-----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, RlsMMuulInWtUAb9LNEbREOV5Ig1RrTS0tNyXvNzxoXEk8vd0CpCwzk5LZSRHlF9 WiHzO+Vxse0yI3VelykX5g== /in/edgar/work/20000620/0000932471-00-000595/0000932471-00-000595.txt : 20000920 0000932471-00-000595.hdr.sgml : 20000920 ACCESSION NUMBER: 0000932471-00-000595 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20000430 FILED AS OF DATE: 20000620 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: 657910 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 0001.txt WINDSOR/WINDSOR II SEMIANNUAL VANGUARD WINDSOR(TM) FUND April 30, 2000 semiannual [SHIP GRAPHIC] [A MEMBER OF THE VANGUARD GROUP LOGO] HAVE THE PRINCIPLES OF INVESTING CHANGED? In a world of frenetic change in business, technology, and the financial markets, it is natural to wonder whether the basic principles of investing have changed. We don't think so. The most successful investors over the coming decade will be those who began the new century with a fundamental understanding of risk and who had the discipline to stick with long-term investment programs. Certainly, investors today confront a challenging, even unprecedented, environment. Valuations of market indexes are at or near historic highs. The strength and duration of the bull market in U.S. stocks have inflated people's expectations and diminished their recognition of the market's considerable risks. And the incredible divergence in stock returns--many technology-related stocks gained 100% or more in 1999, yet prices fell for more than half of all stocks--has made some investors question the idea of diversification. And then there is the Internet. Undeniably, it is a powerful medium for communications and transacting business. For investors, the Internet is a vast source of information about investments, and online trading has made it inexpensive and convenient to trade stocks and invest in mutual funds. However, new tools do not guarantee good workmanship. Information is not the same as wisdom. Indeed, much of the information, opinion, and rumor that swirl about financial markets each day amounts to "noise" of no lasting significance. And the fact that rapid-fire trading is easy does not make it beneficial. Frequent trading is almost always counterproductive because costs--even at low commission rates--and taxes detract from the returns that the markets provide. Sadly, many investors jump into a "hot" mutual fund just in time to see it cool off. Meanwhile, long-term fund investors are hurt by speculative trading activity because they bear part of the costs involved in accommodating purchases and redemptions. Vanguard believes that intelligent investors should resist short-term thinking and focus instead on a few time-tested principles: o Invest for the long term. Pursuing your long-term investment goals is more like a marathon than a sprint. o Diversify your investments with holdings in stocks, bonds, and cash investments. Remember that, at any moment, some part of a diversified portfolio will lag other parts, and be wary of taking on more risk by "piling onto" the best-performing part of your holdings. Today's leader could well be tomorrow's laggard. o Step back from the daily frenzy of the markets; focus on your overall asset allocation. o Capture as much of the market's return as possible by minimizing costs and taxes. Costs and taxes diminish long-term returns while doing nothing to reduce the risks you incur as an investor. - -------------------------------------------------------------------------------- CONTENTS Report From The Chairman .......... 1 Fund Profile ...................... 8 The Markets In Perspective ........ 4 Performance Summary ...............10 Adviser's Report .................. 6 Financial Statements ..............11 - -------------------------------------------------------------------------------- All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. "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 5000(R)" and "Wilshire 4500" are trademarks of Wilshire Associates Incorporated. REPORT FROM THE CHAIRMAN [PHOTO OF JOHN J. BRENNAN] JOHN J. BRENNAN The stock market displayed a split personality during the six months ended April 30, 2000, the first half of Vanguard Windsor Fund's fiscal year. For the first four months, the market enthusiastically embraced technology-related stocks and shunned value stocks. Then a 180-degree turn enabled Windsor Fund to erase a decline of about 10% from November through February and to gain 2.6% for the full period. The table at right shows the half-year results for Windsor Fund, the average multi-cap value fund, and two unmanaged benchmarks: the Russell 1000 Value Index (the value stocks within the 1,000 largest U.S. stocks) and the large-capitalization Standard & Poor's 500 Index, which includes both growth and value stocks. --------------------------------------------------- TOTAL RETURNS SIX MONTHS ENDED APRIL 30, 2000 --------------------------------------------------- Vanguard Windsor Fund 2.6% --------------------------------------------------- Average Multi-Cap Value Fund* 3.9% --------------------------------------------------- Russell 1000 Value Index -1.0% --------------------------------------------------- S&P 500 Index 7.2% --------------------------------------------------- *Derived from data provided by Lipper Inc. Windsor Fund's total return (capital change plus reinvested dividends) is based on a decrease in net asset value from $16.91 per share on October 31, 1999, to $15.25 per share on April 30, 2000. The return is adjusted for a $0.16 per share dividend from net investment income and a $1.90 per share distribution from net realized capital gains. THE PERIOD IN REVIEW The U.S. economy displayed remarkable vigor during the six months. Its staying power was impressive, too: April marked the 109th month of uninterrupted expansion--more than nine years without a recession. Preliminary estimates for the first quarter of 2000 indicated that the economy was growing at a 5.4% annual rate, a strong follow-up to the previous quarter's astounding 7.3% rate. A growing economy creates a good climate for stocks, and corporate profits posted robust gains. The overall stock market, as measured by the Wilshire 5000 Total Market Index, rose 9.7% for the half-year. However, concerns about inflation and the high valuations of many tech stocks led to frequent and significant day-to-day swings in the market. The volatility was especially evident among small-cap and technology issues. The small-cap Russell 2000 Index, for example, saw a 35.2% gain from October 31 through February 29 followed by a - -12.2% return in March and April, resulting in a half-year return of 18.7%. --------------------------------------------------------------- TOTAL RETURNS ---------------------------------------- OCT. 31, 1999, FEB. 29, 2000, STOCK INDEX TO FEB. 29, 2000 TO APR. 30, 2000 --------------------------------------------------------------- Russell 1000 Growth 16.3% 2.1% Russell 1000 Value -10.7 10.9 --------------------------------------------------------------- Russell 2000 Growth 58.8% -19.5% Russell 2000 Value 7.1 1.1 --------------------------------------------------------------- MSCI EAFE Growth 18.9% -4.8% MSCI EAFE Value -1.4 2.0 --------------------------------------------------------------- Nasdaq Composite 58.8% -17.7% --------------------------------------------------------------- The table above shows the striking shift in leadership from growth stocks in the first four months of the period to value stocks in the final two. The 1 pattern was evident overseas, too, as indicated by results for the growth and value segments of the Morgan Stanley Capital International Europe, Australasia, Far East (EAFE) Index of international stocks. The bull market in stocks continued despite three quarter-point (0.25%) increases in short-term interest rates by the Federal Reserve Board, which boosted its target federal-funds rate from 5.25% to 6.0%. The yield on Treasury bills responded by climbing 74 basis points (0.74 percentage point) to 5.83% as of April 30. However, long-term interest rates went the other way. The yield of the benchmark 30-year Treasury bond fell 20 basis points, on balance, ending the half-year at 5.96%. The yield for the 10-year Treasury note rose 19 basis points during the period, to 6.21%, and the overall bond market, as measured by the Lehman Brothers Aggregate Bond Index, recorded a 1.4% total return. PERFORMANCE OVERVIEW Thanks to its comeback in March and April, Windsor Fund achieved a 2.6% return for the six months ended April 30. The fund outperformed the Russell 1000 Value Index--a good yardstick for large- and mid-cap value stocks--by 3.6 percentage points during the half-year. However, Windsor's return was behind the 3.9% gain recorded by the average multi-cap value fund and the 7.2% return of the S&P 500 Index. One sector--technology--explained much of the fund's shortfall versus both the S&P 500 and the average peer fund. Windsor (and the Russell 1000 Value Index) had an average weighting of about 6% in tech stocks during the half-year, which was about one-half of the tech weighting for the average multi-cap value fund and less than one-quarter the tech holdings of the S&P 500 Index. Given the sector's gain of nearly 40% during the six months, a light weighting in tech stocks was a definite handicap. Another factor was the lagging performance of the financial-services sector, where Windsor Fund, like the Russell 1000 Value Index, held more than one-quarter of its assets--a heavier weighting than either the average peer fund or the S&P 500 Index. Financial stocks posted an average decline of about -7%, as investors anticipated that higher interest rates would crimp profits. Windsor's financial-services holdings did a bit worse, returning -11%. - -------------------------------------------------------------------------------- TOTAL ASSETS MANAGED AS OF APRIL 30, 2000 ------------------------------------ $ MILLION PERCENTAGE - -------------------------------------------------------------------------------- Wellington Management Company, LLP $11,522 74% Sanford C. Bernstein & Co., Inc. 3,643 24 Cash Reserve* 330 2 - -------------------------------------------------------------------------------- Total $15,495 100% - -------------------------------------------------------------------------------- * This cash reserve is invested in equity index futures to simulate investment in stocks; each adviser may also maintain a modest cash reserve. Elsewhere, however, our advisers generally added value versus the indexes with good stock selections in the consumer-discretionary, health-care, and materials & processing sectors. The table above presents the share of assets supervised by each adviser as of April 30. IN SUMMARY The spring turnabout in stocks, when downtrodden value issues suddenly rose and technology-dominated growth indexes plummeted, served as a vivid reminder of the stock market's short-term unpredictability and volatility. Such sudden shifts in market leadership are certain to occur now and then, but their timing and duration are extremely unpredictable. That is why we advocate diversification 2 and a long-term orientation. Investors who maintain exposure to the major asset classes through balanced portfolios of well-diversified stock funds, bond funds, and money market funds have generally found it easier to maintain equilibrium in turbulent times. We urge you to base your investment plans on your own goals, time horizon, and risk tolerance--and then to stick with those plans over the long haul. /S/ John J. Brennan Chairman and Chief Executive Officer May 12, 2000 3 THE MARKETS IN PERSPECTIVE SIX MONTHS ENDED APRIL 30, 2000 A surging economy, rising corporate profits, and enthusiasm for technology stocks carried broad stock market indexes higher during the volatile but generally rewarding six months ended April 30, 2000. Stocks rose despite a modest pickup in inflation and a rise in interest rates, both of which did some damage to bond prices. Through the first four months of the period, the stock market was dominated by optimism about the long-term outlook for technology, telecommunications, and media companies. But sentiment then shifted and the tech and telecom groups fell sharply, giving back some of the spectacular gains achieved over the previous year or so. For both bond and stock investors, uncertainty centered mainly on how the Federal Reserve Board would react to the surprising performance of the U.S. economy, which grew at a 7.3% pace in the final three months of 1999 and at a still-robust 5.4% during the first quarter of 2000. With U.S. unemployment at a three-decade low of 3.9%, Fed policymakers grew increasingly concerned that inflation was bound to worsen. The Fed raised short-term interest rates by 0.25 percentage point three times during the six-month period. These boosts, following identical increases in June and August of 1999, took the Fed's target for short-term rates to 6.0%. Yet the economy continued to soar--including even the housing and automobile sectors, which often are the first to slow down in response to higher interest rates. - -------------------------------------------------------------------------------- TOTAL RETURNS PERIODS ENDED APRIL 30, 2000 - -------------------------------------------------------------------------------- 6 MONTHS 1 YEAR 5 YEARS* - -------------------------------------------------------------------------------- STOCKS S&P 500 Index 7.2% 10.1% 25.3% Russell 2000 Index 18.7 18.4 15.3 Wilshire 5000 Index 9.7 12.2 23.9 MSCI EAFE Index 6.8 14.2 10.7 - -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index 1.4% 1.3% 6.8% Lehman 10 Year Municipal Bond Index 2.4 -0.3 6.1 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 2.7 5.1 5.2 - -------------------------------------------------------------------------------- OTHER Consumer Price Index 1.8% 3.0% 2.4% - -------------------------------------------------------------------------------- *Annualized. Inflation gauges provided ambiguous readings. The Consumer Price Index increased 1.8% and 3.0% for the 6- and 12-month periods ended April 30, but much of the acceleration in inflation was due to higher energy and food prices. The core inflation rate, which excludes those sectors, was up a less-ominous 2.2% over the year. U.S. STOCK MARKETS The technology sector, which accounts for about one-quarter of the stock market's total value, dominated the market during the half-year, despite suffering a sharp setback late in the period. Even after a -34% fall from March 10 through mid-April, the tech-heavy Nasdaq Composite Index registered a 30.8% return for the six months. The overall stock market, as measured by the Wilshire 5000 Total Market Index, gained 9.7%. There was a decided split in results from large- and small-capitalization stocks. 