-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, N+B8FqwW6W3Cov9pQWJug/XDD04lO7Q7w+qdxyOcr2tUGNMgLkkVOD8nckPqECR1 NBF3G75WD00SCESjvz5Qbg== 0000893220-98-001111.txt : 19980619 0000893220-98-001111.hdr.sgml : 19980618 ACCESSION NUMBER: 0000893220-98-001111 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19980430 FILED AS OF DATE: 19980617 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD/WINDSOR FUNDS INC CENTRAL INDEX KEY: 0000107606 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 510082711 STATE OF INCORPORATION: DE FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: N-30D SEC ACT: SEC FILE NUMBER: 811-00834 FILM NUMBER: 98649732 BUSINESS ADDRESS: STREET 1: PO BOX 2600 STREET 2: V37 CITY: VALLEY FORGE STATE: PA ZIP: 19482 BUSINESS PHONE: 6106696289 MAIL ADDRESS: STREET 1: PO BOX 2600 STREET 2: V37 CITY: VALLEY FORGE STATE: PA ZIP: 19482 FORMER COMPANY: FORMER CONFORMED NAME: WINDSOR FUNDS INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: WINDSOR FUNDS DATE OF NAME CHANGE: 19851031 FORMER COMPANY: FORMER CONFORMED NAME: WINDSOR FUND INC DATE OF NAME CHANGE: 19850424 - -----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, K9WoSmMhZYUmPNJWmT5N/U2JX4XvsLWvNtpG0feRQOX5OckDbds3EKcbOkqFUW+z +XyXdEbAQwG+aQOoqsOlng== 0000893220-98-001111.txt : 19980618 0000893220-98-001111.hdr.sgml : 19980618 ACCESSION NUMBER: 0000893220-98-001111 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19980430 FILED AS OF DATE: 19980617 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: VANGUARD/WINDSOR FUNDS INC CENTRAL INDEX KEY: 0000107606 STANDARD INDUSTRIAL CLASSIFICATION: [] IRS NUMBER: 510082711 STATE OF INCORPORATION: DE FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: N-30D SEC ACT: SEC FILE NUMBER: 811-00834 FILM NUMBER: 98649732 BUSINESS ADDRESS: STREET 1: PO BOX 2600 STREET 2: V37 CITY: VALLEY FORGE STATE: PA ZIP: 19482 BUSINESS PHONE: 6106696289 MAIL ADDRESS: STREET 1: PO BOX 2600 STREET 2: V37 CITY: VALLEY FORGE STATE: PA ZIP: 19482 FORMER COMPANY: FORMER CONFORMED NAME: WINDSOR FUNDS INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: WINDSOR FUNDS DATE OF NAME CHANGE: 19851031 FORMER COMPANY: FORMER CONFORMED NAME: WINDSOR FUND INC DATE OF NAME CHANGE: 19850424 N-30D 1 VANGUARD WINDSOR FUNDS SEMI ANNUAL REPORT 1998 1 VANGUARD/ WINDSOR FUND Semiannual Report - April 30, 1998 [PHOTO] [THE VANGUARD GROUP LOGO] 2 OUR CREW MAKES THE DIFFERENCE Throughout our history, The Vanguard Group has received considerable attention as the low-cost provider of mutual funds. While such accolades are gratifying, we are most proud, not of our low operating expenses or the billions of dollars we manage, but of our sterling reputation created by the Vanguard crew. We recognize that it is our crew members--more than 7,000 highly motivated men and women--who form the cornerstone of our operations. We could not survive long--let alone prosper--without them. That's why we chose this fiscal year's fund reports to celebrate the spirit, enthusiasm, and achievements of our crew. (We call those who work at Vanguard crew members, not employees, because they operate as a team to accomplish our mission of serving you, our clients.) But while we prize the collective contributions of our crew, we also take time to recognize the importance of the individual. Each calendar quarter, we present our Award For Excellence to a handful of crew members who have demonstrated particular excellence in the performance of their jobs and who embody "The Vanguard Spirit." Our report cover shows only a few of the more than 300 crew members who have received this distinction since 1984. They, along with the rest of our valiant crew, look forward to serving you in the years ahead. [PHOTO] [PHOTO] John C. Bogle John J. Brennan Senior Chairman Chairman & CEO CONTENTS A MESSAGE TO OUR SHAREHOLDERS ............ 1 THE MARKETS IN PERSPECTIVE ............... 5 REPORT FROM THE ADVISER .................. 7 PERFORMANCE SUMMARY ...................... 9 PORTFOLIO PROFILE ........................ 10 FINANCIAL STATEMENTS ..................... 12
All comparative mutual fund data are from Lipper Analytical Services, Inc., or Morningstar unless otherwise noted. 3 FELLOW SHAREHOLDER, The U.S. stock market's record-shattering rise continued during the six months ended April 30, 1998, the first half of Vanguard/Windsor Fund's 1998 fiscal year. Your Fund earned +17.6% in the period, a return that, while superb on an absolute basis and fully competitive with our peers, fell short of the remarkable gain in the overall market. The adjacent table compares Windsor's total return (capital change plus reinvested dividends) for the six-month period with those of the average value (growth and income) mutual fund and the unmanaged Standard & Poor's 500 Composite Stock Price Index, which is dominated by large-capitalization stocks.
- - ---------------------------------------------- TOTAL RETURNS SIX MONTHS ENDED APRIL 30, 1998 - - ---------------------------------------------- Vanguard/Windsor Fund +17.6% - - ---------------------------------------------- Average Value Fund +17.9% - - ---------------------------------------------- S&P 500 Index +22.5% - - ----------------------------------------------
The Fund's return is based on a decrease in net asset value from $19.55 per share on October 31, 1997, to $19.50 per share on April 30, 1998, with the latter figure adjusted for a dividend of $0.12 per share paid from net investment income and a distribution of $2.88 per share paid from net realized capital gains. Both payments were made on December 17, 1997. THE PERIOD IN REVIEW The U.S. economy's performance during the six months ended April 30 was, quite simply, astounding. After growing by nearly 4% in 1997, the economy expanded at a 4.8% annual pace in the January-March period, even though a stronger U.S. dollar and economic turmoil in Asia began to crimp U.S. exports and to boost sales of imported goods. The nation's unemployment rate fell to 4.3% in April, its lowest level in more than 28 years. Remarkably, the strong job market and robust economic growth did not push up prices; key inflation measures actually showed a slowing in price increases. Financial markets flourished in this ideal environment. Interest rates declined by roughly 20 basis points (0.20 percentage point) on balance during the six months, engendering modest price increases in bonds. The Lehman Brothers Aggregate Bond Index, a good measure of the overall taxable bond market, returned +3.6%. The yield on 3-month U.S. Treasury bills was 4.97% on April 30, nearly one-quarter percentage point below the 5.20% level at which it began the half-year. In the stock market, investor confidence--some would say overconfidence--was evident, as prices surged despite lackluster growth in corporate profits and uncertainty about how Asia's financial and economic woes would affect the U.S. economy. The S&P 500 Index rose every month of the period, and its six-month total return of +22.5% was equal to approximately two years' worth of returns at the stock market's long-term annual average of about +11%. In such gaudy company, Windsor Fund's +17.6% return admittedly appears somewhat pale, although it was in line with the +17.9% earned by the average value fund. The main reason that Windsor--and its value peers, for that matter--trailed the Index was that large-cap growth stocks dominated the S&P 500's performance during the period. The Index's growth component earned +25.1%, fully one-quarter more than the +19.8% return on its value component. Although growth stocks--those selling at relatively high 1 4 prices in relation to such measures as book value, dividends, and past earnings--have held sway for most of the past three years, we note that over very long periods, returns on value and growth stocks have been remarkably similar. Though we have no idea when the tide will turn, we fully expect that value stocks will "return to fight again." During the period, we were hurt in comparison with the S&P 500 Index by our relatively large stakes in cyclical stocks--those whose earnings are considered to be especially vulnerable to an economic slowdown, which some investors are anticipating. We were overweighted versus the Index in three cyclical sectors whose returns lagged the overall market: materials & processing (23% of the Fund on average versus 6% of the Index), auto & transportation (10% versus 4%), and producer durables (13% versus 4%). Also, returns on our stock selections lagged the market return within the materials & processing and health-care sectors, which more than offset our good stock selection in the auto and utilities groups. The long-standing investment strategy followed by the Fund's adviser, Wellington Management Company, is to take relatively large positions in stocks and industry sectors that are currently out of favor with most investors. This strategy has often resulted in returns that diverge significantly from the returns of the overall market over periods of a year or even longer. In addition, the general level of stock prices can move substantially over short periods--and not always on the upside. Given these wide interim variations in market leadership, to say nothing of wide variations in market levels, Windsor Fund shareholders--and investors in stock funds generally--should maintain a long-term horizon. IN SUMMARY Stock investors have enjoyed truly historic gains in recent years. The S&P 500 Index produced a cumulative return just shy of +130% in the three years ended April 30, 1998, an annualized return of +32%--nearly three times the long-term annual return on U.S. stocks. Such outsized returns cannot be expected to continue indefinitely. Indeed, investors in stocks are sure to encounter downturns--possibly severe ones--from time to time. Because the risks of stocks--like their returns--can be sizable, we recommend that investors hold balanced portfolios of stock funds, bond funds, and money market funds in proportions suitable to each person's financial situation, investment goals, and attitude toward risk. Such a balanced portfolio should help investors to "stay the course" toward their investment objectives, whether the financial markets provide smooth or stormy sailing. /s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN John C. Bogle John J. Brennan Senior Chairman Chairman and Chief Executive Officer May 12, 1998 2 5 Notice To Shareholders At a special meeting on May 1, 1998, shareholders of Vanguard/Windsor Fund overwhelmingly approved five proposals. The proposals and voting results were: 1. REORGANIZATION INTO A DELAWARE BUSINESS TRUST. This change will reduce the amount of state taxes the Fund pays annually by more than $1.6 million. Approved by 97.84% of the shares voted, as follows:
----------------------------------------------------------- FOR AGAINST ABSTAIN ----------------------------------------------------------- 764,637,561 8,316,973 8,557,149 -----------------------------------------------------------
2a. INVESTMENT LIMITATION CHANGES--INTERFUND LENDING PROGRAM. Permits Windsor Fund to participate in Vanguard's interfund lending program, which allows funds to loan money to each other if--and only if--it makes good financial sense to do so on both sides of the transaction. The interfund lending program won't be an integral part of your Fund's investment program; it is a contingency arrangement for managing unusual cash flows. Approved by 95.84% of the shares voted, as follows:
----------------------------------------------------------- FOR AGAINST ABSTAIN ----------------------------------------------------------- 748,974,361 19,625,341 12,911,981 -----------------------------------------------------------
2b. INVESTMENT LIMITATION CHANGES--BORROWING MONEY AND PLEDGING ASSETS. This change sets standard limits of 15% of net assets on the amount of money Vanguard funds can borrow from all sources and on the amount of assets that can be pledged to secure any loans. Approved by 93.96% of the shares voted, as follows:
----------------------------------------------------------- FOR AGAINST ABSTAIN ----------------------------------------------------------- 734,337,719 32,561,305 14,612,660 -----------------------------------------------------------
2c. INVESTMENT LIMITATION CHANGES--INVESTMENTS IN SECURITIES OWNED BY AFFILIATES. This change eliminated a Fund policy of avoiding investments in securities that are owned in certain amounts by Directors, officers, and key advisory personnel. This policy was well-intentioned but wrongly focused and unnecessary in light of the Fund's Code of Ethics and other regulatory protections against conflicts of interest on the part of Fund management. Approved by 95.19% of the shares voted, as follows:
----------------------------------------------------------- FOR AGAINST ABSTAIN ----------------------------------------------------------- 743,939,195 24,139,563 13,432,926 -----------------------------------------------------------
(continued on next page) 3 6 2d. INVESTMENT LIMITATION CHANGES--INVESTMENTS IN ASSESSABLE SECURITIES. This change eliminated a long-standing, arcane Fund policy of not purchasing assessable securities. Such securities are not a factor in today's world of publicly traded securities, where the Fund's investments are focused. Approved by 95.50% of the shares voted, as follows:
----------------------------------------------------------- FOR AGAINST ABSTAIN ----------------------------------------------------------- 746,377,274 21,770,503 13,363,906 -----------------------------------------------------------
4 7 THE MARKETS IN PERSPECTIVE Six Months Ended April 30, 1998 Financial markets, it is said, don't like surprises. But when the surprises are positive--remarkably strong economic growth coupled with conspicuously tame inflation--the markets seem to cope quite nicely. So it was during the half-year ended April 30, when the good times kept rolling for U.S. stock and bond markets. The stock market produced half-year returns that would have been excellent even for a full year. The bond market, helped by lower interest rates, generated solid returns. Plentiful jobs--the nation's unemployment rate fell in April to a 28-year low of 4.3%--and rising wages clearly put American households in a buying mood. (The stock market's big gains, by pumping up millions of families' investment accounts, certainly didn't dampen spirits either.) With strong spending by consumers leading the way, the U.S. economy grew at an annual rate of about 4%, even after adjusting for inflation. Although most economists believe that sustained growth in excess of 3% is bound to be inflationary, evidence to support the theory has been scarce of late. Consumer prices rose just 0.6% during the six months, and the Consumer Price Index was up a relatively benign 1.4% for the 12 months ended April 30, 1998. Wholesale prices declined 1.2% during the past year. Stiff competitive pressure, including an increasing flow of imported products and materials, appears to be keeping the lid on prices, despite the bubbling economy.
- - --------------------------------------------------------------------------------------------- TOTAL RETURNS PERIODS ENDED APRIL 30, 1998 ------------------------------------------ 6 MONTHS 1 YEAR 5 YEARS* - - --------------------------------------------------------------------------------------------- EQUITY S&P 500 Index 22.5% 41.1% 23.2% Russell 2000 Index 11.9 42.4 18.5 MSCI EAFE Index 15.6 19.2 10.4 - - --------------------------------------------------------------------------------------------- FIXED INCOME Lehman Aggregate Bond Index 3.6% 10.9% 6.9% Lehman 10-Year Municipal Bond Index 2.5 9.0 6.6 Salomon Brothers Three-Month U.S. Treasury Bill Index 2.6 5.3 4.9 - - --------------------------------------------------------------------------------------------- OTHER Consumer Price Index 0.6% 1.4% 2.4% - - --------------------------------------------------------------------------------------------- *Annualized.
