------------------------------------------------------------------------------------------
POSITION(S) HELD WITH
NAME FUND (NUMBER OF
(YEAR OF BIRTH) VANGUARD FUNDS
TRUSTEE/OFFICER OVERSEEN BY
SINCE TRUSTEE/OFFICER) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
- ------------------------------------------------------------------------------------------------------------
JOHN J. BRENNAN* Chairman of the Chairman of the Board, Chief Executive Officer, and Director/Trustee
(1954) Board, Chief of The Vanguard Group, Inc., and of each of the investment companies
May 1987 Executive Officer, served by The Vanguard Group.
and Trustee
(118)
- ------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
CHARLES D. ELLIS Trustee The Partners of '63 (pro bono ventures in education); Senior Advisor
(1937) (118) to Greenwich Associates (international business strategy consulting);
January 2001 Successor Trustee of Yale University; Overseer of the Stern School of
Business at New York University; Trustee of the Whitehead Institute
for Biomedical Research.
- ------------------------------------------------------------------------------------------------------------
RAJIV L. GUPTA Trustee Chairman and Chief Executive Officer (since October 1999), Vice
(1945) (118) Chairman (January-September 1999), and Vice President (prior to
December 2001 September 1999) of Rohm and Haas Co. (chemicals); Director of
Technitrol, Inc. (electronic components), and Agere Systems
(communications components); Board Member of the American Chemistry
Council; and Trustee of Drexel University.
- ------------------------------------------------------------------------------------------------------------
JOANN HEFFERNAN Trustee Vice President, Chief Information Officer, and Member of the
HEISEN (118) Executive Committee of Johnson & Johnson (pharmaceuticals/consumer
(1950) products); Director of the Medical Center at Princeton and Women's
July 1998 Research and Education Institute.
- ------------------------------------------------------------------------------------------------------------
BURTON G. MALKIEL TRUSTEE Chemical Bank Chairman's Professor of Economics,Princeton University;
(1932) (116) Director of Vanguard Investment Series plc (Irish invest-ment fund)
May 1977 (since November 2001), Vanguard Group (Ireland)Limited (Irish
investment management firm)(since November 2001),Prudential Insurance
Co. of America, BKF Capital (investment management), The Jeffrey Co.
(holding company), and NeuVis, Inc.(software company).
- ------------------------------------------------------------------------------------------------------------
the funds. Among board members' responsibilities are selecting investment
advisors for the funds; monitoring fund operations, performance, and costs;
reviewing contracts; nominating and selecting new trustees/directors; and
electing Vanguard officers.
Each trustee serves a fund until its termination; or until the trustee's
retirement, resignation, or death; or otherwise as specified in the fund's
organizational documents. Any trustee may be removed at a shareholders' meeting
by a vote representing two-thirds of the net asset value of all shares of the
fund together with shares of other Vanguard funds organized within the same
trust. The table on these two pages shows information for each trustee and
executive officer of the fund. The mailing address of the trustees and officers
is P.O. Box 876, Valley Forge, PA 19482.
POSITION(S) HELD WITH
NAME FUND (NUMBER OF
(YEAR OF BIRTH) VANGUARD FUNDS
TRUSTEE/OFFICER OVERSEEN BY
SINCE TRUSTEE/OFFICER) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
- ------------------------------------------------------------------------------------------------------------
Alfred M. Rankin, Jr. Trustee Chairman, President, Chief Executive Officer, and Director of NACCO
(1941) (118) Industries, Inc. (forklift trucks/housewares/lignite); Director of
January 1993 Goodrich Corporation (industrial products/aircraft systems and
services); Director of Standard Products Company (supplier for
the automotive industry) until 1998.
- ------------------------------------------------------------------------------------------------------------
J. Lawrence Wilson Trustee Retired Chairman and Chief Executive Officer of Rohm and Haas Co.
(1936) (118) (chemicals); Director of Cummins Inc. (diesel engines), The Mead
April 1985 Corp. (paper products), and AmerisourceBergen Corp. (pharmaceuti-cal
distribution); Trustee of Vanderbilt University.
- ------------------------------------------------------------------------------------------------------------
EXECUTIVE OFFICERS*
R. Gregory Barton Secretary Managing Director and General Counsel of The Vanguard Group, Inc.;
(1951) (118) Secretary of The Vanguard Group and of each of the investment
June 2001 companies served by The Vanguard Group.
- ------------------------------------------------------------------------------------------------------------
Thomas J. Higgins Treasurer Principal of The Vanguard Group, Inc.; Treasurer of each of the
(1957) (118) investment companies served by The Vanguard Group.
July 1998
- ------------------------------------------------------------------------------------------------------------
*Officers of the funds are "interested persons" as defined in the Investment
Company Act of 1940.
More information about the trustees is in the Statement of Additional
Information, available from The Vanguard Group.
- ------------------------------------------------------------------------------------------------------------
VANGUARD SENIOR MANAGEMENT TEAM
MORTIMER J. BUCKLEY, Information Technology. MICHAEL S. MILLER, Planning and Development.
JAMES H. GATELY, Investment Programs and Services. RALPH K. PACKARD, Finance.
KATHLEEN C. GUBANICH, Human Resources. GEORGE U. SAUTER, Chief Investment Officer.
F. WILLIAM MCNABB, III, Client Relationship Group.
- ------------------------------------------------------------------------------------------------------------
JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996.
- ------------------------------------------------------------------------------------------------------------
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VALLEY FORGE, PA 19482-2600
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All other marks are the exclusive property of their respective owners.
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FOR MORE INFORMATION
This report is intended for the fund's shareholders. It may not be distributed
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fund prospectus.
To receive a free copy of the prospectus or the Statement of Additional
Information, or to request additional information about the fund or other
Vanguard funds, please contact us at one of the adjacent telephone numbers or by
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All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc.,
unless otherwise noted.
WORLD WIDE WEB
www.vanguard.com
FUND INFORMATION
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(C) 2004 THE VANGUARD GROUP, INC.
ALL RIGHTS RESERVED.
VANGUARD MARKETING
CORPORATION, DISTRIBUTOR.
Q520 032004
VANGUARD(R) REIT INDEX FUND
JANUARY 31, 2004
ANNUAL REPORT
THE VANGUARD GROUP(R)LOGO
HOW TO READ YOUR FUND REPORT
This report contains information that can help you evaluate your investment. It
includes details about your fund's return and presents data and analysis that
provide insight into the fund's performance and investment approach.
By reading the letter from Vanguard's chairman, you'll get an understanding of
how the fund invests and how the market environment affected its performance.
The statistical information that follows can help you understand how the fund's
performance and characteristics stack up against those of similar funds and
market benchmarks.
It's important to keep in mind that any opinions expressed here are just that:
informed opinions. They should not be considered promises or advice. These
opinions, like the statistics, cover the period through the date on the cover of
this report. The risks of investing in the fund are spelled out in the
prospectus.
Frequent updates on the fund's performance and information about some of its
holdings are available on Vanguard.com(R).
- --------------------------------------------------------------------------------
CONTENTS
1 letter from the chairman
6 fund profile
7 glossary of investment terms
8 performance summary
10 your fund's after-tax returns
11 about your fund's expenses
12 financial statements
- --------------------------------------------------------------------------------
SUMMARY
* During the 12 months ended January 31, 2004, the Investor Shares of
Vanguard REIT Index Fund posted a remarkable return of 45.4%
* Stocks soared on the strength of good economic news, an upswing in
corporate profits, and a shift in investor sentiment.
* Real estate investment trusts outperformed the broad market by a healthy
margin, benefiting from both the eco-nomic expansion and the
low-interest-rate environment, which increased the allure of the relatively
high yields offered by REITs.
Want less clutter in your mailbox? Just register with VANGUARD.COM and opt to
get fund reports online.
LETTER FROM THE CHAIRMAN
FELLOW SHAREHOLDER,
The 12 months ended January 31, 2004, were terrific for stocks in general, but
especially for those of real estate investment trusts. The Investor Shares of
Vanguard REIT Index Fund returned an excellent 45.4%, ahead of the return of the
broad U.S. stock market but a bit short of the return of the fund's target
index.
[PICTURES OF JOHN J. BRENNAN]
- ----------------------------------------------------
2004 TOTAL RETURNS FISCAL YEAR ENDED
JANUARY 31
- ----------------------------------------------------
VANGUARD REIT INDEX FUND
Investor Shares 45.4%
Admiral Shares 45.6
Institutional Shares* 6.5
Morgan Stanley REIT Index 46.8
Average Real Estate Fund** 45.5
Target REIT CompositeY 45.7
Wilshire 5000 Index 38.1
- ----------------------------------------------------
*Return since inception on December 2, 2003.
**Derived from data provided by Lipper Inc.
+The Target REIT Composite consists of the Morgan Stanley REIT Index adjusted to
include a 2% cash position (Lipper Money Market Average).
The adjacent table shows the total returns (capital change plus reinvested
distributions) for all three of the fund's share classes--including the recently
introduced Institutional Shares--along with the fund's comparative measures and
the overall stock market, as represented by the Wilshire 5000 Total Market
Index. Details of the fund's returns appear in the table on page 5.
On January 31, the Investor Shares yielded 5.3%, and the Admiral and
Institutional Shares yielded 5.4%. For both classes of shares, these yields were
well below their respective levels of 7.4% and 7.5% at the start of the fiscal
year because of the tremendous capital appreciation of the fund. (These figures
include some payments that represent a return of capital by the underlying
REITs, an amount that is determined by each REIT at the end of its fiscal year.)
If you own the fund in a taxable account, you may wish to see page 10 for a
report on the fund's after-tax returns.
1
- --------------------------------------------------------------------------------
ADMIRAL(TM) SHARES
A lower-cost class of shares available to many longtime shareholders and to
those with significant investments in the fund.
INSTITUTIONAL SHARES
This class of shares also carries low expenses and is available for a minimum
investment of $10 million.
- --------------------------------------------------------------------------------
STOCKS GENERATED OUTSTANDING RETURNS IN THE FISCAL YEAR
For the 12 months ended January 31, the Wilshire 5000 Index returned a
remarkable 38.1%. Even more impressive was that REITs outperformed the broad
market for the fourth consecutive year.
At the start of the period, investors were apprehensive. War with Iraq was
imminent, and the labor market and manufacturing industries were stagnating,
despite the broad economy's slow-but-steady expansion. Within weeks, however,
the United States and its allies had begun and successfully completed major
combat operations in Iraq. And in the succeeding months, the economic picture
also brightened: The unemployment rate declined, and manufacturing began to
stir. In the quarter ended September 30, the U.S. economy grew at an annualized
rate of 8.2%; estimates put fourth-quarter gross domestic product growth at
about 4.0%.
With each piece of good news, the stock market's mood inched from cautious
toward cavalier. For the full 12 months, small-capitalization stocks
outperformed large-cap stocks by more than 20 percentage points.
- --------------------------------------------------------------------------------
MARKET BAROMETER AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED JANUARY 31, 2004
-------------------------------------
ONE THREE FIVE
YEAR YEARS YEARS
- --------------------------------------------------------------------------------
STOCKS
Russell 1000 Index (Large-caps) 35.6% -4.2% -0.5%
Russell 2000 Index (Small-caps) 58.0 6.0 7.8
Wilshire 5000 Index (Entire market) 38.1 -3.0 0.1
MSCI All Country World Index
ex USA (International) 48.9 -0.9 1.9
- --------------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 4.9% 7.3% 6.6%
(Broad taxable market)
Lehman Municipal Bond Index 6.2 6.5 5.7
Citigroup 3-Month Treasury Bill Index 1.0 2.1 3.4
================================================================================
CPI
Consumer Price Index 1.9% 1.9% 2.4%
- --------------------------------------------------------------------------------
RISK WAS REWARDED IN THE BOND MARKET
The same behavior was apparent in the fixed income market. Demand for
default-risk-free U.S. Treasuries was initially extreme, boosting the price of
the 10-year Treasury note while reducing its yield to just above 3% in June. By
year-end, however, the mood had changed. The Lehman
2
Brothers High Yield Bond Index, a benchmark of below-investment-grade bonds,
recorded a 12-month return of 27.2%, while investment-grade bonds, as measured
by the Lehman Aggregate Bond Index, returned 4.9%.
Short-term interest rates were the fixed income market's one constant, remaining
low--and lower--throughout the period. The yield of the 3-month Treasury bill, a
proxy for money market rates, ended the fiscal year at 0.91%, 26 basis points
lower than at the start of the period.
REITS MADE BIG ACROSS-THE-BOARD GAINS
The 45.4% return of Vanguard REIT Index Fund's Investor Shares in fiscal 2004
was by far the best performance in the fund's eight-year history. As noted
earlier, the fund's returns fell behind that of the target Morgan Stanley REIT
Index. However, it's important to remember that the index carries no operating
or transaction costs, nor does it hold cash, which is a drag on results when
real estate securities are soaring. (The fund holds about 2% of its assets in
cash for liquidity purposes; another of the fund's comparative measures, the
Target REIT Composite, reflects this adjustment.)
Demand for REITs was high during the 12 months, in part because of investors'
appetite for yield. As the year progressed and short-term interest rates
remained low, many investors were drawn to REIT yields, which were far above
those of short-term investments such as money market funds and short-maturity
bonds, and were more than three times higher than the yield of the overall stock
market. Other factors also contributed to the big gains in real estate
investments, not the least of which were the strong returns of stocks in
general. And while low interest rates were a turnoff for many investors, they
actually aided heavy-borrowing property owners. Also boosting REITs was the
economic expansion, which is a boon to the builders and landlords who rely on
healthy companies to rent their offices and stores.
Very few REIT stocks were left behind during the 12-month advance. Each of the
fund's ten largest holdings, which together represented about a third of assets
on January 31, registered a return of more than 26%. Its biggest holding, Equity
Office Properties Trust, which owns hundreds of urban and suburban office
buildings, returned 33%; Simon Property Group, its second biggest position and
the nation's biggest shopping mall owner, returned 69%.
3
With most REITs advancing, sector returns were strong as well. Office,
industrial, retail, and residential REITs posted significant advances. The
strongest of the bunch, however, was the retail sector, where increases in
consumer spending boosted the fortunes of shopping properties. Office REITs
surged too, as confidence about economic growth seemed to outweigh concerns
about rising vacancy rates and sky-high valuations.
OUR LONGER-TERM RESULTS STAND UP WELL
It should go without saying that the fund's heady 12-month returns should not be
considered a promise of what's to come. Prudent investors should expect future
returns that are far lower. But while the fortunes of real estate investments
are impossible to predict, investors in Vanguard REIT Index Fund should be
confident that the fund will strive to deliver returns in line with those of its
target index. Our low costs and the skilled investment management of our
Quantitative Equity Group, which manages all of Vanguard's stock index funds,
are the key ingredients in the fund's ability to achieve its objective. (See
page 11 for details on the fund's expenses and how these costs measure up
against those of similar funds.)
- --------------------------------------------------------------------------------
TOTAL RETURNS MAY 13, 1996,* THROUGH
JANUARY 31, 2004
- --------------------------------------------------------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RETURN INITIAL INVESTMENT
- --------------------------------------------------------------------------------
REIT Index Fund
Investor Shares 13.1% $25,856
Morgan Stanley REIT Index 13.2 26,001
Average Real Estate Fund 12.7 25,095
Target REIT Composite 13.0 25,749
Wilshire 5000 Index 8.4 18,697
- --------------------------------------------------------------------------------
*Fund inception.