4 The large-cap S&P 500 Index returned 7.2%, while the rest of the U.S. stock market gained 19.2%. Top performers during the half-year were companies in computer software and hardware, semiconductors, Internet-related businesses, and wireless communications. Fully half of the 58 companies in the S&P 500's technology group gained more than 50%, and the average return for tech stocks exceeded 39%. A number of tech-related companies in the producer-durables sector also posted impressive gains, and the sector as a whole returned 32%. A return of 34% was achieved by the oil-drilling and services companies in the "other energy" category, which benefited from higher oil and gas prices. The worst-performing sector was consumer staples (-18%), a category that includes supermarket, food, beverage, and tobacco stocks. Next in line were financial-services companies (-7%), hurt by higher short-term interest rates, which tend to raise borrowing costs for banks and can lead to increased loan defaults. U.S. BOND MARKETS The Federal Reserve Board's three rate increases succeeded in elevating other short-term rates. For example, yields of 3-month U.S. Treasury bills rose during the half-year to 5.83%, an increase of 0.74 percentage point (74 basis points) that virtually matched the Fed's target. However, long-term rates didn't move nearly as far. The 10-year Treasury note rose just 19 basis points, to 6.21%, as of April 30. And yields actually fell a bit for very long-term Treasury bonds, a result of shrinking supply. Because of the federal government's budget surplus, the U.S. Treasury decided to reduce issuance of new bonds and to buy back some of its existing long-term bonds. As investors reacted, the yield of the 30-year Treasury declined 20 basis points--from 6.16% to 5.96%--during the half-year. The result of higher short-term rates and relatively stable long-term rates was an unusual inversion in the Treasury yield curve. Instead of the usual upward-sloping curve--which shows yields increasing in tandem with maturities--there was a pronounced drop-off. As of April 30, the yield of 30-year Treasuries was two-thirds of a percentage point below the 6.62% yield on 3-year Treasury notes. A similar pattern emerged outside the Treasury market, although long-term yields remained above yields for short-term corporate, municipal, and mortgage-backed securities. The overall bond market, as measured by the Lehman Aggregate Bond Index, provided a 1.4% return, as an average price decline of - -2.0% offset most of a 3.4% income return. INTERNATIONAL STOCK MARKETS Despite declines in March and April, stock markets in Europe, Asia, and many emerging markets produced strong half-year gains as investors responded to improving global economic growth and a rise in corporate merger-and-acquisition activity. However, many of the gains were slashed for U.S. investors as the dollar gained strength against most other currencies. (Conversely, when the dollar falls in value, returns from abroad are enhanced for U.S. investors.) In U.S.-dollar terms, the overall return from developed foreign markets was a very solid 6.8%, as measured by the Morgan Stanley Capital International Europe, Australasia, Far East Index. However, in local currencies, the EAFE Index return was 16.4%. In Europe, an average 21.1% gain in local-currency terms was reduced to 8.4% for U.S. investors because of the dollar's strength. Stocks in the Pacific region, which is dominated by Japan, returned 3.6% in dollars, less than half the 7.5% gain in local currencies. The Select Emerging Markets Free Index returned 12.3% in U.S. dollars, with the biggest gains in Turkey (+148%), Russia (+123%), and Israel (+50%). 5 ADVISER'S REPORT Until recently, the stock market had been narrowly focused on technology stocks. From mid-1999 through April 2000, tech stocks, which constitute about 30% of the S&P 500 Index, returned 46%, while the remainder of the market declined about 3%. Such narrowness is symptomatic of a market that is anxious and uncertain. In this instance, the uncertainty concerns Federal Reserve Board policy. How much will policymakers raise the federal funds rate, beyond the five quarter-percentage-point increases so far, to achieve their objectives of slowing the economy and keeping inflation in check? And will we wind up in a recession as a result of this process? Narrow markets often culminate in valuation extremes, and that happened again this time. At their peak in March, technology stocks were clearly overvalued, at 63 to 64 times estimates of this year's earnings. Even after declining some 20% through April 30, they are still too high--at over 50 times earnings--in relation to the 11% growth rate of information technology, broadly defined. Further, we see a deceleration in growth rates for some important technology subsectors in 2001, e.g., semiconductor shipments, PC sales, and cellular telephone sales. Deceleration in growth is a traditional sell signal for technology investors. Non-technology stocks--which, of course, include most of the value stocks that are Windsor's staple fare--bottomed in late February and have had a strong recovery since then, both absolutely and relative to the market. Financials, retailers, and industrial cyclicals have all enjoyed pops of 15% to 20% or more from their lows. In part, this rebound is due to their having been oversold in late February. Also, there has been some rotation of money out of technology stocks into these stocks. And it may be that--Fed or no Fed--the market is becoming less diffident about the sustainability of U.S. economic growth. We think the odds favor the Fed being successful--as it was in 1994--in slowing the economy to a more sustainable 4% real growth rate from the 6% pace that we have seen over the last three quarters. The Fed's task is made easier by the lack of inventory buildups or other imbalances in the economy at present and by the fact that labor productivity continues to increase very strongly at an annualized rate of about 3.5%. Wage pressures are building, but will probably settle out at 4%-5%. With sustainable productivity growth on the order of 3%, this should keep the increase in unit-labor costs--which has been running at only about 0.5% year over year--to about 2%. That, in turn, should help keep core inflation--now 2.2% year over year, as measured by the Consumer Price Index--at 2.5%-3%. Inflation is restrained by the brutal competition that we see in one end market after another, especially in the growing number of markets that are globalizing. If all this plays out reasonably according to the script and the economy continues on a sustainable growth track, we should see--especially once an end is in sight to the Fed's rate increases--a broader stock market than we've experienced since mid-1999. It is in such broad markets that value stocks in general, and Windsor in particular, typically shine. - -------------------------------------------------------------------------------- INVESTMENT PHILOSOPHY The fund reflects a belief 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 fund may concentrate a large portion of assets in those securities or industries the advisers believe offer the best return potential. - -------------------------------------------------------------------------------- 6 If, instead, the United States winds up in a recession, common stocks in general will suffer for a period, though we believe technology stocks will suffer more than others because technology spending gets deferred during recessions. With technology stocks still selling at 50 times earnings at the end of April, and other sectors selling at a much less demanding 20 times, it is hard to see how technology stocks would not be hit harder in an economic downturn. We continue to forage for truly undervalued stocks. In the last six months, we made large additions, at opportunistic prices, to our holdings in Associates First Capital, TJX Companies, Pharmacia, and MCI WorldCom. Each of these four stocks is now among our ten largest holdings, and each has quite significant upside potential from current levels. Our overall approach remains consistent with that used by the Windsor Fund for more than three decades--an emphasis on low-P/E stocks; a willingness to concentrate the portfolio where we have the most conviction; price opportunism on the buy side and price discipline on the sell side; plus a dash of imagination and a constant eye on the always-changing world of business. We admire and understand the "new economy" as much as the next guy, and will give Windsor shareholders as much participation in it as possible. But we'll do so on our terms; i.e., the stocks have to be undervalued relative to their growth rate. Two recent examples of this approach were our purchases of Alcatel and Arrow Electronics, made mostly last year when the stocks were trading at low P/Es. We've doubled our money on these holdings. Our overall portfolio trades at about 15-16 times estimated 2000 earnings, a 35% discount to the market P/E. Yet our holdings offer about the same projected five-year earnings growth rate as the market. This combination of below-market price and at-market growth prospects is our value proposition. A closing of this P/E discount would result in significant appreciation potential for Windsor Fund shareholders. Charles T. Freeman, Portfolio Manager May 12, 2000 7 FUND PROFILE WINDSOR FUND This Profile provides a snapshot of the fund's characteristics as of April 30, 2000, compared where appropriate to an unmanaged index. Key elements of this Profile are defined on page 9. PORTFOLIO CHARACTERISTICS - -------------------------------------------------------- WINDSOR S&P 500 - -------------------------------------------------------- Number of Stocks 176 500 Median Market Cap $8.1B $87.5B Price/Earnings Ratio 14.6x 26.8x Price/Book Ratio 2.2x 5.3x Yield 1.6% 1.2% Return on Equity 14.6% 24.1% Earnings Growth Rate 9.9% 16.1% Foreign Holdings 10.7% 1.2% Turnover Rate 38%* -- Expense Ratio 0.31%* -- Cash Reserves 1.3% -- *Annualized. INVESTMENT FOCUS - -------------------------------------------------------- [GRID] STYLE................VALUE MARKET CAP...........MEDIUM VOLATILITY MEASURES - -------------------------------------------------------- WINDSOR S&P 500 - -------------------------------------------------------- R-Squared 0.77 1.00 Beta 1.09 1.00 TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) - -------------------------------------------------------- AT&T Corp. 4.3% Alcoa Inc. 4.0 Citigroup, Inc. 4.0 Associates First Capital Corp. 3.2 Pharmacia Corp. 2.8 Aventis SA 2.4 MCI WorldCom, Inc. 2.4 TJX Cos., Inc. 2.3 International Business Machines Corp. 2.2 Washington Mutual, Inc. 2.2 - -------------------------------------------------------- Top Ten 29.8% SECTOR DIVERSIFICATION (% OF COMMON STOCKS) - -------------------------------------------------------- APRIL 30, 1999 APRIL 30, 2000 -------------------------------- WINDSOR WINDSOR S&P 500 -------------------------------- Auto & Transportation .. 4.1% 7.1% 2.1% Consumer Discretionary . 2.6 6.9 12.3 Consumer Staples ....... 0.0 1.0 5.3 Financial Services ..... 28.8 23.3 13.5 Health Care ............ 8.5 10.4 9.8 Integrated Oils ........ 4.0 4.4 4.4 Other Energy ........... 9.4 8.4 1.8 Materials & Processing . 20.9 17.1 2.5 Producer Durables ...... 6.8 3.1 4.2 Technology ............. 4.3 6.1 27.8 Utilities .............. 6.7 11.5 9.6 Other .................. 3.9 0.7 6.7 - -------------------------------------------------------- 8 BETA. A measure of the magnitude of a fund'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 fund 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 fund'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 fund. EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. INVESTMENT FOCUS. This grid indicates the focus of a fund 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 fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund 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 fund, the weighted average price/book ratio of the stocks it holds. PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total return were precisely synchronized with the overall market's return, its R-squared would be 1.00. If a fund'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 fund, the weighted average return on equity for the companies whose stocks it holds. SECTOR DIVERSIFICATION. The percentages of a fund'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 fund has invested in its ten largest holdings. (The average for stock mutual funds is about 35%.) As this percentage rises, a fund'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. Funds 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 fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. 9 PERFORMANCE SUMMARY WINDSOR FUND 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. An investor's shares, when redeemed, could be worth more or less than their original cost. TOTAL INVESTMENT RETURNS: OCTOBER 31, 1979-APRIL 30, 2000 - -------------------------------------------------------------------------------- WINDSOR FUND S&P 500 WINDSOR FUND S&P 500 FISCAL CAPITAL INCOME TOTAL TOTAL FISCAL CAPITAL INCOME TOTAL TOTAL YEAR RETURN RETURN RETURN RETURN YEAR RETURN RETURN RETURN RETURN - -------------------------------------------------------------------------------- 1980 17.2% 7.0% 24.2% 32.1% 1991 35.7% 9.0% 44.7% 33.5% 1981 11.1 6.9 18.0 0.6 1992 4.3 5.0 9.3 10.0 1982 14.2 7.0 21.2 16.3 1993 24.6 3.7 28.3 14.9 1983 25.3 7.3 32.6 27.8 1994 3.7 2.6 6.3 3.9 1984 9.6 6.9 16.5 6.3 1995 14.2 3.6 17.8 26.4 1985 16.6 6.7 23.3 19.4 1996 19.6 3.6 23.2 24.1 1986 22.8 6.5 29.3 33.2 1997 24.3 2.7 27.0 32.1 1987 2.7 1.9 4.6 6.4 1998 -2.0 1.2 -0.8 22.0 1988 18.9 8.1 27.0 14.8 1999 12.1 1.6 13.7 25.7 1989 11.9 5.2 17.1 26.4 2000* 1.7 0.9 2.6 7.2 1990 -31.8 3.9 -27.9 -7.5 - -------------------------------------------------------------------------------- *Six months ended April 30, 2000. See Financial Highlights table on page 16 for dividend and capital gains information for the past five years. AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 2000* - -------------------------------------------------------------------------------- 10 YEARS INCEPTION --------------------------- DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL - -------------------------------------------------------------------------------- Windsor Fund 10/23/1958 7.74% 15.68% 9.86% 3.46% 13.32% - -------------------------------------------------------------------------------- * SEC rules require that we provide this average annual total return information through the latest calendar quarter. 