Economic troubles in Asia--where currency and banking crises are afflicting several nations--have resulted in lower prices for many imported goods and are being blamed by some U.S. companies for cutting into profits. But Asia's problems haven't spooked U.S. consumers and investors, and have only slightly slowed the domestic economy's powerful momentum. U.S. EQUITY MARKETS Wall Street sprinted to record heights during the half-year. The gains were broad-based, although the big blue chip stocks again led the way. Large-capitalization stocks, as represented by the S&P 500 Index, returned 22.5%, nearly double the 11.9% return on the small-cap Russell 2000 Index. Lower interest rates supported stock prices by making interest-bearing investments relatively less attractive to investors looking for a place to put new cash. The good inflation news helped, too. Even so, the size of the market's gains was surprising in light of an evident slowing in the growth rate for corporate profits. Since November, analysts have been reducing their estimates of future corporate earnings, and actual profits reported 5 8 for the January-March quarter were only modestly above those of first-quarter 1997. If corporate earnings growth does not accelerate, stocks may lose some of their allure. Health-care stocks were the market's best-performing sector during the period, as a number of hot-selling new drugs and exciting potential therapies heightened interest in pharmaceutical companies. Also, some health-maintenance organization stocks rebounded from depressed levels. The only sectors that didn't post double-digit gains during the half-year were integrated oil companies (up 9.5%) and the "other energy" group, which includes oil-services and exploration firms (down 3.5%). Lower energy prices--a key factor in inflation's good behavior--explained the weakness in energy stocks. U.S. FIXED-INCOME MARKETS Fixed-income investors earned the coupon rates on their bonds during the half-year, and saw a modest rise in the prices of their holdings, thanks to declining interest rates. The Lehman Aggregate Bond Index, a good measure of the overall market for taxable bonds, provided a 3.6% return for the six months, bringing its total return over the past 12 months to 10.9%, a superb inflation-adjusted return of 9.5%. The yield on the benchmark 30-year U.S. Treasury bond decreased from 6.15% on October 31, 1997, to 5.95% on April 30. A rate decline of 20 basis points in the face of such strong economic growth was possible because inflation--the enemy of the fixed-income investor--was so weak during the six months. Short-term interest rates also declined, although the Federal Reserve Board made no policy changes. The yield on 3-month U.S. Treasury bills fell from 5.20% on October 31 to 4.97% on April 30, at least partly because it became clear that the federal government would run a sizable budget surplus, which will reduce the Treasury's need to borrow and, therefore, reduce the supply of new Treasury securities. INTERNATIONAL EQUITY MARKETS Europe's stock markets were even hotter than Wall Street during the first half of fiscal 1998, while most Asian markets declined in U.S. dollar terms. Overall, the Morgan Stanley Capital International Europe, Australasia, Far East Index gained 15.6% in U.S. dollar terms. The Index returned 21.3% in local currency terms, but a generally stronger U.S. dollar cut the result for U.S. investors. European markets were buoyed by a variety of factors and rose 33.6% in local-currency terms. The dollar's gains against European currencies diminished the return for U.S. investors only slightly to a still-exceptional 29.2%. The markets benefited from signs that the economic slump on the continent is ending, from evidence that corporate managements are adopting a U.S.-style emphasis on adding shareholder value, and from increasing confidence that the planned adoption of the euro--a single European currency--would begin as planned in January 1999. The Pacific region's experience was very different. Although some emerging markets (Malaysia, Thailand, South Korea) rebounded from their lows, stock returns for the region on balance fell 8.8% in U.S.-dollar terms. Japan, by far the Pacific Rim's largest market, was beset by economic recession and dropped 10.0%, while Hong Kong fell 9.6%. Investors in Tokyo were decidedly unimpressed with the Japanese government's program for reviving the economy and dealing with the problems of the nation's banking system. Emerging markets, as a group, returned 5.6% in dollar terms. Gains in Greece (50.0%), Hungary (30.1%), Brazil (16.6%), and Argentina (13.7%) more than offset weakness in Asian emerging markets, most notably Indonesia (down a stunning 61.4%). 6 9 REPORT FROM THE ADVISER Vanguard/Windsor Fund's return during the first half of the fiscal year trailed the S&P 500 Index's return, 17.6% to 22.5%, and essentially matched the 17.4% return of the average growth and income fund (not including S&P 500 Index funds). When the period is broken into fiscal quarters, the results are what you see at right.
- - ----------------------------------------------------------------------------- TOTAL RETURNS THREE MONTHS ENDED -------------------------------------- JANUARY 31, 1998 APRIL 30, 1998 - - ----------------------------------------------------------------------------- Vanguard/Windsor Fund 2.4% 14.9% - - ----------------------------------------------------------------------------- S&P 500 Index 7.6% 13.8% - - ----------------------------------------------------------------------------- Average Growth and Income Fund* 4.5% 12.4% - - ----------------------------------------------------------------------------- *Excludes S&P 500 Index Funds.
Our relatively poor first quarter reflects the impact of the Asian financial and economic crisis on the Fund, particularly our overweighted position in cyclical stocks, which underperformed in this period. In the second quarter, the market became more comfortable with cyclicals, and we had a chance to recoup some of the first-quarter shortfall. Our noncyclical concentrations were, for the most part, good relative performers for the six-month period, e.g., financials, telephone, and cable stocks. For the 28 months since we took the reins of the Fund at the beginning of 1996, we rank third of the sixteen largest actively managed growth, growth-and-income, and capital appreciation mutual funds, while trailing the S&P, +77.0% versus +88.7%. The S&P 500's price/earnings ratio--now at 24.4 times estimated 1998 earnings--continues to be surprisingly high. The long-term average P/E ratio for the Index is about 15. Even when adjusted for the relatively low level of interest rates, the current P/E is about 15%-20% higher than the level that the historical relationship with long-term interest rates would indicate. There are many who argue that interest rates are headed lower, which would better justify current stock prices. But we doubt rates are going lower. The domestic economy is too strong for that, even when the full impact of the Asian crisis is felt later this year. We expect the economy to continue to grow at an annual pace of 3%-plus, even after subtracting 1 percentage point for Asia. Our forecast assumes that consumer spending, which accounts for two-thirds of our economy, will grow in line with increases in disposable income, which is expanding at a 4% rate, after adjusting for inflation. Growth could be faster than we expect if there is also a "wealth effect" on consumer spending from the booming stock market and lofty mortgage refinancing activity. If the economy continues to grow at 3% or better, wage inflation will pick up, unless labor productivity accelerates. But figures for the January-March quarter show that productivity is improving at only a 0.2% pace and that unit-labor costs rose at a 3.8% annual rate for the second quarter in a row. This is clearly problematic and 7 10 will show up in higher inflation at the consumer level, in the form of downward pressure on corporate profits, or both. We think these concerns have to get to the stock market at some point, especially with the P/E ratio so high. So, if the market is headed lower, what is our strategy? In a broad way, we are counting on the relative cheapness of our stocks to cushion the downside if and when the market finally corrects. Our holdings are trading at prices equal to about 16 times our estimates of 1998 earnings, a 35% discount to the market's P/E. Our P/E is an even-lower 13--and the discount an even-greater 45%--when based on the earnings that we actually use for our price targets (the difference in earnings calculations is mostly based on the adding back of goodwill amortization, a phony charge against earnings). Also, while we are still fully invested, as is our commitment--with 96% of our assets in equities, to be precise--we have, at the margin, been buying more defensive merchandise, as the market has moved further away from fair value as we see it. In the past two or three months, this defensive posture has been manifested by a new 2% position in real estate investment trusts (REITs) and a 3% addition to our energy position. Importantly, though, while we are looking for defensive names, we insist that they have an "offensive" aspect. We will continue to pass on consumer nondurables, local telephone companies, electric utilities, and other overpriced "sleep well" stocks, where the total-return-to-P/E relationship doesn't make sense to us. Thus, while the REITs we've bought yield 5.5%-7%, they are also growing 10% annually. And the energy addition is mostly in domestic companies whose production is tilted toward natural gas, which our analysis pegs as the most dynamic part of the oil patch. Our goal remains to deliver to you a full plate of equities that can generate unusual returns, and whose return prospects outweigh the underlying investment risks. Charles T. Freeman, Portfolio Manager Wellington Management Company, LLP May 13, 1998 INVESTMENT PHILOSOPHY The adviser believes that superior long-term investment results can be achieved by emphasizing common stocks that are generally misunderstood, out of favor, or undervalued by fundamental measures such as price/earnings ratio or dividend yield. The adviser will concentrate a large portion of the Fund's assets in those securities it believes offer the best return potential. 8 11 PERFORMANCE SUMMARY All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the Fund. Note, too, that both share price and return can fluctuate widely, so an investment in the Fund could lose money.
WINDSOR FUND TOTAL INVESTMENT RETURNS: OCTOBER 31, 1977-APRIL 30, 1998 - - --------------------------------------------------------------------- WINDSOR FUND S&P 500 FISCAL CAPITAL INCOME TOTAL TOTAL YEAR RETURN RETURN RETURN RETURN - - --------------------------------------------------------------------- 1978 6.2% 5.0% 11.2% 6.3% 1979 13.5 6.0 19.5 15.3 1980 17.2 7.0 24.2 32.1 1981 11.1 6.9 18.0 0.6 1982 14.2 7.0 21.2 16.3 1983 25.3 7.3 32.6 27.8 1984 9.6 6.9 16.5 6.3 1985 16.6 6.7 23.3 19.4 1986 22.8 6.5 29.3 33.2 1987 2.7 1.9 4.6 6.4 1988 18.9 8.1 27.0 14.8 1989 11.9 5.2 17.1 26.4 1990 -31.8 3.9 -27.9 -7.5 1991 35.7 9.0 44.7 33.5 1992 4.3 5.0 9.3 10.0 1993 24.6 3.7 28.3 14.9 1994 3.7 2.6 6.3 3.9 1995 14.2 3.6 17.8 26.4 1996 19.6 3.6 23.2 24.1 1997 24.3 2.7 27.0 32.1 1998* 16.9 0.7 17.6 22.5 - - ---------------------------------------------------------------------
*Six months ended April 30, 1998. See Financial Highlights table on page 17 for dividend and capital gains information for the past five years.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 1998* - - ----------------------------------------------------------------------------------------------------------------------- 10 YEARS INCEPTION -------------------------------------- DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL - - ----------------------------------------------------------------------------------------------------------------------- Windsor Fund 10/23/1958 33.05% 19.91% 12.12% 4.34% 16.46% - - -----------------------------------------------------------------------------------------------------------------------
*SEC rules require that we provide this average annual total return information through the latest calendar quarter. 9 12 PORTFOLIO PROFILE Windsor Fund This Profile provides a snapshot of the Fund's characteristics as of April 30, 1998, compared where appropriate to an unmanaged index. Key elements of this Profile are defined on page 11.
