-----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, IeLPOx2zvAhCNnQuNBzj5CdpJFBMYUeRtPHImk5uKiTwkO9+RQc94aJnrpBDEbag VJlTf5wmGoCyFn8EitEdaQ== 0000932471-00-000811.txt : 20001225 0000932471-00-000811.hdr.sgml : 20001225 ACCESSION NUMBER: 0000932471-00-000811 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20001031 FILED AS OF DATE: 20001222 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: 795043 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 FUNDS ANNUAL REPORTS Vanguard Windsor(TM)Fund Annual Report October 31, 2000 [SHIP] [THE VANGUARD GROUP LOGO] OUR REPORTS TO THE OWNERS At Vanguard, we regard our investors not as mere customers but as owners of the enterprise. For that's exactly what a mutual fund shareholder is--part owner of an investment company. In our reports to you on how the company is doing, we have tried to convey information without hyperbole and in the context of broad market trends and relevant benchmarks. We've introduced several changes to this year's annual reports to make them even more useful. Among the changes: - Larger type and redesigned graphics to make the reports easier to read. - An at-a-glance summary of key points about fund performance and the financial markets. - A table--included for many funds--in which the investment adviser highlights significant changes in holdings. - Comparisons of fund performance and characteristics against both a broad market index and a "best fit" benchmark. We hope you'll find that these changes make the reports even more accessible and informative. SUMMARY * Vanguard Windsor Fund earned 11.6% during the 12 months ended October 31, 2000, surpassing returns for both its average peer fund and its index benchmarks. * Value stocks in general, and Windsor's holdings in particular, rebounded during the second half of the fiscal year. * The fund benefited from strong stock picks in several sectors, especially the financial services and consumer discretionary groups. CONTENTS 1 Letter from the Chairman 6 Notice to Shareholders 7 Adviser's Report 9 Fund Profile 10 Glossary of Investment Terms 11 Performance Summary 12 Report on After-Tax Returns 13 Financial Statements 22 Report of Independent Accountants LETTER from the Chairman Fellow Shareholders, VANGUARD WINDSOR FUND earned 11.6% in the fiscal year ended October 31, which was a turbulent period for stocks. Windsor outpaced the broad market as well as our benchmarks: the average multi-cap value fund, the Russell 1000 Value Index, and the Standard & Poor's 500 Index. We thank our shareholders for their patience in recent years when value stocks generated returns well below those of growth issues. It took discipline to stick with value investing when price momentum--buying stocks mainly because their prices had risen--was a driving force on Wall Street. However, it appears that pundits who declared the death of value investing were off target. 2000 TOTAL RETURNS FISCAL YEAR ENDED OCTOBER 31 - -------------------------------------------------- Vanguard Windsor Fund 11.6% Average Multi-Cap Value Fund* 10.9 Russell 1000 Value Index 5.5 S&P 500 Index 6.1 - -------------------------------------------------- *Derived from data provided by Lipper Inc. The table above presents the 12-month returns of the fund and its benchmarks. The 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 $16.44 per share on October 31, 2000, and is adjusted for dividends totaling $0.29 per share paid from net investment income and a distribution of $1.90 per share paid from net realized capital gains. If you own Vanguard Windsor Fund in a taxable account, we call your attention to a review of the fund's after-tax returns on page 12. MARKET BAROMETER AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED OCTOBER 31, 2000 ONE THREE FIVE YEAR YEARS YEARS - -------------------------------------------------------------------------------- STOCKS S&P 500 Index (Large-caps) 6.1% 17.6% 21.7% Russell 2000 Index (Small-caps) 17.4 5.9 12.4 Wilshire 5000 Index (Entire market) 8.1 16.0 20.1 MSCI EAFE Index (International) -2.7 9.7 8.9 - -------------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index (Entire market) 7.3% 5.7% 6.3% Lehman 10 Year Municipal Bond Index 8.2 5.0 5.7 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 5.7 5.2 5.2 ================================================================================ CPI Consumer Price Index 3.4% 2.5% 2.5% - -------------------------------------------------------------------------------- FINANCIAL MARKETS IN REVIEW The U.S. stock market began the fiscal year like a skyrocket as investors targeted technology-related stocks. In the first two months of the 1 period, the broad market gained more