[SHIP] [VANGUARD LOGO]
April 22, 2005
Christian Sandoe, Esq.
Division of Investment Management
U.S. Securities and Exchange Commission VIA E-MAIL
450 Fifth Street, N.W., Fifth Floor
Washington, D.C. 20549
RE: VANGUARD INDEX FUNDS (THE "TRUST"); FILE NO. 2-56846
Dear Mr. Sandoe:
Thank you for your comments of April 14, 2005 regarding the Trust's 95th
Post-Effective Amendment to the Registration Statement that was filed on
February 28, 2005 pursuant to Rule 485(a). The following are our responses to
each of your comments. Each prospectus page reference is to the Investor Shares
and Admiral Shares version of the Vanguard U.S. Stock Index Funds' prospectus.
COMMENT 1: ADDITION OF MID-CAP RISK TO VANGUARD TOTAL STOCK MARKET INDEX
FUND (PAGE 2)
Comment: If the Vanguard Total Stock Market Index Fund (the "Stock Fund")
invests in mid-cap stocks, move mid-cap risk disclosure to the
Primary Risks section of the prospectus.
Response: Item 2 of Form N-1A requires a summary of "the principal risks of
investing in the Fund, including the risks to which the Fund's
portfolio as a whole is subject" (emphasis added). This requires
disclosure of the risks of a fund's overall portfolio, not every
risk associated with each type of security held by the fund. The
Commission's approach to risk disclosure is succinctly summarized
in the 1998 release adopting sweeping revisions to Form N-1A
(Investment Company Act Release No. 23064 (March 13, 1998). Part
II.A.3.b of the release states "disclosure about the risks
associated with each type of security in which the fund may
invest does not effectively communicate to [investors] the
overall risks of investing in the fund. In the Commission's view,
disclosing the risks of each possible portfolio investment,
rather than the overall risks of investing in a fund, does not
help investors evaluate a particular fund or compare the risks of
the fund with those of other funds."
Mr. Christian Sandoe
Aprill 22, 2005
Page 2 of 3
Applying the Commission's position to the Stock Fund, we conclude
that disclosing mid-cap risk in Item 2 would not effectively
communicate the overall risks of investing in the Stock Fund. The
risk of investing in funds focused on mid- or small-cap stocks is
that their returns can be more volatile than the returns of funds
investing in large-cap stocks. This risk, however, is not
significant for the Stock Fund for two primary reasons. First,
large-capitalization stocks constitute the preponderance of the
Stock Fund's assets. Second, the Stock Fund's limited exposure to
mid-and small-cap stocks is spread across the whole universe of
domestic stocks. The result of this diversification is to limit
sector-specific and stock-specific risk, including mid-cap risk.
The modest, and broad, exposure to mid- and small-cap stocks
actually served to reduce the volatility of returns. For the
36-month period ended March 31, 2005, the Stock Fund had a beta
of 1.00 versus the Dow Jones Wilshire 5000 Composite Index (i.e.,
matched the volatility exactly). Relative to the S&P 500 Index,
the Stock Fund's beta was 0.98% (i.e., slightly less volatile
than the large-cap-only S&P 500 Index).
Highlighting the potential volatility of a relatively small
portion of the Stock Fund's holdings in the Primary Risks section
of the prospectus would be inappropriate, potentially misleading,
and contrary to the intent of the Commission.
COMMENT 2: INVESTMENT ADVISOR CLARIFICATION (PAGE 34)
Comment: In the Investment Advisor section of the prospectus, better
clarify that George Sauter oversees, rather than does the
day-to-day management, of the Funds within the Trust.
Response: We believe that the disclosure is clear as written. The paragraph
describing Mr. Sauter states that he is responsible for the
"oversight of approximately $530 billion managed by Vanguard's
Quantitative Equity and Fixed Income Groups." Furthermore, the
introduction to the "Plain Talk About The Funds' Portfolio
Managers" clearly states that the individuals listed in the
highlighted "Plain Talk" box are "primarily responsible for the
day-to-day management of the Funds' portfolios." In light of our
clear statements about the roles of each individual, we do not
believe that it is necessary to state that Mr. Sauter does not
have day-to-day management responsibilities for the Funds.
COMMENT 3: REVISE BOARD REVIEW OF ADVISORY CONTRACTS
(PAGE B-29 IN THE STATEMENT OF ADDITIONAL INFORMATION ("SAI")
Comment: Add disclosure to the SAI that relates the factors considered by
each Fund's board in reviewing investment advisory agreements to
the particulars of each Fund, pursuant to Item 12(b)(10) of Form
N-1A.