PORTFOLIO CHARACTERISTICS - - ----------------------------------------------------------------------- WINDSOR S&P 500 - - ----------------------------------------------------------------------- Number of Stocks 125 500 Median Market Cap $8.7B $44.0B Price/Earnings Ratio 16.7x 24.4x Price/Book Ratio 2.5x 4.4x Yield 1.3% 1.5% Return on Equity 13.9% 21.3% Earnings Growth Rate 13.3% 16.2% Foreign Holdings 8.2% 1.9% Turnover Rate 44%* -- Expense Ratio 0.28%* -- Cash Reserves 3.7% --
*Annualized. INVESTMENT FOCUS - - ----------------------------------------------------------------------- [GRAPH]
VOLATILITY MEASURES - - ----------------------------------------------------------------------- WINDSOR S&P 500 - - ----------------------------------------------------------------------- R-Squared 0.67 1.00 Beta 0.78 1.00
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) - - ------------------------------------------------------------------ Citicorp 5.9% First Union Corp. 4.1 Rhone-Poulenc SA 3.7 Columbia/HCA Healthcare Corp. 3.5 Aluminum Co. of America 3.2 AT&T Corp. 2.8 The Boeing Co. 2.8 Delta Air Lines, Inc. 2.7 Caterpillar, Inc. 2.7 Burlington Resources, Inc. 2.5 - - ------------------------------------------------------------------ Top Ten 33.9%
SECTOR DIVERSIFICATION (% OF COMMON STOCK) - - ----------------------------------------------------------------------------------------------------------------- APRIL 30, 1997 APRIL 30, 1998 ------------------------------------------------------------------------ WINDSOR WINDSOR S&P 500 ------------------------------------------------------------------------ Auto & Transportation 12.4% 8.0% 3.2% Consumer Discretionary 1.5 0.4 9.9 Consumer Staples 0.0 0.0 10.4 Financial Services 20.5 21.7 18.4 Health Care 1.9 12.7 11.8 Integrated Oils 6.8 4.0 6.8 Other Energy 3.3 6.4 1.2 Materials & Processing 25.1 19.5 5.8 Producer Durables 7.4 12.0 4.0 Technology 12.3 4.4 12.6 Utilities 7.8 7.0 10.2 Other 1.0 3.9 5.7 - - -----------------------------------------------------------------------------------------------------------------
10 13 BETA. A measure of the magnitude of a portfolio's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a portfolio with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. CASH RESERVES. The percentage of a portfolio's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a portfolio. EXPENSE RATIO. The percentage of a portfolio'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 portfolio's net assets represented by stocks or American Depositary Receipts of companies based outside the United States. INVESTMENT FOCUS. This grid indicates the focus of a portfolio in terms of two attributes: market capitalization (large, medium, or small) and relative valuation (growth, value, or a blend). MEDIAN MARKET CAP. An indicator of the size of companies in which a portfolio invests; the midpoint of market capitalization (market price x shares outstanding) of a portfolio's stocks, weighted by the proportion of the portfolio's assets invested in each stock. Stocks representing half of the portfolio's assets have market capitalization above the median, and the rest are below it. NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio holds, the more diversified it is and the more likely to perform in line with the overall stock market. PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a portfolio, 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 portfolio, 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 portfolio's past returns can be explained by the returns from the overall market (or its benchmark index). If a portfolio's total return were precisely synchronized with the overall market's return, its R-squared would be 1.00. If a portfolio's returns bore no relationship to the market'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 portfolio, the weighted average return on equity for the companies whose stocks it holds. SECTOR DIVERSIFICATION. The percentages of a portfolio's common stocks that come from each of the major industry groups that compose the stock market. TEN LARGEST HOLDINGS. The percentage of net assets that a portfolio has invested in its ten largest holdings. (The average for stock mutual funds is about 30%.) As this percentage rises, a portfolio's returns are likely to be more volatile, because they are more dependent on the fortunes of a few companies. TURNOVER RATE. An indication of trading activity during the period. Portfolios with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). YIELD. A snapshot of a portfolio's income from interest and dividends. The yield, expressed as a percentage of the portfolio'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 dividends paid on stocks in the index. 11 14 FINANCIAL STATEMENTS April 30, 1998 (unaudited) 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, preferred 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 on both a dollar and per-share basis. 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. 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* WINDSOR FUND SHARES (000) - - --------------------------------------------------------------------- COMMON STOCKS (94.8%) - - --------------------------------------------------------------------- AUTO & TRANSPORTATION (7.5%) - - -(1) America West Holdings Corp. Class B 2,692,300 $ 81,442 Chrysler Corp. 3,836,922 154,196 Compagnie Generale des Establissements Michelin B Shares 7,474,400 470,615 - - - Continental Airlines, Inc. Class B 550,600 32,417 (1) Delta Air Lines, Inc. 5,374,861 624,828 Ford Motor Co. 4,932,653 225,977 The Goodyear Tire & Rubber Co. 180,400 12,628 - - - Northwest Airlines Corp. Class A 2,898,700 152,182 ----------- 1,754,285 ----------- CONSUMER DISCRETIONARY (0.4%) - - - BJ's Wholesale Club, Inc. 372,000 14,903 - - -(1) HomeBase, Inc. 2,487,900 20,836 (1) Unisource Worldwide, Inc. 4,920,200 62,425 ----------- 98,164 ----------- FINANCIAL SERVICES (20.6%) Allstate Corp. 544,500 52,408 CIGNA Corp. 2,321,700 480,447 (1) Camden Property Trust REIT 2,450,100 71,819 Canadian Imperial Bank of Commerce 4,665,700 165,341 Citicorp 9,133,500 1,374,592 Equity Residential Properties Trust REIT 3,124,900 153,511 First Union Corp. 15,916,498 960,959 (1) Golden West Financial Corp. 5,221,100 549,847 (1) IPC Holdings Ltd. 1,689,700 54,704 Liberty Property Trust REIT 3,747,200 95,788 NationsBank Corp. 4,997,218 378,539 (1) The PMI Group Inc. 2,092,600 170,024 PartnerRe Ltd. 2,116,200 105,942 Washington Federal Inc. 143,220 4,028 Washington Mutual, Inc. 2,279,043 159,675 ----------- 4,777,624 ----------- HEALTH CARE (12.0%) Aetna Inc. 4,789,500 387,051 Columbia/HCA Healthcare Corp. 24,726,000 814,413 - - -(1) Foundation Health Systems Class A 7,267,660 210,308 - - -(1) Pacificare Health Systems Inc. Class A 1,126,300 79,123 - - - Pacificare Health Systems Inc. Class B 1,957,500 140,206 Pharmacia & Upjohn, Inc. 6,762,200 284,435 Rhone-Poulenc SA ADR 17,480,152 865,268 Rhone-Poulenc SA Class A 102,071 4,988 ----------- 2,785,792 ----------- INTEGRATED OILS (3.8%) (1) Cabot Oil & Gas Corp. Class A 2,255,200 52,856 (1) Lyondell Petrochemical Co. 9,188,803 302,082 Murphy Oil Corp. 1,573,200 80,921 USX-Marathon Group 12,684,100 454,249 ----------- 890,108 ----------- OTHER ENERGY (6.0%) Apache Corp. 5,154,700 182,348 (1) Burlington Resources, Inc. 12,150,200 571,059 Diamond Offshore Drilling, Inc. 1,004,000 50,828 - - -(1) EEX Corp. 7,445,497 72,128 Pioneer Natural Resources Co. 2,536,000 60,706 Transocean Offshore, Inc. 3,497,000 195,395
12 15
- - --------------------------------------------------------------------- MARKET VALUE* SHARES (000) - - --------------------------------------------------------------------- (1) Ultramar Diamond Shamrock Corp. 5,555,100 $ 179,499 Valero Energy Corp. 2,832,600 91,705 ----------- 1,403,668 ----------- MATERIALS & PROCESSING (18.5%) (1) AK Steel Corp. 6,199,352 130,186 Abitibi-Consolidated, Inc. 10,000,000 148,750 (1) Albany International Corp. 2,400,000 68,400 Alcan Aluminium Ltd. 3,891,900 126,487 Alumax, Inc. 2,384,600 117,740 (1) Aluminum Co. of America 9,553,300 740,381 (1) Bowater Inc. 2,897,780 162,095 - - -(1) Burlington Industries, Inc. 3,986,700 69,767 Centex Construction Products, Inc. 335,900 12,344 (1) Century Aluminum Co. 2,000,000 33,875 (1) Champion International Corp. 6,494,000 349,458 Deltic Timber Corp. 538,171 15,372 (1) Geon Co. 2,480,000 59,210 (1) Georgia Gulf Corp. 3,705,300 95,180 (1) Georgia Pacific Group 5,858,800 452,226 (1) IMC Global Inc. 11,042,280 397,522 - - - IMC Global Warrants Exp. 12/22/2000 644,066 2,979 Jefferson Smurfit Group PLC ADR 2,349,460 86,343 - - -(1) Kaiser Aluminum & Chemical Corp. 5,929,334 61,887 Lafarge Corp. 2,045,800 81,832 (1) Mississippi Chemical Corp. 1,934,800 35,068 Owens Corning 663,000 27,556 Pechiney SA ADR A 2,831,628 62,473 (1) Phosphate Resources Partners Ltd. 8,973,200 59,447 (1) Reynolds Metals Co. 6,702,548 442,368 - - - Ryerson Tull, Inc. Class A 1,411,100 28,751 - - -(1) Stone Container Corp. 9,470,000 155,071 Terra Industries, Inc. 3,165,700 34,031 (1) The Timber Company 9,139,900 234,210 ----------- 4,291,009 ----------- PRODUCER DURABLES (11.4%) - - - Beazer Homes USA, Inc. 171,900 4,190 The Boeing Co. 13,057,500 653,691 (1) Case Corp. 7,242,500 460,351 Caterpillar, Inc. 10,881,700 619,577 - - - CommScope, Inc. 1,782,500 28,966 Deere & Co. 3,527,900 206,162 - - -(1) General Semiconductor, Inc. 2,912,500 39,865 (1) Kaufman & Broad Home Corp. 1,977,500 57,471 Lincoln Electric Co. 139,200 6,577 Lincoln Electric Co. Class A 342,100 16,036 (1) MDC Holdings, Inc. 1,156,300 19,874 New Holland NV 5,193,400 127,238 Northrop Grumman Corp. 2,123,700 224,449 Tektronix, Inc. 1,672,200 71,905 - - -(1) Toll Brothers, Inc. 2,175,066 60,630 - - -(1) U.S. Home Corp. 1,149,296 47,696 ----------- 2,644,678 ----------- TECHNOLOGY (4.1%) - - -(1) Advanced Micro Devices, Inc. 9,135,200 253,502 Avnet, Inc. 632,000 38,987 - - -(1) General Instrument Corp. 14,570,000 326,914 (1) Scientific-Atlanta, Inc. 7,716,400 184,229 - - - Seagate Technology 5,858,216 156,341 ----------- 959,973 ----------- UTILITIES (6.7%) AT&T Corp. 10,935,000 656,783 (1) Comcast Corp. Class A 2,884,900 100,791 Comcast Corp. Class A Special 5,921,200 212,053 - - - Cox Communications Class A 2,787,100 124,374 MCI Communications Corp. 6,250,000 314,453 Sprint Corp. 2,061,500 140,826 ----------- 1,549,280 ----------- OTHER (3.8%) Kemira Oy ADR 3,982,500 85,624 Miscellaneous (3.4%) 778,954 ----------- 864,578 ----------- - - --------------------------------------------------------------------- TOTAL COMMON STOCKS (COST $16,486,433) 22,019,159 - - --------------------------------------------------------------------- PREFERRED STOCKS (1.3%) - - --------------------------------------------------------------------- News Corp. Ltd. ADR 6,666,700 155,417 - - - Petroleo Brasileiro SA ADR 5,593,000 140,524 - - --------------------------------------------------------------------- TOTAL PREFERRED STOCKS (COST $243,555) 295,941 - - --------------------------------------------------------------------- CONVERTIBLE PREFERRED STOCKS (0.2%) - - --------------------------------------------------------------------- Beazer Homes USA, Inc. 8.00% Cvt. Pfd. 370,000 12,303 Continental Airlines, Inc. Finance Trust 8.50% Cvt. Pfd. 175,000 21,678 Owens Corning Capital LLC 6.50% Cvt. Pfd. 200,000 10,713 - - --------------------------------------------------------------------- TOTAL CONVERTIBLE PREFERRED STOCKS (COST $30,877) 44,694 - - --------------------------------------------------------------------- FACE AMOUNT (000) - - --------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (4.5%) - - --------------------------------------------------------------------- COMMERCIAL PAPER American Express Credit Corp. 5.50%, 5/29/1998 $100,000 99,572 Associates Corp. NA 5.51%, 5/12/1998 75,000 74,874 Chevron USA 5.50%, 5/14/1998 35,000 34,930 Ford Motor Credit Co. 5.50%, 5/22/1998 50,000 49,840 General Electric Co. 5.51%, 5/22/1998 100,000 99,679 General Motors Acceptance Corp. 5.51%, 5/19/1998 100,000 99,724 International Business Machines Credit Corp. 5.50%, 5/27/1998 40,000 39,841
13 16
- - --------------------------------------------------------------------- FACE MARKET AMOUNT VALUE* WINDSOR FUND (000) (000) - - --------------------------------------------------------------------- Merrill Lynch & Co. 5.51%, 5/29/1998 $100,000 $ 99,571 MetLife Funding Inc. 5.538%, 5/20/1998 25,000 24,927 Motorola Inc. 5.50%, 5/14/1998 27,989 27,933 5.51%, 5/18/1998 20,000 19,948 Procter & Gamble Co. 5.50%, 5/27/1998 50,000 49,801 5.50%, 5/29/1998 10,000 9,957 Prudential Funding Corp. 5.50%, 5/15/1998 100,000 99,786 REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 5.52%, 5/1/1998--Note F 118,521 118,521 The First Boston Corporation (Dated 4/30/1998, Repurchase Value $105,972,000, Collateralized by U. S. Treasury Bond 11.875%, 11/15/2003) 5.48%, 5/1/1998 105,956 105,956 - - --------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (COST $1,054,862) 1,054,860 - - --------------------------------------------------------------------- TOTAL INVESTMENTS (100.8%) (COST $17,815,727) 23,414,654 - - --------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-0.8%) - - --------------------------------------------------------------------- Other Assets--Note C 90,873 Liabilities--Note F (284,628) ----------- (193,755) - - --------------------------------------------------------------------- NET ASSETS (100%) - - --------------------------------------------------------------------- Applicable to 1,190,972,416 outstanding $.01 par value shares (authorized 1,550,000,000 shares) $23,220,899 ===================================================================== NET ASSET VALUE PER SHARE $19.50 =====================================================================
* See Note A in Notes to Financial Statements. - Non-Income-Producing Security. (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 $8,200,654,000. ADR--American Depositary Receipt. REIT--Real Estate Investment Trust.
- - --------------------------------------------------------------------- AMOUNT PER (000) SHARE - - --------------------------------------------------------------------- AT APRIL 30, 1998, NET ASSETS CONSISTED OF: - - --------------------------------------------------------------------- Paid in Capital $16,003,449 $13.44 Undistributed Net Investment Income 66,128 .06 Accumulated Net Realized Gains 1,552,395 1.30 Unrealized Appreciation-- Note E 5,598,927 4.70 - - --------------------------------------------------------------------- NET ASSETS $23,220,899 $19.50 =====================================================================
14 17 STATEMENT OF OPERATIONS This Statement shows dividend and interest 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 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) on investments during the period.
- - -------------------------------------------------------------------------------------------------------- WINDSOR FUND SIX MONTHS ENDED APRIL 30, 1998 (000) - - -------------------------------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 129,471 Interest 20,676 ------------ Total Income 150,147 ------------ EXPENSES Investment Advisory Fees--Note B Basic Fee 13,138 Performance Adjustment (7,553) The Vanguard Group--Note C Management and Administrative 20,626 Marketing and Distribution 2,255 Taxes (other than income taxes) 801 Custodian Fees 84 Auditing Fees 5 Shareholders' Reports 160 Annual Meeting and Proxy Costs 153 Directors' Fees and Expenses 21 ------------ Total Expenses 29,690 Expenses Paid Indirectly--Note C (2,582) ------------ Net Expenses 27,108 - - -------------------------------------------------------------------------------------------------------- NET INVESTMENT INCOME 123,039 - - -------------------------------------------------------------------------------------------------------- REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD* 1,551,224 - - -------------------------------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 1,871,417 - - -------------------------------------------------------------------------------------------------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $3,545,680 ========================================================================================================
*Dividend income and realized net gain from affiliated companies were $33,951,000 and $156,333,000, respectively. 15 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 that is 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.