As the above table shows, the fund's results since its birth in 1996 have,
overall, been excellent, both on an absolute basis and relative to its
comparative measures and the broad stock market.
WITH CONCENTRATION COMES VOLATILITY
Vanguard REIT Index Fund, which provides broad-based, low-cost exposure to the
real estate market, can add valuable diversification to your investment program.
However, it's important to keep in mind that although a diversifier's value lies
in the fact that it often moves in a different direction from other types of
investments, that direction isn't always up. (We don't have to look too far back
for evidence. In fiscal 1999, the fund returned -17.3% while the broad stock
market returned 27.3%. But while the broad market retreated significantly during
the
4
2000-2002 calendar years, the REIT Index Fund gained 47.3%) Simply put,
investors in Vanguard REIT Index Fund--or in any fund that is concentrated in a
particular industry or sector--must have two things: a strong stomach and a good
memory.
I want to close by thanking you for entrusting your assets to Vanguard. In light
of reports of late trading and market-timing at some competing investment
management firms, I also want to assure you that Vanguard has long had policies
and procedures in place to identify and deter such behavior. More important,
Vanguard shareholders are served by a crew of the highest integrity. Finally,
our client-owned corporate structure is the most effective means I can imagine
of aligning our day-to-day efforts with your long-term financial goals.
Sincerely,
/S/JOHN J. BRENNAN
John J. Brennan
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
FEBRUARY 12, 2004
- --------------------------------------------------------------------------------
YOUR FUND'S PERFORMANCE AT A GLANCE JANUARY 31, 2003-JANUARY 31, 2004
DISTRIBUTIONS PER SHARE
--------------------------------
STARTING ENDING INCOME CAPITAL RETURN OF
SHARE PRICE SHARE PRICE DIVIDENDS GAINS CAPITAL
- --------------------------------------------------------------------------------
REIT Index Fund
Investor Shares $11.52 $15.83 $0.678 $0.000 $0.102
Admiral Shares 49.14 67.56 2.931 0.000 0.436
Institutional Shares* 10.00 10.46 0.157 0.000 0.023
- --------------------------------------------------------------------------------
*Inception date 12/2/2003.
5
FUND PROFILE AS OF 1/31/2004
This Profile provides a snapshot of the fund's characteristics, compared where
appropriate with both its unmanaged target index and a broad market index. Key
terms are defined on page 7.
REIT INDEX FUND
- --------------------------------------------------------------------
PORTFOLIO CHARACTERISTICS
TARGET BROAD
FUND INDEX* INDEX**
- --------------------------------------------------------------------
Number of Stocks 115 115 5,190
Median Market Cap $2.8B $2.8B $28.0B
Price/Earnings Ratio 21.6x 21.6x 25.4x
Price/Book Ratio 2.1x 2.1x 3.1x
Yield 5.3% 1.5%
Investor Shares 5.3%+
Admiral Shares 5.4%+
Institutional Shares 5.4%+
Return on Equity 9.9% 9.9% 15.8%
Earnings Growth Rate -1.7% -1.7% 5.2%
Foreign Holdings 0.0% 0.0% 0.9%
Turnover Rate 7% -- --
Expense Ratio -- --
Investor Shares 0.24%
Admiral Shares 0.18%
Institutional Shares 0.15%YY
Short-Term Reserves 2% -- --
- --------------------------------------------------------------------
- ---------------------------------------------
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
Equity Office Properties Trust REIT 5.5%
Simon Property Group, Inc. REIT 4.8
Equity Residential REIT 3.7
General Growth Properties Inc. REIT 3.0
Vornado Realty Trust REIT 3.0
Public Storage, Inc. REIT 2.8
ProLogis REIT 2.7
Archstone-Smith Trust REIT 2.4
Kimco Realty Corp. REIT 2.4
Boston Properties, Inc. REIT 2.3
- ---------------------------------------------
Top Ten 32.6%
- ---------------------------------------------
The "Ten Largest Holdings" excludes any temporary cash investments and equity
index products.
- -------------------------------
INVESTMENT FOCUS
STYLE Value
MARKET CAP
- -------------------------------
- ------------------------------------------------------------
VOLATILITY MEASURES
TARGET BROAD
FUND INDEX* FUND INDEX**
- ------------------------------------------------------------
R-Squared 1.00 1.00 0.21 1.00
Beta 0.97 1.00 0.27 1.00
- ------------------------------------------------------------
- -----------------------------------------------
FUND ALLOCATION BY REIT TYPE (% OF PORTFOLIO)
Retail 25%
Apartments 17
Office 18
Industrial 16
Diversified 12
Health Care 6
Hotels 4
Short-Term Reserves 2
- -----------------------------------------------
Total 100%
- -----------------------------------------------
*Morgan Stanley REIT Index.
**Wilshire 5000 Index.
+This yield includes some payments that represent a return of capital by the
underlying REITs. The amount of the return of capital is determined by each REIT
only after its fiscal year ends.
++Annualized.
VISIT OUR WEBSITE AT VANGUARD.COM
FOR REGULARLY UPDATED FUND INFORMATION.
6
GLOSSARY OF INVESTMENT TERMS
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of a given market index. The index is assigned a
beta of 1.00. Compared with a given index, a fund with a beta of 1.20 typically
would have seen its share price rise or fall by 12% when the index rose or fell
by 10%. A fund's beta should be reviewed in conjunction with its R-squared (see
definition below). The lower the R-squared, the less correlation there is
between the fund and the index, and the less reliable beta is as an indicator of
volatility.
- --------------------------------------------------------------------------------
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
- --------------------------------------------------------------------------------
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
- --------------------------------------------------------------------------------
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or depositary receipts of companies based outside the United States.
- --------------------------------------------------------------------------------
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
- --------------------------------------------------------------------------------
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
- --------------------------------------------------------------------------------
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
- --------------------------------------------------------------------------------
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the market in general, as measured by a given index. If a
fund's total returns were precisely synchronized with an index's returns, its
R-squared would be 1.00. If the fund's returns bore no relationship to the
index's returns, its R-squared would be 0.
- --------------------------------------------------------------------------------
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
- --------------------------------------------------------------------------------
SHORT-TERM RESERVES. The percentage of a fund invested in highly liquid,
short-term securities that can be readily converted to cash.
- --------------------------------------------------------------------------------
TURNOVER RATE. An indication of the fund's trading activity. Funds with high
turnover rates incur higher transaction costs and may be more likely to
distribute capital gains (which may be taxable to investors).
- --------------------------------------------------------------------------------
YIELD. A snapshot of a fund's income from dividends, interest, and
return-of-capital distributions. The index yield is based on the current
annualized rate of dividends and other distributions provided by securities in
the index.
- --------------------------------------------------------------------------------
7
PERFORMANCE SUMMARY As of 1/31/2004
All of the returns in this report represent past performance, which is not a
guarantee of future results that may be achieved by the fund. (For the most
recent performance, which may be higher or lower than that cited, visit our
website at www.vanguard.com.) Note, too, that both investment returns and
principal value can fluctuate widely, so that an investor's shares, when sold,
could be worth more or less than their original cost. The returns shown do not
reflect taxes that a shareholder would pay on fund distributions or on the sale
of fund shares.
REIT INDEX FUND
- --------------------------------------------------------------------------------
CUMULATIVE PERFORMANCE MAY 13, 1996-JANUARY 31, 2004
REIT INDEX MORGAN AVERAGE TARGET
FUND INVESTOR WILSHIRE STANLEY REAL ESTATE REIT
SHARES** 5000 INDEX REIT INDEX FUND+ COMPOSITE
5/13/1996 10000 10000 10000 10000 10000
199607 10270 9512 10244 10074 10276
199610 11186 10484 11179 10932 11201
199701 13033 11644 13077 12618 13066
199704 12637 11609 12664 12184 12664
199707 14067 14002 14107 13968 14081
199710 14825 13796 14922 14683 14842
199801 15258 14590 15266 14981 15217
199804 14873 16630 14831 14916 14797
199807 13720 16388 13669 13685 13644
199810 12964 15836 12900 12620 12913
199901 12617 18569 12524 12554 12546
199904 13544 19478 13435 13514 13442
199907 13174 19395 13041 13288 13057
199910 12224 19902 12092 12101 12131
200001 12485 21212 12360 12270 12391
200004 13583 21778 13457 13216 13472
200007 15298 21497 15180 15058 15166
200010 14418 21514 14293 14427 14301
200101 15747 20475 15644 15670 15630
200104 15957 18708 15861 15630 15846
200107 16902 18271 16823 16616 16791
200110 16256 16020 16187 15727 16172
200201 17573 17337 17535 17007 17492
200204 19157 16859 19156 18596 19078
200207 18898 14239 18837 18333 18767
200210 17355 13872 17270 16801 17237
200301 17784 13543 17715 17252 17674
200304 19210 14569 19188 18632 19114
200307 21801 16065 21837 21242 21699
200310 23059 17262 23131 22452 22959
200401 25856 18697 26001 25095 25749
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED JANUARY 31, 2004
------------------------------------- FINAL VALUE
ONE FIVE SINCE OF A $10,000
YEAR YEARS INCEPTION* INVESTMENT
- --------------------------------------------------------------------------------
REIT Index Fund
Investor Shares** 45.39% 15.43% 13.10% $25,856
Wilshire 5000 Index 38.05 0.14 8.44 18,697
Morgan Stanley REIT Index 46.78 15.73 13.18 26,001
Average Real Estate Fund+ 45.46 14.86 12.66 25,095
- --------------------------------------------------------------------------------
FINAL VALUE
ONE SINCE OF A $250,000
YEAR INCEPTION* INVESTMENT
- --------------------------------------------------------------------------------
REIT Index Fund Admiral Shares** 45.57% 22.12% $389,524
Wilshire 5000 Index 38.05 4.84 277,634
Morgan Stanley REIT Index 46.78 22.58 392,761
- --------------------------------------------------------------------------------
FINAL VALUE OF
SINCE A $10,000,000
INCEPTION* INVESTMENT
- --------------------------------------------------------------------------------
REIT Index Fund
Institutional Shares** 6.49% $10,648,847
Wilshire 5000 Index 5.89 10,589,433
Morgan Stanley REIT Index 6.57 10,657,339
- --------------------------------------------------------------------------------
*Inception dates are May 13, 1996, for the Investor Shares; November 12, 2001,
for the Admiral Shares; and December 2, 2003, for the Institutional Shares.
**Total return figures do not reflect the 1% fee assessed on redemptions of
shares held for less than one year.
+Derived from data provided by Lipper Inc.
Note: See Financial Highlights tables on pages 17-19 for information on
dividends, capital gains, and return of capital.
8
- --------------------------------------------------------------------------------
FISCAL-YEAR TOTAL RETURNS (%) MAY 13, 1996-JANUARY 31, 2004
REIT INDEX MORGAN
FUND INVESTOR STANLEY
SHARES** REIT INDEX
1997 30.3 30.8
1998 17.1 16.7
1999 -17.3 -18.0
2000 -1.0 -1.3
2001 26.1 26.6
2002 11.6 12.1
2003 1.2 1.0
2004 45.4 46.8
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2003
This table presents average annual total returns through the latest calendar
quarter--rather than through the end of the fiscal period. Securities and
Exchange Commission rules require that we provide this information.
SINCE INCEPTION
ONE FIVE ---------------------------
INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------
REIT Index Fund*
Investor Shares 5/13/1996 35.65% 13.90% 6.69% 5.94% 12.63%
Admiral Shares 11/12/2001 35.78 20.68** -- -- --
Institutional Shares 12/2/2003 1.01** -- -- -- --
- --------------------------------------------------------------------------------
*Total return figures do not reflect the 1% fee assessed on redemptions of
shares held for less than one year.
**Return since inception.
9
YOUR FUND'S AFTER-TAX RETURNS
This table presents returns for your fund both before and after taxes. The
after-tax returns are shown in two ways: (1) assuming that an investor owned the
fund during the entire period and paid taxes on the fund's distributions, and
(2) assuming that an investor paid taxes on the fund's distributions and sold
all shares at the end of each period.
Calculations are based on the highest individual federal income tax and capital
gains tax rates in effect at the times of the distributions and the hypothetical
sales. State and local taxes were not considered. After-tax returns reflect the
reduced tax rates on ordinary income (including qualified dividend income) and
short-term capital gains that became effective as of January 1, 2003, and on
long-term capital gains realized on or after May 6, 2003. To calculate qualified
dividend income, we use actual 2003 figures and estimates for 2004. (In the
example, returns after the sale of fund shares may be higher than those assuming
no sale. This occurs when the sale would have produced a capital loss. The
calculation assumes that the investor received a tax deduction for the loss.)
The table shows returns for Investor Shares only; returns for other share
classes will differ. Please note that your actual after-tax returns will depend
on your tax situation and may differ from those shown. Also note that if you own
the fund in a tax-deferred account, such as an individual retirement account or
a 401(k) plan, this information does not apply to you. Such accounts are not
subject to current taxes.
Finally, keep in mind that a fund's performance--whether before or after
taxes--does not guarantee future results.
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2004
SINCE
ONE YEAR FIVE YEARS INCEPTION*
------------------------------------------
REIT Index Fund Investor Shares**
Returns Before Taxes 45.39% 15.43% 13.10%
Returns After Taxes on Distributions 42.95 12.99 10.79
Returns After Taxes on Distributions
and Sale of Fund Shares 29.29 11.78 9.93
- --------------------------------------------------------------------------------
*May 13, 1996.
**Total return figures do not reflect the 1% fee assessed on redemptions of
shares held for less than one year.
10
ABOUT YOUR FUND'S EXPENSES
All mutual funds have operating expenses. These expenses include costs for
portfolio management, administrative services, and shareholder reports (like
this one), among others. Operating expenses, which are deducted from a fund's
gross income, directly reduce the investment return of the fund. A fund's
expenses are expressed as a percentage of its net assets. This figure is known
as the expense ratio.
A HYPOTHETICAL EXAMPLE
We believe it is important for you to understand the impact of costs on your
investment. The following example illustrates the costs that you would incur
over a 12-month period if you invested $10,000 in the fund, using the fund's
actual return and operating expenses for the fiscal year ended January 31, 2004.
The cost in dollars is calculated by applying the expense ratio to the average
balance in the hypothetical account. For comparative purposes, we also list the
average expense ratio for the fund's peer group, which is derived from data
provided by Lipper Inc.
- --------------------------------------------------------------------------------
COST OF $10,000 FUND PEER GROUP*
INVESTMENT IN FUND EXPENSE RATIO EXPENSE RATIO
- --------------------------------------------------------------------------------
REIT INDEX FUND
Investor Shares $29 0.24% 1.66%
Admiral Shares 22 0.18 --
Institutional Shares** 15 0.15 --
- --------------------------------------------------------------------------------
*Average Real Estate Fund.
**Since inception, December 2, 2003; annualized.
The calculation assumes no shares were sold. Your actual costs may have been
higher or lower, depending on the amount of your investment and your holding
period. Peer-group ratio captures data through year-end 2003.