Mr. Christian Sandoe
April 22, 2005
Page 3 of 3
Response: Item 12(b)(10) requires funds to "discuss in reasonable detail
the material factors and the conclusions with respect thereto
that formed the basis for the board of directors approving the
existing investment advisory contract." We have revised our
existing disclosure regarding board approval of investment
advisory agreements.
We propose to revise the relevant SAI disclosure as indicated in
Appendix A to this letter. Please note that the proposed
disclosure in Appendix A is subject to editorial revision and
completion.
COMMENT 4: 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 Each 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 Each 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 Funds acknowledge that:
o The Funds are 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 Funds 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 call me at (610) 669-5284 if you have any further questions.
Sincerely,
Lisa L. B. Matson
Associate Counsel
The Vanguard Group, Inc.
Enclosure
APPENDIX A
BOARD REVIEW OF INVESTMENT ADVISORY ARRANGEMENTS
Each Fund's board of trustees oversees the Fund's management and performance on
a regular basis. In addition, the board considers annually whether each Fund and
its shareholders continue to benefit from the internalized management structure
whereby the Fund receives investment management services at cost from Vanguard's
Quantitative Equity Group. Vanguard provides the board with monthly, quarterly,
and annual analyses of the Quantitative Equity Group's performance. In addition,
Vanguard provides the board with quarterly self-evaluations and certain other
information the board deems important to evaluate the short- and long-term
performance of each Fund's internalized management. Each Fund's portfolio
managers meet with the board periodically to discuss the management and
performance of the Fund.
When considering whether to continue the internalized management structure
of each Fund, the board examines several factors, but does not identify any
particular factor as controlling their decision. The board also reviews the
investment performance of each Fund compared with a peer group of funds and an
appropriate index.
After reviewing and considering various factors as they relate to the
Funds, the board determines whether it would be in the best interests of the
respective fund shareholders to continue the internalized management
arrangement.
In its most recent review of each Fund's advisory arrangement, the board
identified no single factor that controlled the decision. The primary factors
underlying the board's determination to renew each Fund's advisory arrangements
were as follows:
VANGUARD TOTAL STOCK MARKET INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services at cost to
the Fund:
- - The nature, extent, and quality of the services provided.
- - The investment performance of the Fund's assets managed by Vanguard.
- - The fair market value of the services provided.
- - A comparative analysis of expense ratios of, and advisory fees paid by,
similar funds.
- - Vanguard's control of the operating expenses of the Fund.
The specific Fund performance and advisory fee information considered by
the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)
------------------------------------
ADVISORY FEES
EXPRESSED AS AN
5 YEARS 10 YEARS ANNUAL EFFECTIVE
1 YEAR ENDED ENDED ENDED RATE OF THE FUNDS'
12/31/2004 12/31/2004 12/31/2004 EXPENSE RATIO AVERAGE NET ASSET
---------- ---------- ---------- ------------- -----------------
INDEX FUND INVESTOR SHARES* 12.52% -1.44% 11.81% 0.19% Less than 0.01%
Average Multi-Cap Core Fund** 11.05 -0.48 10.91 1.36 0.56
Dow Jones Wilshire 5000 Index 12.62 -1.42 11.92 N/A N/A
* Information about the Fund's other share classes may be found elsewhere in
this Statement of Additional Information.
** Derived from data provided by Lipper Inc.
- - The board considered the Fund's short- and long-term investment
performance, which is disclosed in the table above. The board concluded
that the Fund outperformed or performed near the average multi-cap core
fund and its benchmark index over the short- and long-term.
- - The board concluded that, in the aggregate, the nature, extent, and quality
of services provided by Vanguard to the Fund are appropriate and should
continue.
- - The board assessed the advisory expenses incurred by the Fund and
considered the fair market value of the services provided in light of the
expenses incurred. The board concluded that the expenses incurred were
significantly less than the average advisory fee paid by others in the
Fund's Lipper peer group.
- - Based upon its most recent evaluation of the investment staff, the
portfolio management process, the investment performance, and the at-cost,
internalized management arrangements, the board of the Fund determined that
it would be in the best interests of the Fund's shareholders to continue
its internalized management arrangement.
B-30
- - 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 interests of the Fund's
shareholders was to continue the investment management arrangement with
Vanguard.
VANGUARD 500 INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services at cost to
the Fund:
- - The nature, extent, and quality of the services provided.
- - The investment performance of the Fund's assets managed by Vanguard.
- - The fair market value of the services provided.
- - A comparative analysis of expense ratios of, and advisory fees paid by,
similar funds.
- - Vanguard's control of the operating expenses of the Fund.
