November 17, 2004
Christian Sandoe, Esq.
Division of Investment Management
U.S. Securities and Exchange Commission via electronic filing
450 Fifth Street,
N.W., Fifth Floor
Washington, D.C. 20549
Re: Vanguard Convertible Securities Fund
Dear Mr. Sandoe:
The following responds to your comments of November 15, 2004 on the
post-effective amendment of the registration statement of Vanguard Convertible
Securities Fund. You commented on PEA number 27 that was filed on October 1,
2004 pursuant to Rule 485(a).
COMMENT 1: PROSPECTUS - PRIMARY INVESTMENT STRATEGIES
COMMENT: Vanguard defines convertible securities to include corporate
bonds and preferred stocks that are convertible into common
stock, as well as debt securities with warrants or common
stock attached. How do the debt securities with warrants or
common stock attached fit the definition of convertible
securities if these debt securities are not technically
convertible?
RESPONSE: The securities in question are equity-linked debt securities.
Given that they are fixed income instruments with the option
to gain equity exposure via the warrants or detachable stock,
they have economic characteristics substantially similar to
the other securities held by the fund.
COMMENT 2: PROSPECTUS - PRIMARY RISKS
COMMENT: Sector risk is listed as a primary risk, but no specific
sectors are listed. Please provide more specific information
regarding these sectors.
RESPONSE: We are removing the sector risk bullet from the list of
primary risks in the fund profile, as well as from the Item 4
disclosure since there are no specific sectors at this time
that present a primary risk to investors in the fund. This
disclosure was appropriate a few years ago when tech stocks
were very prevalent, but is no longer appropriate and should
be deleted.
COMMENT 3: PROSPECTUS - PRIMARY RISKS
COMMENT: In the Credit Risk section Vanguard says, "Companies that
issue convertible securities are often small to medium size,
and they often have low credit ratings." Accordingly, there
should be a statement describing small and mid-cap market
risk.
RESPONSE: We do not plan to add a statement describing small and mid-cap
market risk. The fund primarily owns debt securities that are
convertible to equity securities. It is true that the
companies issuing these securities are often small to medium
size. However, since the debt securities are very rarely, if
ever, held to conversion, shareholders are seldom, if ever,
exposed to the market-cap risks of the equity securities. The
real risk to fund shareholders based on the size of the
issuers is the low credit rating of these issuers.
Accordingly, we think the existing disclosure is appropriate.
COMMENT 4: - PROSPECTUS - AVERAGE ANNUAL TOTAL RETURN TABLE
COMMENT: Fix the date in the first footnote to the table.
RESPONSE: We have fixed the date.
COMMENT 5: - PROSPECTUS - AVERAGE ANNUAL TOTAL RETURN TABLE
COMMENT: A fund cannot use a brand new index as a broad-based index.
RESPONSE: The Merrill Lynch All US Convertibles Index has been in
existence for at least the past ten years. We did not
initially include the performance for this benchmark in the
table since the table shows performance through December 31,
2003, and the new benchmark will not take effect until
December 1, 2004. However, to avoid confusion, we will include
the Merrill Lynch benchmark's performance in our 485(b)
filing, and it will appear in the printed prospectus.
COMMENT 6: - PROSPECTUS - FEES AND EXPENSES
COMMENT: You commented regarding the difference between the fund's
expense ratio for fiscal year 2003 (0.84%), which is included
in our Plain Talk About Expenses, compared to the estimated
expense ratio for fiscal 2004 (0.71%), which is included in
the Annual Fund Operating Expense table. You noted that we
should explain the drop in expenses from 2003 to 2004.
RESPONSE: We included the estimated expense ratio in the Annual Fund
Operating Expense table since this prospectus includes six-
month financials derived from the shareholder report. We will
update the Plain Talk About Expenses to include this estimated
expense ratio for 2004 rather than the actual 2003 expense
ratio, so there will not be a discrepancy between the expense
ratios in the table and the Plain Talk box. We do not plan to
include text explaining the difference in expense ratio from
2003 to 2004
since it is solely attributable to an increase of
over $200 million in the fund's asset base.
COMMENT 7: - PROSPECTUS - MORE ON THE FUND
COMMENT: IF THE FUND'S OBJECTIVE IS NON-FUNDAMENTAL, STATE THAT FACT IN THE
PROSPECTUS.
RESPONSE: The fund's objective is fundamental, so we will add the
missing disclosure to the list of fundamental objectives
in the SAI.
COMMENT 8: - SAI - BOARD REVIEW OF INVESTMENT ADVISORY ARRANGEMENTS
COMMENT: FLESH OUT THE DISCUSSION OF WHAT THE BOARD CONSIDERED IN
REVIEWING THE ADVISORY ARRANGEMENTS FOR THE FUND.
RESPONSE: We have expanded the discussion of the board's consideration
of the fund's advisory arrangements. (See attached.)
COMMENT 9: TANDY REQUIREMENTS
COMMENT: The SEC is now requiring all registrants to provide at the end
of response letters to registration statement comments, the
following statements:
o The Fund is responsible for the adequacy and accuracy
of the disclosure in the filing.
o Staff comments or changes in response to staff comments
in the filings reviewed by the staff do not foreclose
the Commission from taking any action with respect to
the filing.
o The Fund may not assert staff comments as a defense in
any proceeding initiated by the Commission or any
person under the federal securities laws of the United
States.