10 FINANCIAL STATEMENTS APRIL 30, 2000 (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, 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, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. - -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR FUND SHARES (000) - -------------------------------------------------------------------------------- COMMON STOCKS (96.5%)+ - -------------------------------------------------------------------------------- AUTO & TRANSPORTATION (6.8%) Compagnie Generale des Etablissements Michelin Class B 6,000,586 199,584 Eaton Corp. 2,015,900 169,336 Canadian National Railway Co. 5,692,100 159,735 Delta Air Lines, Inc. 2,298,722 121,258 Delphi Automotive Systems Corp. 2,937,059 56,171 o(1)America West Holdings Corp. Class B 3,484,500 50,961 Burlington Northern Santa Fe Corp. 1,949,000 47,020 Southwest Airlines Co. 2,113,400 45,834 Union Pacific Corp. 1,072,300 45,171 Genuine Parts Co. 1,486,500 39,021 CSX Corp. 1,619,900 33,917 Norfolk Southern Corp. 1,923,600 33,903 Ford Motor Co. 578,800 31,653 Dana Corp. 886,200 26,918 --------------- 1,060,482 --------------- CONSUMER DISCRETIONARY (6.7%) (1)TJX Cos., Inc. 18,395,100 352,956 (1)Ross Stores, Inc. 8,625,000 178,969 May Department Stores Co. 5,180,600 142,466 o(1)Republic Services, Inc. Class A 9,866,500 135,048 o Jones Apparel Group, Inc. 2,341,400 69,510 Whirlpool Corp. 619,800 40,364 o Federated Department Stores, Inc. 1,100,300 37,410 Sears, Roebuck & Co. 841,800 30,831 VF Corp. 994,300 28,089 o Saks Inc. 1,239,100 14,172 Dillard's Inc. 616,900 8,598 --------------- 1,038,413 --------------- CONSUMER STAPLES (1.0%) Philip Morris Cos., Inc. 2,502,900 54,751 ConAgra, Inc. 2,395,800 45,221 SuperValu Inc. 942,100 19,490 Tyson Foods, Inc. 1,812,600 18,919 IBP, Inc. 736,500 12,152 --------------- 150,533 --------------- FINANCIAL SERVICES (22.5%) Citigroup, Inc. 10,505,300 624,409 Associates First Capital Corp. 22,028,700 488,762 Washington Mutual, Inc. 13,316,664 340,407 CIGNA Corp. 4,046,300 322,692 (1)Golden West Financial Corp. 8,995,800 306,982 (1)Dime Bancorp, Inc. 7,771,300 145,712 Bank of America Corp. 2,313,500 113,361 U.S. Bancorp 5,493,900 111,595 (1)Liberty Property Trust REIT 3,378,800 83,625 UnionBanCal Corp. 2,949,800 81,673 FleetBoston Financial Corp. 2,009,530 71,213 PartnerRe Ltd. 1,860,500 68,373 Bank One Corp. 2,220,900 67,737 TCF Financial Corp. 2,704,100 63,208 First Union Corp. 1,944,300 61,975 The Chubb Corp. 907,500 57,740 Charter One Financial 2,400,000 48,750 Allstate Corp. 2,025,200 47,845 American International Group, Inc. 382,900 41,999 11 - -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR FUND SHARES (000) - -------------------------------------------------------------------------------- KeyCorp 2,167,600 40,101 MBIA, Inc. 803,800 39,738 National City Corp. 2,185,700 37,157 American General Corp. 637,000 35,672 AMBAC Financial Group Inc. 579,900 27,835 Torchmark Corp. 1,061,800 26,611 Summit Bancorp 873,700 22,170 Morgan Stanley Dean Witter & Co. 276,000 21,183 (1)IPC Holdings Ltd. 1,649,800 21,035 Fannie Mae 344,600 20,784 The Chase Manhattan Corp. 197,800 14,254 J.P. Morgan & Co., Inc. 99,900 12,825 Regions Financial Corp. 509,450 10,412 Old Republic International Corp.383,800 5,469 Horace Mann Educators Corp. 257,300 3,747 --------------- 3,487,051 --------------- HEALTH CARE (10.0%) Pharmacia Corp. 8,632,904 431,106 Aventis SA ADR 6,586,550 370,493 Aetna Inc. 3,752,000 217,147 Tenet Healthcare Corp. 7,242,800 184,691 Columbia/HCA Healthcare Corp. 5,019,200 142,733 o(1)Pacificare Health Systems, Inc. 2,566,000 131,989 o Foundation Health Systems Class A 6,028,660 60,663 Aventis SA Class A 99,671 5,495 Bergen Brunswig Corp. Class A 1,017,100 5,085 --------------- 1,549,402 --------------- INTEGRATED OILS (4.3%) Exxon Mobil Corp. 1,863,461 144,768 USX-Marathon Group 5,397,700 125,834 Petro Canada 4,735,800 79,917 Shell Transport & Trading Co. ADR 1,302,300 62,836 Occidental Petroleum Corp. 2,623,200 56,235 Texaco Inc. 1,060,700 52,505 Phillips Petroleum Co. 1,105,400 52,437 Conoco Inc. Class B 1,831,300 45,554 Amerada Hess Corp. 666,700 42,419 --------------- 662,505 --------------- OTHER ENERGY (8.1%) Burlington Resources, Inc. 8,251,700 324,395 o Anderson Exploration Ltd. 12,472,400 199,503 Union Pacific Resources Group, Inc. 9,264,500 177,763 Anadarko Petroleum Corp. 2,636,300 114,514 (1)Ultramar Diamond Shamrock Corp. 4,547,400 112,548 Valero Energy Corp. 2,701,300 78,338 o Santa Fe Snyder Corp. 8,142,300 74,807 Devon Energy Corp. 1,201,975 57,920 (1)Cabot Oil & Gas Corp. Class A 2,409,500 44,726 Tosco Corp. 1,279,300 41,018 Ashland, Inc. 607,000 20,714 Alberta Energy Co. Ltd. 191,600 6,023 --------------- 1,252,269 --------------- MATERIALS & PROCESSING (16.5%) Alcoa Inc. 9,643,834 625,644 Air Products & Chemicals, Inc. 7,442,500 231,183 - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- (1)Engelhard Corp. 11,454,200 201,164 (1)Abitibi-Consolidated, Inc. 15,176,789 165,048 Jefferson Smurfit Group PLC ADR 5,853,641 128,048 o Smurfit-Stone Container Corp. 6,081,950 92,750 Hercules, Inc. 5,314,000 82,699 Lyondell Chemical Co. 4,385,903 80,591 Pechiney SA ADR A 2,861,128 62,945 o Packaging Corp. of America 5,260,000 62,462 Dow Chemical Co. 543,300 61,393 Praxair, Inc. 1,108,200 49,246 Lafarge Corp. 1,938,300 48,942 Reynolds Metals Co. 700,000 46,550 International Paper Co. 1,248,300 45,875 Fort James Corp. 1,650,800 39,516 Archer-Daniels-Midland Co. 3,798,715 37,750 AK Steel Corp. 3,318,652 36,713 Willamette Industries, Inc. 909,600 34,735 Georgia Pacific Group 912,900 33,549 Champion International Corp. 493,400 32,441 Nucor Corp. 732,600 31,502 Phosphate Resources Partners LP 4,018,800 30,894 (1)Century Aluminum Co. 2,000,000 28,000 Sonoco Products Co. 1,202,300 25,098 o(1)Kaiser Aluminum & Chemical Corp. 5,789,334 24,605 o American Standard Cos., Inc. 591,400 24,247 Temple-Inland Inc. 467,800 23,448 Crown Cork & Seal Co., Inc. 1,398,300 22,722 Sherwin-Williams Co. 893,300 22,221 o Owens-Illinois, Inc. 1,303,800 17,601 o Albany International Corp. 1,092,455 16,592 Boise Cascade Corp. 473,900 15,431 Cabot Corp. 553,300 14,939 Great Lakes Chemical Corp. 485,000 13,065 Owens Corning 615,500 11,194 o Burlington Industries, Inc. 2,383,700 10,429 Mississippi Chemical Corp. 1,241,500 9,544 Ryerson Tull, Inc. 625,846 7,745 Armstrong World Industries Inc. 211,300 4,134 --------------- 2,552,655 --------------- PRODUCER DURABLES (3.0%) Alcatel SA ADR 3,994,600 181,505 o(1)Toll Brothers, Inc. 3,529,166 76,539 CNH Global NV 3,865,100 52,179 Northrop Grumman Corp. 552,300 39,144 (1)Kaufman & Broad Home Corp. 1,804,100 34,729 (1)MDC Holdings, Inc. 1,156,300 22,042 The BFGoodrich Co. 625,800 19,947 o(1)Beazer Homes USA, Inc. 860,464 16,456 Thomas & Betts Corp. 475,800 14,661 Centex Corp. 464,900 11,216 --------------- 468,418 --------------- TECHNOLOGY (5.9%) International Business Machines Corp. 3,067,100 342,365 o(1)Arrow Electronics, Inc. 6,991,400 306,311 Avnet, Inc. 1,067,800 83,956 o(1)General Semiconductor, Inc. 3,468,600 69,372 o Ceridian Corp. 2,290,300 49,671 o Adaptec, Inc. 873,700 23,590 12 - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- Motorola, Inc. 132,000 15,716 o Ingram Micro, Inc. 732,500 14,421 o Litton Industries, Inc. 279,900 12,158 --------------- 917,560 --------------- UTILITIES (11.1%) AT&T Corp. 14,416,016 673,048 o MCI WorldCom, Inc. 8,270,639 375,797 o Adelphia Communications Corp. Class A 3,359,800 166,520 PG&E Corp. 1,919,100 49,777 Consolidated Edison Inc. 1,376,000 48,418 Ameren Corp. 1,272,300 46,677 New Century Energies, Inc. 1,365,300 44,543 FirstEnergy Corp. 1,704,100 43,348 Central & South West Corp. 1,778,500 38,571 SBC Communications Inc. 837,720 36,703 Cinergy Corp. 1,334,900 35,709 o MediaOne Group, Inc. 415,000 31,384 Allegheny Energy, Inc. 978,900 29,734 Bell Atlantic Corp. 491,100 29,098 GPU, Inc. 993,600 27,883 BellSouth Corp. 557,900 27,163 GTE Corp. 160,000 10,840 --------------- 1,715,213 --------------- OTHER (0.6%) Cooper Industries, Inc. 1,103,600 37,867 Minnesota Mining & Manufacturing Co. 271,800 23,511 Miscellaneous (0.3%) 39,648 --------------- 101,026 --------------- - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $13,702,843) 14,955,527 - -------------------------------------------------------------------------------- CONVERTIBLE PREFERRED STOCK (0.1%) - -------------------------------------------------------------------------------- Kaufman & Broad Home Corp. 8.25% Cvt. Pfd. (Cost $23,120) 3,163,700 20,762 - -------------------------------------------------------------------------------- FACE AMOUNT (000) - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (4.5%)+ - -------------------------------------------------------------------------------- Federal Home Loan Mortgage Corp. (2)5.86%, 5/11/2000 $5,000 4,992 (2)5.93%, 5/4/2000 3,000 2,998 Federal National Mortgage Assn. (2)5.86%, 5/4/2000 3,500 3,498 (2)6.15%, 7/13/2000 7,000 6,915 Repurchase Agreements Collateralized by U.S. Government Obligations in a Pooled Cash Account 5.75%, 5/1/2000 486,366 486,366 5.79%, 5/1/2000--Note G 191,275 191,275 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (COST $696,044) 696,044 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (101.1%) (COST $14,422,007) 15,672,333 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- MARKET VALUE* (000) - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-1.1%) - -------------------------------------------------------------------------------- Other Assets--Note C 68,353 Liabilities--Note G (246,052) --------------- (177,699) - -------------------------------------------------------------------------------- NET ASSETS (100%) - -------------------------------------------------------------------------------- Applicable to 1,016,116,677 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $15,494,634 ================================================================================ NET ASSET VALUE PER SHARE $15.25 ================================================================================ * See Note A in Notes to Financial Statements. o Non-Income-Producing Security. + The fund invests a portion of its reserves in equity markets through the use of index futures contracts. After giving effect to futures investments, the fund's effective common stock and temporary cash investment positions represent 98.6% and 2.4%, respectively of net assets. See Note F 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 $2,508,817,000. (2) Securities with an aggregate value of $18,403,000 have been segregated as initial margin for open futures contracts. ADR--American Depositary Receipt. REIT--Real Estate Investment Trust. - ----------------------------------------------------------- AT APRIL 30, 2000, NET ASSETS CONSISTED OF: - ----------------------------------------------------------- AMOUNT PER (000) SHARE - ----------------------------------------------------------- Paid in Capital $13,139,077 $12.93 Undistributed Net Investment Income 72,084 .07 Accumulated Net Realized Gains 1,025,128 1.01 Unrealized Appreciation-- Note F Investment Securities 1,250,326 1.23 Futures Contracts 8,019 .01 - ----------------------------------------------------------- Net Assets $15,494,634 $15.25 =========================================================== 13 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 FUND SIX MONTHS ENDED APRIL 30, 2000 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME Income Dividends* $ 147,409 Interest 11,055 Security Lending 688 --------------- Total Income 159,152 --------------- Expenses Investment Advisory Fees--Note B Basic Fee 9,949 Performance Adjustment (5,773) The Vanguard Group--Note C Management and Administrative 18,936 Marketing and Distribution 968 Custodian Fees 138 Auditing Fees 10 Shareholders' Reports 204 Trustees' Fees and Expenses 10 --------------- Total Expenses 24,442 Expenses Paid Indirectly--Note D (1,272) --------------- Net Expenses 23,170 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 135,982 - -------------------------------------------------------------------------------- REALIZED NET GAIN Investment Securities Sold* 1,022,053 Futures Contracts 13,220 - -------------------------------------------------------------------------------- REALIZED NET GAIN 1,035,273 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities (812,793) Futures Contracts 1,751 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (811,042) ================================================================================ NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $360,213 ================================================================================ *Dividend income and realized net loss from affiliated companies were $22,782,000 and $(7,275,000), respectively. 14 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 FUND -------------------------------- SIX MONTHS YEAR ENDED ENDED APR. 30, 2000 OCT. 31, 1999 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 135,982 $ 277,607 Realized Net Gain 1,035,273 1,940,531 Change in Unrealized Appreciation (Depreciation) (811,042) 42,819 Net Increase in Net Assets Resulting from Operations 360,213 2,260,957 - -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income (157,419) (255,285) Realized Capital Gain (1,869,365) (1,341,486) -------------------------------- Total Distributions (2,026,784) (1,596,771) CAPITAL SHARE TRANSACTIONS1 Issued 527,072 1,402,297 Issued in Lieu of Cash Distributions 1,905,431 1,504,748 Redeemed (2,095,020) (5,102,907) Net Increase (Decrease) from Capital Share Transactions 337,483 (2,195,862) - -------------------------------------------------------------------------------- Total Decrease (1,329,088) (1,531,676) - -------------------------------------------------------------------------------- Net Assets Beginning of Period 16,823,722 18,355,398 -------------------------- End of Period $15,494,634 $16,823,722 ================================================================================ 1Shares Issued (Redeemed) Issued 35,206 82,191 Issued in Lieu of Cash Distributions 127,710 100,940 Redeemed (141,789) (311,166) --------------------------- Net Increase (Decrease) in Shares Outstanding 21,127 (128,035) ================================================================================ 15 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.