- - -------------------------------------------------------------------------------------------------------- WINDSOR FUND ------------------------------- SIX MONTHS YEAR ENDED ENDED APR. 30, 1998 OCT. 31, 1997 (000) (000) - - -------------------------------------------------------------------------------------------------------- INCREASE IN NET ASSETS OPERATIONS Net Investment Income $ 123,039 $ 357,653 Realized Net Gain 1,551,224 3,052,726 Change in Unrealized Appreciation (Depreciation) 1,871,417 887,426 -------------------------------- Net Increase in Net Assets Resulting from Operations 3,545,680 4,297,805 -------------------------------- DISTRIBUTIONS Net Investment Income (126,869) (402,197) Realized Capital Gain (3,044,991) (1,237,831) -------------------------------- Total Distributions (3,171,860) (1,640,028) -------------------------------- CAPITAL SHARE TRANSACTIONS1 Issued 819,446 2,267,286 Issued in Lieu of Cash Distributions 3,015,358 1,562,364 Issued in Exchange for Net Assets of Gemini II--Note G -- 263,239 Redeemed (1,665,794) (1,913,647) -------------------------------- Net Increase from Capital Share Transactions 2,169,010 2,179,242 - - -------------------------------------------------------------------------------------------------------- Total Increase 2,542,830 4,837,019 - - -------------------------------------------------------------------------------------------------------- NET ASSETS Beginning of Period 20,678,069 15,841,050 -------------------------------- End of Period $23,220,899 $20,678,069 ======================================================================================================== 1Shares Issued (Redeemed) Issued 44,774 123,045 Issued in Lieu of Cash Distributions 180,344 92,396 Issued in Exchange for Net Assets of Gemini II--Note G -- 13,730 Redeemed (92,001) (103,790) -------------------------------- Net Increase in Shares Outstanding 133,117 125,381 ========================================================================================================
16 19 FINANCIAL HIGHLIGHTS This table summarizes the Fund's investment results and distributions to shareholders on a per-share basis. It also presents the Fund's 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. Finally, the table lists the Fund's Average Commission Rate Paid, a disclosure required by the Securities and Exchange Commission beginning in 1996. This rate is calculated by dividing total commissions paid on portfolio securities by the total number of shares purchased and sold on which commissions were charged.
- - ------------------------------------------------------------------------------------------------------------------------- WINDSOR FUND YEAR ENDED OCTOBER 31, FOR A SHARE OUTSTANDING SIX MONTHS ENDED ----------------------------------------------------------- THROUGHOUT EACH PERIOD APRIL 30, 1998 1997 1996 1995 1994 1993 - - ------------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $19.55 $16.99 $15.55 $14.55 $14.95 $12.37 - - ------------------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .11 .36 .43 .44 .44 .37 Net Realized and Unrealized Gain on Investments 2.84 3.94 2.85 1.86 .42 2.98 ---------------------------------------------------------------------- Total from Investment Operations 2.95 4.30 3.28 2.30 .86 3.35 ---------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.12) (.41) (.46) (.44) (.37) (.39) Distributions from Realized Capital Gains (2.88) (1.33) (1.38) (.86) (.89) (.38) ---------------------------------------------------------------------- Total Distributions (3.00) (1.74) (1.84) (1.30) (1.26) (.77) - - ------------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $19.50 $19.55 $16.99 $15.55 $14.55 $14.95 ========================================================================================================================= TOTAL RETURN 17.64% 27.04% 23.16% 17.80% 6.35% 28.29% ========================================================================================================================= RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $23,221 $20,678 $15,841 $13,008 $11,406 $10,537 Ratio of Total Expenses to Average Net Assets 0.28%* 0.27% 0.31% 0.45% 0.45% 0.40% Ratio of Net Investment Income to Average Net Assets 1.14%* 1.89% 2.75% 3.01% 3.11% 2.68% Portfolio Turnover Rate 44%* 61% 34% 32% 34% 25% Average Commission Rate Paid $.0572 $.0576 $.0579 N/A N/A N/A - - -------------------------------------------------------------------------------------------------------------------------
*Annualized. 17 20 NOTES TO FINANCIAL STATEMENTS Vanguard/Windsor Fund is registered under the Investment Company Act of 1940 as a diversified open-end investment company, or mutual fund. A. The following significant accounting policies conform to generally accepted accounting principles for mutual funds. The Fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. 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. 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. 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. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 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. The basic fee is subject to quarterly adjustments based on performance relative to the S&P 500 Index. For the six months ended April 30, 1998, the advisory fee represented an effective annual basic rate of 0.12% of the Fund's average net assets before a decrease of $7,553,000 (0.07%) based on performance. 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 Directors. At April 30, 1998, the Fund had contributed capital of $1,324,000 to Vanguard (included in Other Assets), representing 6.6% of Vanguard's capitalization. The Fund's Directors and officers are also Directors and officers of Vanguard. Vanguard has asked the Fund's investment adviser to direct certain portfolio 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 administrative expenses. For the six months ended April 30, 1998, these arrangements reduced the Fund's expenses by $2,582,000 (an annual rate of 0.02% of average net assets). D. During the six months ended April 30, 1998, the Fund purchased $4,660,834,000 of investment securities and sold $5,837,762,000 of investment securities, other than temporary cash investments. 18 21 E. At April 30, 1998, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $5,598,927,000, consisting of unrealized gains of $5,915,632,000 on securities that had risen in value since their purchase and $316,705,000 in unrealized losses on securities that had fallen in value since their purchase. F. The market value of securities on loan to brokers/dealers at April 30, 1998, was $112,328,000, for which the Fund held cash collateral of $118,521,000. Cash collateral received is invested in repurchase agreements. G. On June 19, 1997, the Fund acquired Gemini II Fund's net assets pursuant to an agreement approved by Gemini II Fund's shareholders on June 18, 1997. The acquisition was accomplished by a tax-free exchange of 13,730,319 of the Fund's capital shares for the 9,232,207 outstanding Gemini II Fund shares on June 19, 1997. Gemini II Fund's net assets of $263,239,000, including $57,791,000 of unrealized appreciation, were combined with Windsor Fund's net assets of $19,820,772,000, resulting in combined net assets of $20,084,011,000 on the merger date. 19 22 DIRECTORS AND OFFICERS JOHN C. BOGLE Senior Chairman of the Board and Director of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. JOHN J. BRENNAN Chairman, Chief Executive Officer, and Director of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. ROBERT E. CAWTHORN Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Managing Director of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun Company, Inc., and Westinghouse Electric Corp. BARBARA BARNES HAUPTFUHRER Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions, Inc., Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance Co., and Ladies Professional Golf Association; Trustee Emerita of Wellesley College. BRUCE K. MacLAURY President Emeritus of The Brookings Institution; Director of American Express Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, Princeton University; Director of Prudential Insurance Co. of America, Amdahl Corp., Baker Fentress & Co., The Jeffrey Co., and Southern New England Telecommunications Co. ALFRED M. RANKIN, JR. Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co. JOHN C. SAWHILL President and Chief Executive Officer of The Nature Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and President of New York University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., and NACCO Industries. JAMES O. WELCH, JR. Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp. J. LAWRENCE WILSON Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins Engine Co. and The Mead Corp.; Trustee of Vanderbilt University. OTHER FUND OFFICERS RAYMOND J. KLAPINSKY Secretary; Managing Director and Secretary of The Vanguard Group, Inc.; Secretary of each of the investment companies in The Vanguard Group. RICHARD F. HYLAND Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies in The Vanguard Group. KAREN E. WEST Controller; Principal of The Vanguard Group, Inc.; Controller of each of the investment companies in The Vanguard Group. OTHER VANGUARD OFFICERS R. GREGORY BARTON Managing Director, Legal Department. ROBERT A. DiSTEFANO Managing Director, Information Technology. JAMES H. GATELY Managing Director, Individual Investor Group. KATHLEEN C. GUBANICH Managing Director, Human Resources. IAN A. MacKINNON Managing Director, Fixed Income Group. F. WILLIAM McNABB, III Managing Director, Institutional Investor Group. MICHAEL S. MILLER Managing Director, Planning and Development. RALPH K. PACKARD Managing Director and Chief Financial Officer. GEORGE U. SAUTER Managing Director, Core Management Group. "Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500," and "500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell Company is the owner of trademarks and copyrights relating to the Russell Indexes. "Wilshire 4500" and "Wilshire 5000" are trademarks of Wilshire Associates. 23 VANGUARD FAMILY OF FUNDS STOCK FUNDS Convertible Securities Fund Equity Income Fund Explorer Fund Growth and Income Portfolio Horizon Fund Aggressive Growth Portfolio Capital Opportunity Portfolio Global Equity Portfolio Index Trust 500 Portfolio Extended Market Portfolio Growth Portfolio Mid Capitalization Stock Portfolio Small Capitalization Growth Stock Portfolio Small Capitalization Stock Portfolio Small Capitalization Value Stock Portfolio Total Stock Market Portfolio Value Portfolio Institutional Index Fund International Equity Index Fund Emerging Markets Portfolio European Portfolio Pacific Portfolio International Growth Portfolio International Value Portfolio Morgan Growth Fund PRIMECAP Fund Selected Value Portfolio Specialized Portfolios Energy Portfolio Gold & Precious Metals Portfolio Health Care Portfolio REIT Index Portfolio Utilities Income Portfolio Tax-Managed Fund Capital Appreciation Portfolio Growth and Income Portfolio Total International Portfolio Trustees' Equity Fund U.S. Portfolio U.S. Growth Portfolio Windsor Fund Windsor II MONEY MARKET FUNDS Admiral Funds U.S. Treasury Money Market Portfolio Money Market Reserves Federal Portfolio Prime Portfolio Municipal Bond Fund Money Market Portfolio State Tax-Free Funds (CA, NJ, NY, OH, PA) Treasury Money Market Portfolio BOND FUNDS Admiral Funds Intermediate-Term U.S. Treasury Portfolio Long-Term U.S. Treasury Portfolio Short-Term U.S. Treasury Portfolio Bond Index Fund Intermediate-Term Bond Portfolio Long-Term Bond Portfolio Short-Term Bond Portfolio Total Bond Market Portfolio Fixed Income Securities Fund GNMA Portfolio High Yield Corporate Portfolio Intermediate-Term Corporate Portfolio Intermediate-Term U.S. Treasury Portfolio Long-Term Corporate Portfolio Long-Term U.S. Treasury Portfolio Short-Term Corporate Portfolio Short-Term Federal Portfolio Short-Term U.S. Treasury Portfolio Municipal Bond Fund High-Yield Portfolio Insured Long-Term Portfolio Intermediate-Term Portfolio Limited-Term Portfolio Long-Term Portfolio Short-Term Portfolio Preferred Stock Fund State Tax-Free Funds (CA, FL, NJ, NY, OH, PA) BALANCED FUNDS Asset Allocation Fund Balanced Index Fund Horizon Fund Global Asset Allocation Portfolio LifeStrategy Portfolios Conservative Growth Portfolio Growth Portfolio Income Portfolio Moderate Growth Portfolio STAR Portfolio Tax-Managed Fund Balanced Portfolio Wellesley Income Fund Wellington Fund Q222-4/1998 (C) 1998 Vanguard Marketing Corporation, Distributor. All rights reserved. [THE VANGUARD GROUP LOGO] Post Office Box 2600 Valley Forge, Pennsylvania 19482 FUND INFORMATION 1-800-662-7447 INDIVIDUAL ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 www.vanguard.com online@vanguard.com All Vanguard funds are offered by prospectus only. Prospectuses contain more complete information on advisory fees, distribution charges, and other expenses and should be read carefully before you invest or send money. Prospectuses can be obtained directly from The Vanguard Group. 24 VANGUARD/ WINDSOR II Semiannual Report - April 30, 1998 [PHOTO] [THE VANGUARD GROUP LOGO] 25 OUR CREW MAKES THE DIFFERENCE Throughout our history, The Vanguard Group has received considerable attention as the low-cost provider of mutual funds. While such accolades are gratifying, we are most proud, not of our low operating expenses or the billions of dollars we manage, but of our sterling reputation created by the Vanguard crew. We recognize that it is our crew members--more than 7,000 highly motivated men and women--who form the cornerstone of our operations. We could not survive long--let alone prosper--without them. That's why we chose this fiscal year's fund reports to celebrate the spirit, enthusiasm, and achievements of our crew. (We call those who work at Vanguard crew members, not employees, because they operate as a team to accomplish our mission of serving you, our clients.) But while we prize the collective contributions of our crew, we also take time to recognize the importance of the individual. Each calendar quarter, we present our Award For Excellence to a handful of crew members who have demonstrated particular excellence in the performance of their jobs and who embody "The Vanguard Spirit." Our report cover shows only a few of the more than 300 crew members who have received this distinction since 1984. They, along with the rest of our valiant crew, look forward to serving you in the years ahead. [PHOTO] [PHOTO] John C. Bogle John J. Brennan Senior Chairman Chairman & CEO CONTENTS A MESSAGE TO OUR SHAREHOLDERS . . . . . . . . . . . . . . 1 THE MARKETS IN PERSPECTIVE . . . . . . . . . . . . . . . 5 REPORT FROM THE ADVISER . . . . . . . . . . . . . . . . . 7 PERFORMANCE SUMMARY . . . . . . . . . . . . . . . . . . . 9 PORTFOLIO PROFILE . . . . . . . . . . . . . . . . . . . . 10 FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . 12
All comparative mutual fund data are from Lipper Analytical Services, Inc., or Morningstar unless otherwise noted. 26 FELLOW SHAREHOLDER, The U.S. stock market's record-shattering rise continued during the six months ended April 30, 1998, the first half of Vanguard/Windsor II's fiscal year. Your Fund's record was superb, as we earned a total return of +21.8% for the six months, far ahead of our average competitor and just a bit behind the Standard & Poor's 500 Composite Stock Price Index. The adjacent table compares the Fund's total return (capital change plus reinvested dividends) for the six months with those of the average value (growth and income) mutual fund and the unmanaged S&P 500 Index, which is dominated by large-capitalization stocks.