You can find more information about the fund's expenses, including annual
expense ratios for the past five years, in the Financial Statements section of
this report. For additional information on operating expenses and other
shareholder costs, please refer to the appropriate fund prospectus. The
prospectus presents hypothetical shareholder costs over various time periods
based upon a $10,000 investment and a return of 5% a year. This standardized
example, which appears in all mutual fund prospectuses, may be useful to you in
comparing the costs of investing in different funds.
11
FINANCIAL STATEMENTS AS OF 1/31/2004
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Real Estate
Investment Trusts are listed in descending market-value order. Temporary cash
investments and other assets are added to, and liabilities are subtracted from,
the value of Total Real Estate Investment Trusts to calculate the fund's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the fund to
arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying the
composition of the fund's net assets. Because all income and any realized gains
must be distributed to shareholders each year, the bulk of net assets consists
of Paid-in Capital (money invested by shareholders). The amounts shown for
Undistributed Net Investment Income and Accumulated Net Realized Gains usually
approximate the sums the fund had available to distribute to shareholders as
income dividends or capital gains as of the statement date, but may differ
because certain investments or transactions may be treated differently for
financial statement and tax purposes. Any Accumulated Net Realized Losses, and
any cumulative excess of distributions over net income or net realized gains,
will appear as negative balances. Unrealized Appreciation (Depreciation) is the
difference between the market value of the fund's investments and their cost,
and reflects the gains (losses) that would be realized if the fund were to sell
all of its investments at their statement-date values.
- --------------------------------------------------------------------------------
MARKET
VALUE*
REIT INDEX FUND SHARES (000)
- --------------------------------------------------------------------------------
REAL ESTATE INVESTMENT TRUSTS (98.0%)
- --------------------------------------------------------------------------------
Equity Office Properties Trust REIT 7,798,775 $ 231,234
Simon Property Group, Inc. REIT 3,877,891 201,844
Equity Residential REIT 5,373,787 156,377
General Growth Properties Inc. REIT 4,191,450 125,744
Vornado Realty Trust REIT 2,246,210 125,675
Public Storage, Inc. REIT 2,474,031 117,541
ProLogis REIT 3,510,029 114,567
Archstone-Smith Trust REIT 3,730,650 102,332
Kimco Realty Corp. REIT 2,154,056 99,367
Boston Properties, Inc. REIT 1,910,345 95,575
Duke Realty Corp. REIT 2,651,596 87,158
Rouse Co. REIT 1,766,617 86,988
* Host Marriott Corp. REIT 6,227,418 78,901
Health Care Properties Investors REIT 1,263,492 71,046
Avalonbay Communities, Inc. REIT 1,388,585 68,180
Apartment Investment & Management Co.
Class A REIT 1,837,937 64,659
Liberty Property Trust REIT 1,615,333 62,320
Developers Diversified Realty
Corp. REIT 1,685,297 57,941
AMB Property Corp. REIT 1,594,801 55,738
The Macerich Co. REIT 1,126,186 54,203
Hospitality Properties Trust REIT 1,221,009 51,099
Weingarten Realty Investors REIT 1,063,132 50,499
Regency Centers Corp. REIT 1,165,333 48,594
New Plan Excel Realty Trust REIT 1,906,348 48,059
Chelsea Property Group REIT 847,919 47,076
Trizec Properties, Inc. REIT 2,944,604 46,790
Mack-Cali Realty Corp. REIT 1,136,661 46,114
United Dominion Realty Trust REIT 2,475,212 45,791
Mills Corp. REIT 939,589 44,198
Pan Pacific Retail Properties, Inc. REIT 786,021 40,174
Federal Realty Investment Trust REIT 959,522 39,619
Ventas, Inc. REIT 1,562,829 39,071
Arden Realty Group, Inc. REIT 1,253,252 38,851
Catellus Development Corp. REIT 1,472,200 38,513
American Financial Realty Trust REIT 2,105,300 38,148
Health Care Inc. REIT 960,569 37,174
12
- --------------------------------------------------------------------------------
MARKET
VALUE*
REIT INDEX FUND SHARES (000)
- --------------------------------------------------------------------------------
CenterPoint Properties Corp. REIT 448,453 $ 35,921
CBL & Associates Properties, Inc. REIT 590,240 35,680
HRPT Properties Trust REIT 3,360,784 35,624
Crescent Real Estate, Inc. REIT 1,936,211 34,852
Healthcare Realty Trust Inc. REIT 835,165 34,284
Shurgard Storage Centers, Inc.
Class A REIT 890,374 33,843
Camden Property Trust REIT 772,848 33,619
CarrAmerica Realty Corp. REIT 1,024,710 32,555
BRE Properties Inc. Class A REIT 974,764 32,226
SL Green Realty Corp. REIT 735,324 31,597
Realty Income Corp. REIT 739,600 30,538
Reckson Associates Realty Corp. REIT 1,167,768 29,836
Cousins Properties, Inc. REIT 947,828 29,098
Highwood Properties, Inc. REIT 1,036,469 28,296
First Industrial Realty Trust REIT 771,629 28,226
Nationwide Health Properties, Inc. REIT 1,273,850 27,770
Essex Property Trust, Inc. REIT 444,650 27,635
Prentiss Properties Trust REIT 821,329 27,515
Heritage Property Investment Trust REIT 901,452 26,277
Pennsylvania REIT 690,084 25,782
Equity One, Inc. REIT 1,334,565 24,289
Home Properties, Inc. REIT 601,330 24,083
Brandywine Realty Trust REIT 860,367 23,798
Washington REIT 810,841 23,758
Alexandria Real Estate
Equities, Inc. REIT 373,821 23,121
Taubman Co. REIT 974,109 22,629
Capital Automotive REIT 635,952 22,443
Senior Housing Properties Trust REIT 1,237,906 22,381
Post Properties, Inc. REIT 741,401 20,722
Colonial Properties Trust REIT 511,048 20,544
Gables Residential Trust REIT 555,836 20,066
Maguire Properties, Inc. REIT 821,400 19,960
PS Business Parks, Inc. REIT 420,792 18,220
Kilroy Realty Corp. REIT 547,249 17,922
Commercial Net LeaseRealty REIT 965,947 17,677
Glimcher Realty Trust REIT 683,014 17,205
Lexington Corporate Properties Trust REIT 791,098 16,692
Manufactured Home Communities, Inc. REIT 438,507 14,734
Sun Communities, Inc. REIT 369,052 14,526
EastGroup Properties, Inc. REIT 406,739 14,134
Summit Properties, Inc. REIT 610,948 14,101
Entertainment Properties Trust REIT 383,441 13,574
* FelCor Lodging Trust, Inc. REIT 1,152,687 13,544
Mid-America Apartment
Communities, Inc. REIT 388,099 13,393
Getty Realty Holding Corp. REIT 480,980 12,833
Corporate Office Properties
Trust, Inc. REIT 576,514 12,747
Keystone Property Trust REIT 513,600 12,106
Koger Equity, Inc. REIT 507,234 11,732
Tanger Factory Outlet
Centers, Inc. REIT 259,652 10,879
Glenborough Realty Trust, Inc. REIT 541,821 10,517
Cornerstone Realty Income
Trust, Inc. REIT 1,122,132 10,413
Sovran Self Storage, Inc. REIT 269,980 10,070
Parkway Properties Inc. REIT 210,549 9,896
AMLI Residential Properties Trust REIT 371,330 9,766
Bedford Property Investors, Inc. REIT 316,635 9,325
LaSalle Hotel Properties REIT 468,024 9,243
Ramco-Gershenson Properties Trust REIT 320,820 8,797
Kramont Realty Trust REIT 468,174 8,708
Saul Centers, Inc. REIT 309,068 8,506
Investors Real Estate Trust REIT 792,546 8,282
Equity Inns, Inc. REIT 830,275 7,846
U.S. Restaurant Properties, Inc. REIT 438,731 7,845
Town & Country Trust REIT 307,227 7,834
Acadia Realty Trust REIT 532,327 7,133
Innkeepers USA Trust REIT 731,804 6,981
Universal Health Realty Income REIT 228,323 6,952
Correctional Properties Trust REIT 213,753 6,876
Omega Healthcare Investors, Inc. REIT 655,550 6,811
Winston Hotels, Inc. REIT 510,618 5,362
Urstadt Biddle Properties Class A REIT 361,722 5,354
Great Lakes, Inc. REIT 313,193 4,764
Mission West Properties Inc. REIT 346,382 4,493
One Liberty Properties, Inc. REIT 150,800 3,385
Boykin Lodging Co. REIT 337,946 3,200
Associated Estates Realty Corp. REIT 379,180 2,965
13
- --------------------------------------------------------------------------------
MARKET
VALUE*
REIT INDEX FUND SHARES (000)
- --------------------------------------------------------------------------------
Sizeler Property Investors, Inc. REIT 255,375 $ 2,855
American Land Lease, Inc. REIT 138,358 2,793
United Mobile Homes, Inc. REIT 155,925 2,702
Monmouth Real Estate Investment Corp. REIT 277,002 2,465
- --------------------------------------------------------------------------------
TOTAL REAL ESTATE INVESTMENT TRUSTS (Cost $3,183,772) $ 4,094,286
- --------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (4.5%)
- --------------------------------------------------------------------------------
Repurchase Agreements
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
1.02%, 2/2/2004 $ 94,445 94,445
1.02%, 2/2/2004--Note E 94,753 94,753
- --------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS (Cost $189,198) $ 189,198
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (102.5%) (Cost $3,372,970) $ 4,283,484
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-2.5%)
- --------------------------------------------------------------------------------
Other Assets--Note B 19,584
Security Lending Collateral Payable to
Brokers--Note E (94,753)
Other Liabilities (30,365)
-------------
$ (105,534)
-------------
- --------------------------------------------------------------------------------
NET ASSETS (100%) $ 4,177,950
================================================================================
*See Note A in Notes to Financial Statements.
*Non-income-producing security.
- --------------------------------------------------------------------------------
AMOUNT
(000)
- --------------------------------------------------------------------------------
AT JANUARY 31, 2004, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
Paid-in Capital $ 3,280,724
Overdistributed Net Investment Income (2,967)
Accumulated Net Realized Losses (10,321)
Unrealized Appreciation 910,514
- --------------------------------------------------------------------------------
NET ASSETS $ 4,177,950
================================================================================
Investor Shares--Net Assets
Applicable to 213,661,721 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $ 3,382,672
- --------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE-- INVESTOR SHARES $ 15.83
================================================================================
Admiral Shares--Net Assets
Applicable to 10,844,779 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $ 732,640
- --------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE-- ADMIRAL SHARES $ 67.56
================================================================================
Institutional Shares--Net Assets
Applicable to 5,989,978 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $ 62,638
- --------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE-- INSTITUTIONAL SHARES $ 10.46
================================================================================
See Note C in Notes to Financial Statements for the tax-basis components of net
assets.
14
STATEMENT OF OPERATIONS
This Statement shows the types of income earned by the fund during the reporting
period, and details the operating expenses charged to each class of its shares.
These expenses directly reduce the amount of investment income available to pay
to shareholders as income dividends. This Statement also shows any Net Gain
(Loss) realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) of investments during the period.
- --------------------------------------------------------------------------------
REIT INDEX FUND
YEAR ENDED JANUARY 31, 2004
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends $ 126,649
Interest 699
Security Lending 83
- --------------------------------------------------------------------------------
Total Income $ 127,431
- --------------------------------------------------------------------------------
Expenses
The Vanguard Group--Note B
Investment Advisory Services 114
Management and Administrative
Investor Shares 5,118
Admiral Shares 809
Institutional Shares 10
Marketing and Distribution
Investor Shares 321
Admiral Shares 70
Institutional Shares --
Custodian Fees 104
Auditing Fees 15
Shareholders' Reports
Investor Shares 84
Admiral Shares 1
Institutional Shares --
Trustees' Fees and Expenses 3
- --------------------------------------------------------------------------------
Total Expenses $ 6,649
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME $ 120,782
- --------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Capital Gain Distributions Received $ 29,814
Investment Securities Sold (4,064)
- --------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS) 25,750
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
OF INVESTMENT SECURITIES $ 947,256
- --------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $ 1,093,788
================================================================================
15
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the net amount shareholders invested in
or redeemed from the fund. Distributions and Capital Share Transactions are
shown separately for each class of shares.
- --------------------------------------------------------------------------------
REIT INDEX FUND
---------------------------------
YEAR ENDED JANUARY 31,
---------------------------------
2004 2003
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 120,782 $ 93,873
Realized Net Gain (Loss) 25,750 12,286
Change in Unrealized Appreciation (Depreciation) 947,256 (129,618)
- --------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets
Resulting from Operations 1,093,788 (23,459)
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Net Investment Income
Investor Shares (120,313) (91,711)
Admiral Shares (26,996) (15,239)
Institutional Shares (406) --
Realized Capital Gain
Investor Shares -- --
Admiral Shares -- --
Institutional Shares -- --
Return of Capital
Investor Shares (18,118) (12,784)
Admiral Shares (4,012) (2,101)
Institutional Shares (60) --
- --------------------------------------------------------------------------------
Total Distributions (169,905) (121,835)
- --------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS--NOTE F
Investor Shares 891,693 587,012
Admiral Shares 248,406 176,675
Institutional Shares 59,922 --
- --------------------------------------------------------------------------------
Net Increase (Decrease) from Capital
Share Transactions 1,200,021 763,687
- --------------------------------------------------------------------------------
Total Increase (Decrease) 2,123,904 618,393
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 2,054,046 1,435,653
- --------------------------------------------------------------------------------
End of Period $4,177,950 $2,054,046
================================================================================
16
financial highlights
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis for each class of shares. It also presents the
Total Return and shows net investment income and expenses as percentages of
average net assets. These data will help you assess: the variability of the
fund's net income and total returns from year to year; the relative
contributions of net income and capital gains to the fund's total return; how
much it costs to operate the fund; and the extent to which the fund tends to
distribute capital gains. The table also shows the Portfolio Turnover Rate, a
measure of trading activity. A turnover rate of 100% means that the average
security is held in the fund for one year.
REIT INDEX FUND INVESTOR SHARES
- ----------------------------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
------------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $11.52 $12.10 $11.61 $ 9.91 $10.81
- ----------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .579 .606 .631 .642 .660
Net Realized and Unrealized Gain (Loss)
on Investments* 4.511 (.426) .669 1.878 (.780)
- ----------------------------------------------------------------------------------------------------------------
Total from Investment Operations 5.090 .180 1.300 2.520 (.120)
- ----------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.678) (.667) (.631) (.644) (.670)
Distributions from Realized Capital Gains -- -- -- -- --
Return of Capital (.102) (.093) (.179) (.176) (.110)
- ----------------------------------------------------------------------------------------------------------------
Total Distributions (.780) (.760) (.810) (.820) (.780)
- ----------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $15.83 $11.52 $12.10 $11.61 $ 9.91
================================================================================================================
TOTAL RETURN** 45.39% 1.20% 11.59% 26.13% -1.04%
================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Ratios/Supplemental Data
Net Assets, End of Period (Millions) $3,383 $1,734 $1,270 $1,092 $888
Ratio of Total Expenses to Average Net Assets 0.24% 0.27% 0.28% 0.33% 0.33%
Ratio of Net Investment Income to Average Net Assets 4.10% 4.90% 5.35% 5.73% 5.98%
Portfolio Turnover Rate 7% 12% 10% 21%+ 12%
================================================================================================================
*Includes increases from redemption fees of $.00, $.01, $.00, $.00, and, $.01.