- ----------------------------------------------------------------------------------------------------------------- WINDSOR FUND YEAR ENDED OCTOBER 31, FOR A SHARE OUTSTANDING SIX MONTHS ENDED ----------------------------------------------- THROUGHOUT EACH PERIOD APRIL 30, 2000 1999 1998 1997 1996 1995 NET ASSET VALUE, BEGINNING OF PERIOD $16.91 $16.34 $19.55 $16.99 $15.55 $14.55 - ----------------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .14 .27 .23 .36 .43 .44 Net Realized and Unrealized Gain (Loss) on Investments .26 1.77 (.32) 3.942 .85 1.86 - ----------------------------------------------------------------------------------------------------------------- Total from Investment Operations .40 2.04 (.09) 4.30 3.28 2.30 - ----------------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.16) (.24) (.24) (.41) (.46) (.44) Distributions from Realized Capital Gains (1.90) (1.23) (2.88) (1.33) (1.38) (.86) - ----------------------------------------------------------------------------------------------------------------- Total Distributions (2.06) (1.47) (3.12) (1.74) (1.84) (1.30) ================================================================================================================= Net Asset Value, End of Period $15.25 $16.91 $16.34 $19.55 $16.99 $15.55 ================================================================================================================= Total Return 2.63% 13.74% -0.78% 27.04% 23.16% 17.80% ================================================================================================================= Ratios/Supplemental Data Net Assets, End of Period (Millions) $15,495 $16,824 $18,355 $20,678 $15,841 $13,008 Ratio of Total Expenses to Average Net Assets 0.31%* 0.28% 0.27% 0.27% 0.31% 0.45% Ratio of Net Investment Income to Average Net Assets 1.72%* 1.56% 1.31% 1.89% 2.75% 3.01% Portfolio Turnover Rate 38%* 56% 48% 61% 34% 32% =================================================================================================================
*Annualized. 16 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. Securities for which market quotations are not readily available are valued by methods deemed by the Board of Trustees to represent fair 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 CONTRACTS: 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 share 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. WELLINGTON MANAGEMENT COMPANY, LLP, and Sanford C. Bernstein & Co., Inc., provide investment advisory services to the fund for FEES CALCULATED AT AN ANNUAL PERCENTAGE RATE OF AVERAGE NET ASSETS. THE BASIC FEE OF WELLINGTON MANAGEMENT COMPANY, LLP, is subject to quarterly adjustments based on performance relative to the S&P 500 Index for the preceding three years. For the six months ended April 30, 2000, the aggregate investment advisory fee represented an effective annual basic rate of 0.13% of the fund's average net assets before a decrease of $5,773,000 (0.07%) based on performance. The Vanguard Group manages the cash reserves of the fund on an at-cost basis. 17 NOTES TO FINANCIAL STATEMENTS (CONTINUED) C. The Vanguard Group furnishes at cost corporate management, administrative, marketing, and distribution services. The costs of such services are allocated to the fund under methods approved by the Board of Trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At April 30, 2000, the fund had contributed capital of $2,973,000 to Vanguard (included in Other Assets), representing 0.02% of net assets and 3.0% of Vanguard's capitalization. The fund's Trustees and officers are also Directors and officers of Vanguard. D. The fund has asked its investment advisers to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund's management and administrative expenses. The fund's custodian bank has also agreed to reduce its fees when the fund maintains cash on deposit in the non-interest-bearing custody account. For the six months ended April 30, 2000, directed brokerage and custodian fee offset arrangements reduced expenses by $1,238,000 and $34,000, respectively. The total expense reduction represented an effective annual rate of 0.02% of the fund's average net assets. E. During the six months ended April 30, 2000, the fund purchased $2,928,822,000 of investment securities and sold $4,620,624,000 of investment securities, other than temporary cash investments. F. At April 30, 2000, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $1,250,326,000, consisting of unrealized gains of $3,188,465,000 on securities that had risen in value since their purchase and $1,938,139,000 in unrealized losses on securities that had fallen in value since their purchase. At April 30, 2000, the aggregate settlement value of open futures contracts expiring in June 2000 and the related unrealized appreciation were: - -------------------------------------------------------------------------------- (000) ----------------------------------- AGGREGATE NUMBER OF SETTLEMENT UNREALIZED FUTURES CONTRACTS LONG CONTRACTS VALUE APPRECIATION - -------------------------------------------------------------------------------- S&P 500 Index 848 $309,520 $7,735 S&P MidCap 400 Index 60 14,483 284 - -------------------------------------------------------------------------------- G. The market value of securities on loan to broker/dealers at April 30, 2000, was $184,926,000, for which the fund held cash collateral of $191,275,000. Cash collateral received is invested in repurchase agreements. 18 THE VANGUARD(R) FAMILY OF FUNDS STOCK FUNDS - -------------------------------------------------------------------------------- 500 Index Fund Aggressive Growth Fund Capital Opportunity Fund Convertible Securities Fund Emerging Markets Stock Index Fund Energy Fund Equity Income Fund European Stock Index Fund Explorer(TM) Fund Extended Market Index Fund* Global Equity Fund Gold and Precious Metals Fund Growth and Income Fund Growth Index Fund* Health Care Fund Institutional Index Fund* International Growth Fund International Value Fund Mid-Cap Index Fund* Morgan(TM) Growth Fund Pacific Stock Index Fund PRIMECAP Fund REIT Index Fund Selected Value Fund Small-Cap Growth Index Fund* Small-Cap Index Fund* Small-Cap Value Index Fund* Tax-Managed Capital Appreciation Fund* Tax-Managed Growth and Income Fund* Tax-Managed International Fund* Tax-Managed Small-Cap Fund* Total International Stock Index Fund Total Stock Market Index Fund* U.S. Growth Fund Utilities Income Fund Value Index Fund* Windsor(TM) Fund Windsor(TM) II Fund BALANCED FUNDS - -------------------------------------------------------------------------------- Asset Allocation Fund Balanced Index Fund Global Asset Allocation Fund LifeStrategy(R) Conservative Growth Fund LifeStrategy(R) Growth Fund LifeStrategy(R) Income Fund LifeStrategy(R) Moderate Growth Fund STAR(TM) Fund Tax-Managed Balanced Fund Wellesley(R) Income Fund Wellington(TM) Fund BOND FUNDS - -------------------------------------------------------------------------------- Admiral(TM) Intermediate-Term Treasury Fund Admiral(TM) Long-Term Treasury Fund Admiral(TM) Short-Term Treasury Fund GNMA Fund High-Yield Corporate Fund High-Yield Tax-Exempt Fund Insured Long-Term Tax-Exempt Fund Intermediate-Term Bond Index Fund Intermediate-Term Corporate Fund Intermediate-Term Tax-Exempt Fund Intermediate-Term Treasury Fund Limited-Term Tax-Exempt Fund Long-Term Bond Index Fund Long-Term Corporate Fund Long-Term Tax-Exempt Fund Long-Term Treasury Fund Preferred Stock Fund Short-Term Bond Index Fund Short-Term Corporate Fund* Short-Term Federal Fund Short-Term Tax-Exempt Fund Short-Term Treasury Fund State Tax-Exempt Bond Funds(California, Florida, Massachusetts, New Jersey, New York, Ohio, Pennsylvania) Total Bond Market Index Fund* MONEY MARKET FUNDS - -------------------------------------------------------------------------------- Admiral(TM) Treasury Money Market Fund Federal Money Market Fund Prime Money Market Fund* State Tax-Exempt Money Market Funds (California, New Jersey, New York, Ohio, Pennsylvania) Tax-Exempt Money Market Fund Treasury Money Market Fund VARIABLE ANNUITY PLAN - -------------------------------------------------------------------------------- Balanced Portfolio Diversified Value Portfolio Equity Income Portfolio Equity Index Portfolio Growth Portfolio High-Grade Bond Portfolio High Yield Bond Portfolio International Portfolio Mid-Cap Index Portfolio Money Market Portfolio REIT Index Portfolio Short-Term Corporate Portfolio Small Company Growth Portfolio *Offers Institutional Shares. For information about Vanguard funds and our variable annuity plan, including charges and expenses, obtain a prospectus from The Vanguard Group, P.O. Box 2600, Valley Forge, PA 19482-2600. Read it carefully before you invest or send money. 19 [BLANK PAGE] - -------------------------------------------------------------------------------- THE PEOPLE WHO GOVERN YOUR FUND The Trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are part owner of the fund. Your fund Trustees also serve on the Board of Directors of The Vanguard Group, which is owned by the funds and exists solely to provide services to them on an at-cost basis. Seven of Vanguard's eight board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. They bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new Trustees/Directors; and electing Vanguard officers. The list below provides a brief description of each Trustee's professional affiliations. Noted in parentheses is the year in which the Trustee joined the Vanguard Board. TRUSTEES JOHN J. BRENNAN * (1987) Chairman of the Board, Chief Executive Officer, and Director/Trustee of The Vanguard Group, Inc., and each of the investment companies in The Vanguard Group. JOANN HEFFERNAN HEISEN * (1998) Vice President, Chief Information Officer, and a member of the Executive Committee of Johnson & Johnson; Director of Johnson & JohnsonoMerck Consumer Pharmaceuticals Co., The Medical Center at Princeton, and Women's Research and Education Institute. BRUCE K. MACLAURY * (1990) President Emeritus of The Brookings Institution; Director of American Express Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp. BURTON G. MALKIEL * (1977) Chemical Bank Chairman's Professor of Economics, Princeton University; Director of Prudential Insurance Co. of America, Banco Bilbao Gestinova, Baker Fentress & Co., The Jeffrey Co., and Select Sector SPDR Trust. ALFRED M. RANKIN, JR. * (1993) Chairman, President, Chief Executive Officer, and Director of NACCO Industries, Inc.; Director of The BFGoodrich Co. JOHN C. SAWHILL * (1991) 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., NACCO Industries, and Newfield Exploration Co. JAMES O. WELCH, JR. * (1971) 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 * (1985) Retired Chairman of Rohm & Haas Co.; Director of AmeriSource Health Corporation, 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. THOMAS J. HIGGINS * Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies in The Vanguard Group. VANGUARD MANAGING DIRECTORS R. GREGORY BARTON * Legal Department. ROBERT A. DISTEFANO * Information Technology. JAMES H. GATELY * Individual Investor Group. KATHLEEN C. GUBANICH * Human Resources. IAN A. MACKINNON * Fixed Income Group. F. WILLIAM MCNABB, III * Institutional Investor Group. MICHAEL S. MILLER * Planning and Development. RALPH K. PACKARD * Chief Financial Officer. GEORGE U. SAUTER * Quantitative Equity Group. [SHIP LOGO] [THE VANGUARD GROUP (R) LOGO] Post Office Box 2600 Valley Forge, Pennsylvania 19482-2600 ABOUT OUR COVER Our cover art, depicting HMS Vanguard at sea, is a reproduction of Leading the Way, a 1984 work created and copyrighted by noted naval artist Tom Freeman, of Forest Hill, Maryland. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 INDIVIDUAL ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. Q222-062000 (C) 2000 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. VANGUARD WINDSOR II (TM) FUND April 30, 2000 semiannual [SHIP GRAPHIC] [A MEMBER OF THE VANGUARD GROUP LOGO] HAVE THE PRINCIPLES OF INVESTING CHANGED? In a world of frenetic change in business, technology, and the financial markets, it is natural to wonder whether the basic principles of investing have changed. We don't think so. The most successful investors over the coming decade will be those who began the new century with a fundamental understanding of risk and who had the discipline to stick with long-term investment programs. Certainly, investors today confront a challenging, even unprecedented, environment. Valuations of market indexes are at or near historic highs. The strength and duration of the bull market in U.S. stocks have inflated people's expectations and diminished their recognition of the market's considerable risks. And the incredible divergence in stock returns--many technology-related stocks gained 100% or more in 1999, yet prices fell for more than half of all stocks--has made some investors question the idea of diversification. And then there is the Internet. Undeniably, it is a powerful medium for communications and transacting business. For investors, the Internet is a vast source of information about investments, and online trading has made it inexpensive and convenient to trade stocks and invest in mutual funds. However, new tools do not guarantee good workmanship. Information is not the same as wisdom. Indeed, much of the information, opinion, and rumor that swirl about financial markets each day amounts to "noise" of no lasting significance. And the fact that rapid-fire trading is easy does not make it beneficial. Frequent trading is almost always counterproductive because costs--even at low commission rates--and taxes detract from the returns that the markets provide. Sadly, many investors jump into a "hot" mutual fund just in time to see it cool off. Meanwhile, long-term fund investors are hurt by speculative trading activity because they bear part of the costs involved in accommodating purchases and redemptions. Vanguard believes that intelligent investors should resist short-term thinking and focus instead on a few time-tested principles: o Invest for the long term. Pursuing your long-term investment goals is more like a marathon than a sprint. o Diversify your investments with holdings in stocks, bonds, and cash investments. Remember that, at any moment, some part of a diversified portfolio will lag other parts, and be wary of taking on more risk by "piling onto" the best-performing part of your holdings. Today's leader could well be tomorrow's laggard. o Step back from the daily frenzy of the markets; focus on your overall asset allocation. o Capture as much of the market's return as possible by minimizing costs and taxes. Costs and taxes diminish long-term returns while doing nothing to reduce the risks you incur as an investor. - -------------------------------------------------------------------------------- CONTENTS Report From The Chairman .......... 