The specific Fund performance and advisory fee information considered by
the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)
------------------------------------
ADVISORY FEES
EXPRESSED AS AN
5 YEARS 10 YEARS ANNUAL EFFECTIVE
1 YEAR ENDED ENDED ENDED RATE OF THE FUNDS'
12/31/2004 12/31/2004 12/31/2004 EXPENSE RATIO AVERAGE NET ASSET
---------- ---------- ---------- ------------- -----------------
VANGUARD 500 INDEX FUND
INVESTOR SHARES* 10.74% -2.38% 12.00% 0.18% Less than 0.01%
Average Large-Cap Core Fund** 7.79 -4.05 9.82 1.45 0.61
S&P 500 Index 10.88 -2.30 12.07 N/A N/A
* Information about the Fund's other share classes may be found elsewhere in
this Statement of Additional Information.
** Derived from data provided by Lipper Inc.
- - The board considered the Fund's short- and long-term investment
performance, which is disclosed in the table above. The board concluded
that the Fund outperformed the average large-cap core fund and performed
near its benchmark index over the short- and long-term.
- - The board concluded that, in the aggregate, the nature, extent, and quality
of services provided by Vanguard to the Fund are appropriate and should
continue.
- - The board assessed the advisory expenses incurred by the Fund and
considered the fair market value of the services provided in light of the
expenses incurred. The board concluded that the expenses incurred were
significantly less than the average advisory fee paid by others in the
Fund's Lipper peer group.
- - Based upon its most recent evaluation of the investment staff, the
portfolio management process, the investment performance, and the at-cost,
internalized management arrangements, the board of the Fund determined that
it would be in the best interests of the Fund's shareholders to continue
its internalized management arrangement.
- - 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 interests of the Fund's
shareholders was to continue the investment management arrangement with
Vanguard.
VANGUARD EXTENDED MARKET INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services at cost to
the Fund:
- - The nature, extent, and quality of the services provided.
- - The investment performance of the Fund's assets managed by Vanguard.
- - The fair market value of the services provided.
- - A comparative analysis of expense ratios of, and advisory fees paid by,
similar funds.
- - Vanguard's control of the operating expenses of the Fund.
B-31
The specific Fund performance and advisory fee information considered by
the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)
------------------------------------
ADVISORY FEES
EXPRESSED AS AN
5 YEARS 10 YEARS ANNUAL EFFECTIVE
1 YEAR ENDED ENDED ENDED RATE OF THE FUNDS'
12/31/2004 12/31/2004 12/31/2004 EXPENSE RATIO AVERAGE NET ASSET
---------- ---------- ---------- ------------- -----------------
VANGUARD EXTENDED MARKET INDEX FUND
INVESTOR SHARES* 18.71% 1.37% 12.16% 0.25% Less than 0.005%
Average Mid-Cap Core Fund** 15.52 5.78 14.01 1.54 0.67
Dow Jones Wilshire 4500 Index 18.57 1.38 11.97 N/A N/A
* Information about the Fund's other share classes may be found elsewhere in
this Statement of Additional Information.
** Derived from data provided by Lipper Inc.
- - The board considered the Fund's short- and long-term investment
performance, which is disclosed in the table above. The board concluded
that the Fund outperformed the average mid-cap core fund over the
short-term, and outperformed or performed near its benchmark index over the
short- and long-term.
- - The board concluded that, in the aggregate, the nature, extent, and quality
of services provided by Vanguard to the Fund are appropriate and should
continue.
- - The board assessed the advisory expenses incurred by the Fund and
considered the fair market value of the services provided in light of the
expenses incurred. The board concluded that the expenses incurred were
significantly less than the average advisory fee paid by others in the
Fund's Lipper peer group.
- - Based upon its most recent evaluation of the investment staff, the
portfolio management process, the investment performance, and the at-cost,
internalized management arrangements, the board of the Fund determined that
it would be in the best interests of the Fund's shareholders to continue
its internalized management arrangement.
- - 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 interests of the Fund's
shareholders was to continue the investment management arrangement with
Vanguard.
VANGUARD LARGE-CAP INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services at cost to
the Fund:
- - The nature, extent, and quality of the services provided.
- - The investment performance of the Fund's assets managed by Vanguard.
- - The fair market value of the services provided.
- - A comparative analysis of expense ratios of, and advisory fees paid by,
similar funds.
- - Vanguard's control of the operating expenses of the Fund.
The specific Fund performance and advisory fee information considered by
the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)
------------------------------------
5 YEARS 10 YEARS ADVISORY FEES
(or since (or since EXPRESSED AS AN
inception) inception) ANNUAL EFFECTIVE
1 YEAR ENDED ENDED ENDED RATE OF THE FUNDS'
12/31/2004 12/31/2004 12/31/2004 EXPENSE RATIO AVERAGE NET ASSET
---------- ---------- ---------- ------------- -----------------
VANGUARD LARGE-CAP INDEX FUND
INVESTOR SHARES* (Inception date
January 30, 2004) 9.13% N/A N/A 0.20% 0.01%
Average Large-Cap Core Fund** 6.13 N/A N/A 1.45 0.61
MSCI US Prime Market 750 Index 9.31 N/A N/A N/A N/A
* Information about the Fund's other share classes may be found elsewhere in
this Statement of Additional Information.