**Total returns do not reflect the 1% fee assessed on redemptions of shares held
for less than one year.
+The portfolio turnover rate excluding in-kind redemptions was 14%.
17
FINANCIAL HIGHLIGHTS (CONTINUED)
REIT INDEX FUND ADMIRAL SHARES
- --------------------------------------------------------------------------------
NOV. 12,
YEAR ENDED 2001* TO
JANUARY 31, JAN. 31,
--------------- -----------
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2004 2003 2002
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $49.14 $51.65 $50.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income 2.508 2.619 .494
Net Realized and Unrealized Gain (Loss)
on Investments** 19.279 (1.854) 2.401
- --------------------------------------------------------------------------------
Total from Investment Operations 21.787 .765 2.895
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (2.931) (2.878) (.970)
Distributions from Realized Capital Gains -- -- --
Return of Capital (.436) (.397) (.275)
- --------------------------------------------------------------------------------
Total Distributions (3.367) (3.275) (1.245)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $67.56 $49.14 $51.65
================================================================================
TOTAL RETURN+ 45.57% 1.19% 5.78%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $733 $320 $166
Ratio of Total Expenses to Average Net Assets 0.18% 0.21% 0.23%++
Ratio of Net Investment Income to
Average Net Assets 4.16% 4.99% 5.27%++
Portfolio Turnover Rate 7% 12% 10%
================================================================================
*Inception.
**Includes increases from redemption fees of $.01, $.03, and $.01.
+Total returns do not reflect the 1% fee assessed on redemptions of shares held
for less than one year.
++Annualized.
18
REIT INDEX FUND INSTITUTIONAL SHARES
- --------------------------------------------------------------------------------
DEC. 2,
2003* TO
JAN. 31,
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD 2004
- --------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $10.00
- --------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .065
Net Realized and Unrealized Gain (Loss) on Investments .575
- --------------------------------------------------------------------------------
Total from Investment Operations .640
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.157)
Distributions from Realized Capital Gains --
Return of Capital (.023)
- --------------------------------------------------------------------------------
Total Distributions (.180)
- --------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $10.46
================================================================================
TOTAL RETURN** 6.49%
================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $63
Ratio of Total Expenses to Average Net Assets 0.15%+
Ratio of Net Investment Income to Average Net Assets 4.19%+
Portfolio Turnover Rate 7%
================================================================================
*Inception.
**Total returns do not reflect the 1% fee assessed on redemptions of shares held
for less than one year.
+Annualized.
SEE ACCOMPANYING NOTES, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
19
NOTES TO FINANCIAL STATEMENTS
Vanguard REIT Index Fund is registered under the Investment Company Act of 1940
as an open-end investment company, or mutual fund. The fund offers three classes
of shares: Investor Shares, Admiral Shares, and Institutional Shares. Investor
Shares are available to any investor who meets the fund's minimum purchase
requirements. Admiral Shares are designed for investors who meet certain
administrative, servicing, tenure, and account-size criteria. Institutional
Shares were first issued on December 2, 2003, and are designed for investors who
meet certain administrative and servicing criteria and invest a minimum of $10
million. A. The following significant accounting policies conform to generally
accepted accounting principles for U.S. mutual funds. The fund consistently
follows such policies in preparing its financial statements.
1. SECURITY VALUATION: Securities are valued as of the close of trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation
date. Equity securities are valued at the latest quoted sales prices or official
closing prices taken from the primary market in which each security trades; such
securities not traded on the valuation date are valued at the mean of the latest
quoted bid and asked prices. Securities for which market quotations are not
readily available, or whose values have been materially affected by events
occurring before the fund's pricing time but after the close of the securities'
primary markets, are valued by methods deemed by the board of trustees to
represent fair value. Temporary cash investments acquired over 60 days to
maturity are valued using the latest bid prices or using valuations based on a
matrix system (which considers such factors as security prices, yields,
maturities, and ratings), both as furnished by independent pricing services.
Other temporary cash investments are valued at amortized cost, which
approximates market value.
2. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances into a pooled cash account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
3. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold. Fees assessed on redemptions of
capital shares are credited to paid-in capital.
Each class of shares has equal rights as to assets and earnings, except that
each class separately bears certain class-specific expenses related to
maintenance of shareholder accounts (included in Management and Administrative
expenses) and shareholder reporting. Marketing and distribution expenses are
allocated to each class of shares based on a method approved by the board of
trustees. Income, other non-class-specific expenses, and gains and losses on
investments are allocated to each class of shares based on its relative net
assets.
20
B. The Vanguard Group furnishes at cost investment advisory, corporate
management, administrative, marketing, and distribution services. The costs of
such services are allocated to the fund under methods approved by the board of
trustees. The fund has committed to provide up to 0.40% of its net assets in
capital contributions to Vanguard. At January 31, 2004, the fund had contributed
capital of $584,000 to Vanguard (included in Other Assets), representing 0.01%
of the fund's net assets and 0.58% of Vanguard's capitalization. The fund's
trustees and officers are also directors and officers of Vanguard.
C. Distributions are determined on a tax basis and may differ from net
investment income and realized capital gains for financial reporting purposes.
Differences may be permanent or temporary. Permanent differences are
reclassified among capital accounts in the financial statements to reflect their
tax character. Temporary differences arise when certain items of income,
expense, gain, or loss are recognized in different periods for financial
statement and tax purposes; these differences will reverse at some time in the
future. Differences in classification may also result from the treatment of
short-term gains as ordinary income for tax purposes.
The fund has reclassified $25,750,000 from paid-in capital to undistributed net
investment income, representing utilized capital loss carryforwards that are
required to be included in distributable net income for tax purposes. For tax
purposes, at January 31, 2004, the fund had no ordinary income available for
distribution. The fund had available realized losses of $10,321,000 to offset
future net capital gains of $5,986,000 through January 31, 2008, and $4,335,000
through January 31, 2010.
At January 31, 2004, net unrealized appreciation of investment securities for
tax purposes was $910,514,000, consisting of unrealized gains of $943,493,000 on
securities that had risen in value since their purchase and $32,979,000 in
unrealized losses on securities that had fallen in value since their purchase.
D. During the year ended January 31, 2004, the fund purchased $1,361,230,000 of
investment securities and sold $197,580,000 of investment securities other than
temporary cash investments.
E. The market value of securities on loan to broker/dealers at January 31, 2004,
was $92,583,000, for which the fund held cash collateral of $94,753,000. The
fund invests cash collateral received in repurchase agreements, and records a
liability for the return of the collateral, during the period the securities are
on loan.
21
F. Capital share transactions for each class of shares were:
- -------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
-------------------------------------------
2004 2003
--------------------- -------------------
AMOUNT SHARES AMOUNT SHARES
(000) (000) (000) (000)
- -------------------------------------------------------------------------------------------
Investor Shares
Issued $1,253,610 89,871 $ 942,074 74,970
Issued in Lieu of Cash Distributions 122,986 8,894 92,075 7,490
Redeemed* (484,903) (35,699) (447,137) (36,787)
---------------------------------------------
Net Increase (Decrease)--Investor Shares 891,693 63,066 587,012 45,673
---------------------------------------------
Admiral Shares
Issued 375,481 6,421 219,353 4,113
Issued in Lieu of Cash Distributions 23,399 395 12,965 248
Redeemed* (150,474) (2,482) (55,643) (1,057)
---------------------------------------------
Net Increase (Decrease)--Admiral Shares 248,406 4,334 176,675 3,304
---------------------------------------------
Institutional Shares
Issued 59,643 5,962 -- --
Issued in Lieu of Cash Distributions 279 28 -- --
Redeemed -- -- -- --
--------------------------------------------
Net Increase (Decrease)--
Institutional Shares 59,922 5,990 -- --
- -------------------------------------------------------------------------------------------
*Net of redemption fees of $864,000 and $1,395,000, respectively (fund totals).
22
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Trustees of Vanguard REIT Index Fund:
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard REIT Index Fund (the "Fund") at January 31, 2004, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended and the financial highlights for each of
the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the Fund's management; our responsibility
is to express an opinion on these financial statements based on our audits. We
conducted our audits of these financial statements in accordance with auditing
standards generally accepted in the United States of America, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits, which included confirmation
of securities at January 31, 2004 by correspondence with the custodian, provide
a reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
PHILADELPHIA, PENNSYLVANIA
MARCH 8, 2004
23
THE PEOPLE WHO GOVERN YOUR FUND
The trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are a part owner of
the fund. Your fund trustees also serve on the board of directors of The
Vanguard Group, Inc., which is owned by the Vanguard(R) funds and provides
services to them on an at-cost basis.
A majority of Vanguard's board members are independent, meaning that they have
no affiliation with Vanguard or the funds they oversee, apart from the sizable
personal investments they have made as private individuals.
Our independent board members bring distinguished backgrounds in business,
academia, and public service to their task of working with Vanguard officers to
establish the policies and oversee the activities of
- ------------------------------------------------------------------------------------------------------------
POSITION(S) HELD WITH
NAME FUND (NUMBER OF
(YEAR OF BIRTH) VANGUARD FUNDS
TRUSTEE/OFFICER OVERSEEN BY
SINCE TRUSTEE/OFFICER) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
- ------------------------------------------------------------------------------------------------------------
JOHN J. BRENNAN* Chairman of the Chairman of the Board, Chief Executive Officer, and Director/Trustee
(1954) Board, Chief of The Vanguard Group, Inc., and of each of the investment companies
May 1987 Executive Officer, served by The Vanguard Group.
and Trustee
(118)
- ------------------------------------------------------------------------------------------------------------
INDEPENDENT TRUSTEES
CHARLES D. ELLIS Trustee The Partners of '63 (pro bono ventures in education); Senior Advisor
(1937) (118) to Greenwich Associates (international business strategy consulting);
January 2001 Successor Trustee of Yale University; Overseer of the Stern School of
Business at New York University; Trustee of the Whitehead Institute
for Biomedical Research.
- ------------------------------------------------------------------------------------------------------------
RAJIV L. GUPTA Trustee Chairman and Chief Executive Officer (since October 1999), Vice
(1945) (118) Chairman (January-September 1999), and Vice President (prior to
December 2001 September 1999) of Rohm and Haas Co. (chemicals); Director of
Technitrol, Inc. (electronic components), and Agere Systems
(communications components); Board Member of the American Chemistry
Council; and Trustee of Drexel University.
- ------------------------------------------------------------------------------------------------------------
JOANN HEFFERNAN Trustee Vice President, Chief Information Officer, and Member of the
HEISEN (118) Executive Committee of Johnson & Johnson (pharmaceuticals/consumer
(1950) products); Director of the Medical Center at Princeton and Women's
July 1998 Research and Education Institute.
- ------------------------------------------------------------------------------------------------------------
BURTON G. MALKIEL TRUSTEE Chemical Bank Chairman's Professor of Economics,Princeton University;
(1932) (116) Director of Vanguard Investment Series plc (Irish invest-ment fund)
May 1977 (since November 2001), Vanguard Group (Ireland)Limited (Irish
investment management firm)(since November 2001),Prudential Insurance
Co. of America, BKF Capital (investment management), The Jeffrey Co.
(holding company), and NeuVis, Inc.(software company).
- ------------------------------------------------------------------------------------------------------------
the funds. Among board members' responsibilities are selecting investment
advisors for the funds; monitoring fund operations, performance, and costs;
reviewing contracts; nominating and selecting new trustees/directors; and
electing Vanguard officers.
Each trustee serves a fund until its termination; or until the trustee's
retirement, resignation, or death; or otherwise as specified in the fund's
organizational documents. Any trustee may be removed at a shareholders' meeting
by a vote representing two-thirds of the net asset value of all shares of the
fund together with shares of other Vanguard funds organized within the same
trust. The table on these two pages shows information for each trustee and
executive officer of the fund. The mailing address of the trustees and officers
is P.O. Box 876, Valley Forge, PA 19482.
POSITION(S) HELD WITH
NAME FUND (NUMBER OF
(YEAR OF BIRTH) VANGUARD FUNDS
TRUSTEE/OFFICER OVERSEEN BY
SINCE TRUSTEE/OFFICER) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
- ------------------------------------------------------------------------------------------------------------
Alfred M. Rankin, Jr. Trustee Chairman, President, Chief Executive Officer, and Director of NACCO
(1941) (118) Industries, Inc. (forklift trucks/housewares/lignite); Director of
January 1993 Goodrich Corporation (industrial products/aircraft systems and
services); Director of Standard Products Company (supplier for
the automotive industry) until 1998.
- ------------------------------------------------------------------------------------------------------------
J. Lawrence Wilson Trustee Retired Chairman and Chief Executive Officer of Rohm and Haas Co.
(1936) (118) (chemicals); Director of Cummins Inc. (diesel engines), The Mead
April 1985 Corp. (paper products), and AmerisourceBergen Corp. (pharmaceuti-cal
distribution); Trustee of Vanderbilt University.
- ------------------------------------------------------------------------------------------------------------
EXECUTIVE OFFICERS*
R. Gregory Barton Secretary Managing Director and General Counsel of The Vanguard Group, Inc.;
(1951) (118) Secretary of The Vanguard Group and of each of the investment
June 2001 companies served by The Vanguard Group.
- ------------------------------------------------------------------------------------------------------------
Thomas J. Higgins Treasurer Principal of The Vanguard Group, Inc.; Treasurer of each of the
(1957) (118) investment companies served by The Vanguard Group.
July 1998
- ------------------------------------------------------------------------------------------------------------
*Officers of the funds are "interested persons" as defined in the Investment
Company Act of 1940.
More information about the trustees is in the Statement of Additional
Information, available from The Vanguard Group.
- ------------------------------------------------------------------------------------------------------------
VANGUARD SENIOR MANAGEMENT TEAM
MORTIMER J. BUCKLEY, Information Technology. MICHAEL S. MILLER, Planning and Development.
JAMES H. GATELY, Investment Programs and Services. RALPH K. PACKARD, Finance.
KATHLEEN C. GUBANICH, Human Resources. GEORGE U. SAUTER, Chief Investment Officer.
F. WILLIAM MCNABB, III, Client Relationship Group.
- ------------------------------------------------------------------------------------------------------------
JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996.
- ------------------------------------------------------------------------------------------------------------
[VANGUARD SHIP LOGO]
THE VANGUARD GROUP(R)
POST OFFICE BOX 2600
VALLEY FORGE, PA 19482-2600
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All other marks are the exclusive property of their respective owners.
ABOUT OUR COVER
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Michael Kahn.
FOR MORE INFORMATION
This report is intended for the fund's shareholders. It may not be distributed
to prospective investors unless it is preceded or accompanied by the appropriate
fund prospectus.
To receive a free copy of the prospectus or the Statement of Additional
Information, or to request additional information about the fund or other
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All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc.,
unless otherwise noted.
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(C) 2004 THE VANGUARD GROUP, INC.