1 Fund Profile ...................... 8 The Markets In Perspective ........ 4 Performance Summary ...............10 Adviser's Report .................. 6 Financial Statements ..............11 - -------------------------------------------------------------------------------- All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc., unless otherwise noted. "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 5000(R)" and "Wilshire 4500" are trademarks of Wilshire Associates Incorporated. REPORT FROM THE CHAIRMAN [PHOTO OF JOHN J. BRENNAN] JOHN J. BRENNAN Vanguard Windsor II Fund recorded a -3.4% return during the six months ended April 30, 2000, lagging both the average total return of competing funds and the results for the fund's unmanaged market indexes. There was a bright spot in this disappointing period, however: Your fund rebounded strongly in the final seven weeks, handily topping its comparative standards during that span. The table at right presents the six-month total returns (capital change plus reinvested dividends) for Windsor II, the average large-capitalization value fund, the Russell 1000 Value Index (comprising the value issues among the 1,000 largest U.S. stocks), and the Standard & Poor's 500 Index. The fund's return is based on a decline in net asset value from $29.03 per share on October 31, 1999, to $25.15 per share on April 30, 2000, with the latter figure adjusted for a dividend of $0.38 per share paid from net investment income and a distribution of $2.50 per share paid from net realized capital gains. -------------------------------------------- TOTAL RETURNS SIX MONTHS ENDED APRIL 30, 2000 -------------------------------------------- Vanguard Windsor II Fund -3.4% -------------------------------------------- Average Large-Cap Value Fund* 3.6% -------------------------------------------- Russell 1000 Value Index -1.0% -------------------------------------------- S&P 500 Index 7.2% -------------------------------------------- *Derived from data provided by Lipper Inc. THE PERIOD IN REVIEW The U.S. economy displayed remarkable vigor during the six months. Its staying power was impressive, too: April marked the 109th month of uninterrupted expansion--more than nine years without a recession. Preliminary estimates for the first quarter of 2000 indicated that the economy was growing at a 5.4% annual rate, a strong follow-up to the previous quarter's astounding 7.3% rate. A growing economy creates a good climate for stocks, and corporate profits posted robust gains as well. The overall stock market, as measured by the Wilshire 5000 Total Market Index, rose 9.7% for the half-year. However, concerns about inflation and the high valuations of many technology stocks led to frequent market swings. The volatility was especially evident among small-cap and tech issues. The small-cap Russell 2000 Index, for example, saw a 35.2% gain from October 31 through February 29 followed by a -12.2% decline in March and April, resulting in an 18.7% return for the half-year. The adjacent table shows the striking shift in leadership from growth stocks in the first four months of the period to value stocks in the final two. The pattern was - -------------------------------------------------------------- TOTAL RETURNS ------------------------------------- OCT. 31, 1999, FEB. 29, 2000, STOCK INDEX TO FEB. 29, 2000 TO APR. 30, 2000 - -------------------------------------------------------------- Russell 1000 Growth 16.3% 2.1% Russell 1000 Value -10.7 10.9 - -------------------------------------------------------------- Russell 2000 Growth 58.8% -19.5% Russell 2000 Value 7.1 1.1 - -------------------------------------------------------------- MSCI EAFE Growth 18.9% -4.8% MSCI EAFE Value -1.4 2.0 - -------------------------------------------------------------- Nasdaq Composite 58.8% -17.7% - -------------------------------------------------------------- 1 evident overseas, too, as indicated by results for the growth and value segments of the Morgan Stanley Capital International Europe, Australasia, Far East (EAFE) Index of international stocks. The bull market in stocks continued despite three quarter-point (0.25%) increases in short-term interest rates by the Federal Reserve Board, which boosted its target federal-funds rate from 5.25% to 6.00%. The yield on 3-month Treasury bills responded by climbing 74 basis points (0.74 percentage point), to 5.83% as of April 30. However, long-term interest rates went the other way. The yield of the 30-year Treasury bond fell 20 basis points, on balance, ending the half-year at 5.96%. The yield for the 10-year Treasury note rose 19 basis points during the period, to 6.21%, and the overall bond market, as measured by the Lehman Brothers Aggregate Bond Index, recorded a 1.4% total return. PERFORMANCE OVERVIEW Vanguard Windsor II Fund's return of -3.4% lagged that of the Russell 1000 Value Index--a good benchmark for the fund, given its focus on large-cap value stocks--by 2.4 percentage points. We also trailed the average large-cap value fund by 7.0 percentage points and the S&P 500 Index by 10.6 percentage points. Compared with both competing funds and the indexes, we were hurt by our small stake in technology. The high valuations of tech stocks and their lack of dividends kept most of them off our advisers' buy lists, so your fund held only about 5% of its equity assets in technology companies during the period. The sector's hot performance has made it the largest weighting in the S&P 500 Index, accounting for more than one-quarter of the benchmark as of April 30. Within the tech sector, Windsor II's holdings gained about 10%--a solid result but well off the 39% pace set by the overall sector in the index. The fund's holdings of banks and other financial-services stocks also proved detrimental, declining about -14% during the six months ended April 30. By comparison, this sector dropped -7% within the S&P 500 Index. Our stock selections also underperformed the indexes in the consumer-discretionary group. On the positive side, the fund benefited from its heavily overweighted position (about 10% of equities versus 1.5% for the S&P 500 Index) in "other energy" stocks, which were among the market's strongest performers during the half-year. Also, the fund was aided somewhat by holding a relatively small stake in the health-care sector, a market laggard. (The health sector represented about 10% of the S&P 500 during the period, but averaged about 2.5% of Windsor II's equity assets.) After a long and painful wait, Windsor II shareholders--and value investors generally--finally got some good news in March and April, as the stock market appeared to grow more conscious of valuations. This drove down the price of many Internet and other technology stocks, while benefiting many of the value stocks that are Windsor II's stock-in-trade. As noted on page 6 by Barrow, Hanley, Mewhinney & Strauss, the fund's lead adviser, the sudden improvement did not stem from any change in the fund's approach. What changed--and in a hurry--was investor sentiment. From March 10 through April 30, the fund gained 12.0%, outpacing both the S&P 500 Index (up 4.2%) and the Russell 1000 Value Index (up 9.5%). Of course, this is a very short period, but the sharp change in market leadership reinforces the importance of maintaining a consistent investment approach. As you know, our philosophy of maintaining a diversified portfolio of value stocks--typically out-of-favor issues with below-average price/earnings ratios and above-average 2 dividend yields--is carried out by four managers, each having full discretion in managing a portion of the fund's assets. The adjacent table shows the allocation to each adviser as of April 30. - -------------------------------------------------------------------------------- TOTAL ASSETS MANAGED AS OF APRIL 30, 2000 ----------------------------- $ MILLION PERCENTAGE - -------------------------------------------------------------------------------- Barrow, Hanley, Mewhinney & Strauss, Inc. $13,403 58% Equinox Capital Management, Inc. 3,848 17 Tukman Capital Management, Inc. 3,163 14 Vanguard Quantitative Equity Group 1,418 6 Cash Reserve* 1,105 5 - -------------------------------------------------------------------------------- Total $22,937 100% - -------------------------------------------------------------------------------- * This cash reserve is invested in equity index futures to simulate investment in stocks; each adviser may also maintain a modest cash reserve. IN SUMMARY The spring turnabout in stocks, when downtrodden value issues suddenly rose and technology-dominated growth indexes plummeted, served as a vivid reminder of the stock market's short-term unpredictability and volatility. Such sudden shifts in market leadership are certain to occur now and then, but their timing and duration are extremely unpredictable. That is why we advocate diversification and a long-term orientation. Investors who maintain exposure to the major asset classes through balanced portfolios of stock funds, bond funds, and money market funds have generally found it easier to maintain equilibrium in turbulent times. We urge you to base your investment plans on your own goals, time horizon, and risk tolerance--and then to stick with those plans over the long haul. /S/ John J. Brennan Chairman and Chief Executive Officer May 15, 2000 3 THE MARKETS IN PERSPECTIVE SIX MONTHS ENDED APRIL 30, 2000 A surging economy, rising corporate profits, and enthusiasm for technology stocks carried broad stock market indexes higher during the volatile but generally rewarding six months ended April 30, 2000. Stocks rose despite a modest pickup in inflation and a rise in interest rates, both of which did some damage to bond prices. Through the first four months of the period, the stock market was dominated by optimism about the long-term outlook for technology, telecommunications, and media companies. But sentiment then shifted and the tech and telecom groups fell sharply, giving back some of the spectacular gains achieved over the previous year or so. For both bond and stock investors, uncertainty centered mainly on how the Federal Reserve Board would react to the surprising performance of the U.S. economy, which grew at a 7.3% pace in the final three months of 1999 and at a still-robust 5.4% during the first quarter of 2000. With U.S. unemployment at a three-decade low of 3.9%, Fed policymakers grew increasingly concerned that inflation was bound to worsen. The Fed raised short-term interest rates by 0.25 percentage point three times during the six-month period. These boosts, following identical increases in June and August of 1999, took the Fed's target for short-term rates to 6.0%. Yet the economy continued to soar--including even the housing and automobile sectors, which often are the first to slow down in response to higher interest rates. - -------------------------------------------------------------------------------- TOTAL RETURNS PERIODS ENDED APRIL 30, 2000 ------------------------------------- 6 MONTHS 1 YEAR 5 YEARS* - -------------------------------------------------------------------------------- STOCKS S&P 500 Index 7.2% 10.1% 25.3% Russell 2000 Index 18.7 18.4 15.3 Wilshire 5000 Index 9.7 12.2 23.9 MSCI EAFE Index 6.8 14.2 10.7 - -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index 1.4% 1.3% 6.8% Lehman 10 Year Municipal Bond Index 2.4 -0.3 6.1 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 2.7 5.1 5.2 - -------------------------------------------------------------------------------- OTHER Consumer Price Index 1.8% 3.0% 2.4% - -------------------------------------------------------------------------------- *Annualized. Inflation gauges provided ambiguous readings. The Consumer Price Index increased 1.8% and 3.0% for the 6- and 12-month periods ended April 30, but much of the acceleration in inflation was due to higher energy and food prices. The core inflation rate, which excludes those sectors, was up a less-ominous 2.2% over the year. U.S. STOCK MARKETS The technology sector, which accounts for about one-quarter of the stock market's total value, dominated the market during the half-year, despite suffering a sharp setback late in the period. Even after a -34% fall from March 10 through mid-April, the tech-heavy Nasdaq Composite Index registered a 30.8% return for the six months. The overall stock market, as measured by the Wilshire 5000 Total Market Index, gained 9.7%. There was a decided split in results from large- and small-capitalization stocks. 