** Derived from data provided by Lipper Inc.
B-32
- - The board considered the Fund's investment performance since inception,
which is disclosed in the preceding table. The board concluded that during
that time period the Fund outperformed or performed near the average
large-cap core fund and its benchmark index.
- - The board concluded that, in the aggregate, the nature, extent, and quality
of services provided by Vanguard to the Fund are appropriate and should
continue.
- - The board assessed the advisory expenses incurred by the Fund and
considered the fair market value of the services provided in light of the
expenses incurred. The board concluded that the expenses incurred were
significantly less than the average advisory fee paid by others in the
Fund's Lipper peer group.
- - Based upon its most recent evaluation of the investment staff, the
portfolio management process, the investment performance, and the at-cost,
internalized management arrangements, the board of the Fund determined that
it would be in the best interests of the Fund's shareholders to continue
its internalized management arrangement.
- - 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 interests of the Fund's
shareholders was to continue the investment management arrangement with
Vanguard.
VANGUARD MID-CAP INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services at cost to
the Fund:
- - The nature, extent, and quality of the services provided.
- - The investment performance of the Fund's assets managed by Vanguard.
- - The fair market value of the services provided.
- - A comparative analysis of expense ratios of, and advisory fees paid by,
similar funds.
- - Vanguard's control of the operating expenses of the Fund.
The specific Fund performance and advisory fee information considered by
the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)
------------------------------------
10 YEARS ADVISORY FEES
(or since EXPRESSED AS AN
5 YEARS inception) ANNUAL EFFECTIVE
1 YEAR ENDED ENDED ENDED RATE OF THE FUNDS'
12/31/2004 12/31/2004 12/31/2004 EXPENSE RATIO AVERAGE NET ASSET
---------- ---------- ---------- ------------- -----------------
VANGUARD MID-CAP INDEX FUND
INVESTOR SHARES* (Inception
date May 21, 1998) 20.35% 10.13% 11.28% 0.22% Less than 0.005%
Average Mid-Cap Core Fund** 15.52 5.78 9.33 1.54 0.67
Spliced Mid Cap Index+ 20.52 10.00 10.99 N/A N/A
* Information about the Fund's other share classes may be found elsewhere in
this Statement of Additional Information.
** Derived from data provided by Lipper Inc.
+ The Spliced Index reflects the performance of the Fund's previous index
through May 16, 2003, and of the current MSCI Index thereafter.
- - The board considered the Fund's short- and long-term investment
performance, which is disclosed in the table above. The board concluded
that for each time period the Fund outperformed the average mid-cap core
fund and performed near its benchmark index.
- - The board concluded that, in the aggregate, the nature, extent, and quality
of services provided by Vanguard to the Fund are appropriate and should
continue.
- - The board assessed the advisory expenses incurred by the Fund and
considered the fair market value of the services provided in light of the
expenses incurred. The board concluded that the expenses incurred were
significantly less than the average advisory fee paid by others in the
Fund's Lipper peer group.
- - Based upon its most recent evaluation of the investment staff, the
portfolio management process, the investment performance, and the at-cost,
internalized management arrangements, the board of the Fund determined that
it would be in the best interests of the Fund's shareholders to continue
its internalized management arrangement.
- - 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 interests of the Fund's
shareholders was to continue the investment management arrangement with
Vanguard.
B-33
VANGUARD SMALL-CAP INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services at cost to
the Fund:
- - The nature, extent, and quality of the services provided.
- - The investment performance of the Fund's assets managed by Vanguard.
- - The fair market value of the services provided.
- - A comparative analysis of expense ratios of, and advisory fees paid by,
similar funds.
- - Vanguard's control of the operating expenses of the Fund.
The specific Fund performance and advisory fee information considered by
the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)
------------------------------------
ADVISORY FEES
EXPRESSED AS AN
5 YEARS 10 YEARS ANNUAL EFFECTIVE
1 YEAR ENDED ENDED ENDED RATE OF THE FUNDS'
12/31/2004 12/31/2004 12/31/2004 EXPENSE RATIO AVERAGE NET ASSET
---------- ---------- ---------- ------------- -----------------
VANGUARD SMALL-CAP INDEX
FUND INVESTOR SHARES* 19.90% 6.98% 12.28% 0.23% Less than 0.005%
Average Small-Cap Core
Fund** 18.38 9.57 14.51 1.73 0.71
Spliced Small Cap
Index+ 20.01 6.65 11.56 N/A N/A
* Information about the Fund's other share classes may be found elsewhere in
this Statement of Additional Information.