ALL RIGHTS RESERVED.
VANGUARD MARKETING
CORPORATION, DISTRIBUTOR.
Q1230 032004
VANGUARD(R) DIVIDEND GROWTH FUND
JANUARY 31, 2004
ANNUAL REPORT
THE VANGUARD GROUP (R) LOGO
HOW TO READ YOUR FUND REPORT
This report contains information that can help you evaluate your investment. It
includes details about your fund's return and presents data and analysis that
provide insight into the fund's performance and investment approach.
By reading the letter from Vanguard's chairman, John J. Brennan, together with
the letter from the managers who select securities for your fund, you'll get an
understanding of how the fund invests and how the market environment affected
its performance. The statistical information that follows can help you
understand how the fund's performance and characteristics stack up against those
of similar funds and market benchmarks.
It's important to keep in mind that the opinions expressed by Vanguard's
investment managers are just that: informed opinions. They should not be
considered promises or advice. The opinions, like the statistics, cover the
period through the date on the cover of this report. As things change--and in
the financial markets you can be certain only of change--an investment manager's
job is to evaluate new information and make adjustments, if necessary. Of
course, the risks of investing in the fund are spelled out in the prospectus.
Frequent updates on the fund's performance and information about some of its
holdings are available on Vanguard.com(R).
- --------------------------------------------------------------------------------
CONTENTS
1 letter from the chairman
6 report from the advisor
8 fund profile
9 glossary of investment terms
10 performance summary
12 your fund's after-tax returns
13 about your fund's expenses
14 financial statements
22 advantages of vanguard.com
- --------------------------------------------------------------------------------
SUMMARY
- - Vanguard Dividend Growth Fund returned 36.1% during the fiscal year ended
January 31, 2004.
- - The fund's return outpaced those of its average mutual fund peer and its
benchmark index.
- - The fund's holdings in financial services earned excellent returns and
contributed the most to the overall return. Several other sectors also
posted outstanding results.
- --------------------------------------------------------------------------------
Want less clutter in your mailbox? Just register with VANGUARD.COM and opt to
get fund reports online.
LETTER FROM THE CHAIRMAN
FELLOW SHAREHOLDER,
For its fiscal year ended January 31, 2004, Vanguard Dividend Growth Fund
registered an excellent total return of 36.1%. The fund outperformed its average
mutual fund peer by 5.1 percentage points, and surpassed its unmanaged
benchmark, the Russell 1000 Index, by 0.5 percentage point, in large part
because of solid stock selection among financial services companies.
[PICTURES OF JOHN J. BRENNAN]
- ----------------------------------------------
2004 TOTAL RETURNS FISCAL YEAR ENDED
JANUARY 31
- ----------------------------------------------
VANGUARD DIVIDEND GROWTH FUND 36.1%
Russell 1000 Index 35.6
Average Large-Cap Core Fund* 31.0
Wilshire 5000 Index 38.1
- ----------------------------------------------
*Derived from data provided by Lipper Inc.
The table at left presents the total return (capital change plus reinvested
dividends) for the fund as well as for its comparative standards. For beginning
and ending share prices, along with the fund's per-share distributions, please
see the table on page 5. If you own the fund in a taxable account, you may wish
to review the report on after-tax returns on page 12.
STOCKS GENERATED OUTSTANDING RETURNS
For the 12 months ended January 31, the broad U.S. stock market, as represented
by the Wilshire 5000 Total Market Index, returned a remarkable 38.1%.
At the start of the period, investors were apprehensive. War with Iraq was
imminent, and the labor market and manufacturing industries were stagnating,
despite the broad economy's slow-but-steady expansion. Within weeks, however,
the United States and its allies had begun and successfully completed major
combat operations in Iraq. And in the succeeding months, the economic picture
also brightened: The unemployment rate declined, and manufacturing began to
stir. In the
1
quarter ended September 30, the U.S. economy grew at an annualized rate of 8.2%;
estimates put fourth-quarter gross domestic product growth at about 4.0%.
With each piece of good news, the market's mood inched from cautious toward
cavalier. For the full 12 months, small-capitalization stocks outperformed
large-cap stocks by more than 20 percentage points.
RISK WAS REWARDED IN THE BOND MARKET
The same behavior was apparent in the fixed income market. Demand for
default-risk-free U.S. Treasuries was initially extreme, boosting the price of
the 10-year Treasury note while reducing its yield to just above 3% in June. By
year-end, however, the mood had changed. The Lehman Brothers High Yield Bond
Index, a benchmark of below-investment-grade bonds, recorded a 12-month return
of 27.2%, while investment-grade bonds, as measured by the Lehman Aggregate Bond
Index, returned 4.9%.
- --------------------------------------------------------------------------------
MARKET BAROMETER AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED JANUARY 31, 2004
-------------------------------
ONE THREE FIVE
YEAR YEARS YEARS
- --------------------------------------------------------------------------------
STOCKS
Russell 1000 Index (Large-caps) 35.6% -4.2% -0.5%
Russell 2000 Index (Small-caps) 58.0 6.0 7.8
Wilshire 5000 Index (Entire market) 38.1 -3.0 0.1
MSCI All Country World Index
ex USA (International) 48.9 -0.9 1.9
- --------------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 4.9% 7.3% 6.6%
(Broad taxable market)
Lehman Municipal Bond Index 6.2 6.5 5.7
Citigroup 3-Month Treasury Bill Index 1.0 2.1 3.4
================================================================================
CPI
Consumer Price Index 1.9% 1.9% 2.4%
- --------------------------------------------------------------------------------
Short-term interest rates were the fixed income market's one constant, remaining
low--and lower--throughout the period. The yield of the 3-month Treasury bill, a
proxy for money market rates, ended the fiscal year at 0.91%, 26 basis points
lower than at the start of the period.
THE RENEWED INTEREST IN DIVIDENDS WAS A BOON TO YOUR FUND
On January 31, the fund completed its first fiscal year of operation under the
revised investment objective and strategy adopted in December 2002. Formerly
devoted to utilities, the fund now focuses on companies with stable to growing
dividends in all sectors. The new mandate has greatly expanded the fund's
investment universe.
2
- --------------------------------------------------------------------------------
Dividend Growth Fund's excellent 36.1% total return was the result of generous
gains in all sectors of the stock market. Financial services and producer
durables stocks were among its top performers. Stock selections in health care
and technology also provided solid returns.
- --------------------------------------------------------------------------------
While the fund's absolute performance was primarily a reflection of investors'
voracious appetite for stocks in recent months, the fund's advisor, Wellington
Management Company, llp, helped the cause with superior stock selection. The
fund earned strong returns from stocks of companies that boosted their dividends
after passage of a new federal law that afforded qualified dividends the same
favorable tax treatment as capital gains. This change increased the appeal of
dividend-paying stocks to many investors, a fact recognized by corporate
managers. Well over half of the fund's holdings announced higher per-share
dividends during the period. Some, in fact, raised their dividends more than
once.
The fund earned gains in all sectors of the stock market. Among the top
performers were holdings in the financial services and producer durables
sectors. These two groups accounted for roughly 31% of fund assets as of January
31, 2004, yet contributed nearly 40% to total return. Leaders among the fund's
financial services holdings were Citigroup (whose dividend more than doubled in
three separate actions), ACE (dividend up 12%), and Merrill Lynch (dividend
unchanged). Among producer durables holdings, Caterpillar (dividend up 6%),
Dover (dividend up 11%), and Cooper Industries (dividend unchanged) were the
biggest contributors.
The advisor's stock selections in health care and technology also brought solid
returns. In the health care sector, medical device makers and pharmaceutical
companies were especially successful, as a number saw higher earnings during the
period and raised their dividend payouts. In the technology group, the fund's
hardware and chip makers saw stellar growth as the sector thundered back after
several years of losses.
Utilities stocks were the fund's poorest performers. Several dividend-rich
telecommunications holdings, including Verizon Communications and AT&T, had poor
earnings, which hurt their share prices.
The Report from the Advisor, which begins on page 6, provides more details about
the fund's positioning and performance during the fiscal year.
3
THE FUND'S LONG-TERM RECORD: NO MIRROR IN THIS CASE
Wellington Management Company, your fund's advisor, has skillfully carried out
its charge to turn the former Utilities Income Fund into the broadly diversified
Dividend Growth Fund. We thank Wellington for its efforts and applaud the first
year's results.
- ---------------------------------------------------------
TOTAL RETURNS TEN YEARS ENDED
JANUARY 31, 2004
- ---------------------------------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RETURN INITIAL INVESTMENT
- ---------------------------------------------------------
Dividend Growth Fund 6.3% $18,353
Dividend Growth
Spliced Index 6.1 18,140
Dividend Growth
Spliced Average 5.3 16,690
Wilshire 5000 Index 10.5 27,107
- ---------------------------------------------------------
Note: The footnotes on page 10 describe the changes
in composition of the benchmark and peer group.
We normally encourage investors to judge a mutual fund on the basis of long-term
performance, rather than just one year's results. Because of your fund's
dramatic shift in focus, however, its long-term record has only limited
relevance. Still, in the adjacent table we compare the fund's ten-year results
with those of two standards made up of its former and present benchmarks. For
perspective, we also show the performance of the broad stock market. The table
shows annualized returns for the decade along with the outcome of hypothetical
$10,000 investments.
A key element of your fund's long-term success, both in the past as a utilities
fund and--we anticipate--in the future, is its significant cost advantage over
similar mutual funds. For a comparison of the fund's cost with the average cost
of its competitors, see page 13.
ALWAYS HAVE PATIENCE AND A PLAN
After a few trying years in which the fund suffered poor performance under its
previous investment focus, I am pleased to be writing about an "up" year.
Whether the fund's performance--or that of the financial markets, for that
matter--is up or down, though, the message we offer to investors remains the
same. Whatever the market environment, the keys to successful long-term
investing are balance, diversification, and low costs. If you make these
principles the foundation of your investment plan, you'll be positioned to
survive--and ultimately to thrive--no matter what occurs. For investors in
search of stocks that offer attractive prospects for increasing dividends,
Vanguard Dividend Growth Fund may be a smart choice.
4
Unfortunately, although the past year brought financial rewards to many
investors, it also brought disappointment and a sense of disbelief. The reports
of late trading and market-timing at some competing investment management firms
have been as disturbing to us as they no doubt have been to you. I want to close
this letter with an assurance to you that Vanguard has long had policies and
procedures in place to identify and deter such behavior. More important,
Vanguard shareholders are served by a crew of the highest integrity working
within a client-owned corporate structure that aligns our day-to-day efforts
with your long-term financial goals.
Thank you for investing your assets with Vanguard.
Sincerely,
/S/JOHN J. BRENNAN
John J. Brennan
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
FEBRUARY 13, 2004
- --------------------------------------------------------------------------------
YOUR FUND'S PERFORMANCE AT A GLANCE JANUARY 31, 2003-JANUARY 31, 2004
DISTRIBUTIONS PER SHARE
-----------------------------
STARTING ENDING INCOME CAPITAL
SHARE PRICE SHARE PRICE DIVIDENDS GAINS
- --------------------------------------------------------------------------------
Dividend Growth Fund $8.48 $11.33 $0.19 $0.00
- --------------------------------------------------------------------------------
5
REPORT FROM THE ADVISOR
Vanguard Dividend Growth Fund gained 36.1% for the fiscal year ended January 31,
2004. This exceeded both the 35.6% return of the Russell 1000 Index and the
31.0% average return of competing large-cap funds.
THE INVESTMENT ENVIRONMENT
Investors' enthusiasm for stocks grew during the fiscal year as the U.S.
economic recovery finally began to materialize. Emerging momentum in business
investment resulted in annualized gross domestic product growth of more than 8%
in the third quarter of 2003 and about 4% in the fourth quarter. The fourth
quarter also saw big gains in new orders and factory employment, leaving little
doubt that the manufacturing sector was beginning to improve.
- --------------------------------------------------------------------------------
The advisor believes that the fund can provide current income and long-term
growth of capital and income by investing in a diversified portfolio of stocks
that have excellent prospects for maintaining dividend payments and increasing
earnings and dividends over time.
- --------------------------------------------------------------------------------
Corporate earnings grew strongly, fueled by the significant cost-cutting moves
of prior years and long-awaited revenue growth. For multinational companies with
significant overseas business, profits were boosted by the weak U.S. dollar.
After the dramatic losses of the previous three years, the markets finished the
period with substantial gains. While smaller, speculative stocks posted the
highest results and garnered the financial headlines, the markets' gains were
broad-based.
THE FUND'S SUCCESSES
The most significant contributors to the period's return were the fund's
holdings in the health care, producer durables, technology, and financial
services sectors. Individual stocks that performed well included Aventis,
Motorola, Altria Group, Guidant, ACE, IBM, Nokia, C.R. Bard, Cooper Industries,
and United Technologies.
Many of the companies in which we are invested--in fact, from an asset
perspective, more than half of the fund--increased their dividends during the
period. We saw dividend increases of more than 10% from United
6
Technologies, Wachovia, FedEx (its first increase since commencing a dividend in
2002), Golden West Financial, Automatic Data Processing, Fannie Mae, Citigroup,
Procter & Gamble, SBC Communications (which paid three special dividends), and
H&R Block.
Other increases also stood out. Microsoft doubled its initial payout, signaling
its intent to begin growing its dividend. Intel also doubled its dividend. Bank
One increased its dividend twice, the second time by 80%, and McDonald's
increased its dividend by 70%.
THE FUND'S SHORTFALLS
Relative to the index, the fund's underweighted position in the technology
sector detracted from performance. The fund also endured a disappointing
dividend cut from Schering-Plough.
THE FUND'S POSITIONING
Strong business orders, modest inventory levels, federal tax cuts on dividends,
and higher productivity levels should continue to stimulate healthy economic
growth in the coming fiscal year. The Federal Reserve Board's patient and
accommodative policy in keeping interest rates low should also provide support.
Employment growth is necessary for sustainable economic expansion, and we hope
the modest level of job creation to date will be enough. Corporate earnings
increases will continue to be a key driver of stock market performance; renewed
revenue growth should keep earnings on the rise.
The fund remains positioned to take advantage of economic growth with its
holdings in the energy, materials, and producer durables sectors. Holdings
within the financial services sector reflect continued improvement in the
capital markets and continued strength in insurance industry fundamentals. Our
health care holdings reflect solid balance sheets, strong cash flows, attractive
valuations, strong commitments to dividends, and improved product introductions
in the near- to mid-term.
We remain optimistic that corporate management will continue to use dividends as
an important method of returning capital to shareholders. We are also confident
that steady growth of dividends will be a key contributor to the fund's total
return over the long run.
MINERVA BUTLER, VICE PRESIDENT
WELLINGTON MANAGEMENT COMPANY, LLP
FEBRUARY 20, 2004
7
FUND PROFILE As of 1/31/2004
This Profile provides a snapshot of the fund's characteristics, compared where
indicated with both an appropriate market index and a broad market index. Key
terms are defined on page 9.