4 The large-cap S&P 500 Index returned 7.2%, while the rest of the U.S. stock market gained 19.2%. Top performers during the half-year were companies in computer software and hardware, semiconductors, Internet-related businesses, and wireless communications. Fully half of the 58 companies in the S&P 500's technology group gained more than 50%, and the average return for tech stocks exceeded 39%. A number of tech-related companies in the producer-durables sector also posted impressive gains, and the sector as a whole returned 32%. A return of 34% was achieved by the oil-drilling and services companies in the "other energy" category, which benefited from higher oil and gas prices. The worst-performing sector was consumer staples (-18%), a category that includes supermarket, food, beverage, and tobacco stocks. Next in line were financial-services companies (-7%), hurt by higher short-term interest rates, which tend to raise borrowing costs for banks and can lead to increased loan defaults. U.S. BOND MARKETS The Federal Reserve Board's three rate increases succeeded in elevating other short-term rates. For example, yields of 3-month U.S. Treasury bills rose during the half-year to 5.83%, an increase of 0.74 percentage point (74 basis points) that virtually matched the Fed's target. However, long-term rates didn't move nearly as far. The 10-year Treasury note rose just 19 basis points, to 6.21%, as of April 30. And yields actually fell a bit for very long-term Treasury bonds, a result of shrinking supply. Because of the federal government's budget surplus, the U.S. Treasury decided to reduce issuance of new bonds and to buy back some of its existing long-term bonds. As investors reacted, the yield of the 30-year Treasury declined 20 basis points--from 6.16% to 5.96%--during the half-year. The result of higher short-term rates and relatively stable long-term rates was an unusual inversion in the Treasury yield curve. Instead of the usual upward-sloping curve--which shows yields increasing in tandem with maturities--there was a pronounced drop-off. As of April 30, the yield of 30-year Treasuries was two-thirds of a percentage point below the 6.62% yield on 3-year Treasury notes. A similar pattern emerged outside the Treasury market, although long-term yields remained above yields for short-term corporate, municipal, and mortgage-backed securities. The overall bond market, as measured by the Lehman Aggregate Bond Index, provided a 1.4% return, as an average price decline of - -2.0% offset most of a 3.4% income return. INTERNATIONAL STOCK MARKETS Despite declines in March and April, stock markets in Europe, Asia, and many emerging markets produced strong half-year gains as investors responded to improving global economic growth and a rise in corporate merger-and-acquisition activity. However, many of the gains were slashed for U.S. investors as the dollar gained strength against most other currencies. (Conversely, when the dollar falls in value, returns from abroad are enhanced for U.S. investors.) In U.S.-dollar terms, the overall return from developed foreign markets was a very solid 6.8%, as measured by the Morgan Stanley Capital International Europe, Australasia, Far East Index. However, in local currencies, the EAFE Index return was 16.4%. In Europe, an average 21.1% gain in local-currency terms was reduced to 8.4% for U.S. investors because of the dollar's strength. Stocks in the Pacific region, which is dominated by Japan, returned 3.6% in dollars, less than half the 7.5% gain in local currencies. The Select Emerging Markets Free Index returned 12.3% in U.S. dollars, with the biggest gains in Turkey (+148%), Russia (+123%), and Israel (+50%). 5 ADVISER'S REPORT During the past six months, Windsor II Fund declined -3.4% while the S&P 500 Index rose 7.2% and the value portion of the S&P 500 rose 2.7%. All of our shortfall occurred in the first part of the period, when the market continued to show disgust for value investments and to shower attention on the high-technology, communications, and Internet issues. That trend seemed to change after March 10, when stocks with higher price/earnings ratios experienced a sharp reversal and value stocks seemed at last to capture the market's attention. From March 10 through April 30, Windsor II's share price improved 12%, while the S&P 500 posted a 4% rise, and the value part of the S&P 500 registered a 6% gain. So far in May, the improvement relative to our benchmarks is continuing. In our letter to you six months ago, we mentioned that there was evidence of inflation that the Federal Reserve appeared to be overlooking. Now these signs can be seen without reading glasses. We expect that record low unemployment, red-hot demand, and rising prices will evoke a stronger response from the Fed later this month. Further actions by the Fed to raise short-term interest rates will begin to slow economic activity, which will be a good thing in the long run. Corporate profits in the first quarter of 2000 have been quite strong. Our fund's holdings generally have issued good earnings reports. We don't see many sectors of weakness and, in fact, expect much-improved results from energy and chemical companies. The dollar has been quite strong versus most major currencies, even in light of the nation's large negative balance of trade. The reason for the strength is the significant inflow of investment funds into our markets. Over the longer term, we would not be surprised to see these flows reverse and the dollar decline. The fund's P/E ratio is about half that of the S&P 500 Index; the price/book ratio is less than half that of the index, and the dividend yield is twice the yield on the S&P 500. We have never had a portfolio that sold at such steep discounts to the market. What has caused this? Quite simply, investors have been changing investments based on their short-term performance. In the recent past, the two largest hedge funds in the country have reorganized and sold the major portion of their assets. At the same time, the largest value-oriented mutual funds have experienced significant redemptions, and investors have put most of the proceeds into growth funds. All of this caused the crescendo of high-tech performance and weighed down the prices of value stocks. Is the assault on value over? It certainly appears so. Windsor II is performing better--not because we changed things but because the market itself has changed. The major reason we have outperformed since mid-March is that we did not own the overpriced issues. This is precisely the stance that contributed to our lack of success last year. Windsor II has a significant concentration in energy issues (about 19% of equities) and in electric - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- 6 utilities (about 9%). These are not new holdings. We have allowed this buildup because of rapidly improving fundamentals for these groups. These stocks are less sensitive to the economic cycle and to more-restrictive Federal Reserve policies that could have a significant impact on many businesses. Barrow, Hanley, Mewhinney & Strauss, Inc. May 10, 2000 7 FUND PROFILE WINDSOR II FUND This Profile provides a snapshot of the fund's characteristics as of April 30, 2000, compared where appropriate to an unmanaged index. Key elements of this Profile are defined on page 9. PORTFOLIO CHARACTERISTICS - -------------------------------------------------------- WINDSOR II S&P 500 - -------------------------------------------------------- Number of Stocks 279 500 Median Market Cap $31.4B $87.5B Price/Earnings Ratio 15.7x 26.8x Price/Book Ratio 2.5x 5.3x Yield 2.4% 1.2% Return on Equity 18.5% 24.1% Earnings Growth Rate 9.0% 16.1% Foreign Holdings 4.1% 1.2% Turnover Rate 23%* -- Expense Ratio 0.37%* -- Cash Reserves 1.8% -- *Annualized. INVESTMENT FOCUS - -------------------------------------------------------- STYLE..................VALUE MARKET CAP.............LARGE VOLATILITY MEASURES - -------------------------------------------------------- WINDSOR II S&P 500 - -------------------------------------------------------- R-Squared 0.77 1.00 Beta 0.90 1.00 TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS) - -------------------------------------------------------- Citigroup, Inc. 2.8% Baker Hughes, Inc. 2.5 BP Amoco PLC ADR 2.5 Schlumberger Ltd. 2.3 Phillips Petroleum Co. 2.3 The Chase Manhattan Corp. 2.2 GTE Corp. 2.1 Bank of America Corp. 2.1 Halliburton Co. 2.1 Sears, Roebuck & Co. 2.0 - -------------------------------------------------------- Top Ten 22.9% SECTOR DIVERSIFICATION (% OF COMMON STOCKS) - -------------------------------------------------------------------- APRIL 30, 1999 APRIL 30, 2000 ----------------------------------------- WINDSOR II WINDSOR II S&P 500 ----------------------------------------- Auto & Transportation ..... 3.9% 2.4% 2.1% Consumer Discretionary .... 12.9 13.4 12.3 Consumer Staples .......... 6.6 5.7 5.3 Financial Services ........ 28.0 24.8 13.5 Health Care ............... 2.3 3.7 9.8 Integrated Oils ........... 4.8 9.1 4.4 Other Energy .............. 7.6 10.3 1.8 Materials & Processing .... 4.3 4.9 2.5 Producer Durables ......... 9.7 0.2 4.2 Technology ................ 2.8 4.8 27.8 Utilities ................. 16.1 15.4 9.6 Other ..................... 1.0 5.3 6.7 - -------------------------------------------------------------------- 8 BETA. A measure of the magnitude of a fund'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 fund 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 fund'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 fund. EXPENSE RATIO. The percentage of a fund's average net assets used to pay its annual administrative and advisory expenses. These expenses directly reduce returns to investors. FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks or American Depositary Receipts of companies based outside the United States. INVESTMENT FOCUS. This grid indicates the focus of a fund 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 fund invests; the midpoint of market capitalization (market price x shares outstanding) of a fund's stocks, weighted by the proportion of the fund's assets invested in each stock. Stocks representing half of the fund's assets have market capitalizations above the median, and the rest are below it. NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund 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 fund, the weighted average price/book ratio of the stocks it holds. PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share earnings over the past year. For a fund, the weighted average P/E of the stocks it holds. P/E is an indicator of market expectations about corporate prospects; the higher the P/E, the greater the expectations for a company's future growth. R-SQUARED. A measure of how much of a fund's past returns can be explained by the returns from the overall market (or its benchmark index). If a fund's total return were precisely synchronized with the overall market's return, its R-squared would be 1.00. If a fund'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 fund, the weighted average return on equity for the companies whose stocks it holds. SECTOR DIVERSIFICATION. The percentages of a fund'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 fund has invested in its ten largest holdings. (The average for stock mutual funds is about 35%.) As this percentage rises, a fund'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. Funds 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 fund's income from interest and dividends. The yield, expressed as a percentage of the fund's net asset value, is based on income earned over the past 30 days and is annualized, or projected forward for the coming year. The index yield is based on the current annualized rate of dividends paid on stocks in the index. 9 PERFORMANCE SUMMARY WINDSOR II FUND 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. An investor's shares, when redeemed, could be worth more or less than their original cost. TOTAL INVESTMENT RETURNS: JUNE 24, 1985-APRIL 30, 2000 - -------------------------------------------------------------------------------- WINDSOR II FUND S&P 500 WINDSOR II FUND S&P 500 FISCAL CAPITAL INCOME TOTAL TOTAL FISCAL CAPITAL INCOME TOTAL TOTAL YEAR RETURN RETURN RETURN RETURN YEAR RETURN RETURN RETURN RETURN - -------------------------------------------------------------------------------- 1985 -0.9% 1.1% 0.2% 1.8% 1993 15.8% 3.7% 19.5% 14.9% 1986 31.2 4.4 35.6 33.2 1994 -0.8 3.0 2.2 3.9 1987 -0.6 1.5 0.9 6.4 1995 19.2 3.9 23.1 26.4 1988 14.5 6.0 20.5 14.8 1996 23.8 3.4 27.2 24.1 1989 19.5 5.2 24.7 26.4 1997 28.1 3.2 31.3 32.1 1990 -21.5 4.0 -17.5 -7.5 1998 14.1 2.4 16.5 22.0 1991 29.4 7.2 36.6 33.5 1999 2.2 2.4 4.6 25.7 1992 7.9 4.6 12.5 10.0 2000* -4.7 1.3 -3.4 7.2 - -------------------------------------------------------------------------------- *Six months ended April 30, 2000. 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, 2000* - -------------------------------------------------------------------------------- 10 YEARS INCEPTION ------------------------------- DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL - -------------------------------------------------------------------------------- Windsor II Fund 6/24/1985 -7.76% 17.88% 10.78% 3.53% 14.31% - -------------------------------------------------------------------------------- *SEC rules require that we provide this average annual total return information through the latest calendar quarter. 10 FINANCIAL STATEMENTS APRIL 30, 2000 (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, 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, but may differ because certain investments or transactions may be treated differently for financial statement and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess of distributions over net income or net realized gains, will appear as negative balances. Unrealized Appreciation (Depreciation) is the difference between the market value of the fund's investments and their cost, and reflects the gains (losses) that would be realized if the fund were to sell all of its investments at their statement-date values. - -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR II FUND SHARES (000) - -------------------------------------------------------------------------------- COMMON STOCKS (93.4%)+ Auto & Transportation (2.3%) General Motors Corp. 3,023,400 283,066 Ford Motor Co. 3,753,000 205,242 Delta Air Lines, Inc. 114,400 6,035 TRW, Inc. 96,700 5,657 PACCAR, Inc. 110,200 5,241 Burlington Northern Santa Fe Corp. 200,800 4,844 o UAL Corp. 79,600 4,607 Eaton Corp. 49,800 4,183 o Navistar International Corp. 117,300 4,106 Meritor Automotive, Inc. 57,400 861 ------------- 523,842 ------------- CONSUMER DISCRETIONARY (12.5%) Sears, Roebuck & Co. 12,741,900 466,672 Waste Management, Inc. 24,746,597 392,852 O(1) Kmart Corp. 39,991,300 324,929 Gannett Co., Inc. 3,987,300 254,689 Wal-Mart Stores, Inc. 4,507,500 249,603 The Walt Disney Co. 4,418,432 191,373 o Cendant Corp. 11,353,800 175,274 Time Warner, Inc. 1,561,000 140,392 Newell Rubbermaid, Inc. 5,479,200 138,007 O(1) Service Corp. International 25,287,900 129,600 Tribune Co. 3,005,500 116,839 Target Corp. 1,259,000 83,802 J.C. Penney Co., Inc. 5,646,800 77,996 Kimberly-Clark Corp. 931,200 54,068 o AT&T Corp.