- - -------------------------------------------------- TOTAL RETURNS SIX MONTHS ENDED APRIL 30, 1998 - - -------------------------------------------------- Vanguard/Windsor II +21.8% - - -------------------------------------------------- Average Value Fund +17.9% - - -------------------------------------------------- S&P 500 Index +22.5% - - --------------------------------------------------
The Fund's return is based on an increase in its net asset value from $29.36 per share on October 31, 1997, to $32.69 per share on April 30, 1998, with the latter figure adjusted for the reinvestment of a dividend of $0.46 per share paid from net investment income and a distribution of $2.19 per share paid from net capital gains realized in 1997. THE PERIOD IN REVIEW The U.S. economy's performance during the six months ended April 30 was, quite simply, astounding. After growing by nearly 4% in 1997, the economy expanded at a 4.8% annual pace in the January-March period, even though a stronger U.S. dollar and economic turmoil in Asia began to crimp U.S. exports and to boost sales of imported goods. The nation's unemployment rate fell to 4.3% in April, its lowest level in more than 28 years. Yet a strong job market and robust economic growth did not push up prices; key inflation measures actually showed a slowing in price increases. Financial markets flourished in this ideal environment. Interest rates declined by roughly 20 basis points (0.20%) on balance during the six months, engendering modest price increases in bonds. The Lehman Brothers Aggregate Bond Index, a good measure of the overall taxable bond market, returned +3.6%. The yield on 3-month U.S. Treasury bills was 4.97% on April 30, nearly one-quarter percentage point below the 5.20% level at which it began the half-year. In the stock market, investor confidence--some would say overconfidence--was evident, as prices surged despite lackluster growth in corporate profits and uncertainty about how Asia's financial and economic woes would affect the U.S. economy. The S&P 500 Index rose in every month of the period, and its six-month total return of +22.5% was equal to approximately two years' worth of returns at the stock market's long-term annual average of about +11%. Windsor II did nearly as well, earning +21.8%, a return that was nearly 4 percentage points higher than the +17.9% earned by the average value fund. Our performance was particularly gratifying in light of the market's strong bias toward large growth stocks during the period. The growth component of the S&P 500 Index earned +25.1%, fully 1 27 one-quarter more than the +19.8% return on the Index's value stocks, which resemble Windsor II's holdings far more closely. Although growth stocks--those selling at relatively high prices in relation to such measures as book value, dividends, and past earnings--have held sway for most of the past three years, we note that, over very long periods, returns on value and growth stocks have been remarkably similar. Though we have no idea when the tide will turn, we fully expect that value stocks will "return to fight again." Our tiny shortfall in relation to the S&P 500 Index was due primarily to our heavier stake in energy stocks, which accounted during the period for about 12% of the Fund's assets, versus an 8% weighting in the Index. Weak oil prices hurt the performance of integrated oil companies and other energy stocks during the six months. Our advisers' excellent stock selection was a factor in our margin of superiority over competing value funds. Another factor was the stock market's pronounced bias toward big stocks. Large-cap issues, as represented by the S&P 500 Index, returned +22.5% during the period, some 40% above the +15.8% return earned by the rest of the stock market, as measured by the Wilshire 4500 Equity Index. The average value fund had a considerably larger commitment to mid- and small-cap stocks than Windsor II.
- - ----------------------------------------------------------- TOTAL ASSETS MANAGED AS OF APRIL 30, 1998 -------------------- $ MILLION PERCENT - - ----------------------------------------------------------- Barrow, Hanley, Mewhinney & Strauss, Inc. $20,397 68% Equinox Capital Management, Inc. 2,966 10 Tukman Capital Management, Inc. 2,925 10 Vanguard Core Management Group 1,696 6 Cash Reserves* 1,771 6 - - ----------------------------------------------------------- Total $29,755 100% - - -----------------------------------------------------------
*Index futures are used so that the performance of cash reserves mimics that of common stocks. Each adviser also may maintain a modest cash reserve. The Fund's philosophy is to invest in a diversified group of stocks that on balance have below-average prices in relation to earnings and dividends. Four advisers, each of whom has full discretion in investing a portion of the Fund's assets, select our holdings. The adjacent table shows the allocation of assets to each adviser as of April 30, 1998. Like most equity mutual funds, Windsor II maintains a modest cash reserve, in part to accommodate redemptions of shares. Because stocks generally provide higher returns than cash investments over long periods, such cash holdings can serve as a drag on long-term returns. To avoid this drag, your Fund began in December to use equity index futures contracts to give its cash pool the performance of common stocks. This practice enables Windsor II to simulate full investment in stocks while keeping cash on hand to meet any redemptions. We believe this change will improve returns over the long run, although it should lead to a slight increase in the Fund's share-price fluctuations. IN SUMMARY Stock investors have enjoyed historic gains in recent years. The S&P 500 Index produced a cumulative return just shy of +130% in the three years ended April 30, 1998, an annualized rate of +32%--three times the stock market's long-term rate of return. Such outsized returns cannot be expected to continue indefinitely. Indeed, investors in stocks are sure to encounter downturns--possibly severe ones--from time to time. Because the risks of stocks--like their returns--can be sizable, we recommend that investors hold balanced portfolios of stock funds, bond funds, and money market funds 2 28 in proportions suitable to each person's financial situation, investment goals, and attitude toward risk. Such a balanced portfolio should help investors to "stay the course" toward their investment objectives, whether the financial markets provide smooth or stormy sailing. /s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN John C. Bogle John J. Brennan Senior Chairman Chairman and Chief Executive Officer May 13, 1998 Notice to Shareholders At a special meeting on May 1, 1998, shareholders of Vanguard/Windsor II overwhelmingly approved five proposals. The proposals and voting results were: 1. REORGANIZATION INTO A DELAWARE BUSINESS TRUST. This change will reduce the amount of state taxes the Fund pays annually by more than $1.9 million. Approved by 96.48% of the shares voted, as follows:
------------------------------------------------ FOR AGAINST ABSTAIN ------------------------------------------------ 518,902,916 8,356,171 10,552,739 ------------------------------------------------
2a. INVESTMENT LIMITATION CHANGES--INTERFUND LENDING PROGRAM. Permits Windsor II to participate in Vanguard's interfund lending program, which allows funds to loan money to each other if--and only if--it makes good financial sense to do so on both sides of the transaction. The interfund lending program won't be an integral part of your Fund's investment program; it is a contingency arrangement for managing unusual cash flows. Approved by 94.10% of the shares voted, as follows:
------------------------------------------------ FOR AGAINST ABSTAIN ------------------------------------------------ 506,103,665 17,298,699 14,409,462 ------------------------------------------------
2b. INVESTMENT LIMITATION CHANGES--BORROWING MONEY AND PLEDGING ASSETS. This change sets standard limits of 15% of net assets on the amount of money Vanguard funds can borrow from all sources and on the amount of assets that can be pledged to secure any loans. Approved by 92.94% of the shares voted, as follows:
------------------------------------------------ FOR AGAINST ABSTAIN ------------------------------------------------ 499,861,173 21,575,623 16,375,030 ------------------------------------------------
(continued on next page) 3 29 2c. INVESTMENT LIMITATION CHANGES--INVESTMENTS IN SECURITIES OWNED BY AFFILIATES. This change eliminated a Fund policy of avoiding investments in securities that are owned in certain amounts by Directors, officers, and key advisory personnel. This policy was well-intentioned but wrongly focused and unnecessary in light of the Fund's Code of Ethics and other regulatory protections against conflicts of interest on the part of Fund management. Approved by 93.24% of the shares voted, as follows:
------------------------------------------------ FOR AGAINST ABSTAIN ------------------------------------------------ 501,437,763 21,233,642 15,140,420 ------------------------------------------------
2d. INVESTMENT LIMITATION CHANGES--INVESTMENTS IN ASSESSABLE SECURITIES. This change eliminated a long-standing, arcane Fund policy of not purchasing assessable securities. Such securities are not a factor in today's world of publicly traded securities, where the Fund's investments are focused. Approved by 93.53% of the shares voted, as follows:
------------------------------------------------ FOR AGAINST ABSTAIN ------------------------------------------------ 503,016,644 18,086,307 16,708,875 ------------------------------------------------
4 30 THE MARKETS IN PERSPECTIVE Six Months Ended April 30, 1998 Financial markets, it is said, don't like surprises. But when the surprises are positive--remarkably strong economic growth coupled with conspicuously tame inflation--the markets seem to cope quite nicely. So it was during the half-year ended April 30, when the good times kept rolling for U.S. stock and bond markets. The stock market produced half-year returns that would have been excellent even for a full year. The bond market, helped by lower interest rates, generated solid returns. Plentiful jobs--the nation's unemployment rate fell in April to a 28-year low of 4.3%--and rising wages clearly put American households in a buying mood. (The stock market's big gains, by pumping up millions of families' investment accounts, certainly didn't dampen spirits either.) With strong spending by consumers leading the way, the U.S. economy grew at an annual rate of about 4%, even after adjusting for inflation. Although most economists believe that sustained growth in excess of 3% is bound to be inflationary, evidence to support the theory has been scarce of late. Consumer prices rose just 0.6% during the six months, and the Consumer Price Index was up a relatively benign 1.4% for the 12 months ended April 30, 1998. Wholesale prices declined 1.2% during the past year. Stiff competitive pressure, including an increasing flow of imported products and materials, appears to be keeping the lid on prices, despite the bubbling economy.
- - ----------------------------------------------------------------------- TOTAL RETURNS PERIODS ENDED APRIL 30, 1998 ------------------------------- 6 MONTHS 1 YEAR 5 YEARS* - - ----------------------------------------------------------------------- EQUITY S&P 500 Index 22.5% 41.1% 23.2% Russell 2000 Index 11.9 42.4 18.5 MSCI EAFE Index 15.6 19.2 10.4 - - ----------------------------------------------------------------------- FIXED INCOME Lehman Aggregate Bond Index 3.6% 10.9% 6.9% Lehman 10-Year Municipal Bond Index 2.5 9.0 6.6 Salomon Brothers Three-Month U.S. Treasury Bill Index 2.6 5.3 4.9 - - ----------------------------------------------------------------------- OTHER Consumer Price Index 0.6% 1.4% 2.4% - - -----------------------------------------------------------------------
*Annualized. Economic troubles in Asia--where currency and banking crises are afflicting several nations--have resulted in lower prices for many imported goods and are being blamed by some U.S. companies for cutting into profits. But Asia's problems haven't spooked U.S. consumers and investors, and have only slightly slowed the domestic economy's powerful momentum. U.S. EQUITY MARKETS Wall Street sprinted to record heights during the half-year. The gains were broad-based, although the big blue chip stocks again led the way. Large-capitalization stocks, as represented by the S&P 500 Index, returned 22.5%, nearly double the 11.9% return on the small-cap Russell 2000 Index. Lower interest rates supported stock prices by making interest-bearing investments relatively less attractive to investors looking for a place to put new cash. The good inflation news helped, too. Even so, the size of the market's gains was surprising in light of an evident slowing in the growth rate for corporate profits. Since November, analysts have been reducing their estimates of future corporate earnings, and actual profits reported 5 31 for the January-March quarter were only modestly above those of first-quarter 1997. If corporate earnings growth does not accelerate, stocks may lose some of their allure. Health-care stocks were the market's best-performing sector during the period, as a number of hot-selling new drugs and exciting potential therapies heightened interest in pharmaceutical companies. Also, some health-maintenance organization stocks rebounded from depressed levels. The only sectors that didn't post double-digit gains during the half-year were integrated oil companies (up 9.5%) and the "other energy" group, which includes oil-services and exploration firms (down 3.5%). Lower energy prices--a key factor in inflation's good behavior--explained the weakness in energy stocks. U.S. FIXED-INCOME MARKETS Fixed-income investors earned the coupon rates on their bonds during the half-year, and saw a modest rise in the prices of their holdings, thanks to declining interest rates. The Lehman Aggregate Bond Index, a good measure of the overall market for taxable bonds, provided a 3.6% return for the six months, bringing its total return over the past 12 months to 10.9%, a superb inflation-adjusted return of 9.5%. The yield on the benchmark 30-year U.S. Treasury bond decreased from 6.15% on October 31, 1997, to 5.95% on April 30. A rate decline of 20 basis points in the face of such strong economic growth was possible because inflation--the enemy of the fixed-income investor--was so weak during the six months. Short-term interest rates also declined, although the Federal Reserve Board made no policy changes. The yield on 3-month U.S. Treasury bills fell from 5.20% on October 31 to 4.97% on April 30, at least partly because it became clear that the federal government would run a sizable budget surplus, which will reduce the Treasury's need to borrow and, therefore, reduce the supply of new Treasury securities. INTERNATIONAL EQUITY MARKETS Europe's stock markets were even hotter than Wall Street during the first half of fiscal 1998, while most Asian markets declined in U.S. dollar terms. Overall, the Morgan Stanley Capital International Europe, Australasia, Far East Index gained 15.6% in U.S. dollar terms. The Index returned 21.3% in local currency terms, but a generally stronger U.S. dollar cut the result for U.S. investors. European markets were buoyed by a variety of factors and rose 33.6% in local-currency terms. The dollar's gains against European currencies diminished the return for U.S. investors only slightly to a still-exceptional 29.2%. The markets benefited from signs that the economic slump on the continent is ending, from evidence that corporate managements are adopting a U.S.-style emphasis on adding shareholder value, and from increasing confidence that the planned adoption of the euro--a single European currency--would begin as planned in January 1999. The Pacific region's experience was very different. Although some emerging markets (Malaysia, Thailand, South Korea) rebounded from their lows, stock returns for the region on balance fell 8.8% in U.S.-dollar terms. Japan, by far the Pacific Rim's largest market, was beset by economic recession and dropped 10.0%, while Hong Kong fell 9.6%. Investors in Tokyo were decidedly unimpressed with the Japanese government's program for reviving the economy and dealing with the problems of the nation's banking system. Emerging markets, as a group, returned 5.6% in dollar terms. Gains in Greece (50.0%), Hungary (30.1%), Brazil (16.6%), and Argentina (13.7%) more than offset weakness in Asian emerging markets, most notably Indonesia (down a stunning 61.4%). 6 32 REPORT FROM THE ADVISER The first half of fiscal 1998, which ended on April 30, was another very good period for investors. The S&P 500 Index posted an impressive return of 22.5%. Vanguard/ Windsor II's return of 21.8% almost matched that of the market and exceeded both the 19.8% return of the S&P/BARRA Value Index and the 17.9% earned by the average growth-and-income mutual fund. These are indeed unusual times, as stock market returns have been running at several times the historical average, and seem to improve with each successive quarter. The economy has surely helped the market with good growth. While employment is at an all-time high and the unemployment rate at its lowest level in nearly three decades, there has been almost no inflation. Nonetheless, the biggest reason for the good fortune of the stock market is the unprecedented cash flow from individuals into mutual funds. We hope that these investors truly have a long-term perspective, because equity markets are volatile. The market averages are difficult to beat. Many managers, acting out of self-preservation or on specific direction, have become "closet indexers." In other words, they feel obligated to replicate in their funds the S&P 500 Index's weightings in the largest issues. This approach "guarantees" that any underperformance in their other holdings does not seriously penalize overall results. With a good portion of the significant cash flow into mutual funds being funneled into index funds and "closet indexers," one result is that the biggest stocks seem to have become overpriced. The largest ten issues in the S&P 500 have a current price/earnings ratio of 35.9, a price/book ratio of 11.6, and a dividend yield of 1.1%. This compares to your Fund's P/E of 17.3 (based on forecast earnings), price/book of about 3.0, and dividend yield, before expenses, of 2.5%. Based on your Fund's definition of value, the largest S&P companies need to post significantly higher profitability and growth to justify such lofty prices. We have made every effort to insulate Windsor II from the adverse effects of overvaluation in case of a market reversal. Our holdings definitely do not replicate the S&P 500 Index. In fact, the top ten S&P stocks represent only 4% of the assets in your Fund versus their 19% weighting in the Index. We feel fortunate that Windsor II has performed well without having a significant stake in these Index-dominating companies, and we believe that your Fund's return will be superior to that of the Index at the end of this unprecedented economic expansion and market explosion. In the past six months, the Fund's makeup has changed somewhat. We reduced our commitment to energy stocks, in the belief that there should be a closer relationship between the price of the stocks and the price of oil. Electric utilities represent a higher percentage of the Fund now than six months ago, because this is one of the few sectors where we find high dividend yields. Several of these stocks have also had good price 7 33 moves. Retail stocks have performed well, and our holdings in miscellaneous areas have increased generally for company-specific reasons. We believe the current makeup of the Fund will serve you well. Barrow, Hanley, Mewhinney & Strauss, Inc. May 12, 1998 INVESTMENT PHILOSOPHY The Fund reflects a belief that superior long-term investment results can be achieved by holding a diversified portfolio of out-of-favor stocks with below-average price/earnings ratios, above-average dividend yields, and the prospect of above-average total return. 8 34 PERFORMANCE SUMMARY All of the data on this page represent past performance, which cannot be used to predict future returns that may be achieved by the Fund. Note, too, that both share price and return can fluctuate widely, so an investment in the Fund could lose money.