DIVIDEND GROWTH FUND
- --------------------------------------------------------------------------------
PORTFOLIO CHARACTERISTICS
COMPARATIVE BROAD
FUND INDEX* INDEX**
- --------------------------------------------------------------------------------
Number of Stocks 85 992 5,190
Median Market Cap $31.0B $41.8B $28.0B
Price/Earnings Ratio 18.9x 21.5x 25.4x
Price/Book Ratio 3.1x 3.1x 3.1x
Yield 1.7% 1.7% 1.5%
Return on Equity 22.2% 20.7% 15.8%
Earnings Growth Rate 4.5% 8.3% 5.2%
Foreign Holdings 6.4% 0.0% 0.9%
Turnover Rate 23% -- --
Expense Ratio 0.40% -- --
Short-Term Reserves 3% -- --
- --------------------------------------------------------------------------------
- --------------------------------------------
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
Citigroup, Inc. 2.2%
(banking)
ACE Ltd. 2.1
(insurance)
Merrill Lynch & Co., Inc. 2.1
(financial services)
Altria Group, Inc. 2.0
(tobacco)
Pfizer Inc. 2.0
(pharmaceuticals)
International Business Machines Corp. 1.9
(computer hardware)
XL Capital Ltd. Class A 1.9
(insurance)
Aventis SA ADR 1.8
(pharmaceuticals)
Microsoft Corp. 1.7
(software)
Guidant Corp. 1.7
(medical)
- --------------------------------------------
Top Ten 19.4%
- --------------------------------------------
The "Ten Largest Holdings" excludes any
temporary cash investments and equity
index products.
- --------------------------------------------------------------
VOLATILITY MEASURES
SPLICED BROAD
FUND INDEX+ FUND INDEX**
- --------------------------------------------------------------
R-Squared 0.91 1.00 0.63 1.00
Beta 0.80 1.00 0.68 1.00
- --------------------------------------------------------------
- --------------------------------------------------------------
SECTOR DIVERSIFICATION (% OF PORTFOLIO)
COMPARATIVE BROAD
FUND INDEX* INDEX**
- --------------------------------------------------------------
Auto & Transportation 2% 2% 3%
Consumer Discretionary 11 14 15
Consumer Staples 6 7 6
Financial Services 21 23 23
Health Care 16 14 13
Integrated Oils 6 4 3
Other Energy 0 2 2
Materials & Processing 6 3 4
Producer Durables 11 4 4
Technology 8 15 15
Utilities 7 7 7
Other 3 5 5
- --------------------------------------------------------------
Short-Term Reserves 3% -- --
- --------------------------------------------------------------
- -----------------------------------
INVESTMENT FOCUS
STYLE Blend
MARKET CAP Large
- -----------------------------------
*Russell 1000 Index.
**Wilshire 5000 Index.
+Dividend Growth Spliced Index (known as the Utilities
Composite Index prior to December 6, 2002; 100%
Russell 1000 Index thereafter).
VISIT OUR WEBSITE AT VANGUARD.COM
FOR REGULARLY UPDATED FUND INFORMATION.
8
GLOSSARY OF INVESTMENT TERMS
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of a given market index. The index is assigned a
beta of 1.00. Compared with a given index, a fund with a beta of 1.20 typically
would have seen its share price rise or fall by 12% when the index rose or fell
by 10%. A fund's beta should be reviewed in conjunction with its R-squared (see
definition below). The lower the R-squared, the less correlation there is
between the fund and the index, and the less reliable beta is as an indicator of
volatility.
- --------------------------------------------------------------------------------
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
- --------------------------------------------------------------------------------
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
- --------------------------------------------------------------------------------
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or depositary receipts of companies based outside the United States.
- --------------------------------------------------------------------------------
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
- --------------------------------------------------------------------------------
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
- --------------------------------------------------------------------------------
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
- --------------------------------------------------------------------------------
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the market in general, as measured by a given index. If a
fund's total returns were precisely synchronized with an index's returns, its
R-squared would be 1.00. If the fund's returns bore no relationship to the
index's returns, its R-squared would be 0.
- --------------------------------------------------------------------------------
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
- --------------------------------------------------------------------------------
SHORT-TERM RESERVES. The percentage of a fund invested in highly liquid,
short-term securities that can be readily converted to cash.
- --------------------------------------------------------------------------------
TURNOVER RATE. An indication of the fund's trading activity. Funds with high
turnover rates incur higher transaction costs and may be more likely to
distribute capital gains (which may be taxable to investors).
- --------------------------------------------------------------------------------
YIELD. A snapshot of a fund's income from interest and dividends. The yield,
expressed as a percentage of the fund's net asset value, is based on income
earned over the past 30 days and is annualized, or projected forward for the
coming year. The index yield is based on the current annualized rate of income
provided by securities in the index.
- --------------------------------------------------------------------------------
9
PERFORMANCE SUMMARY
All of the returns in this report represent past performance, which is not a
guarantee of future results that may be achieved by the fund. (For the most
recent performance, which may be higher or lower than that cited, visit our
website at www.vanguard.com.) Note, too, that both investment returns and
principal value can fluctuate widely, so that an investor's shares, when sold,
could be worth more or less than their original cost. The returns shown do not
reflect taxes that a shareholder would pay on fund distributions or on the sale
of fund shares.
DIVIDEND GROWTH FUND
- --------------------------------------------------------------------------------
CUMULATIVE PERFORMANCE JANUARY 31, 1994-JANUARY 31, 2004
- --------------------------------------------------------------------------------
DIVIDEND DIVIDEND
GROWTH GROWTH
DIVIDEND WILSHIRE RUSSELL SPLICED SPLICED
GROWTH FUND* 5000 INDEX 1000 INDEX INDEX** AVERAGE+
199401 10000 10000 10000 10000 10000
199404 9378 9423 9433 9348 9425
199407 9354 9535 9606 9432 9285
199410 9222 9923 9963 9229 9220
199501 9553 9898 9993 9804 9390
199504 9981 10826 10951 10139 9664
199507 10570 12025 12119 10756 10215
199510 11469 12478 12655 11767 10838
199601 12368 13574 13854 12769 11745
199604 12001 14307 14376 12162 11522
199607 11940 13791 14027 12028 11383
199610 12596 15199 15555 12630 12076
199701 13050 16881 17408 13348 12917
199704 12725 16831 17590 13162 12581
199707 13886 20301 21088 14250 13944
199710 14280 20001 20508 14699 14226
199801 16074 21152 21994 16867 15826
199804 17068 24110 25005 17809 17080
199807 16891 23760 25064 17889 16953
199810 18220 22960 24551 19562 17340
199901 19276 26922 28721 20880 18784
199904 19639 28239 30082 21211 19262
199907 19845 28119 29988 21713 19974
199910 19632 28854 30832 21373 20517
200001 19813 30753 32158 21560 21998
200004 20092 31574 33827 22559 21941
200007 19535 31166 33231 22897 22132
200010 21724 31192 33624 27766 23324
200101 21216 29684 31936 26652 22559
200104 22122 27123 29206 28056 22746
200107 19318 26489 28347 24691 20850
200110 17751 23226 24869 21292 18109
200201 17566 25136 26726 19694 17325
200204 18283 24442 25707 19630 17169
200207 15023 20644 21853 14763 14209
200210 14359 20112 21238 13928 13370
200301 13487 19635 20694 13373 12744
200304 14234 21122 22247 14376 13536
200307 15712 23291 24299 15702 15049
200310 16723 25027 25977 16787 15612
200401 18353 27107 28071 18140 16690
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED JANUARY 31, 2004
------------------------------
FINAL VALUE
ONE FIVE TEN OF A $10,000
YEAR YEARS YEARS INVESTMENT
- --------------------------------------------------------------------------------
Dividend Growth Fund* 36.08% -0.98% 6.26% $18,353
Wilshire 5000 Index 38.05 0.14 10.49 27,107
Russell 1000 Index 35.65 -0.46 10.87 28,071
Dividend Growth Spliced Index** 35.65 -2.77 6.14 18,140
Dividend Growth Spliced Average+ 30.96 -2.34 5.26 16,690
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FISCAL-YEAR TOTAL RETURNS (%) JANUARY 31, 1994-JANUARY 31, 2004
- --------------------------------------------------------------------------------
DIVIDEND GROWTH
DIVIDEND GROWTH FUND SPLICED INDEX
1995 -4.5 -2.0
1996 29.5 30.2
1997 5.5 4.5
1998 23.2 26.4
1999 19.9 23.8
2000 2.8 3.3
2001 7.1 23.6
2002 -17.2 -26.1
2003 -23.2 -32.1
2004 36.1 35.6
- --------------------------------------------------------------------------------
* Prior to December 6, 2002, the fund was known as the Utilities Income Fund.
** Prior to December 6, 2002, the comparative benchmark was known as the
Utilities Composite Index. The index weightings have been: 80% S&P
Utilities Index, 20% Lehman Utility Bond Index through June 30, 1996; 40%
S&P Utilities Index, 40% S&P Telephone Index, and 20% Lehman Utility Bond
Index through April 30, 1999; 63.75% S&P Utilities Index, 21.25% S&P
Telephone Index, and 15% Lehman Utility Bond Index through March 31, 2000;
75% S&P Utilities Index, 25% S&P Telephone Index through December 31, 2001;
75% S&P Utilities Index, 25% S&P Integrated Telecommunication Services
Index through December 6, 2002; and Russell 1000 Index thereafter.
+ Derived from data provided by Lipper Inc.
Note: See Financial Highlights table on page 18 for dividend and capital gains
information.
10
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR PERIODS ENDED DECEMBER 31, 2003
This table presents average annual total returns through the latest calendar
quarter--rather than through the end of the fiscal period. Securities and
Exchange Commission rules require that we provide this information.
ONE FIVE TEN YEARS
---------------
INCEPTION DATE YEAR YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------
Dividend Growth Fund 5/15/1992 29.20% -1.62% 2.12% 4.01% 6.13%
- --------------------------------------------------------------------------------
11
This table presents returns for your fund both before and after taxes. The
after-tax returns are shown in two ways: (1) assuming that an investor owned the
fund during the entire period and paid taxes on the fund's distributions, and
(2) assuming that an investor paid taxes on the fund's distributions and sold
all shares at the end of each period.
Calculations are based on the highest individual federal income tax and capital
gains tax rates in effect at the times of the distributions and the hypothetical
sales. State and local taxes were not considered. After-tax returns reflect the
reduced tax rates on ordinary income (including qualified dividend income) and
short-term capital gains that became effective as of January 1, 2003, and on
long-term capital gains realized on or after May 6, 2003. To calculate qualified
dividend income, we use actual 2003 figures and estimates for 2004. (In the
example, returns after the sale of fund shares may be higher than those assuming
no sale. This occurs when the sale would have produced a capital loss. The
calculation assumes that the investor received a tax deduction for the loss.)
Please note that your actual after-tax returns will depend on your tax situation
and may differ from those shown. Also note that if you own the fund in a
tax-deferred account, such as an individual retirement account or a 401(k) plan,
this information does not apply to you. Such accounts are not subject to current
taxes.
Finally, keep in mind that a fund's performance--whether before or after
taxes--does not guarantee future results.
- -------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED JANUARY 31, 2004
ONE YEAR FIVE YEARS TEN YEARS
---------------------------------
DIVIDEND GROWTH FUND
Returns Before Taxes 36.08% -0.98% 6.26%
Returns After Taxes on Distributions 35.71 -2.74 4.13
Returns After Taxes on Distributions and Sale of Fund Shares 23.88 -1.63 4.26
- --------------------------------------------------------------------------------------------------
12
ABOUT YOUR FUND'S EXPENSES
All mutual funds have operating expenses. These expenses include costs for
portfolio management, administrative services, and shareholder reports (like
this one), among others. Operating expenses, which are deducted from a fund's
gross income, directly reduce the investment return of the fund. A fund's
expenses are expressed as a percentage of its net assets. This figure is known
as the expense ratio.
A HYPOTHETICAL EXAMPLE
We believe it is important for you to understand the impact of costs on your
investment. The following example illustrates the costs that you would incur
over a 12-month period if you invested $10,000 in the fund, using the fund's
actual return and operating expenses for the fiscal year ended January 31, 2004.
The cost in dollars is calculated by applying the expense ratio to the average
balance in the hypothetical account. For comparative purposes, we also list the
average expense ratio for the fund's peer group, which is derived from data
provided by Lipper Inc.
- --------------------------------------------------------------------------------
COST OF $10,000 FUND PEER GROUP*
INVESTMENT IN FUND EXPENSE RATIO EXPENSE RATIO
- --------------------------------------------------------------------------------
Dividend Growth Fund $47 0.40% 1.44%
- --------------------------------------------------------------------------------
*Average Large-Cap Core Fund.
The calculation assumes no shares were sold. Your actual costs may have been
higher or lower, depending on the amount of your investment and your holding
period. Peer-group ratio captures data through year-end 2003.
You can find more information about the fund's expenses, including annual
expense ratios for the past five years, in the Financial Statements section of
this report. For additional information on operating expenses and other
shareholder costs, please refer to the fund's prospectus. The prospectus
presents hypothetical shareholder costs over various time periods based upon a
$10,000 investment and a return of 5% a year. This standardized example, which
appears in all mutual fund prospectuses, may be useful to you in comparing the
costs of investing in different funds.
13
FINANCIAL STATEMENTS AS OF 1/31/2004
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.) and by
industry sector. Other assets are added to, and liabilities are subtracted from,
the value of Total Investments to calculate the fund's Net Assets. Finally, Net
Assets are divided by the outstanding shares of the fund to arrive at its share
price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying the
composition of the fund's net assets. Because all income and any realized gains
must be distributed to shareholders each year, the bulk of net assets consists
of Paid-in Capital (money invested by shareholders). The amounts shown for
Undistributed Net Investment Income and Accumulated Net Realized Gains usually
approximate the sums the fund had available to distribute to shareholders as
income dividends or capital gains as of the statement date, but may differ
because certain investments or transactions may be treated differently for
financial statement and tax purposes. Any Accumulated Net Realized Losses, and
any cumulative excess of distributions over net income or net realized gains,
will appear as negative balances. Unrealized Appreciation (Depreciation) is the
difference between the market value of the fund's investments and their cost,
and reflects the gains (losses) that would be realized if the fund were to sell
all of its investments at their statement-date values.