-Liberty Media Class A 251,200 12,544 - -------------------------------------------------------------------------------- Eastman Kodak Co. 113,000 6,321 McDonald's Corp. 165,200 6,298 o Tricon Global Restaurants, Inc. 159,900 5,457 Darden Restaurants Inc. 270,500 4,987 o Toys R Us, Inc. 294,800 4,496 R.R. Donnelley & Sons Co. 204,200 4,339 Galileo International, Inc. 180,400 4,172 o CBS Corp. 64,600 3,795 Whirlpool Corp. 52,200 3,400 Wendy's International, Inc. 151,200 3,383 Reader's Digest Assn., Inc. Class A 103,900 3,325 The Limited, Inc. 66,200 2,991 o Viacom Inc. Class B 54,100 2,942 o Outback Steakhouse 85,300 2,794 The Warnaco Group, Inc. Class A 226,600 2,408 May Department Stores Co. 74,037 2,036 o The Neiman Marcus Group, Inc. Class A 60,600 1,560 Dillard's Inc. 68,800 959 o ACNielson Corp. 28,600 660 Hertz Corp. Class A 16,400 511 Harcourt General, Inc. 7,700 288 ------------- 2,875,762 ------------- CONSUMER STAPLES (5.4%) Anheuser-Busch Cos., Inc. 5,329,500 376,062 Philip Morris Cos., Inc. 14,143,800 309,395 PepsiCo, Inc. 5,464,200 200,468 Imperial Tobacco Group ADR 14,451,000 196,895 H.J. Heinz Co. 2,462,100 83,711 11 - -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR II FUND SHARES (000) - -------------------------------------------------------------------------------- Sara Lee Corp. 2,509,800 37,647 Bestfoods 100,000 5,025 IBP, Inc. 249,700 4,120 Ralston-Ralston Purina Group 213,400 3,775 SuperValu Inc. 157,000 3,248 Tyson Foods, Inc. 296,400 3,094 Nabisco Holdings Corp. Class A 74,400 2,795 McCormick & Co., Inc. 71,200 2,221 ConAgra, Inc. 50,000 944 Brown-Forman Corp. Class B 15,100 824 ------------- 1,230,224 ------------- FINANCIAL SERVICES (23.2%) Citigroup, Inc. 10,749,480 638,922 The Chase Manhattan Corp. 6,953,056 501,055 Bank of America Corp. 9,882,412 484,237 Washington Mutual, Inc. 17,255,230 441,086 First Union Corp. 13,279,402 423,281 American International Group, Inc. 3,697,161 405,532 Allstate Corp. 15,392,444 363,646 Wells Fargo Co. 7,616,300 312,744 Bank One Corp. 9,975,965 304,267 Fannie Mae 4,453,900 268,626 Morgan Stanley Dean Witter & Co. 2,488,900 191,023 PNC Financial Services Group 4,204,500 183,421 Aon Corp. 6,736,062 182,295 J.P. Morgan & Co., Inc. 1,102,200 141,495 o John Hancock Financial Services, Inc. 7,512,300 137,099 American General Corp. 1,996,800 111,821 Conseco Inc. 2,244,000 12,202 Merrill Lynch & Co., Inc. 114,200 11,641 FleetBoston Financial Corp. 246,184 8,724 Mellon Financial Corp. 271,000 8,706 CIGNA Corp. 104,600 8,342 The Bank of New York Co., Inc. 181,600 7,457 Marsh & McLennan Cos., Inc. 68,200 6,722 American Express Co. 41,600 6,243 Golden West Financial Corp. 164,900 5,627 Bear Stearns Co., Inc. 125,900 5,398 SouthTrust Corp. 216,600 5,171 A.G. Edwards & Sons, Inc. 136,850 5,149 First Data Corp. 104,200 5,073 Dime Bancorp, Inc. 266,500 4,997 Compass Bancshares Inc. 264,100 4,886 The PMI Group Inc. 98,450 4,769 Hartford Life, Inc. 95,900 4,723 Host Marriott Corp. REIT 434,300 4,642 First Virginia Banks, Inc. 126,700 4,625 o Golden State Bancorp Inc. 298,400 4,588 Ryder System, Inc. 203,400 4,513 Peoples Heritage Financial Group Inc. 337,800 4,413 Deluxe Corp. 174,500 4,395 St. Paul Cos., Inc. 122,200 4,353 Pacific Century Financial Corp. 206,000 4,236 Countrywide Credit Industries, Inc. 149,886 4,141 Dow Jones & Co., Inc. 63,000 4,087 MGIC Investment Corp. 79,700 3,811 Nationwide Financial Services, Inc. 134,400 3,738 UnionBanCal Corp. 129,391 3,583 Dun & Bradstreet Corp. 107,400 3,235 State Street Corp. 31,400 3,042 Equity Office Properties Trust REIT 110,900 3,015 Huntington Bancshares Inc. 161,800 2,953 Heller Financial, Inc. 138,800 2,698 Equity Residential Properties Trust REIT 59,000 2,685 City National Corp. 72,200 2,658 Provident Financial Group, Inc. 87,400 2,562 Cullen/Frost Bankers, Inc. 91,000 2,247 GATX Corp. 58,400 2,088 Astoria Financial Corp. 72,800 2,007 Freddie Mac 42,400 1,948 Spieker Properties, Inc. REIT 43,500 1,928 Associated Banc-Corp. 75,400 1,927 Duke Realty Investments, Inc. REIT 80,100 1,737 Firstar Corp. 69,200 1,721 Apartment Investment & Management Co. Class A REIT 42,800 1,701 Hibernia Corp. Class A 147,900 1,571 CCB Financial Corp. 38,100 1,507 Archstone Communities Trust REIT 66,400 1,436 ProLogis Trust REIT 70,900 1,396 Public Storage, Inc. REIT 61,800 1,383 Lehman Brothers Holdings, Inc. 14,700 1,206 Commerce Bancshares, Inc. 36,603 1,130 Mercantile Bankshares Corp. 37,300 1,063 Simon Property Group, Inc. REIT 40,800 1,035 o DST Systems, Inc. 7,700 571 SunTrust Banks, Inc. 10,700 543 Household International, Inc. 10,500 438 U.S. Bancorp 12,800 260 American National Insurance Co. 4,700 243 Sovereign Bancorp, Inc. 28,017 193 WestAmerica Bancorporation 3,200 80 Charter One Financial 2,300 47 ------------- 5,315,759 ------------- HEALTH CARE (3.4%) American Home Products Corp. 4,296,500 241,410 Bristol-Myers Squibb Co. 4,406,200 231,050 Columbia/HCA Healthcare Corp. 5,515,900 156,858 Johnson & Johnson 1,462,100 120,623 Pharmacia Corp. 153,272 7,654 UnitedHealth Group Inc. 103,400 6,895 Abbott Laboratories 141,000 5,420 Tenet Healthcare Corp. 165,000 4,208 o IVAX Corp. 120,450 3,297 o Chiron Corp. 66,100 2,991 C.R. Bard, Inc. 48,500 2,113 12 - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- Merck & Co., Inc. 29,500 2,050 DENTSPLY International Inc. 52,400 1,523 Mylan Laboratories, Inc. 23,000 653 Mallinckrodt, Inc. 17,600 473 ------------- 787,218 ------------- INTEGRATED OILS (8.5%) BP Amoco PLC ADR 11,098,572 566,026 Phillips Petroleum Co. 11,319,200 536,955 Occidental Petroleum Corp. 18,382,800 394,081 Exxon Mobil Corp. 3,167,428 246,070 Unocal Corp. 4,430,600 143,164 Conoco Inc. Class B 1,268,700 31,559 Chevron Corp. 188,900 16,080 Texaco Inc. 180,600 8,940 Amerada Hess Corp. 89,600 5,701 Kerr-McGee Corp. 77,600 4,016 ------------- 1,952,592 ------------- OTHER ENERGY (9.6%) (1) Baker Hughes, Inc. 18,052,000 574,279 Schlumberger Ltd. 7,025,600 537,898 Halliburton Co. 10,647,700 470,495 Williams Cos., Inc. 7,187,746 268,193 Enron Corp. 2,869,500 199,968 Transocean Sedco Forex Inc. 2,712,631 127,494 Tosco Corp. 170,200 5,457 Apache Corp. 104,500 5,062 Union Pacific Resources Group, Inc. 198,900 3,816 Ultramar Diamond Shamrock Corp. 145,700 3,606 EOG Resources, Inc. 81,700 2,032 Ashland, Inc. 26,600 908 ------------- 2,199,208 ------------- MATERIALS & PROCESSING (4.5%) (1) Fort James Corp. 13,072,100 312,913 (1) Millennium Chemicals, Inc. 7,368,142 146,902 Dow Chemical Co. 1,149,300 129,871 Hanson PLC ADR 3,291,850 120,358 O(1) Pactiv Corp. 13,054,000 106,880 Phelps Dodge Corp. 1,671,500 77,307 (1) CK Witco Corp. 6,238,569 73,303 E.I. du Pont de Nemours & Co. 265,087 12,575 Praxair, Inc. 148,600 6,603 Alcoa Inc. 81,300 5,274 o American Standard Cos., Inc. 121,400 4,977 USG Corp. 117,400 4,901 Boise Cascade Corp. 146,000 4,754 Lafarge Corp. 179,600 4,535 The Timber Co. 194,700 4,515 Willamette Industries, Inc. 106,500 4,067 Crown Cork & Seal Co., Inc. 244,100 3,967 Louisiana-Pacific Corp. 284,300 3,803 Engelhard Corp. 190,100 3,339 Lubrizol Corp. 91,800 2,352 Johns Manville Corp. 220,000 2,296 Avery Dennison Corp. 30,900 2,028 Armstrong World Industries Inc. 96,500 1,888 Westvaco Corp. 18,500 571 Owens Corning 30,800 560 International Paper Co. 9,600 353 ------------- 1,040,892 ------------- - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- PRODUCER DURABLES (0.2%) The Boeing Co. 256,300 10,172 Emerson Electric Co. 146,800 8,056 Northrop Grumman Corp. 73,300 5,195 Cummins Engine Co., Inc. 115,700 4,115 Pitney Bowes, Inc. 80,700 3,299 o Teradyne, Inc. 26,900 2,959 York International Corp. 109,000 2,630 Tecumseh Products Co. Class A 39,760 1,846 o Howmet International Inc. 77,100 1,634 United Technologies Corp. 4,896 304 ------------- 40,210 TECHNOLOGY (4.5%) International Business Machines Corp. 2,655,900 296,465 Electronic Data Systems Corp. 3,722,500 255,922 Intel Corp. 1,495,000 189,585 o Unisys Corp. 5,121,600 118,757 Lucent Technologies, Inc. 1,573,700 97,864 Motorola, Inc. 111,900 13,323 o Advanced Micro Devices, Inc. 94,100 8,257 Hewlett-Packard Co. 55,000 7,425 o Apple Computer, Inc. 52,300 6,488 o National Semiconductor Corp. 102,200 6,209 o Micron Technology, Inc. 38,700 5,389 o Seagate Technology Inc. 103,300 5,249 AVX Corp. 51,100 4,979 Compaq Computer Corp. 160,700 4,700 o NCR Corp. 119,600 4,620 Rockwell International Corp. 84,700 3,335 o 3Com Corp. 13,900 548 1,029,115 UTILITIES (14.3%) GTE Corp. 7,166,900 485,557 (1) Entergy Corp. 18,238,400 463,939 SBC Communications Inc. 9,565,147 419,073 American Electric Power Co., Inc. 9,693,100 355,010 Reliant Energy, Inc. 10,442,100 278,021 FirstEnergy Corp. 10,612,877 269,965 (1) Central & South West Corp. 11,962,100 259,428 AT&T Corp. 4,178,117 195,066 Public Service Enterprise Group, Inc. 4,088,200 146,664 BellSouth Corp. 2,905,500 141,462 o MCI WorldCom, Inc. 3,071,372 139,555 Bell Atlantic Corp. 455,036 26,961 Sprint Corp. 215,580 13,258 o MediaOne Group, Inc. 130,800 9,892 Southern Co. 349,600 8,718 PG&E Corp. 275,900 7,156 Ameren Corp. 164,900 6,050 Telephone & Data Systems, Inc. 55,300 5,641 o Sprint PCS 101,600 5,588 DTE Energy Co. 168,400 5,494 PPL Corp. 222,288 5,307 Duke Energy Corp. 87,300 5,020 GPU, Inc. 177,800 4,990 Energy East Corp. 216,400 4,517 U S WEST, Inc. 60,100 4,278 13 - -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR II FUND SHARES (000) - -------------------------------------------------------------------------------- Unicom Corp. 98,100 3,899 o U.S. Cellular Corp. 50,500 3,033 Pinnacle West Capital Corp. 76,700 2,694 FPL Group, Inc. 59,500 2,689 o Citizens Utilities Co. Class B 147,600 2,371 ALLTEL Corp. 31,200 2,079 Edison International 102,100 1,946 Northeast Utilities 76,600 1,647 Allegheny Energy, Inc. 52,600 1,598 Cinergy Corp. 50,000 1,338 ------------- 3,289,904 ------------- OTHER (5.0%) General Electric Co. 2,559,200 402,434 Honeywell International Inc. 7,170,362 401,540 (1) ITT Industries, Inc. 8,916,800 281,437 (1) Tenneco Automotive, Inc. 2,610,760 23,171 Minnesota Mining & Manufacturing Co. 126,500 10,942 Johnson Controls, Inc. 89,800 5,685 Cooper Industries, Inc. 134,400 4,612 Fortune Brands, Inc. 160,000 4,000 Loews Corp. 63,000 3,473 o FMC Corp. 38,800 2,258 Brunswick Corp. 98,600 1,892 Lancaster Colony Corp. 39,500 1,037 ------------- 1,142,481 ------------- - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (COST $18,411,277) 21,427,207 - -------------------------------------------------------------------------------- FACE AMOUNT (000) - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (6.6%)+ - -------------------------------------------------------------------------------- FEDERAL HOME LOAN MORTGAGE CORP. (2) 5.90%, 5/18/2000 $ 15,000 14,958 (2) 5.93%, 5/4/2000 8,800 8,796 FEDERAL NATIONAL MORTGAGE ASSN. (2) 6.17%, 7/20/2000 38,000 37,495 REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 5.75%, 5/1/2000 1,436,635 1,436,635 5.79%, 5/1/2000--Note G 9,525 9,525 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (COST $1,507,401) 1,507,409 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (100.0%) (COST $19,918,678) 22,934,616 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- MARKET VALUE* (000) - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES - -------------------------------------------------------------------------------- Other Assets--Note C 110,209 Liabilities--Note G (107,425) ------------- 2,784 ------------- - -------------------------------------------------------------------------------- NET ASSETS (100%) - -------------------------------------------------------------------------------- Applicable to 911,967,295 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $22,937,400 ================================================================================ NET ASSET VALUE PER SHARE $25.15 ================================================================================ * See Note A in Notes to Financial Statements. o Non-Income-Producing Security. + The fund invests a portion of its reserves in equity markets through the use of index futures contracts. After giving effect to futures investments, the fund's effective common stock and temporary cash investment positions represent 98.2% and 1.8%, respectively, of net assets. See Note F 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 $2,696,781,000. (2) Securities with an aggregate value of $61,249,000 have been segregated as initial margin for open futures contracts. ADR--American Depositary Receipt. REIT--Real Estate Investment Trust. - -------------------------------------------------------------------------------- AT APRIL 30, 2000, NET ASSETS CONSISTED OF: - -------------------------------------------------------------------------------- AMOUNT PER (000) SHARE - -------------------------------------------------------------------------------- Paid in Capital $18,924,497 $20.75 Undistributed NetInvestment Income 150,781 .17 Accumulated NetRealized Gains 816,990 .89 Unrealized Appreciation--Note F Investment Securities 3,015,938 3.31 Futures Contracts 29,194 .03 - -------------------------------------------------------------------------------- Net Assets $22,937,400 $25.15 ================================================================================ 14 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 FUND SIX MONTHS ENDED APRIL 30, 2000 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 308,277 Interest 47,076 Security Lending 39 Total Income 355,392 EXPENSES Investment Advisory Fees--Note B Basic Fee 15,374 Performance Adjustment (3,231) The Vanguard Group--Note C Management and Administrative 32,870 Marketing and Distribution 2,121 Custodian Fees 45 Auditing Fees 14 Shareholders' Reports 479 Trustees' Fees and Expenses 17 ------------- Total Expenses 47,689 Expenses Paid Indirectly--Note D (2,184) ------------- Net Expenses 45,505 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 309,887 - -------------------------------------------------------------------------------- REALIZED NET GAIN Investment Securities Sold* 799,117 Futures Contracts 34,214 - -------------------------------------------------------------------------------- REALIZED NET GAIN 833,331 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities (2,392,552) Futures Contracts 10,100 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (2,382,452) - -------------------------------------------------------------------------------- NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $(1,239,234) ================================================================================ *Dividend income and realized net loss from affiliated companies were $64,245,000 and $(375,189,000), respectively. 