WINDSOR II TOTAL INVESTMENT RETURNS: JUNE 24, 1985-APRIL 30, 1998 - - ----------------------------------------------------------- WINDSOR II S&P 500 FISCAL CAPITAL INCOME TOTAL TOTAL YEAR RETURN RETURN RETURN RETURN - - ----------------------------------------------------------- 1985 -0.9% 1.1% 0.2% 1.8% 1986 31.2 4.4 35.6 33.2 1987 -0.6 1.5 0.9 6.4 1988 14.5 6.0 20.5 14.8 1989 19.5 5.2 24.7 26.4 1990 -21.5 4.0 -17.5 -7.5 1991 29.4 7.2 36.6 33.5 1992 7.9 4.6 12.5 10.0 1993 15.8 3.7 19.5 14.9 1994 -0.8 3.0 2.2 3.9 1995 19.2 3.9 23.1 26.4 1996 23.8 3.4 27.2 24.1 1997 28.1 3.2 31.3 32.1 1998* 20.0 1.8 21.8 22.5 - - -----------------------------------------------------------
*Six months ended April 30, 1998. See Financial Highlights table on page 18 for dividend and capital gains information for the past five years.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 1998* - - -------------------------------------------------------------------------------------------------------------------------- 10 YEARS INCEPTION --------------------------------- DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL ------------------------------------------------------------------------- Windsor II 6/24/1985 46.96% 22.06% 14.29% 4.25% 18.54% - - --------------------------------------------------------------------------------------------------------------------------
*SEC rules require that we provide this average annual total return information through the latest calendar quarter. 9 35 PORTFOLIO PROFILE Windsor II This Profile provides a snapshot of the Fund's characteristics as of April 30, 1998, compared where appropriate to an unmanaged index. Key elements of this Profile are defined on page 11.
PORTFOLIO CHARACTERISTICS - - ---------------------------------------------------------- WINDSOR II S&P 500 - - ---------------------------------------------------------- Number of Stocks 279 500 Median Market Cap $25.5B $44.0B Price/Earnings Ratio 20.1x 24.4x Price/Book Ratio 3.1x 4.4x Yield 2.0% 1.5% Return on Equity 17.1% 21.3% Earnings Growth Rate 13.3% 16.2% Foreign Holdings 1.6% 1.9% Turnover Rate 32%* -- Expense Ratio 0.40%* -- Cash Reserves 1.6% -- *Annualized.
INVESTMENT FOCUS - - ---------------------------------------------------------- [GRAPH]
VOLATILITY MEASURES - - ---------------------------------------------------------- WINDSOR II S&P 500 R-Squared 0.90 1.00 Beta 0.86 1.00
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) - - ------------------------------------------------------ The Chase Manhattan Corp. 3.1% International Business Machines Corp. 2.6 Sears, Roebuck & Co. 2.6 GTE Corp. 2.5 Waste Management Inc. 2.5 Anheuser-Busch Cos., Inc. 2.4 BankAmerica Corp. 2.1 Kmart Corp. 2.1 Williams Cos., Inc. 2.0 First Chicago NBD Corp. 2.0 - - ------------------------------------------------------ Top Ten 23.9%
SECTOR DIVERSIFICATION (% OF COMMON STOCKS) - - ------------------------------------------------------------------------------------------------------------------------- APRIL 30, 1997 APRIL 30, 1998 ------------------------------------------------------------- WINDSOR II WINDSOR II S&P 500 ------------------------------------------------------------- Auto & Transportation 3.5% 5.7% 3.2% Consumer Discretionary 7.9 12.0 9.9 Consumer Staples 7.9 5.7 10.4 Financial Services 26.0 25.4 18.4 Health Care 4.4 1.7 11.8 Integrated Oils 11.1 6.2 6.8 Other Energy 4.4 3.2 1.2 Materials & Processing 3.8 3.1 5.8 Producer Durables 4.0 4.6 4.0 Technology 4.3 4.2 12.6 Utilities 12.4 18.0 10.2 Other 10.3 10.2 5.7 - - -------------------------------------------------------------------------------------------------------------------------
10 36 BETA. A measure of the magnitude of a portfolio's past share-price fluctuations in relation to the ups and downs of the overall market (or appropriate market index). The market (or index) is assigned a beta of 1.00, so a portfolio with a beta of 1.20 would have seen its share price rise or fall by 12% when the overall market rose or fell by 10%. CASH RESERVES. The percentage of a portfolio's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing securities. This figure does not include cash invested in futures contracts to simulate stock investment. EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the past five years for the stocks now in a portfolio. EXPENSE RATIO. The percentage of a portfolio'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 portfolio's net assets represented by stocks or American Depositary Receipts of companies based outside the United States. INVESTMENT FOCUS. This grid indicates the focus of a portfolio in terms of two attributes: market capitalization (large, medium, or small) and relative valuation (growth, value, or a blend). MEDIAN MARKET CAP. An indicator of the size of companies in which a portfolio invests; the midpoint of market capitalization (market price x shares outstanding) of a portfolio's stocks, weighted by the proportion of the portfolio's assets invested in each stock. Stocks representing half of the portfolio's assets have market capitalization above the median, and the rest are below it. NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio holds, the more diversified it is and the more likely to perform in line with the overall stock market. PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book value, per share. For a portfolio, 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 portfolio, 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 portfolio's past returns can be explained by the returns from the overall market (or its benchmark index). If a portfolio's total return were precisely synchronized with the overall market's return, its R-squared would be 1.00. If a portfolio's returns bore no relationship to the market'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 portfolio, the weighted average return on equity for the companies whose stocks it holds. SECTOR DIVERSIFICATION. The percentages of a portfolio's common stocks that come from each of the major industry groups that compose the stock market. TEN LARGEST HOLDINGS. The percentage of net assets that a portfolio has invested in its ten largest stocks. (The average for stock mutual funds is about 30%.) As this percentage rises, a portfolio's returns are likely to be more volatile because they are more dependent on the fortunes of a few companies. TURNOVER RATE. An indication of trading activity during the period. Portfolios with high turnover rates incur higher transaction costs and are more likely to distribute capital gains (which are taxable to investors). YIELD. A snapshot of a portfolio's income from interest and dividends. The yield, expressed as a percentage of the portfolio'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 dividends paid on stocks in the index. 11 37 FINANCIAL STATEMENTS April 30, 1998 (unaudited) 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, preferred 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 on both a dollar and per-share basis. 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. 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* WINDSOR II SHARES (000) - - ---------------------------------------------------------------- COMMON STOCKS (92.4%)+ - - ---------------------------------------------------------------- AUTO & TRANSPORTATION (5.3%) Autoliv, Inc. 100,970 $ 2,998 Borg-Warner Automotive, Inc. 27,300 1,698 Burlington Northern Santa Fe Corp. 111,100 10,999 CNF Transportation, Inc. 93,800 3,623 CSX Corp. 1,993,600 104,664 Chrysler Corp. 14,204,700 570,851 Delta Air Lines, Inc. 81,500 9,474 Ford Motor Co. 10,789,400 494,289 General Motors Corp. 5,378,000 362,343 Meritor Automotive, Inc. 139,700 3,606 Norfolk Southern Corp. 130,100 4,350 Southwest Airlines Co. 139,100 3,817 - - - UAL Corp. 63,600 5,545 ------------ 1,578,257 ------------ CONSUMER DISCRETIONARY (11.0%) - - - Boise Cascade Office Products Corp. 96,200 1,846 - - - Borders Group, Inc. 56,400 1,812 - - - Boston Chicken, Inc. 256,000 1,096 Browning-Ferris Industries, Inc. 1,873,000 63,916 Dayton Hudson Corp. 136,400 11,909 Deluxe Corp. 6,300 211 Dillard's Inc. 68,800 2,520 The Walt Disney Co. 1,763,844 219,268 R.R. Donnelley & Sons Co. 109,400 4,820 Eastman Kodak Co. 1,644,200 118,691 Family Dollar Stores, Inc. 146,500 4,981 Gannett Co., Inc. 3,550,900 241,239 - - - Host Marriott Corp. 82,300 1,600 IKON Office Solutions, Inc. 136,000 3,290 International Game Technology 144,700 4,024 - - -(1)Kmart Corp. 35,372,300 616,805 Knight Ridder 23,000 1,341 Lee Enterprises, Inc. 73,300 2,295 - - - MGM Grand, Inc. 37,200 1,256 May Department Stores Co. 49,358 3,045 Maytag Corp. 135,200 6,963 The McGraw-Hill Cos., Inc. 34,000 2,633 New York Times Co. Class A 87,400 6,200 - - - Office Depot, Inc. 193,700 6,416 - - - OfficeMax, Inc. 77,200 1,452 Olsten Corp. 218,700 2,993 J.C. Penney Co., Inc. 12,700 903 Polaroid Corp. 39,700 1,747 Premark International, Inc. 85,700 2,860 - - - Promus Hotel Corp. 21,300 962 Sears, Roebuck & Co. 13,027,700 772,706 The Stanley Works 9,900 507 Time Warner, Inc. 1,740,500 136,629 - - - Toys R Us, Inc. 123,600 3,407 Tribune Co. 112,200 7,405 Wal-Mart Stores, Inc. 4,117,300 208,181 Washington Post Co. Class B 10,200 5,347 Waste Management Inc. 22,377,400 749,643 Whirlpool Corp. 1,041,900 75,017 Wolverine World Wide, Inc. 75,300 2,174 - - - Woolworth Corp. 294,100 6,764 ------------ 3,306,874 ------------ CONSUMER STAPLES (5.3%) Anheuser-Busch Cos., Inc. 15,492,600 709,755 Brown-Forman Corp. Class B 15,100 855 Campbell Soup Co. 118,300 6,070
12 38
- - ---------------------------------------------------------------- MARKET VALUE* SHARES (000) - - ---------------------------------------------------------------- - - - Corn Products International, Inc. 6,125 $ 218 Dean Foods Corp. 132,900 6,230 General Mills, Inc. 66,900 4,520 H.J. Heinz Co. 2,502,500 136,386 Imperial Tobacco Group ADR 12,448,100 175,829 Kellogg Co. 27,500 1,134 - - - The Kroger Co. 124,300 5,205 PepsiCo, Inc. 4,015,300 159,357 Philip Morris Cos., Inc. 7,589,300 283,176 RJR Nabisco Holdings Corp. 286,100 7,957 Sara Lee Corp. 1,367,200 81,434 - - - Vlasic Foods International, Inc. 11,830 273 Weis Markets, Inc. 500 18 ------------ 1,578,417 ------------ FINANCIAL SERVICES (23.4%) H.F. Ahmanson & Co. 5,286,800 403,119 Allstate Corp. 5,815,622 559,754 American Express Co. 4,299,508 438,550 American International Group, Inc. 2,678,287 352,362 AmSouth Bancorp 138,200 8,620 Aon Corp. 3,731,875 240,706 Associates First Capital Corp. 3,444,411 257,470 BB&T Corp. 29,300 1,970 Banc One Corp. 1,944,030 114,333 The Bank of New York Co., Inc. 55,800 3,296 BankAmerica Corp. 7,421,146 630,797 BankBoston Corp. 116,000 12,521 Bankers Trust Corp. 11,700 1,511 Bear Stearns Co., Inc. 55,600 3,173 CIGNA Corp. 2,500 517 - - - CNA Financial Corp. 16,600 2,456 Capital One Financial Corp. 10,200 980 The Chase Manhattan Corp. 6,708,928 929,606 The Chubb Corp. 1,167,000 92,120 Citicorp 200,400 30,160 Comerica, Inc. 130,950 8,765 Conseco Inc. 146,600 7,275 Countrywide Credit Industries, Inc. 105,000 5,079 Duke Realty Investments, Inc. REIT 11,700 279 The Dun & Bradstreet Corp. 73,800 2,620 A.G. Edwards & Sons, Inc. 186,350 8,386 The Equitable Cos. 123,200 7,561 Everest Reinsurance Holdings, Inc. 92,400 3,812 Fannie Mae 5,365,800 321,277 First Chicago NBD Corp. 6,470,771 600,973 First Empire State Corp. 5,300 2,703 First Union Corp. 145,882 8,808 Firstar Corp. 38,700 1,444 Fleet Financial Group, Inc. 29,100 2,514 General Re Corp. 6,300 1,408 Green Point Financial Corp. 152,800 6,064 The Hartford Financial Services Group Inc. 103,900 11,507 Huntington Bancshares Inc. 1,200 43 KeyCorp 25,500 1,012 Lehman Brothers Holdings, Inc. 8,200 583 Loews Corp. 2,900 290 MBIA, Inc. 46,300 3,455 Mellon Bank Corp. 16,500 1,188 Mercury General Corp. 10,100 654 Merrill Lynch & Co., Inc. 55,100 4,835 The Money Store 181,200 5,957 J.P. Morgan & Co., Inc. 27,000 3,544 Morgan Stanley Dean Witter & Co. 2,141,700 168,927 National City Corp. 12,400 859 NationsBank Corp. 434,387 32,905 Northern Trust Corp. 31,572 2,305 Norwest Corp. 409,900 16,268 Old Republic International Corp. 59,800 2,706 The PMI Group Inc. 48,300 3,924 PNC Bank Corp. 9,719,300 587,410 Providian Financial Corp. 129,100 7,770 Regions Financial Corp. 24,800 1,082 St. Paul Cos., Inc. 83,924 7,113 Star Banc Corp. 30,800 1,946 State Street Corp. 159,700 11,419 Summit Bancorp. 