** Derived from data provided by Lipper Inc.
+ The Spliced Index reflects the performance of the Fund's previous index
through May 16, 2003, and of the current MSCI Index thereafter.
- - The board considered the Fund's short- and long-term investment
performance, which is disclosed in the table above. The board concluded
that the Fund outperformed or performed near the average small-cap core
fund and its benchmark index over the short-term. The board noted that the
Fund underperformed the average small-cap core fund but outperformed its
benchmark index over the long-term.
- - The board concluded that, in the aggregate, the nature, extent, and quality
of services provided by Vanguard to the Fund are appropriate and should
continue.
- - The board assessed the advisory expenses incurred by the Fund and
considered the fair market value of the services provided in light of the
expenses incurred. The board concluded that the expenses incurred were
significantly less than the average advisory fee paid by others in the
Fund's Lipper peer group.
- - Based upon its most recent evaluation of the investment staff, the
portfolio management process, the investment performance, and the at-cost,
internalized management arrangements, the board of the Fund determined that
it would be in the best interests of the Fund's shareholders to continue
its internalized management arrangement.
- - 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 interests of the Fund's
shareholders was to continue the investment management arrangement with
Vanguard.
VANGUARD VALUE INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services at cost to
the Fund:
- - The nature, extent, and quality of the services provided.
- - The investment performance of the Fund's assets managed by Vanguard.
- - The fair market value of the services provided.
- - A comparative analysis of expense ratios of, and advisory fees paid by,
similar funds.
- - Vanguard's control of the operating expenses of the Fund.
B-34
The specific Fund performance and advisory fee information considered by
the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)
------------------------------------
ADVISORY FEES
EXPRESSED AS AN
5 YEARS 10 YEARS ANNUAL EFFECTIVE
1 YEAR ENDED ENDED ENDED RATE OF THE FUNDS'
12/31/2004 12/31/2004 12/31/2004 EXPENSE RATIO AVERAGE NET ASSET
---------- ---------- ---------- ------------- -----------------
VANGUARD VALUE INDEX
FUND INVESTOR SHARES* 15.29% 2.43% 12.16% 0.21% Less than 0.005%
Average Large-Cap Value
Fund** 11.94 1.68 11.53 1.41 0.58
Spliced Value Index+ 15.44 2.53 12.27 N/A N/A
* Information about the Fund's other share classes may be found elsewhere in
this Statement of Additional Information.
** Derived from data provided by Lipper Inc.
+ The Spliced Index reflects the performance of the Fund's previous index
through May 16, 2003, and of the current MSCI Index thereafter.
- - The board considered the Fund's short- and long-term investment
performance, which is disclosed in the table above. The board concluded
that the Fund outperformed the average large-cap value fund and performed
near its benchmark index over the short- and long-term.
- - The board concluded that, in the aggregate, the nature, extent, and quality
of services provided by Vanguard to the Fund are appropriate and should
continue.
- - The board assessed the advisory expenses incurred by the Fund and
considered the fair market value of the services provided in light of the
expenses incurred. The board concluded that the expenses incurred were
significantly less than the average advisory fee paid by others in the
Fund's Lipper peer group.
- - Based upon its most recent evaluation of the investment staff, the
portfolio management process, the investment performance, and the at-cost,
internalized management arrangements, the board of the Fund determined that
it would be in the best interests of the Fund's shareholders to continue
its internalized management arrangement.
- - 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 interests of the Fund's
shareholders to was continue the investment management arrangement with
Vanguard.
VANGUARD SMALL-CAP VALUE INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services at cost to
the Fund:
- - The nature, extent, and quality of the services provided.
- - The investment performance of the Fund's assets managed by Vanguard.
- - The fair market value of the services provided.
- - A comparative analysis of expense ratios of, and advisory fees paid by,
similar funds.
- - Vanguard's control of the operating expenses of the Fund.
The specific Fund performance and advisory fee information considered by
the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)
------------------------------------
10 YEARS ADVISORY FEES
(or since EXPRESSED AS AN
5 YEARS inception) ANNUAL EFFECTIVE
1 YEAR ENDED ENDED ENDED RATE OF THE FUNDS'
12/31/2004 12/31/2004 12/31/2004 EXPENSE RATIO AVERAGE NET ASSET
---------- ---------- ---------- ------------- -----------------
VANGUARD SMALL-CAP VALUE
INDEX FUND INVESTOR SHARES*
(Inception date May 21, 1998) 23.55% 15.05% 9.51% 0.23% 0.01%
Average Small-Cap Value Fund** 20.86 16.25 10.34 1.62 0.78
Spliced Small Cap Value Index+ 23.72 14.41 8.85 N/A N/A
* Information about the Fund's other share classes may be found elsewhere in
this Statement of Additional Information.