15 STATEMENT OF CHANGES IN NET ASSETS This Statement shows how the fund's total net assets changed during the two most recent reporting periods. The Operations section summarizes information detailed in the Statement of Operations. The amounts shown as Distributions to shareholders from the fund's net income and capital gains may not match the amounts shown in the Operations section, because distributions are determined on a tax basis and may be made in a period different from the one in which the income was earned or the gains were realized on the financial statements. The Capital Share Transactions section shows the 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 FUND ----------------------------------- SIX MONTHS YEAR ENDED ENDED APR. 30, 2000 OCT. 31, 1999 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income 309,887 670,002 Realized Net Gain 833,331 2,600,015 Change in Unrealized Appreciation (Depreciation) (2,382,452) (1,931,112) Net Increase (Decrease) in Net Assets --------------------------------- Resulting from Operations (1,239,234) 1,338,905 DISTRIBUTIONS --------------------------------- Net Investment Income (382,237) (741,695) Realized Capital Gain (2,514,943) (2,559,664) --------------------------------- Total Distributions (2,897,180) (3,301,359) CAPITAL SHARE TRANSACTIONS1 --------------------------------- Issued 1,784,950 6,123,676 Issued in Lieu of Cash Distributions 2,759,404 3,148,067 Redeemed (8,011,369) (6,407,121) Net Increase (Decrease) from --------------------------------- Capital Share Transactions (3,467,015) 2,864,622 - -------------------------------------------------------------------------------- Total Increase (Decrease) (7,603,429) 902,168 - -------------------------------------------------------------------------------- NET ASSETS Beginning of Period 30,540,829 29,638,661 --------------------------------- End of Period $22,937,400 $30,540,829 ================================================================================ 1Shares Issued (Redeemed) Issued 72,334 198,010 Issued in Lieu of Cash Distributions 110,731 109,009 Redeemed (322,962) (209,049) Net Increase (Decrease) in Shares --------------------------------- Outstanding (139,897) 97,970 ================================================================================ 16 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.
- ------------------------------------------------------------------------------------------------------- WINDSOR II FUND YEAR ENDED OCTOBER 31, FOR A SHARE OUTSTANDING SIX MONTHS ENDED ------------------------------------------- THROUGHOUT EACH PERIOD APRIL 30, 2000 1999 1998 1997 1996 1995 - ------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF PERIOD $29.03 $31.07 $29.36 $24.04 $20.06 $17.33 - ------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .34 .64 .65 .64 .62 .58 Net Realized and Unrealized Gain (Loss) on Investments (1.34) .73 3.91 6.47 4.63 3.17 ------------------------------------------------------------ Total from Investment Operations (1.00) 1.37 4.56 7.11 5.25 3.75 DISTRIBUTIONS ------------------------------------------------------------ Dividends from Net Investment Income (.38) (.74) (.66) (.63) (.58) (.55) Distributions from Realized Capital Gains (2.50) (2.67) (2.19) (1.16) (.69) (.47) ------------------------------------------------------------ Total Distributions (2.88) (3.41) (2.85) (1.79) (1.27) (1.02) NET ASSET VALUE, END OF PERIOD $25.15 $29.03 $31.07 $29.36 $24.04 $20.06 ======================================================================================================= TOTAL RETURN -3.35% 4.57% 16.51% 31.27% 27.17% 23.08% ======================================================================================================= RATIOS/SUPPLEMENTAL DATA Net Assets, End of Period (Millions) $22,937 $30,541 $29,639 $22,568 $14,758 $10,272 Ratio of Total Expenses to Average Net Assets 0.37%* 0.37% 0.41% 0.37% 0.39% 0.40% Ratio of Net Investment Income to Average Net Assets 2.43%* 2.08% 2.16% 2.49% 2.92% 3.27% Portfolio Turnover Rate 23%* 26% 31% 30% 32% 30% ======================================================================================================= *Annualized.
17 NOTES TO FINANCIAL STATEMENTS Vanguard Windsor II 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. Securities for which market quotations are not readily available are valued by methods deemed by the Board of Trustees to represent fair 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 CONTRACTS: 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 share 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. 18 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 $238,000 for the six months endedApril 30, 2000. For the six months ended April 30, 2000, the aggregate investment advisory fee represented an effective annual basic rate of 0.12% of average net assets before a decrease of $3,231,000 (0.03%) 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 Trustees. The fund has committed to provide up to 0.40% of its net assets in capital contributions to Vanguard. At April 30, 2000, the fund had contributed capital of $4,409,000 to Vanguard (included in Other Assets), representing 0.02% of the fund's net assets and 4.4% of Vanguard's capitalization. The fund's Trustees and officers are also Directors and officers of Vanguard. D. The fund has asked its investment advisers to direct certain security trades, subject to obtaining the best price and execution, to brokers who have agreed to rebate to the fund part of the commissions generated. Such rebates are used solely to reduce the fund's management and administrative expenses. For the six months ended April 30, 2000, these arrangements reduced the fund's expenses by $2,184,000 (an annual rate of 0.02% of average net assets). E. During the six months ended April 30, 2000, the fund purchased $2,769,793,000 of investment securities and sold $8,118,147,000 of investment securities, other than temporary cash investments. F. At April 30, 2000, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $3,015,938,000, consisting of unrealized gains of $6,165,368,000 on securities that had risen in value since their purchase and $3,149,430,000 in unrealized losses on securities that had fallen in value since their purchase. At April 30, 2000, the aggregate settlement value of open futures contracts expiring in June 2000 and the related unrealized appreciation (depreciation) were: - -------------------------------------------------------------------------------- (000) ---------------------------------------- Aggregate Unrealized Number of Settlement Appreciation Futures Contracts Long Contracts Value (Depreciation) - -------------------------------------------------------------------------------- S&P 500 Index 2,828 $1,032,220 $29,665 S&P MidCap 400 Index 289 69,757 (471) - -------------------------------------------------------------------------------- G. The market value of securities on loan to broker/dealers at April 30, 2000, was $8,794,000 for which the fund held cash collateral of $9,525,000. Cash collateral received is invested in repurchase agreements. 19 THE VANGUARD(R) FAMILY OF FUNDS STOCK FUNDS - -------------------------------------------------------------------------------- 500 Index Fund Aggressive Growth Fund Capital Opportunity Fund Convertible Securities Fund Emerging Markets Stock Index Fund Energy Fund Equity Income Fund European Stock Index Fund Explorer(TM) Fund Extended Market Index Fund* Global Equity Fund Gold and Precious Metals Fund Growth and Income Fund Growth Index Fund* Health Care Fund Institutional Index Fund* International Growth Fund International Value Fund Mid-Cap Index Fund* Morgan(TM) Growth Fund Pacific Stock Index Fund PRIMECAP Fund REIT Index Fund Selected Value Fund Small-Cap Growth Index Fund* Small-Cap Index Fund* Small-Cap Value Index Fund* Tax-Managed Capital Appreciation Fund* Tax-Managed Growth and Income Fund* Tax-Managed International Fund* Tax-Managed Small-Cap Fund* Total International Stock Index Fund Total Stock Market Index Fund* U.S. Growth Fund Utilities Income Fund Value Index Fund* Windsor(TM) Fund Windsor(TM) II Fund BALANCED FUNDS - -------------------------------------------------------------------------------- Asset Allocation Fund Balanced Index Fund Global Asset Allocation Fund LifeStrategy(R) Conservative Growth Fund LifeStrategy(R) Growth Fund LifeStrategy(R) Income Fund LifeStrategy(R) Moderate Growth Fund STAR(TM) Fund Tax-Managed Balanced Fund Wellesley(R) Income Fund Wellington(TM) Fund BOND FUNDS - -------------------------------------------------------------------------------- Admiral(TM) Intermediate-Term Treasury Fund Admiral(TM) Long-Term Treasury Fund Admiral(TM) Short-Term Treasury Fund GNMA Fund High-Yield Corporate Fund High-Yield Tax-Exempt Fund Insured Long-Term Tax-Exempt Fund Intermediate-Term Bond Index Fund Intermediate-Term Corporate Fund Intermediate-Term Tax-Exempt Fund Intermediate-Term Treasury Fund Limited-Term Tax-Exempt Fund Long-Term Bond Index Fund Long-Term Corporate Fund Long-Term Tax-Exempt Fund Long-Term Treasury Fund Preferred Stock Fund Short-Term Bond Index Fund Short-Term Corporate Fund* Short-Term Federal Fund Short-Term Tax-Exempt Fund Short-Term Treasury Fund State Tax-Exempt Bond Funds(California, Florida, Massachusetts, New Jersey, New York, Ohio, Pennsylvania) Total Bond Market Index Fund* MONEY MARKET FUNDS - -------------------------------------------------------------------------------- Admiral(TM) Treasury Money Market Fund Federal Money Market Fund Prime Money Market Fund* State Tax-Exempt Money Market Funds (California, New Jersey, New York, Ohio, Pennsylvania) Tax-Exempt Money Market Fund Treasury Money Market Fund VARIABLE ANNUITY PLAN - -------------------------------------------------------------------------------- Balanced Portfolio Diversified Value Portfolio Equity Income Portfolio Equity Index Portfolio Growth Portfolio High-Grade Bond Portfolio High Yield Bond Portfolio International Portfolio Mid-Cap Index Portfolio Money Market Portfolio REIT Index Portfolio Short-Term Corporate Portfolio Small Company Growth Portfolio *Offers Institutional Shares. For information about Vanguard funds and our variable annuity plan, including charges and expenses, obtain a prospectus from The Vanguard Group, P.O. Box 2600, Valley Forge, PA 19482-2600. Read it carefully before you invest or send money. 20 - -------------------------------------------------------------------------------- THE PEOPLE WHO GOVERN YOUR FUND The Trustees of your mutual fund are there to see that the fund is operated and managed in your best interests since, as a shareholder, you are part owner of the fund. Your fund Trustees also serve on the Board of Directors of The Vanguard Group, which is owned by the funds and exists solely to provide services to them on an at-cost basis. Seven of Vanguard's eight board members are independent, meaning that they have no affiliation with Vanguard or the funds they oversee, apart from the sizable personal investments they have made as private individuals. They bring distinguished backgrounds in business, academia, and public service to their task of working with Vanguard officers to establish the policies and oversee the activities of the funds. Among board members' responsibilities are selecting investment advisers for the funds; monitoring fund operations, performance, and costs; reviewing contracts; nominating and selecting new Trustees/Directors; and electing Vanguard officers. The list below provides a brief description of each Trustee's professional affiliations. Noted in parentheses is the year in which the Trustee joined the Vanguard Board. TRUSTEES JOHN J. BRENNAN * (1987) Chairman of the Board, Chief Executive Officer, and Director/Trustee of The Vanguard Group, Inc., and each of the investment companies in The Vanguard Group. JOANN HEFFERNAN HEISEN * (1998) Vice President, Chief Information Officer, and a member of the Executive Committee of Johnson & Johnson; Director of Johnson & JohnsonoMerck Consumer Pharmaceuticals Co., The Medical Center at Princeton, and Women's Research and Education Institute. BRUCE K. MACLAURY * (1990) President Emeritus of The Brookings Institution; Director of American Express Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp. BURTON G. MALKIEL * (1977) Chemical Bank Chairman's Professor of Economics, Princeton University; Director of Prudential Insurance Co. of America, Banco Bilbao Gestinova, Baker Fentress & Co., The Jeffrey Co., and Select Sector SPDR Trust. ALFRED M. RANKIN, JR. * (1993) Chairman, President, Chief Executive Officer, and Director of NACCO Industries, Inc.; Director of The BFGoodrich Co. JOHN C. SAWHILL * (1991) 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., NACCO Industries, and Newfield Exploration Co. JAMES O. WELCH, JR. * (1971) 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 * (1985) Retired Chairman of Rohm & Haas Co.; Director of AmeriSource Health Corporation, 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. THOMAS J. HIGGINS * Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the investment companies in The Vanguard Group. VANGUARD MANAGING DIRECTORS R. GREGORY BARTON * Legal Department. ROBERT A. DISTEFANO * Information Technology. JAMES H. GATELY * Individual Investor Group. KATHLEEN C. GUBANICH * Human Resources. IAN A. MACKINNON * Fixed Income Group. F. WILLIAM MCNABB, III * Institutional Investor Group. MICHAEL S. MILLER * Planning and Development. RALPH K. PACKARD * Chief Financial Officer. GEORGE U. SAUTER * Quantitative Equity Group. [SHIP LOGO] [THE VANGUARD GROUP (R) LOGO] Post Office Box 2600 Valley Forge, Pennsylvania 19482-2600 ABOUT OUR COVER Our cover art, depicting HMS Vanguard at sea, is a reproduction of Leading the Way, a 1984 work created and copyrighted by noted naval artist Tom Freeman, of Forest Hill, Maryland. WORLD WIDE WEB www.vanguard.com FUND INFORMATION 1-800-662-7447 INDIVIDUAL ACCOUNT SERVICES 1-800-662-2739 INSTITUTIONAL INVESTOR SERVICES 1-800-523-1036 This report is intended for the fund's shareholders. It may not be distributed to prospective investors unless it is preceded or accompanied by the current fund prospectus. Q732-062000 (C) 2000 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. -----END PRIVACY-ENHANCED MESSAGE-----