162,800 8,160 SunTrust Banks, Inc. 53,200 4,332 Transatlantic Holdings, Inc. 15,800 1,214 Travelers Property Casualty Corp. 113,800 4,780 Travelers Group Inc. 6,742,837 412,577 - - - UICI 199,200 5,777 U.S. Bancorp 67,500 8,573 UnionBanCal Corp. 61,426 6,327 Valley National Bancorp 51,100 2,050 Wachovia Corp. 16,100 1,367 Washington Mutual, Inc. 4,270,500 299,202 Wells Fargo & Co. 732,700 270,000 Zions Bancorp 38,600 1,973 ------------ 6,977,023 ------------ HEALTH CARE (1.6%) Abbott Laboratories 78,800 5,762 Aetna Inc. 1,206,000 97,460 American Home Products Corp. 2,177,700 202,798 Becton, Dickinson & Co. 96,600 6,726 Bristol-Myers Squibb Co. 1,282,700 135,806 Pharmacia & Upjohn, Inc. 63,100 2,654 - - - Tenet Healthcare Corp. 251,900 9,431 United Healthcare Corp. 119,300 8,381 - - - Wellpoint Health Networks Inc. Class A 76,500 5,518 ------------ 474,536 ------------ INTEGRATED OILS (5.7%) Amoco Corp. 8,414,000 372,320 Ashland, Inc. 109,600 5,795 Atlantic Richfield Co. 1,267,200 98,842 Chevron Corp. 226,700 18,745 Enron Corp. 185,700 9,134 Exxon Corp. 6,401,500 466,909 Mobil Corp. 1,832,700 144,783 Murphy Oil Corp. 42,500 2,186 Phillips Petroleum Co. 7,233,000 358,486 Royal Dutch Petroleum Co. ADR 3,532,600 199,813 Sun Co., Inc. 138,800 5,613
13 39
- - ---------------------------------------------------------------- MARKET VALUE* WINDSOR II SHARES (000) - - ---------------------------------------------------------------- Texaco Inc. 165,500 $ 10,178 USX-Marathon Group 163,100 5,841 ------------ 1,698,645 ------------ OTHER ENERGY (3.0%) - - - BJ Services Co. 23,000 863 - - - CalEnergy Co. 183,300 5,980 Camco International, Inc. 41,100 2,790 - - - EVI Inc. 19,200 1,022 (1)Occidental Petroleum Corp. 18,042,900 531,138 Schlumberger Ltd. 3,837,800 318,058 Tidewater, Inc. 140,100 5,551 Tosco Corp. 175,000 6,234 - - - Western Atlas, Inc. 78,600 6,209 ------------ 877,845 ------------ MATERIALS & PROCESSING (2.9%) Alumax, Inc. 8,900 439 Archer-Daniels-Midland Co. 409,500 8,804 Centex Corp. 25,200 876 Champion International Corp. 48,300 2,599 Crompton & Knowles Corp. 63,800 1,910 Dow Chemical Co. 108,000 10,442 E.I. du Pont de Nemours & Co. 453,300 33,006 Eastman Chemical Co. 1,132,050 77,828 Ethyl Corp. 203,700 1,553 Fort James Corp. 3,349,200 166,204 The Timber Co. 77,500 1,986 The BFGoodrich Co. 122,600 6,597 International Paper Co. 12,400 647 Johns Manville Corp. 111,500 1,819 Kimberly-Clark Corp. 1,058,200 53,704 Lafarge Corp. 41,100 1,644 (1)Millennium Chemicals Inc. 6,571,242 235,743 PPG Industries, Inc. 140,800 9,953 Pentair, Inc. 144,000 6,228 Phelps Dodge Corp. 114,000 7,652 Reynolds Metals Co. 24,900 1,643 Sonoco Products Co. 28,600 1,149 USG Corp. 35,000 1,798 USX-U.S. Steel Group 110,300 4,316 (1)Witco Chemical Corp. 5,431,800 215,235 ------------ 853,775 ------------ PRODUCER DURABLES (4.3%) AGCO Corp. 181,000 4,842 The Boeing Co. 22,800 1,141 Case Corp. 102,100 6,490 Caterpillar, Inc. 252,600 14,382 Cummins Engine Co., Inc. 81,200 4,415 Deere & Co. 161,700 9,449 Emerson Electric Co. 37,100 2,360 - - - General Semiconductor, Inc. 252,500 3,456 (1)Honeywell, Inc. 6,336,200 590,059 Lockheed Martin Corp. 63,500 7,072 Mark IV Industries, Inc. 231,200 4,870 Northrop Grumman Corp. 11,900 1,258 Pitney Bowes, Inc. 166,000 7,968 Tecumseh Products Co. Class A 109,100 5,496 Tektronix, Inc. 66,300 2,851 Thiokol Corp. 122,200 6,584 Thomas & Betts Corp. 138,800 8,102 United Technologies Corp. 70,400 6,930 Xerox Corp. 5,166,421 586,389 ------------ 1,274,114 ------------ TECHNOLOGY (3.9%) Computer Sciences Corp. 40,000 2,110 - - - DSC Communications Corp. 125,100 2,252 Electronic Data Systems Corp. 7,953,600 342,005 International Business Machines Corp. 6,689,100 775,100 - - - Jabil Circuit, Inc. 121,600 4,271 - - - National Semiconductor Corp. 57,200 1,258 Rockwell International Corp. 141,800 7,932 - - - Storage Technology Corp. 112,100 9,465 - - - Tech Data Corp. 40,300 2,010 ------------ 1,146,403 ------------ UTILITIES (16.7%) AT&T Corp. 1,884,000 113,158 Ameren Corp. 179,100 7,097 American Electric Power Co., Inc. 5,957,800 284,485 American Water Works Co., Inc. 42,500 1,272 Ameritech Corp. 520,700 22,162 Baltimore Gas & Electric Co. 195,600 6,161 Bell Atlantic Corp. 351,718 32,908 BellSouth Corp. 280,500 18,005 Boston Edison Co. 31,000 1,263 CMS Energy Corp. 176,600 7,715 (1)Central & South West Corp. 10,690,300 278,616 Century Telephone Enterprises, Inc. 2,400 102 Consolidated Edison Inc. 200,000 9,050 DTE Energy Co. 218,900 8,578 Duke Energy Corp. 2,008,200 116,225 (1)Entergy Corp. 22,583,700 561,770 FPL Group, Inc. 165,100 10,247 FirstEnergy Corp. 9,639,277 291,588 GPU, Inc. 199,700 7,913 GTE Corp. 12,918,700 754,937 Houston Industries, Inc. 10,869,900 315,906 IPALCO Enterprises, Inc. 42,200 1,838 Kansas City Power & Light Co. 13,700 408 MCI Communications Corp. 98,600 4,961 New York State Electric & Gas Corp. 191,500 7,995 PacifiCorp 100,000 2,325 Pinnacle West Capital Corp. 109,000 4,823 Public Service Enterprise Group, Inc. 4,521,200 151,743 SBC Communications Inc. 13,944,198 577,813 Southern Co. 77,900 2,064 Sprint Corp. 80,500 5,499 Texas Utilities Co. 232,200 9,288 - - - U.S. Cellular Corp. 205,400 6,727 U S WEST Communications Group 11,244,000 593,121 - - - U S WEST Media Group 54,800 2,069 UtiliCorp United, Inc. 147,200 5,538 (1)Williams Cos., Inc. 19,273,646 609,529 - - - WorldCom, Inc. 2,852,800 122,046 ------------ 4,956,945 ------------
14 40
- - ---------------------------------------------------------------- MARKET VALUE* SHARES (000) - - ---------------------------------------------------------------- OTHER (9.3%) Brunswick Corp. 91,800 $ 2,984 CBS Corp. 9,404,900 335,050 Crane Co. 61,300 3,299 (1)Dresser Industries, Inc. 10,479,000 554,077 Foster Wheeler Corp. 71,800 1,988 General Electric Co. 2,727,000 232,136 Hanson PLC ADR 4,528,550 134,158 (1)ITT Industries, Inc. 8,282,100 301,779 Minnesota Mining & Manufacturing Co. 1,302,700 122,942 National Service Industries, Inc. 1,800 97 Raytheon Co. Class B 8,978,400 508,963 (1)Tenneco, Inc. 13,013,800 560,407 - - - Thermo Electron Corp. 25,000 995 ------------ 2,758,875 ------------ - - ---------------------------------------------------------------- TOTAL COMMON STOCKS (COST $17,286,864) 27,481,709 - - ---------------------------------------------------------------- FACE AMOUNT (000) - - ---------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (9.3%) - - ---------------------------------------------------------------- Federal Home Loan Mortgage Corp. 5.43%, 5/27/1998 $ 58,000 57,773 5.44%, 5/22/1998 125,000 124,603 5.486%, 5/29/1998 67,000 66,717 5.497%, 6/19/1998 89,652 88,991 5.515%, 6/30/1998 15,521 15,381 Federal National Mortgage Assn. 5.44%, 5/13/1998 125,000 124,773 U.S. Treasury Bills (2)4.97%, 7/23/1998 62,000 61,301 (2)5.03%, 7/9/1998 5,000 4,953 REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 5.51%, 5/1/1998 2,241,878 2,241,878 5.52%, 5/1/1998--Note F 4,443 4,443 - - ---------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (COST $2,790,800) 2,790,813 - - ---------------------------------------------------------------- TOTAL INVESTMENTS (101.7%) (COST $20,077,664) 30,272,522 - - ---------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-1.7%) - - ---------------------------------------------------------------- Other Assets--Note C $ 172,904 Liabilities--Note F (690,484) ------------ (517,580) - - ---------------------------------------------------------------- NET ASSETS (100%) - - ---------------------------------------------------------------- Applicable to 910,134,341 outstanding $.01 par value shares (authorized 1,150,000,000 shares) $29,754,942 ================================================================ NET ASSET VALUE PER SHARE $32.69 ================================================================
* See Note A in Notes to Financial Statements. - Non-Income-Producing Security. + The combined market value of common stocks and index futures contracts represents 98.4% of net assets. See Note E in Notes to Financial Statements. (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 $5,055,158,000. (2) Securities with an aggregate value of $66,254,000 have been segregated as initial margin for open futures contracts. ADR-- American Depositary Receipt. REIT-- Real Estate Investment Trust.
- - ---------------------------------------------------------------- AT APRIL 30, 1998, NET ASSETS CONSISTED OF: - - ---------------------------------------------------------------- AMOUNT PER (000) SHARE - - ---------------------------------------------------------------- Paid in Capital $18,095,909 $19.88 Undistributed Net Investment Income 161,285 .18 Accumulated Net Realized Gains 1,238,775 1.36 Unrealized Appreciation-- Note E Investment Securities 10,194,858 11.20 Futures Contracts 64,115 .07 - - ---------------------------------------------------------------- NET ASSETS $29,754,942 $32.69 ================================================================
15 41 STATEMENT OF OPERATIONS This Statement shows dividend and interest 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 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) on investments during the period. If the Fund invested in futures contracts during the period, the results of these investments are shown separately.
- - ------------------------------------------------------------------------------------------------------------------------- WINDSOR II SIX MONTHS ENDED APRIL 30, 1998 (000) - - ------------------------------------------------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 266,750 Interest 53,882 ------------ Total Income 320,632 ------------ EXPENSES Investment Advisory Fees--Note B Basic Fee 16,150 Performance Adjustment 2,910 The Vanguard Group--Note C Management and Administrative 28,509 Marketing and Distribution 2,926 Taxes (other than income taxes) 942 Custodian Fees 23 Auditing Fees 14 Shareholders' Reports 246 Annual Meeting and Proxy Costs 224 Directors' Fees and Expenses 25 ------------ Total Expenses 51,969 Expenses Paid Indirectly--Note C (1,118) ------------ Net Expenses 50,851 - - ------------------------------------------------------------------------------------------------------------------------- NET INVESTMENT INCOME 269,781 - - ------------------------------------------------------------------------------------------------------------------------- REALIZED NET GAIN Investment Securities Sold* 1,104,053 Futures Contracts 134,080 - - ------------------------------------------------------------------------------------------------------------------------- REALIZED NET GAIN 1,238,133 - - ------------------------------------------------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities 3,529,811 Futures Contracts 65,300 - - ------------------------------------------------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 3,595,111 - - ------------------------------------------------------------------------------------------------------------------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $5,103,025 =========================================================================================================================
*Dividend income and realized net gain from affiliated companies were $50,291,000 and $102,674,000, respectively. 16 42 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.