than 11%. Fueling the increase were favorable economic data: Production rose rapidly, unemployment fell below 4% of the workforce, long-term interest rates declined, and inflation was well-behaved, aside from a rise in energy prices. But as the period progressed, the effects of higher short-term interest rates--engineered by the Federal Reserve Board to slow the economy and forestall inflation--began to show. Data suggested that the economy's expansion was decelerating to a moderate pace. And despite solid increases in corporate earnings, doubts grew that companies could sustain the growth pace amid a slowing economy. Investors seemed to grow wary of the lofty prices of many tech stocks in relation to their earnings and other fundamentals. Value stocks--those issues characterized by relatively low prices in relation to earnings, book value, and dividends-- generally benefited from the market's increased emphasis on current earnings. TOTAL RETURNS OCT. 31, 1999, TO APR. 30, 2000, TO FISCAL APR. 30, 2000 OCT. 31, 2000 2000 - -------------------------------------------------------------------------------- Russell 1000 Growth Index 18.7% -7.9% 9.3% Russell 1000 Value Index -1.0 6.6 5.5 - -------------------------------------------------------------------------------- The result was a significant split between first- and second-half results for growth and value stocks, as the table above shows. For the full 12 months, the overall market, as measured by the Wilshire 5000 Total Market Index, returned 8.1%--a decent result but below the double-digit gains investors have seen in recent years. For a change, small- and mid-capitalization stocks outpaced their large-cap counterparts: The small-cap Russell 2000 Index returned 17.4% for the 12 months, 11.3 percentage points ahead of the return of the large-cap S&P 500 Index. The year saw huge variations in returns of various industry groups. For example, higher oil and natural gas prices boosted the oil exploration and services companies in the "other energy" group to a 49% return, making this the top-performing sector within the S&P 500 Index. Other strong sectors included producer durables (31%), health care (16%), and financial services (15%). The year's big losers were telephone companies, which weighed down the utilities group (-15%), and retailers, apparel makers, and other firms in the consumer discretionary sector (-13%). Short-term interest rates rose substantially during the year, with the yield on 3-month U.S. Treasury bills increasing 1.3 percentage points. The increase essentially matched the 1.25-point boost in the federal funds rate accomplished in four steps by the Federal Reserve. Yields were relatively flat, on balance, for most longer-term securities. A rising federal budget surplus shrank the supply of U.S. Treasury bonds, and 2 their yields declined slightly for the fiscal year: The 30-year Treasury's yield fell from 6.16% to 5.79%. Yields on 10-year Treasuries fell by about a quarter-point. In general, bonds turned in solid results during the 12 months. The Lehman Brothers Aggregate Bond Index, a proxy for taxable investment-grade bonds, returned 7.3%, outpacing the S&P 500 Index. Mortgage-backed securities and high-quality corporate bonds performed well, benefiting from investors' shift toward high-quality bonds and away from speculative issues. Prices of high-yield bonds fell by more than 10%, on average, and the Lehman High Yield Index returned -1.6%. FISCAL 2000 PERFORMANCE OVERVIEW Vanguard Windsor Fund's 11.6% return in the fiscal year ended October 31 represented a remarkable comeback. After declining -10.4% from November through February, the fund generated a 24.6% return during the final eight months of our fiscal year. Windsor's full-year gain placed it modestly ahead of the average multi-cap value fund and far in advance of the Russell 1000 Value Index. We also finished the year well ahead of the broad market indexes. The turnabout was not the result of some sudden brilliant change in strategy by our advisers--Wellington Management Company and Sanford C. Bernstein & Co. They have continued to follow their disciplined approaches to selecting stocks. Rather, it seemed that the market began to recognize the merits of a number of stocks that our advisers had selected. The standout group for Windsor was financial services stocks--the fund's largest industry concentration at about one-quarter of assets on average. (This group accounted for more than 30% of the Russell 1000 Value Index.) Windsor's financial stocks earned an average of 26% during the fiscal year, nearly double the average return for the sector in the Russell index. In the consumer discretionary group, Windsor's holdings