- ------------------------------------------------------------------------
MARKET
VALUE*
DIVIDEND GROWTH FUND SHARES (000)
- ------------------------------------------------------------------------
COMMON STOCKS (97.6%)
- ------------------------------------------------------------------------
AUTO & TRANSPORTATION (1.9%)
FedEx Corp. 121,200 $ 8,154
CSX Corp. 241,900 7,634
--------
15,788
--------
CONSUMER DISCRETIONARY (11.2%)
TJX Cos., Inc. 537,800 12,364
Mattel, Inc. 626,500 11,847
McDonald's Corp. 410,900 10,577
Gannett Co., Inc. 120,800 10,354
Home Depot, Inc. 283,600 10,059
Kimberly-Clark Corp. 169,100 9,987
Knight Ridder 103,800 7,984
The Walt Disney Co. 247,500 5,940
Gillette Co. 133,300 4,832
Omnicom Group Inc. 44,000 3,626
Newell Rubbermaid, Inc. 93,200 2,277
Avon Products, Inc. 30,900 1,957
--------
91,804
--------
CONSUMER STAPLES (5.9%)
Altria Group, Inc. 301,100 16,738
General Mills, Inc. 202,600 9,204
Sara Lee Corp. 428,800 9,142
* Safeway, Inc. 396,000 8,946
The Procter & Gamble Co. 43,400 4,387
--------
48,417
--------
FINANCIAL SERVICES (21.2%)
Citigroup, Inc. 366,000 18,110
ACE Ltd. 397,300 17,251
Merrill Lynch & Co., Inc. 291,600 17,143
XL Capital Ltd. Class A 191,800 15,248
American Express Co. 222,400 11,529
Fannie Mae 136,500 10,524
Marsh & McLennan Cos., Inc. 209,600 9,837
Automatic Data Processing, Inc. 225,500 9,640
H & R Block, Inc. 147,700 8,556
Bank of America Corp. 100,100 8,154
Golden West Financial Corp. 75,900 7,873
Wachovia Corp. 161,500 7,468
MBIA, Inc. 117,700 7,415
Bank One Corp. 118,100 5,977
American International Group, Inc. 77,500 5,382
ProLogis REIT 154,800 5,053
Rouse Co. REIT 98,800 4,865
Kimco Realty Corp. REIT 77,700 3,584
--------
$ 173,609
--------
HEALTH CARE (15.5%)
Pfizer Inc. 452,500 16,575
Aventis SA ADR 189,500 14,800
Guidant Corp. 215,400 13,760
Abbott Laboratories 308,900 13,307
Baxter International, Inc. 446,800 13,024
14
- ------------------------------------------------------------------------
MARKET
VALUE*
DIVIDEND GROWTH FUND SHARES (000)
- ------------------------------------------------------------------------
Wyeth 299,100 12,248
Becton, Dickinson & Co. 234,300 10,558
C.R. Bard, Inc. 105,200 9,910
Eli Lilly & Co. 119,800 8,151
AstraZeneca Group PLC ADR 165,900 8,008
Schering-Plough Corp. 393,400 6,900
--------
127,241
--------
INTEGRATED OILS (6.2%)
ConocoPhillips Co. 172,300 11,351
ChevronTexaco Corp. 126,000 10,880
Total SA ADR 122,400 10,808
ExxonMobil Corp. 242,100 9,875
Royal Dutch Petroleum Co. ADR 156,700 7,428
--------
50,342
--------
MATERIALS & PROCESSING (6.3%)
Weyerhaeuser Co. 196,800 12,095
E.I. du Pont de Nemours & Co. 250,700 11,006
Alcoa Inc. 302,900 10,353
International Paper Co. 220,300 9,312
Avery Dennison Corp. 144,300 8,970
--------
51,736
--------
PRODUCER DURABLES (11.2%)
Pitney Bowes, Inc. 317,800 12,896
Nokia Corp. ADR 557,300 11,514
United Technologies Corp. 108,800 10,395
Parker Hannifin Corp. 183,600 10,096
Cooper Industries, Inc. Class A 178,300 10,038
Emerson Electric Co. 131,900 8,428
The Boeing Co. 196,000 8,183
Caterpillar, Inc. 94,300 7,368
Dover Corp. 176,100 7,276
Illinois Tool Works, Inc. 65,000 5,077
--------
91,271
--------
TECHNOLOGY (8.5%)
International Business Machines Corp. 156,100 15,490
Microsoft Corp. 507,900 14,043
Hewlett-Packard Co. 502,300 11,950
Motorola, Inc. 564,500 9,359
* Apple Computer, Inc. 388,600 8,767
* Intuit, Inc. 126,700 6,388
Intel Corp. 108,500 3,320
--------
69,317
--------
UTILITIES (7.3%)
Verizon Communications 339,500 12,514
Pinnacle West Capital Corp. 266,200 10,448
Exelon Corp. 135,800 9,096
SBC Communications Inc. 297,500 7,586
AT&T Corp. 374,900 7,296
FPL Group, Inc. 74,200 4,879
BellSouth Corp. 138,100 $ 4,037
Cinergy Corp. 91,000 3,519
--------
59,375
--------
OTHER (2.4%)
Honeywell International Inc. 321,600 11,616
General Electric Co. 250,300 8,418
--------
20,034
- ----------------------------------------------------------------========
TOTAL COMMON STOCKS
(COST $652,587) 798,934
- ------------------------------------------------------------------------
FACE
AMOUNT
(000)
- ------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (2.6%)
- ------------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled Cash Account
1.022%, 2/2/2004
(COST $21,111) $21,111 21,111
- ------------------------------------------------------------------------
TOTAL INVESTMENTS (100.2%)
(COST $673,698) 820,045
- ------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.2%)
- ------------------------------------------------------------------------
Other Assets--Note C 7,109
Liabilities (8,901)
---------
(1,792)
- ----------------------------------------------------------------=========
NET ASSETS (100%)
- -------------------------------------------------------------------------
Applicable to 72,196,893 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $818,253
========================================================================
NET ASSET VALUE PER SHARE $11.33
========================================================================
*See Note A in Notes to Financial Statements.
*Non-income-producing security.
ADR--American Depositary Receipt.
REIT--Real Estate Investment Trust.
- -----------------------------------------------------------
AT JANUARY 31, 2004, NET ASSETS CONSISTED OF:
- -----------------------------------------------------------
AMOUNT PER
(000) SHARE
- -----------------------------------------------------------
Paid-in Capital $871,596 $12.06
Overdistributed Net
Investment Income (281) --
Accumulated Net Realized Losses (199,409) (2.76)
Unrealized Appreciation 146,347 2.03
- ------------------------------------------------------------
NET ASSETS $818,253 $11.33
============================================================
See Note E in Notes to Financial Statements for the tax-basis
components of net assets.
15
STATEMENT OF OPERATIONS
This Statement shows the types of income earned by the fund during the reporting
period, and details the operating expenses charged to the fund. These expenses
directly reduce the amount of investment income available to pay to shareholders
as income dividends. This Statement also shows any Net Gain (Loss) realized on
the sale of investments, and the increase or decrease in the Unrealized
Appreciation (Depreciation) of investments during the period.
- --------------------------------------------------------------------------------
DIVIDEND GROWTH FUND
YEAR ENDED JANUARY 31, 2004
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends $ 14,173
Interest 179
Security Lending 4
- --------------------------------------------------------------------------------
Total Income 14,356
- --------------------------------------------------------------------------------
EXPENSES
Investment Advisory Fees--Note B 731
The Vanguard Group--Note C
Management and Administrative 1,722
Marketing and Distribution 77
Custodian Fees 13
Auditing Fees 13
Shareholders' Reports 39
Trustees' Fees and Expenses 1
- --------------------------------------------------------------------------------
Total Expenses 2,596
Expenses Paid Indirectly--Note D (88)
- --------------------------------------------------------------------------------
Net Expenses 2,508
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 11,848
- --------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS) ON INVESTMENT SECURITIES SOLD 12,164
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
OF INVESTMENT SECURITIES 172,978
- --------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS $196,990
================================================================================
16
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
fund, either by purchasing shares or by reinvesting distributions, as well as
the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
- --------------------------------------------------------------------------------
DIVIDEND GROWTH FUND
---------------------
YEAR ENDED JANUARY 31,
----------------------
2004 2003
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 11,848 $ 21,934
Realized Net Gain (Loss) 12,164 (117,818)
Change in Unrealized Appreciation (Depreciation) 172,978 (63,615)
- --------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets Resulting
from Operations 196,990 (159,499)
- --------------------------------------------------------------------------------
DISTRIBUTIONS
Net Investment Income (12,644) (22,823)
Realized Capital Gain -- --
- --------------------------------------------------------------------------------
Total Distributions (12,644) (22,823)
- --------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS1
Issued 226,813 177,229
Issued in Lieu of Cash Distributions 10,434 18,658
Redeemed (153,307) (144,994)
- --------------------------------------------------------------------------------
Net Increase (Decrease) from Capital
Share Transactions 83,940 50,893
- --------------------------------------------------------------------------------
Total Increase (Decrease) 268,286 (131,429)
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 549,967 681,396
- --------------------------------------------------------------------------------
End of Period $818,253 $549,967
================================================================================
1Shares Issued (Redeemed)
Issued 22,646 18,208
Issued in Lieu of Cash Distributions 1,010 1,868
Redeemed (16, 311) (14,652)
- --------------------------------------------------------------------------------
Net Increase (Decrease) in Shares Outstanding 7,345 5,424
================================================================================
17
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis. It also presents the Total Return and shows
net investment income and expenses as percentages of average net assets. These
data will help you assess: the variability of the fund's net income and total
returns from year to year; the relative contributions of net income and capital
gains to the fund's total return; how much it costs to operate the fund; and the
extent to which the fund tends to distribute capital gains. The table also shows
the Portfolio Turnover Rate, a measure of trading activity. A turnover rate of
100% means that the average security is held in the fund for one year.
DIVIDEND GROWTH FUND
- ------------------------------------------------------------------------------------------------
YEAR ENDED JANUARY 31,
--------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD 2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $ 8.48 $11.47 $14.71 $14.93 $16.27
- ------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .18 .37 .37 .42 .49
Net Realized and Unrealized Gain (Loss)
on Investments 2.86 (2.98) (2.83) .62 (.12)
- ------------------------------------------------------------------------------------------------
Total from Investment Operations 3.04 (2.61) (2.46) 1.04 .37
- ------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.19) (.38) (.37) (.53) (.51)
Distributions from Realized Capital Gains -- -- (.41) (.73) (1.20)
- ------------------------------------------------------------------------------------------------
Total Distributions (.19) (.38) (.78) (1.26) (1.71)
- ------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $11.33 $ 8.48 $11.47 $14.71 $14.93
================================================================================================
TOTAL RETURN 36.08% -23.22% -17.21% 7.08% 2.79%
================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $818 $550 $681 $888 $854
Ratio of Total Expenses to Average Net Assets 0.40% 0.34% 0.37% 0.37% 0.40%
Ratio of Net Investment Income to Average Net Assets 1.84% 3.57% 2.85% 2.76% 3.13%
Portfolio Turnover Rate 23% 104%* 27% 48% 47%
================================================================================================
*Includes activity related to a change in the fund's investment objective. see
accompanying notes, which are an integral part of the financial statements.
SEE ACCOMPANYING NOTES, WHICH ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
18
NOTES TO FINANCIAL STATEMENTS
Vanguard Dividend Growth Fund is registered under the Investment Company Act of
1940 as an open-end investment company, or mutual fund. A. The following
significant accounting policies conform to generally accepted accounting
principles for U.S. mutual funds. The fund consistently follows such policies in
preparing its financial statements.
1. SECURITY VALUATION: Securities are valued as of the close of trading on
the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation
date. Equity securities are valued at the latest quoted sales prices or official
closing prices taken from the primary market in which each security trades; such
securities not traded on the valuation date are valued at the mean of the latest
quoted bid and asked prices. Securities for which market quotations are not
readily available, or whose values have been materially affected by events
occurring before the fund's pricing time but after the close of the securities'
primary markets, are valued by methods deemed by the board of trustees to
represent fair value. Temporary cash investments acquired over 60 days to
maturity are valued using the latest bid prices or using valuations based on a
matrix system (which considers such factors as security prices, yields,
maturities, and ratings), both as furnished by independent pricing services.
Other temporary cash investments are valued at amortized cost, which
approximates market value.
2. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances into a pooled cash account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
3. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Wellington Management Company, llp, provides investment advisory services to
the fund for a fee calculated at an annual percentage rate of average net
assets. For the year ended January 31, 2004, the advisory fee represented an
effective annual rate of 0.11% of the fund's average net assets. In accordance
with the advisory contract entered into with Wellington Management Company in
May 2003, the investment advisory fee will be subject to quarterly adjustments
based on the performance of the fund relative to the Russell 1000 Index
beginning February 1, 2004.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the board of trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At January 31, 2004, the fund had contributed capital of $120,000 to
Vanguard (included in Other Assets), representing 0.01% of the fund's net assets
and 0.12% of Vanguard's capitalization. The fund's trustees and officers are
also directors and officers of Vanguard.
19
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
D. The fund has asked its investment advisor to direct certain security trades,
subject to obtaining the best price and execution, to brokers who have agreed to
rebate to the fund part of the commissions generated. Such rebates are used
solely to reduce the fund's management and administrative expenses. For the year
ended January 31, 2004, these arrangements reduced the fund's expenses by
$88,000 (an annual rate of 0.01% of average net assets).
E. Distributions are determined on a tax basis and may differ from net
investment income and realized capital gains for financial reporting purposes.
Differences may be permanent or temporary. Permanent differences are
reclassified among capital accounts in the financial statements to reflect their
tax character. Temporary differences arise when certain items of income,
expense, gain, or loss are recognized in different periods for financial
statement and tax purposes; these differences will reverse at some time in the
future. Differences in classification may also result from the treatment of
short-term gains as ordinary income for tax purposes.
For tax purposes, at January 31, 2004, the fund had $594,000 of ordinary
income available for distribution. The fund had available realized losses of
$199,093,000 to offset future net capital gains of $70,259,000 through January
31, 2010, $65,485,000 through January 31, 2011, and $63,349,000 through January
31, 2012.
At January 31, 2004, net unrealized appreciation of investment securities
for tax purposes was $146,347,000, consisting of unrealized gains of
$151,840,000 on securities that had risen in value since their purchase and
$5,493,000 in unrealized losses on securities that had fallen in value since
their purchase.
F. During the year ended January 31, 2004, the fund purchased $223,243,000 of
investment securities and sold $146,490,000 of investment securities other than
temporary cash investments.
20
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Trustees of Vanguard Dividend Growth Fund:
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Dividend Growth Fund, (the "Fund") at January 31, 2004, the results of
its operations for the year then ended, the changes in its net assets for each
of the two years in the period then ended and the financial highlights for each
of the five years in the period then ended, in conformity with accounting
principles generally accepted in the United States of America. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the Fund's management; our responsibility
is to express an opinion on these financial statements based on our audits. We
conducted our audits of these financial statements in accordance with auditing
standards generally accepted in the United States of America, which require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits, which included confirmation
of securities at January 31, 2004 by correspondence with the custodian, provide
a reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
PHILADELPHIA, PENNSYLVANIA
MARCH 8, 2004
- --------------------------------------------------------------------------------
SPECIAL 2003 TAX INFORMATION
(UNAUDITED) FOR VANGUARD DIVIDEND GROWTH FUND
This information for the fiscal year ended January 31, 2004, is included
pursuant to provisions of the Internal Revenue Code.
For corporate shareholders, 100% of investment income (dividend income plus
short-term gains, if any) qualifies for the dividends-received deduction.
The fund intends to distribute the maximum amount of qualified dividend income
allowable. The amount of qualified dividend income distributed by the fund is
provided to individual shareholders on their Form 1099-DIV.
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21
INVESTING IS FAST, EASY, AND SECURE ON VANGUARD.COM
If you're like many Vanguard investors, you believe in planning and taking
control of your own investments. VANGUARD.COM was built for you--and it keeps
getting better.
RESEARCH AND PLAN YOUR INVESTMENTS WITH CONFIDENCE
Use our PLANNING & ADVICE and RESEARCH FUNDS & STOCKS sections to:
* Determine what asset allocation might best suit your needs--by taking our
Investor Questionnaire.