** Derived from data provided by Lipper Inc.
+ The Spliced Index reflects the performance of the Fund's previous index
through May 16, 2003, and of the current MSCI Index thereafter.
B-35
- - The board considered the Fund's short- and long-term investment
performance, which is disclosed in the preceding table. The board concluded
that the Fund outperformed or performed near the average small-cap value
fund and its benchmark index over the short-term. The board noted that the
Fund underperformed the average small-cap value fund over the long-term but
outperformed its benchmark index during that time period
- - The board concluded that, in the aggregate, the nature, extent, and quality
of services provided by Vanguard to the Fund are appropriate and should
continue.
- - The board assessed the advisory expenses incurred by the Fund and
considered the fair market value of the services provided in light of the
expenses incurred. The board concluded that the expenses incurred were
significantly less than the average advisory fee paid by others in the
Fund's Lipper peer group.
- - Based upon its most recent evaluation of the investment staff, the
portfolio management process, the investment performance, and the at-cost,
internalized management arrangements, the board of the Fund determined that
it would be in the best interests of the Fund's shareholders to continue
its internalized management arrangement.
- - 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 interests of the Fund's
shareholders was to continue the investment management arrangement with
Vanguard.
VANGUARD GROWTH INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services at cost to
the Fund:
- - The nature, extent, and quality of the services provided.
- - The investment performance of the Fund's assets managed by Vanguard.
- - The fair market value of the services provided.
- - A comparative analysis of expense ratios of, and advisory fees paid by,
similar funds.
- - Vanguard's control of the operating expenses of the Fund.
The specific Fund performance and advisory fee information considered by
the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)
------------------------------------
ADVISORY FEES
EXPRESSED AS AN
5 YEARS 10 YEARS ANNUAL EFFECTIVE
1 YEAR ENDED ENDED ENDED RATE OF THE FUNDS'
12/31/2004 12/31/2004 12/31/2004 EXPENSE RATIO AVERAGE NET ASSET
---------- ---------- ---------- ------------- -----------------
VANGUARD GROWTH INDEX
FUND INVESTOR SHARES* 7.20% -6.94% 11.52% 0.22% Less than 0.005%
Average Large-Cap
Growth Fund** 7.18 -8.92 9.37 1.51 0.63
Spliced Growth Index+ 7.38 -6.79 11.61 N/A N/A
* Information about the Fund's other share classes may be found elsewhere in
this Statement of Additional Information.
** Derived from data provided by Lipper Inc.
+ The Spliced Index reflects the performance of the Fund's previous index
through May 16, 2003, and of the current MSCI Index thereafter.
- - The board considered the Fund's short- and long-term investment
performance, which is disclosed in the table above. The board concluded
that the Fund outperformed or performed near the average large-cap growth
fund and its benchmark index over the short- and long-term.
- - The board concluded that, in the aggregate, the nature, extent, and quality
of services provided by Vanguard to the Fund are appropriate and should
continue.
- - The board assessed the advisory expenses incurred by the Fund and
considered the fair market value of the services provided in light of the
expenses incurred. The board concluded that the expenses incurred were
significantly less than the average advisory fee paid by others in the
Fund's Lipper peer group.
- - Based upon its most recent evaluation of the investment staff, the
portfolio management process, the investment performance, and the at-cost,
internalized management arrangements, the board of the Fund determined that
it would be in the best interests of the Fund's shareholders to continue
its internalized management arrangement.
B-36
- - 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 interests of the Fund's
shareholders to was continue the investment management arrangement with
Vanguard.
VANGUARD SMALL-CAP GROWTH INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services at cost to
the Fund:
- - The nature, extent, and quality of the services provided.
- - The investment performance of the Fund's assets managed by Vanguard.
- - The fair market value of the services provided.
- - A comparative analysis of expense ratios of, and advisory fees paid by,
similar funds.
- - Vanguard's control of the operating expenses of the Fund.
The specific Fund performance and advisory fee information considered by
the board included the following:
AVERAGE ANNUAL RETURN (BEFORE TAXES)
------------------------------------
10 YEARS ADVISORY FEES
(or since EXPRESSED AS AN
5 YEARS inception) ANNUAL EFFECTIVE
1 YEAR ENDED ENDED ENDED RATE OF THE FUNDS'
12/31/2004 12/31/2004 12/31/2004 EXPENSE RATIO AVERAGE NET ASSET
---------- ---------- ---------- ------------- -----------------
VANGUARD SMALL-CAP GROWTH
INDEX FUND INVESTOR SHARES*
(Inception date May 21, 1998) 16.06% 7.17% 7.50% 0.23% 0.01%
Average Small-Cap Growth Fund** 10.65 -0.98 6.18 1.71 0.77
Spliced Small Cap Growth Index+ 16.13 6.75 7.11 N/A N/A
* Information about the Fund's other share classes may be found elsewhere in
this Statement of Additional Information.