RESPONSE: AS REQUIRED BY THE SEC, WE WILL PROVIDE THE FOREGOING
ACKNOWLEDGEMENTS.
* * * * *
AS REQUIRED BY THE SEC, THE FUND ACKNOWLEDGES THAT:
o The Fund is responsible for the adequacy and accuracy
of the disclosure in the filing.
o Staff comments or changes in response to staff comments
in the filings reviewed by the staff do not foreclose
the Commission from taking any action with respect to
the filing.
o The Fund may not assert staff comments as a defense in
any proceeding initiated by the Commission or any
person under the federal securities laws of the United
States.
Please contact me at (610) 669-1538 with any questions or comments
regarding the above responses or the accompanying attachment. Thank you.
Sincerely,
Judith L. Gaines
Associate Counsel
Attachment
ATTACHMENT
BOARD REVIEW OF INVESTMENT ADVISORY ARRANGEMENTS. The Fund's board of trustees
oversees the Fund's management and performance on a regular basis, and the board
determines annually whether to approve and renew the Fund's investment advisory
agreement. Vanguard provides the board with monthly, quarterly, and annual
analyses of the advisor's performance. In addition, the investment advisor
provides the board with quarterly self-evaluations and certain other information
the board deems important to evaluate the short- and long-term performance of
the advisor. The Fund's portfolio managers meet with the board periodically to
discuss the management and performance of the Fund.
When considering whether to renew an investment advisory contract, the board
examines several factors, but does not identify any particular factor as
controlling their decision. Some of the factors considered by the board include:
the nature, extent, and quality of the advisory services provided as well as
other material facts, such as the investment performance of the Fund's assets
managed by the advisor and the fair market value of the services provided. The
board reviews and considers the extent to which the advisor has realized or will
realize economies of scale as the Fund grows. Additional information is provided
to the board detailing other sources of revenue to the advisor or its affiliates
from its relationship with the Fund and intangible or "fall-out" benefits that
accrue to the advisor and its affiliates, if relevant, and the advisor's control
of the investment expenses of the Fund, such as transaction costs, including
ways in which portfolio transactions for the Fund are conducted and brokers are
selected.
For Vanguard Convertible Securities Fund, the board also takes into account the
nature of the fee arrangements, which include breakpoints that will adjust the
fee downward as the size of the Fund increases and a performance adjustment that
is designed to benefit shareholders by aligning the advisor's fee with the
investment returns delivered to shareholders.
The board also reviews the investment performance of the Fund compared with a
peer group of funds and an appropriate index or combination of indexes, in
addition to a comparative analysis of expense ratios of, and advisory fees paid
by, similar funds. Credit Suisse First Boston is eliminating the Credit Suisse
First Boston Convertible Securities Index, which was the benchmark index for the
Fund. Accordingly, the Fund's board of trustees approved Merrill Lynch All US
Convertibles Index, a similar index tracking U.S. corporate convertible
securities, as the new benchmark index, effective December 1, 2004.
In its most recent review of the Fund's advisory agreement, the board
identified no single factor that controlled the decision. The primary factors
underlying the board's determination to renew the fund's advisory arrangements
were as follows:
ADVISORY FEES
AVERAGE ANNUAL RETURN (BEFORE TAXES) EXPRESSED AS AN
------------------------------------ ANNUAL EFFECTIVE
1 YEAR ENDED 5 YEARS ENDED 10 YEARS ENDED RATE OF THE FUNDS'
11/30/2003 11/30/2003 11/30/2003 EXPENSE RATIO AVERAGE NET ASSETS
----------- ------------ -------------- ------------- ------------------
VANGUARD CONVERTIBLE 28.07% 9.79% 8.71% 0.84% 0.38%
SECURITIES FUND
Average Convertible Securities Fund* 22.06 7.03 8.44 1.49 0.62
CS First Boston Convertible
Securities Index** 23.66 8.28 9.12 N/A N/A
Merrill Lynch All US
Convertibles Index** 22.47 7.46 9.30 N/A N/A
*Derived from data provided by Lipper Inc.
**Credit Suisse First Boston is eliminating the CS First Boston Convertible
Securities Index. The Fund's board of trustees approved Merrill Lynch All US
Convertibles Index as the new benchmark, effective December 1, 2004.
- - The board considered the Fund's short- and long-term performance records,
which are disclosed in the table above. The board determined that the
performance results for the Fund were reasonable, particularly over the
long-term, as compared with relevant performance standards, including the
performance results of the average peer group fund (derived from data
provided by Lipper Inc.) and other appropriate benchmarks.
- - The board assessed the advisory fee paid by the Fund and compared it to the
average advisory fee for the Fund's Lipper peer group. The board took into
account the nature of the fee arrangements, which include breakpoints that
decrease the fee rate as the size of the advisor's portfolio increases. The
board concluded that the advisory fee paid to Oaktree was reasonable and
was significantly less that the average advisory fee paid by others in the
Fund's Lipper peer group.
- - The board evaluated the advisor's investment staff and portfolio management
process, and reviewed the composition and overall performance of the
advisor's portfolio on both a short-term and long-term basis. Following the
review, the board noted the portfolio management team's outstanding
experience and education. The board concluded that the advisor's investment
staff and portfolio management process were solid and were suitable for the
Fund.
- - Finally, the board considered whether the Fund should obtain alternative
portfolio management services and concluded that, under all the
circumstances and based on its informed business judgment, the most
appropriate course of action in the best interest of the Fund's
shareholders was to renew the agreement with Oaktree.