* Find out how much to save for retirement and your children's college
education-- by using our planning tools.
* Learn how to achieve your goals--by reading our PlainTalk(R) investment
guides.
* Find your next fund--by using the Compare Funds, Compare Costs, and Narrow
Your Fund Choices tools.
* Look up fund price, performance history, and distribution information--in a
snap.
INVEST AND MANAGE ACCOUNTS WITH EASE
Log on to VANGUARD.COM to:
* See what you own (at Vanguard and elsewhere) and how your investments are
doing.
* Elect to receive online statements, fund reports (like this one),
prospectuses, and tax forms.
* Analyze your portfolio's holdings and performance.
* Open new accounts, buy and sell shares, and exchange money between
funds--securely and easily.
* Sign up to receive electronic newsletters from Vanguard informing you of
news on our funds, products, and services, as well as on investing and the
financial markets.
Find out what VANGUARD.COM can do for you. Log on today!
22
CAPITALIZE ON YOUR IRA
Are you taking full advantage of your individual retirement account? You really
should be. The contribution limits on IRAs were recently raised, making these
tax-deferred accounts more powerful options for retirement savers.
Here's how you can exploit your IRA--and improve your chances of having the
retirement of your dreams. contribute the maximum amount each year
It may be an obvious point, but if you invest as much in your IRA as the law
allows--currently $3,000 per tax year if you are under age 50 and $3,500 if you
are age 50 or over--you will increase the odds of meeting your retirement goals.
"Max out" every year you can.
MAKE IT AUTOMATIC
Put your IRA on autopilot by taking advantage of Vanguard's Automatic Investment
Plan. Your IRA contributions will be deducted from your bank account on a
schedule of your choosing, making retirement investing a healthy habit.
CONSIDER COST
The owners of low-cost investments keep a larger portion of their gross returns
than the owners of high-cost investments. Over the long term, avoiding costlier
mutual funds and brokerage commissions could significantly boost your retirement
savings. Our low costs are one reason a Vanguard IRA(R) is such a smart choice.
REQUEST A DIRECT ROLLOVER WHEN YOU CHANGE JOBS
Don't spend your retirement assets before you've retired. When you change jobs,
roll your 401(k) or other employer-sponsored retirement plan assets directly
into your IRA.
If you have questions about your IRA, want to transfer an IRA from another
institution to Vanguard, or need help with any other IRA transaction, call our
Retirement Resource Center at 1-800-205-6189 or visit Vanguard.com. You can open
or fund your IRA on our website and have a confirmation in your hand within
minutes.
THE PEOPLE WHO GOVERN YOUR FUND
The trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are a part owner of
the fund. Your fund trustees also serve on the board of directors of The
Vanguard Group, Inc., which is owned by the Vanguard(R) funds and provides
services to them on an at-cost basis.
A majority of Vanguard's board members are independent, meaning that they have
no affiliation with Vanguard or the funds they oversee, apart from the sizable
personal investments they have made as private individuals.
Our independent board members bring distinguished backgrounds in business,
academia, and public service to their task of working with Vanguard officers to
establish the policies and oversee the activities of
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POSITION(S) HELD WITH
NAME FUND (NUMBER OF
(YEAR OF BIRTH) VANGUARD FUNDS
TRUSTEE/OFFICER OVERSEEN BY
SINCE TRUSTEE/OFFICER) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
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JOHN J. BRENNAN* Chairman of the Chairman of the Board, Chief Executive Officer, and Director/Trustee
(1954) Board, Chief of The Vanguard Group, Inc., and of each of the investment companies
May 1987 Executive Officer, served by The Vanguard Group.
and Trustee
(118)
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INDEPENDENT TRUSTEES
CHARLES D. ELLIS Trustee The Partners of '63 (pro bono ventures in education); Senior Advisor
(1937) (118) to Greenwich Associates (international business strategy consulting);
January 2001 Successor Trustee of Yale University; Overseer of the Stern School of
Business at New York University; Trustee of the Whitehead Institute
for Biomedical Research.
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RAJIV L. GUPTA Trustee Chairman and Chief Executive Officer (since October 1999), Vice
(1945) (118) Chairman (January-September 1999), and Vice President (prior to
December 2001 September 1999) of Rohm and Haas Co. (chemicals); Director of
Technitrol, Inc. (electronic components), and Agere Systems
(communications components); Board Member of the American Chemistry
Council; and Trustee of Drexel University.
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JOANN HEFFERNAN Trustee Vice President, Chief Information Officer, and Member of the
HEISEN (118) Executive Committee of Johnson & Johnson (pharmaceuticals/consumer
(1950) products); Director of the Medical Center at Princeton and Women's
July 1998 Research and Education Institute.
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BURTON G. MALKIEL TRUSTEE Chemical Bank Chairman's Professor of Economics,Princeton University;
(1932) (116) Director of Vanguard Investment Series plc (Irish invest-ment fund)
May 1977 (since November 2001), Vanguard Group (Ireland)Limited (Irish
investment management firm)(since November 2001),Prudential Insurance
Co. of America, BKF Capital (investment management), The Jeffrey Co.
(holding company), and NeuVis, Inc.(software company).
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the funds. Among board members' responsibilities are selecting investment
advisors for the funds; monitoring fund operations, performance, and costs;
reviewing contracts; nominating and selecting new trustees/directors; and
electing Vanguard officers.
Each trustee serves a fund until its termination; or until the trustee's
retirement, resignation, or death; or otherwise as specified in the fund's
organizational documents. Any trustee may be removed at a shareholders' meeting
by a vote representing two-thirds of the net asset value of all shares of the
fund together with shares of other Vanguard funds organized within the same
trust. The table on these two pages shows information for each trustee and
executive officer of the fund. The mailing address of the trustees and officers
is P.O. Box 876, Valley Forge, PA 19482.
POSITION(S) HELD WITH
NAME FUND (NUMBER OF
(YEAR OF BIRTH) VANGUARD FUNDS
TRUSTEE/OFFICER OVERSEEN BY
SINCE TRUSTEE/OFFICER) PRINCIPAL OCCUPATION(S) DURING THE PAST FIVE YEARS
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Alfred M. Rankin, Jr. Trustee Chairman, President, Chief Executive Officer, and Director of NACCO
(1941) (118) Industries, Inc. (forklift trucks/housewares/lignite); Director of
January 1993 Goodrich Corporation (industrial products/aircraft systems and
services); Director of Standard Products Company (supplier for
the automotive industry) until 1998.
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J. Lawrence Wilson Trustee Retired Chairman and Chief Executive Officer of Rohm and Haas Co.
(1936) (118) (chemicals); Director of Cummins Inc. (diesel engines), The Mead
April 1985 Corp. (paper products), and AmerisourceBergen Corp. (pharmaceuti-cal
distribution); Trustee of Vanderbilt University.
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EXECUTIVE OFFICERS*
R. Gregory Barton Secretary Managing Director and General Counsel of The Vanguard Group, Inc.;
(1951) (118) Secretary of The Vanguard Group and of each of the investment
June 2001 companies served by The Vanguard Group.
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Thomas J. Higgins Treasurer Principal of The Vanguard Group, Inc.; Treasurer of each of the
(1957) (118) investment companies served by The Vanguard Group.
July 1998
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*Officers of the funds are "interested persons" as defined in the Investment
Company Act of 1940.
More information about the trustees is in the Statement of Additional
Information, available from The Vanguard Group.
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VANGUARD SENIOR MANAGEMENT TEAM
MORTIMER J. BUCKLEY, Information Technology. MICHAEL S. MILLER, Planning and Development.
JAMES H. GATELY, Investment Programs and Services. RALPH K. PACKARD, Finance.
KATHLEEN C. GUBANICH, Human Resources. GEORGE U. SAUTER, Chief Investment Officer.
F. WILLIAM MCNABB, III, Client Relationship Group.
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JOHN C. BOGLE, Founder; Chairman and Chief Executive Officer, 1974-1996.
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[VANGUARD SHIP LOGO]
THE VANGUARD GROUP(R)
POST OFFICE BOX 2600
VALLEY FORGE, PA 19482-2600
Vanguard, The Vanguard Group, Vanguard.com, PlainTalk, Vanguard IRA, and the
ship logo are trademarks of The Vanguard Group, Inc.
All other marks are the exclusive property of their respective owners.
ABOUT OUR COVER
The photographs that appear on the cover of this report are copyrighted by
Michael Kahn.
FOR MORE INFORMATION
This report is intended for the fund's shareholders. It may not be distributed
to prospective investors unless it is preceded or accompanied by the current
fund prospectus.
To receive a free copy of the prospectus or the Statement of Additional
Information, or to request additional information about the fund or other
Vanguard funds, please contact us at one of the adjacent telephone numbers or by
e-mail through Vanguard.com. Prospectuses may also be viewed online.
All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc.,
unless otherwise noted.
WORLD WIDE WEB
www.vanguard.com
FUND INFORMATION
1-800-662-7447
DIRECT INVESTOR ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
TEXT TELEPHONE
1-800-952-3335
(C) 2004 THE VANGUARD GROUP, INC.
ALL RIGHTS RESERVED.
VANGUARD MARKETING
CORPORATION, DISTRIBUTOR.
Q570 032004
ITEM 2: Code of Ethics. The Board of Trustees has adopted a code of ethics that
applies to the principal executive officer, principal financial officer,
principal accounting officer or controller of the Registrant and The Vanguard
Group, Inc., and to persons performing similar functions.
ITEM 3: Audit Committee Financial Expert. All of the members of the Audit
Committee have been determined by the Registrant's Board of Trustees to be Audit
Committee Financial Experts. The members of the Audit Committee are: Charles D.
Ellis, Rajiv L. Gupta, JoAnn Heffernan Heisen, Burton G. Malkiel, Alfred M.
Rankin, Jr., and J. Lawrence Wilson. All Audit Committee members are independent
under applicable rules.
ITEM 4: PRINCIPAL ACCOUNTANT FEES AND SERVICES.
(A) AUDIT FEES.
AUDIT FEES OF THE REGISTRANT
Fiscal Year Ended January 31, 2004: $71,000
Fiscal Year Ended January 31, 2003: $65,000
AGGREGATE AUDIT FEES OF REGISTERED INVESTMENT COMPANIES IN THE VANGUARD GROUP
Fiscal Year Ended January 31, 2004: $1,660,800
Fiscal Year Ended January 31, 2003: $1,620,200
(B) AUDIT-RELATED FEES.
Fiscal Year Ended January 31, 2004: $324,460
Fiscal Year Ended January 31, 2003: $420,280
Includes fees billed in connection with assurance and related services provided
to the Registrant, The Vanguard Group, Inc., Vanguard Marketing Corporation, and
other registered investment companies in the Vanguard Group.
(C) TAX FEES.
Fiscal Year Ended January 31, 2004: $409,900
Fiscal Year Ended January 31, 2003: $103,200
Includes fees billed in connection with compliance, planning, and advice
services provided to the Registrant, The Vanguard Group, Inc., Vanguard
Marketing Corporation, and other registered investment companies in the Vanguard
Group and related to income, excise, and stamp taxes.
(D) ALL OTHER FEES.
Fiscal Year Ended January 31, 2004: $31,000
Fiscal Year Ended January 31, 2003: $367,500
Includes fees billed in connection with benefit plans and statements, risk
management, privacy matters, educational training materials, and other business
advisory services provided to the Registrant, The Vanguard Group, Inc., Vanguard
Marketing Corporation, and other registered investment companies in the Vanguard
Group.
(E) (1) PRE-APPROVAL POLICIES. The policy of the Registrant's Audit Committee is
to consider and, if appropriate, approve before the principal accountant is
engaged for such services, all specific audit and permitted non-audit services
provided to: (1) the Registrant; (2) The Vanguard Group, Inc.; (3) other
entities controlled by The Vanguard Group, Inc. that provide ongoing services to
the Registrant; and (4) other registered investment companies in the Vanguard
Group. In making a determination, the Audit Committee considers whether the
services are consistent with maintaining the principal accountant's
independence.
In the event of a contingency situation in which the principal accountant
is needed to provide services in between scheduled Audit Committee meetings, the
chairman of the Audit Committee would be called on to consider and, if
appropriate, pre-approve audit or permitted non-audit services in an amount
sufficient to complete services through the next Audit Committee meeting, and to
determine if such services would be consistent with maintaining the accountant's
independence. At the next scheduled Audit Committee meeting, services and fees
would be presented to the Audit Committee for formal consideration, and, if
appropriate, approval by the entire Audit Committee. The Audit Committee would
again consider whether such services and fees are consistent with maintaining
the principal accountant's independence.
The Registrant's Audit Committee is informed at least annually of all audit
and non-audit services provided by the principal accountant to the Vanguard
complex, whether such services are provided to: (1) the Registrant; (2) The
Vanguard Group, Inc.; (3) other entities controlled by The Vanguard Group, Inc.
that provide ongoing services to the Registrant; or (4) other registered
investment companies in the Vanguard Group.
(2) No percentage of the principal accountant's fees or services were
approved pursuant to the waiver provision of paragraph (c)(7)(i)(C) of Rule 2-01
of Regulation S-X.
(f) For the most recent fiscal year, over 50% of the hours worked under the
principal accountant's engagement were not performed by persons other than
full-time, permanent employees of the principal accountant.
(G) AGGREGATE NON-AUDIT FEES.
Fiscal Year Ended January 31, 2004: $440,900
Fiscal Year Ended January 31, 2003: $470,700
Includes fees billed for non-audit services provided to the Registrant, The
Vanguard Group, Inc., Vanguard Marketing Corporation, and other registered
investment companies in the Vanguard Group.
(h) For the most recent fiscal year, the Audit Committee has determined that the
provision of all non-audit services was consistent with maintaining the
principal accountant's independence.
ITEM 5: Not applicable.
ITEM 6: Reserved.
ITEM 7: Not applicable.
ITEM 8: Reserved.
ITEM 9: CONTROLS AND PROCEDURES.
(a) Disclosure Controls and Procedures. The Principal Executive and
Financial Officers concluded that the Registrant's Disclosure Controls and
Procedures are effective based on their evaluation of the Disclosure Controls
and Procedures as of a date within 90 days of the filing date of this report.
(b) Internal Control Over Financial Reporting. There were no significant
changes in Registrant's internal control over financial reporting or in other
factors that could significantly affect this control subsequent to the date of
the evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
ITEM 10: EXHIBITS. The following exhibits are attached hereto:
(a) Code of Ethics
(b) Certifications
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
VANGUARD SPECIALIZED FUNDS
BY:_____________(signature)________________
(HEIDI STAM)
JOHN J. BRENNAN*
CHIEF EXECUTIVE OFFICER
Date: March 24, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934 and the
Investment Company Act of 1940, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.
VANGUARD SPECIALIZED FUNDS
BY:_____________(signature)________________
(HEIDI STAM)
JOHN J. BRENNAN*
CHIEF EXECUTIVE OFFICER
Date: March 24, 2004
VANGUARD SPECIALIZED FUNDS
BY:_____________(signature)________________
(HEIDI STAM)
THOMAS J. HIGGINS*
TREASURER
Date: March 24, 2004
*By Power of Attorney. See File Number 2-57689, filed on December 26, 2002.
Incorporated by Reference.