** Derived from data provided by Lipper Inc.
+ The Spliced Index reflects the performance of the Fund's previous index
through May 16, 2003, and of the current MSCI Index thereafter.
- - The board considered the Fund's short- and long-term investment
performance, which is disclosed in the table above. The board concluded
that the Fund significantly outperformed the average small-cap growth fund
over the short- term and outperformed the average small-cap growth fund
over the long-term. The board also noted that the Fund performed near its
benchmark index over the short-term and slightly outperformed its benchmark
index over the long-term.
- - The board concluded that, in the aggregate, the nature, extent, and quality
of services provided by Vanguard to the Fund are appropriate and should
continue.
- - The board assessed the advisory expenses incurred by the Fund and
considered the fair market value of the services provided in light of the
expenses incurred. The board concluded that the expenses incurred were
significantly less than the average advisory fee paid by others in the
Fund's Lipper peer group.
- - Based upon its most recent evaluation of the investment staff, the
portfolio management process, the investment performance, and the at-cost,
internalized management arrangements, the board of the Fund determined that
it would be in the best interests of the Fund's shareholders to continue
its internalized management arrangement.
- - 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 interests of the Fund's
shareholders was to continue the investment management arrangement with
Vanguard.
Based upon its most recent evaluation of each, then existing, Fund's
investment staff, the portfolio management process, the short- and long-term
performance results, and the at-cost, internalized management arrangements for
each Fund, the board determined that it would be in the best interests of each
Fund's shareholders to continue its internalized management arrangements.
B-37
OTHER ACCOUNTS MANAGED
Michael H. Buek managed the 500 Index Fund, Small-Cap Index Fund, and Small-Cap
Value Index Fund, which, as of December 31, 2004, collectively held assets of
$119,258,000,000. Mr. Buek also managed four other registered investment
companies with total assets of $9,615,000,000, as of December 31, 2004, and
three other pooled investment vehicles with total assets of $433,400,000, as of
December 31, 2004.
Donald M. Butler managed the Extended Market Index Fund and Mid-Cap Index Fund,
which, as of December 31, 2004, collectively held assets of $17,748,000,000. Mr.
Butler also managed three other registered investment companies with total
assets of $49,060,000,000, as of December 31, 2004, and two other pooled
investment vehicles with total assets of $1,357,500,000, as of December 31,
2004.
Ryan E. Ludt managed the Large-Cap Index Fund, which, as of December 31, 2004,
held assets of $119,000,000. Mr. Ludt also managed four other registered
investment companies with total assets of $1,817,000,000, as of December 31,
2004, and one other pooled investment vehicle with total assets of
$2,239,500,000, as of December 31, 2004.
Gerard C. O'Reilly managed the Total Stock Market Index Fund, Value Index Fund,
Growth Index Fund, and Small-Cap Growth Index Fund, which, as of December 31,
2004, collectively held assets of $74,673,000,000. Mr. O'Reilly also managed
three other registered investment companies with total assets of $6,280,000,000,
as of December 31, 2004, and one other pooled investment vehicle with total
assets of $226,200,000, as of December 31, 2004.
MATERIAL CONFLICTS OF INTEREST
At Vanguard, individual portfolio managers may manage multiple accounts for
multiple clients. In addition to mutual funds, these other accounts may include
separate accounts, collective trusts, or offshore funds. Vanguard manages
potential conflicts between funds or with other types of accounts through
allocation policies and procedures, internal review processes, and oversight by
directors and independent third parties. Vanguard has developed trade allocation
procedures and controls to ensure that no one client, regardless of type, is
intentionally favored at the expense of another. Allocation policies are
designed to address potential conflicts in situations where two or more funds or
accounts participate in investment decisions involving the same securities.
DESCRIPTION OF COMPENSATION
As of December 31, 2004, a Vanguard portfolio manager's compensation generally
consists of base salary, bonus, and payments under Vanguard's long-term
incentive compensation program. In addition, portfolio managers are eligible for
the standard retirement benefits and health and welfare benefits available to
all Vanguard employees. Also, certain portfolio managers may be eligible for
additional retirement benefits under several supplemental retirement plans that
Vanguard adopted in the 1980's to restore dollar-for-dollar the benefits of
management employees that had been cut back solely as a result of tax law
changes. These plans are structured to provide the same retirement benefits as
the standard retirement benefits.
In the case of portfolio managers responsible for managing multiple
Vanguard funds or accounts, the method used to determine their compensation is
the same for all funds and investment accounts.
