[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 INSTITUTIONAL INDEX FUND (THE "TRUST"); FILE NO. 33-34494
Dear Mr. Sandoe:
Thank you for your comments of April 14, 2005 regarding the Trust's 39th
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 Institutional
Shares and Institutional Plus Shares version of the prospectus.
Comment 1: ADDITION OF MID-CAP RISK IN INSTITUTIONAL TOTAL STOCK MARKET
INDEX FUND (PAGE 3)
Comment: If the Institutional 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
April 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 36)
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
PROHIBITIONS ON RECEIPT OF COMPENSATION OR OTHER CONSIDERATION
The Policies and Procedures prohibit a Vanguard fund, its investment advisor,
and any other person to pay or receive any compensation or other consideration
of any type for the purpose of obtaining disclosure of Vanguard fund portfolio
holdings or other investment positions. "Consideration" includes any agreement
to maintain assets in the fund or in other investment companies or accounts
managed by the investment advisor or by any affiliated person of the investment
advisor.
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 from Vanguard's
Quantitative Equity and Fixed Income Groups (the Groups). Vanguard provides the
board with monthly, quarterly, and annual analyses of the Groups' 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 arrangements, the board
identified no single factor that controlled their decision. The primary factors
underlying the board's determination to renew each Fund's advisory arrangements
were as follows:
VANGUARD INSTITUTIONAL INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services 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 INSTITUTIONAL INDEX FUND
INSTITUTIONAL SHARES* 10.86% -2.26% 12.13% 0.05% 0.02%
Average Large-Cap Core Fund** 7.79 -4.05 9.82 1.45 0.61
Standard & Poor's 500 Index 10.88 -2.30 12.07 N/A N/A
* Information about the Fund's Institutional Plus Shares 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 over the short-
and long-term, and performed at or near its benchmark index.
B-33
- - 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
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 INSTITUTIONAL TOTAL STOCK MARKET INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services 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 INSTITUTIONAL TOTAL STOCK MARKET
INDEX FUND INSTITUTIONAL SHARES*
(Inception August 31, 2001) 12.65% 5.70% N/A 0.06% 0.02%
Average Multi-Cap Core Fund** 11.05 4.31 N/A 1.36 0.56
Dow Jones Wilshire 5000 Index 12.62 5.62 N/A N/A N/A
* Information about the Fund's Institutional Plus Shares may be found
elsewhere in this Statement of Additional information.
** Derived from data provided by Lipper Inc.
- - The board considered the Fund's 1-year and since-inception investment
performance, which is disclosed in the table above. The board concluded
that the Fund outperformed the average multi-cap core fund and performed at
or near its benchmark index during those time frames.
- - 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
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.
B-34
VANGUARD INSTITUTIONAL TOTAL BOND MARKET INDEX FUND
The board considered the following factors when determining whether Vanguard
should continue providing internalized investment management services 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 INSTITUTIONAL TOTAL
BOND MARKET INDEX FUND
(Inception April 26, 2002) 4.36% 5.88% N/A 0.05% 0.02%
Average Intermediate-Term
Investment-Grade Fund* 3.85 5.53 N/A 1.01 0.37
Lehman Brothers Aggregate
Bond Index 4.34 6.11 N/A N/A N/A
* Derived from data provided by Lipper Inc.
- - The board considered the Fund's 1-year and since-inception investment
performance, which is disclosed in the table above. The board concluded
that the Fund outperformed the average intermediate-term investment-grade
fund and performed at or near its benchmark index during those time frames.
- - 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
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.
Based upon its most recent evaluation of each Fund's investment staff, the
portfolio management process, the short- and long-term performance results, and
the management arrangements for each Fund, the board determined that it would be
in the best interests of each Fund's shareholders to continue the Management
Agreement.
OTHER ACCOUNTS MANAGED
Donald M. Butler managed the Institutional Index Fund, which, as of December 31,
2004, held assets of $48,483,000,000. Mr. Butler also managed four other
registered investment companies with total assets of $18,324,400,000, as of
December 31, 2004, and two other pooled investment vehicles with total assets of
$1,357,500,000, as of December 31, 2004.
Michael Perre managed the Institutional Total Stock Market Index Fund, which, as
of December 31, 2004, held assets of $1,240,000,000. Mr. Perre also managed six
other registered investment companies with total assets of $8,238,000,000, as of
December 31, 2004, and two other pooled investment vehicles with total assets of
$9,277,800,000, as of December 31, 2004.
B-35
Kenneth E. Volpert managed the Institutional Total Bond Market Index Fund,
which, as of December 31, 2004, held assets of $1,170,000,000. Mr. Volpert also
managed four other registered investment companies with total assets of
$43,080,600,000, 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.
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,
the portfolio managers did not own any shares of the Institutional Index Funds
they managed.
B-36