- - ------------------------------------------------------------------------------------------------------------------------- WINDSOR II ----------------------------------- SIX MONTHS YEAR ENDED ENDED APR. 30, 1998 OCT. 31, 1997 (000) (000) - - ------------------------------------------------------------------------------------------------------------------------- INCREASE IN NET ASSETS OPERATIONS Net Investment Income $ 269,781 $ 465,699 Realized Net Gain 1,238,133 1,698,039 Change in Unrealized Appreciation (Depreciation) 3,595,111 2,753,749 ----------------------------------- Net Increase in Net Assets Resulting from Operations 5,103,025 4,917,487 ----------------------------------- DISTRIBUTIONS Net Investment Income (355,934) (410,609) Realized Capital Gain (1,694,592) (716,881) ----------------------------------- Total Distributions (2,050,526) (1,127,490) ----------------------------------- CAPITAL SHARE TRANSACTIONS1 Issued 3,825,963 5,466,998 Issued in Lieu of Cash Distributions 1,968,837 1,087,312 Redeemed (1,660,217) (2,534,333) ----------------------------------- Net Increase from Capital Share Transactions 4,134,583 4,019,977 - - ------------------------------------------------------------------------------------------------------------------------- Total Increase 7,187,082 7,809,974 - - ------------------------------------------------------------------------------------------------------------------------- NET ASSETS Beginning of Period 22,567,860 14,757,886 ----------------------------------- End of Period $29,754,942 $22,567,860 ========================================================================================================================= 1Shares Issued (Redeemed) Issued 126,264 205,712 Issued in Lieu of Cash Distributions 70,040 45,084 Redeemed (54,856) (95,875) ----------------------------------- Net Increase in Shares Outstanding 141,448 154,921 =========================================================================================================================
17 43 FINANCIAL HIGHLIGHTS This table summarizes the Fund's investment results and distributions to shareholders on a per-share basis. It also presents the Fund's 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. Finally, the table lists the Fund's Average Commission Rate Paid, a disclosure required by the Securities and Exchange Commission beginning in 1996. This rate is calculated by dividing total commissions paid on portfolio securities by the total number of shares purchased and sold on which commissions were charged.
- - ------------------------------------------------------------------------------------------------------------------------- WINDSOR II YEAR ENDED OCTOBER 31, FOR A SHARE OUTSTANDING SIX MONTHS ENDED ------------------------------------------------------------ THROUGHOUT EACH PERIOD APRIL 30, 1998 1997 1996 1995 1994 1993 - - ------------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $29.36 $24.04 $20.06 $17.33 $17.98 $15.75 - - ------------------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .32 .64 .62 .58 .55 .50 Net Realized and Unrealized Gain (Loss) on Investments 5.66 6.47 4.63 3.17 (.19) 2.47 -------------------------------------------------------------------------- Total from Investment Operations 5.98 7.11 5.25 3.75 .36 2.97 -------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.46) (.63) (.58) (.55) (.51) (.52) Distributions from Realized Capital Gains (2.19) (1.16) (.69) (.47) (.50) (.22) -------------------------------------------------------------------------- Total Distributions (2.65) (1.79) (1.27) (1.02) (1.01) (.74) - - ------------------------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF PERIOD $32.69 $29.36 $24.04 $20.06 $17.33 $17.98 ========================================================================================================================= TOTAL RETURN 21.84% 31.27% 27.17% 23.08% 2.22% 19.51% ========================================================================================================================= RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $29,755 $22,568 $14,758 $10,272 $8,246 $7,486 Ratio of Total Expenses to Average Net Assets 0.40%* 0.37% 0.39% 0.40% 0.39% 0.39% Ratio of Net Investment Income to Average Net Assets 2.10%* 2.49% 2.92% 3.27% 3.26% 3.11% Portfolio Turnover Rate 32%* 30% 32% 30% 24% 26% Average Commission Rate Paid $.0500 $.0523 $.0483 N/A N/A N/A - - -------------------------------------------------------------------------------------------------------------------------
*Annualized. 18 44 NOTES TO FINANCIAL STATEMENTS Vanguard/Windsor II is registered under the Investment Company Act of 1940 as a diversified open-end investment company, or mutual fund. A. The following significant accounting policies conform to generally accepted accounting principles for mutual funds. The Fund consistently follows such policies in preparing its financial statements. 1. SECURITY VALUATION: Equity securities are valued at the latest quoted sales prices as of the close of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such securities not traded on the valuation date are valued at the mean of the latest quoted bid and asked prices. Prices are taken from the primary market in which each security trades. 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. 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. 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. FUTURES: The Fund uses S&P 500 Index and S&P MidCap 400 Index futures contracts to a limited extent, with the objective of maintaining full exposure to the stock market while maintaining liquidity. The Fund may purchase or sell futures contracts to achieve a desired level of investment, whether to accommodate portfolio turnover or cash flows from capital shares transactions. The primary risks associated with the use of futures contracts are imperfect correlation between changes in market values of stocks held by the Fund and the prices of futures contracts, and the possibility of an illiquid market. Futures contracts are valued at their quoted daily settlement prices. The aggregate principal amounts of the contracts are not recorded in the financial statements. Fluctuations in the value of the contracts are recorded in the Statement of Net Assets as an asset (liability) and in the Statement of Operations as unrealized appreciation (depreciation) until the contracts are closed, when they are recorded as realized futures gains (losses). 5. DISTRIBUTIONS: Distributions to shareholders are recorded on the ex-dividend date. Distributions are determined on a tax basis and may differ from net investment income and realized capital gains for financial reporting purposes. 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. B. Barrow, Hanley, Mewhinney & Strauss, Inc.; Equinox Capital Management, Inc.; and Tukman Capital Management, Inc., provide investment advisory services to the Fund for fees calculated at an annual percentage rate of average net assets. The basic fees thus computed for Barrow, Hanley, Mewhinney & Strauss, Inc., are subject to quarterly adjustments based on performance relative to the S&P/BARRA Value Index; such fees for Equinox Capital Management, Inc., are subject to quarterly adjustments based on performance relative to the Russell 1000 Value Index; such fees for Tukman Capital Management, Inc., are subject to quarterly adjustments based on performance relative to the S&P 500 Index. 19 45 The Vanguard Group provides investment advisory services to a portion of the Fund on an at-cost basis; the Fund paid Vanguard advisory fees of $132,000 for the six months ended April 30, 1998. For the six months ended April 30, 1998, the aggregate investment advisory fee represented an effective annual basic rate of 0.13% of average net assets before an increase of $2,910,000 (0.02%) based on performance. 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 Directors. At April 30, 1998, the Fund had contributed capital of $1,653,000 to Vanguard (included in Other Assets), representing 8.3% of Vanguard's capitalization. The Fund's Directors and officers are also Directors and officers of Vanguard. Vanguard has asked the Fund's investment advisers to direct certain portfolio 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 administrative expenses. For the six months ended April 30, 1998, these arrangements reduced the Fund's expenses by $1,118,000 (an annual rate of 0.01% of average net assets). D. During the six months ended April 30, 1998, the Fund purchased $5,777,220,000 of investment securities and sold $3,847,178,000 of investment securities, other than temporary cash investments. E. At April 30, 1998, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $10,194,858,000, consisting of unrealized gains of $10,301,416,000 on securities that had risen in value since their purchase and $106,558,000 in unrealized losses on securities that had fallen in value since their purchase. At April 30, 1998, the aggregate settlement value of open futures contracts expiring in June 1998 and the related unrealized appreciation were:
----------------------------------------------------------------------------------------------- (000) ------------------------------------ AGGREGATE NUMBER OF SETTLEMENT UNREALIZED FUTURES CONTRACTS LONG CONTRACTS VALUE APPRECIATION ----------------------------------------------------------------------------------------------- S&P 500 Index 5,829 $1,630,954 $55,697 S&P MidCap 400 Index 874 164,836 8,418 -----------------------------------------------------------------------------------------------
F. The market value of securities on loan to brokers/dealers at April 30, 1998, was $3,352,000, for which the Fund held cash collateral of $4,443,000. Cash collateral received is invested in repurchase agreements. 20 46 DIRECTORS AND OFFICERS JOHN C. BOGLE Senior Chairman of the Board and Director of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. JOHN J. BRENNAN Chairman, Chief Executive Officer, and Director of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. ROBERT E. CAWTHORN Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Managing Director of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun Company, Inc., and Westinghouse Electric Corp. BARBARA BARNES HAUPTFUHRER Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions, Inc., Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance Co., and Ladies Professional Golf Association; Trustee Emerita of Wellesley College. BRUCE K. MacLAURY President Emeritus of The Brookings Institution; Director of American Express Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp. BURTON G. MALKIEL Chemical Bank Chairman's Professor of Economics, Princeton University; Director of Prudential Insurance Co. of America, Amdahl Corp., Baker Fentress & Co., The Jeffrey Co., and Southern New England Telecommunications Co. ALFRED M. RANKIN, JR. Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co. JOHN C. SAWHILL President and Chief Executive Officer of The Nature Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and President of New York University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., and NACCO Industries. JAMES O. WELCH, JR. Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp. J. LAWRENCE WILSON Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins Engine Co. and The Mead Corp.; Trustee of Vanderbilt University. OTHER FUND OFFICERS RAYMOND J. KLAPINSKY Secretary; Managing Director and Secretary of The Vanguard Group, Inc.; Secretary of each of the investment companies in The Vanguard Group. RICHARD F. HYLAND Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies in The Vanguard Group. KAREN E. WEST Controller; Principal of The Vanguard Group, Inc.; Controller of each of the investment companies in The Vanguard Group. OTHER VANGUARD OFFICERS R. GREGORY BARTON Managing Director, Legal Department. ROBERT A. DiSTEFANO Managing Director, Information Technology. JAMES H. GATELY Managing Director, Individual Investor Group. KATHLEEN C. GUBANICH Managing Director, Human Resources. IAN A. MacKINNON Managing Director, Fixed Income Group. F. WILLIAM McNABB, III Managing Director, Institutional Investor Group. MICHAEL S. MILLER Managing Director, Planning and Development. RALPH K. PACKARD Managing Director and Chief Financial Officer. GEORGE U. SAUTER Managing Director, Core Management Group. "Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500," and "500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell Company is the owner of trademarks and copyrights relating to the Russell Indexes. "Wilshire 4500" and "Wilshire 5000" are trademarks of Wilshire Associates. 47 VANGUARD FAMILY OF FUNDS STOCK FUNDS Convertible Securities Fund Equity Income Fund Explorer Fund Growth and Income Portfolio Horizon Fund Aggressive Growth Portfolio Capital Opportunity Portfolio Global Equity Portfolio Index Trust 500 Portfolio Extended Market Portfolio Growth Portfolio Mid Capitalization Stock Portfolio Small Capitalization Growth Stock Portfolio Small Capitalization Stock Portfolio Small Capitalization Value Stock Portfolio Total Stock Market Portfolio Value Portfolio Institutional Index Fund International Equity Index Fund Emerging Markets Portfolio European Portfolio Pacific Portfolio International Growth Portfolio International Value Portfolio Morgan Growth Fund PRIMECAP Fund Selected Value Portfolio Specialized Portfolios Energy Portfolio Gold & Precious Metals Portfolio Health Care Portfolio REIT Index Portfolio Utilities Income Portfolio Tax-Managed Fund Capital Appreciation Portfolio Growth and Income Portfolio Total International Portfolio Trustees' Equity Fund U.S. Portfolio U.S. Growth Portfolio Windsor Fund Windsor II MONEY MARKET FUNDS Admiral Funds U.S. Treasury Money Market Portfolio Money Market Reserves Federal Portfolio Prime Portfolio Municipal Bond Fund Money Market Portfolio State Tax-Free Funds (CA, NJ, NY, OH, PA) Treasury Money Market Portfolio BOND FUNDS Admiral Funds Intermediate-Term U.S. Treasury Portfolio Long-Term U.S. Treasury Portfolio Short-Term U.S. Treasury Portfolio Bond Index Fund Intermediate-Term Bond Portfolio Long-Term Bond Portfolio Short-Term Bond Portfolio Total Bond Market Portfolio Fixed Income Securities Fund GNMA Portfolio High Yield Corporate Portfolio Intermediate-Term Corporate Portfolio Intermediate-Term U.S. Treasury Portfolio Long-Term Corporate Portfolio Long-Term U.S. Treasury Portfolio Short-Term Corporate Portfolio Short-Term Federal Portfolio Short-Term U.S. Treasury Portfolio Municipal Bond Fund High-Yield Portfolio Insured Long-Term Portfolio Intermediate-Term Portfolio Limited-Term Portfolio Long-Term Portfolio Short-Term Portfolio Preferred Stock Fund State Tax-Free Funds (CA, FL, NJ, NY, OH, PA) BALANCED FUNDS Asset Allocation Fund Balanced Index Fund Horizon Fund Global Asset Allocation Portfolio LifeStrategy Portfolios Conservative Growth Portfolio Growth Portfolio Income Portfolio Moderate Growth Portfolio STAR Portfolio Tax-Managed Fund Balanced Portfolio Wellesley Income Fund Wellington Fund Q732-4/1998 (C) 1998 Vanguard Marketing Corporation, Distributor. All rights reserved. [THE VANGUARD GROUP LOGO] Post Office Box 2600 Valley Forge, Pennsylvania 19482 FUND INFORMATION 1-800-662-7447 INDIVIDUAL ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 www.vanguard.com online@vanguard.com All Vanguard funds are offered by prospectus only. Prospectuses contain more complete information on advisory fees, distribution charges, and other expenses and should be read carefully before you invest or send money. Prospectuses can be obtained directly from The Vanguard Group. - -----END PRIVACY-ENHANCED MESSAGE----- -----END PRIVACY-ENHANCED MESSAGE-----