A portfolio manager's base salary is determined by the manager's experience
and performance in the role, taking into account the ongoing compensation
benchmark analyses performed by the Vanguard Human Resources Department. A
portfolio manager's base salary is generally a fixed amount that may change as a
result of an annual review, upon assumption of new duties, or when a market
adjustment of the position occurs.
A portfolio manager's bonus is determined by a number of factors. One
factor is gross, pre-tax performance of the fund relative to expectations for
how the fund should have performed, given its objectives, policies, strategies
and limitations, and the market environment during the measurement period. This
performance factor is not based on the value of assets held in the fund's
portfolio. For the Funds, the performance factor depends on how closely the
portfolio manager tracks the fund's benchmark index over a one-year period.
Additional factors include the portfolio manager's contributions to the
investment management functions within the sub-asset class, contributions to the
development of other investment professionals and supporting staff, and overall
contributions to strategic planning and decisions for the investment group. The
target bonus is expressed as a percentage of base salary. The actual bonus paid
may be more or less than the target bonus, based on how well the manager
satisfies the objectives stated above. The bonus is paid on an annual basis.
B-38
Under the long-term incentive compensation program, all full-time employees
receive a payment from Vanguard's long-term incentive compensation plan based on
their years of service, job level, and, if applicable, management
responsibilities. Each year, Vanguard's independent directors determine the
amount of the long-term incentive compensation award for that year based on the
investment performance of the Vanguard funds relative to competitors and
Vanguard's operating efficiencies in providing services to the Vanguard funds.
OWNERSHIP OF SECURITIES
Vanguard employees, including portfolio managers, allocate their investments
among the various Vanguard funds based on their own individual investment needs
and goals. Vanguard employees as a group invest a sizeable portion of their
personal assets in Vanguard funds. As of December 31, 2004, Vanguard employees
collectively invested $1.27 billion in Vanguard funds. John J. Brennan, Chairman
and Chief Executive Officer of Vanguard and the Vanguard funds, and George U.
Sauter, Managing Director and Chief Investment Officer, invest substantially all
of their personal financial assets in Vanguard funds.
As of December 31, 2004, Mr. Buek owned shares of the 500 Index Fund within
the $10,001-$50,000 range, and Mr. O'Reilly owned shares of the Total Stock
Market Index Fund in the $100,001-$500,000 range. Except as noted in the
previous sentence, as of December 31, 2004, the portfolio managers did not own
any shares of the Index Funds they managed.
PORTFOLIO TRANSACTIONS
The advisor decides which securities to buy and sell on behalf of a Fund and
then selects the brokers or dealers that will execute the trades on an agency
basis or the dealers with whom the trades will be effected on a principal basis.
For each trade, the advisor must select a broker-dealer that it believes will
provide "best execution." Best execution does not mean the lowest possible
spread or commission rate. In seeking best execution, the SEC has said that an
advisor should consider the full range of a broker-dealer's services. The
factors considered by the advisor in seeking best execution include, but are not
limited to, the broker-dealer's execution capability, clearance and settlement
services, commission rate, trading expertise, willingness and ability to commit
capital, ability to provide anonymity, financial responsibility, reputation and
integrity, responsiveness, access to underwritten offerings and secondary
markets, and access to company management, as well as the value of any research
provided by the broker-dealer. In assessing which broker-dealer can provide best
execution for a particular trade, the advisor also may consider the timing and
size of the order and available liquidity and current market conditions.
Currently, it is each Fund's policy that the advisor may at times pay higher
commissions in recognition of brokerage services felt necessary for the
achievement of better execution of certain securities transactions that
otherwise might not be available. The advisor will only pay such higher
commissions if it believes this to be in the best interest of the Fund.
During the fiscal years ended December 31, 2002, 2003, and 2004, the Funds paid
brokerage commissions in the following amounts:
FUND 2002 2003 2004
- ---- ---- ---- ----
Vanguard Total Stock Market Index Fund $1,919,000 $3,056,000 $3,263,000
Vanguard 500 Index Fund 4,386,000 2,681,000 2,944,000
Vanguard Extended Market Index Fund 758,000 846,000 1,063,000
Vanguard Large-Cap Index Fund N/A N/A 14,000
Vanguard Mid-Cap Index Fund 621,000 1,648,000 860,000
Vanguard Small-Cap Index Fund 2,050,000 1,996,000 1,314,000
Vanguard Value Index Fund 567,000 314,000 289,000
Vanguard Small-Cap Value Index Fund 1,187,000 1,154,000 549,000
Vanguard Growth Index Fund 743,000 1,021,000 574,000
Vanguard Small-Cap Growth Index Fund 133,000 291,000 290,000
B-39