earned about 14% during the fiscal year, compared with a -6% return for this group in the index. Windsor's health care and materials & processing stocks also significantly outperformed those in the index. On the other hand, our fund's overall return was hurt by very poor results from its utilities stocks (down nearly -30%) and by having more than triple the market weighting in the materials & processing sector, a poorly performing segment of the market. - -------------------------------------------------------------------------------- The standout group for Windsor Fund was financial services stocks. - -------------------------------------------------------------------------------- The past year showed that patience and perspective are necessary virtues for value investors, who by definition are choosing securities that have been shunned by many other investors (that's why their prices are relatively low in comparison with earnings and other measures). We note that many individuals who gave into the temptation to alter their investment allocations paid a heavy price. Consider that the largest flows 3 of cash into technology-related mutual funds and out of value funds like Windsor occurred in February and March 2000. The timing of these flows couldn't have been worse. That said, we don't pretend to know what the market has in store next, and we continue to believe that long-term investors should maintain exposure to both value stocks and growth stocks. As fiscal 2000 demonstrated, market leadership can switch suddenly and decisively from growth to value and back again. As we said in our letter one year ago, we believe that Windsor's disciplined approach to seeking value gives the fund a good chance to achieve our goal of providing superior long-term returns. TOTAL ASSETS MANAGED OCTOBER 31, 2000 $ MILLION PERCENTAGE - -------------------------------------------------------------------------------- Wellington Management Company, llp $11,799 74% Sanford C. Berstein & Co., LLC 3,867 24 Cash Investments* 269 2 - -------------------------------------------------------------------------------- Total $15,935 100% - -------------------------------------------------------------------------------- *This cash is invested by The Vanguard Group in equity index futures to simulate investment in stocks; each adviser also maintains a modest cash position. The table above shows the current allocation of Windsor Fund assets between our two advisers. LONG-TERM PERFORMANCE OVERVIEW We're pleased by Windsor Fund's strong relative results during fiscal 2000, but we believe that performance is best measured over the long haul. The table below presents the average annual returns for your fund, the average multi-cap value fund, and two market benchmarks over the past decade. It also presents the results of hypothetical $10,000 investments made ten years ago in each. Windsor Fund's edge over its average competitor amounted to more than $5,000 over the decade. Our record versus the index benchmarks wasn't as good. The Russell 1000 Value Index is a good yardstick for us, although not a precise fit, since some of its constituent stocks are fairly pricey by Windsor standards. The S&P 500 Index, of course, contains both value and growth stocks--a big advantage during the 1990s, when growth stocks were the best performers. Our low operating costs explain much of our margin over our peer fund group. Windsor Fund's expense ratio is a slender 0.31%, or TOTAL RETURNS TEN YEARS ENDED OCTOBER 31, 2000 AVERAGE FINAL VALUE OF ANNUAL A $10,000 RETURN INITIAL INVESTMENT - -------------------------------------------------------------------------------- Vanguard Windsor Fund 17.5% $50,084 Average Multi-Cap Value Fund 16.2 44,732 Russell 1000 Value Index 18.3 53,805 S&P 500 Index 19.4 59,083 - -------------------------------------------------------------------------------- 4 $3.10 per $1,000 of assets, versus the 1.39% ($13.90 per $1,000) charged by the average multi-cap value fund, according to data from Lipper Inc. This cost advantage gives our advisers a head start versus competitors, year after year, in our quest to provide superior returns. (In comparison with indexes, all funds are at a disadvantage, since indexes exist only on paper and incur no costs at all.) Of course, our goal is to provide long-term returns that beat those of both our peer funds and our index benchmark. We hope to improve our relative returns in future years, but stress that it's unlikely that we or the market will match the absolute returns recorded during the past ten years. The stock market's performance during the 1990-2000 decade was one of its best ever; returns were far above the 11% to 12% annual average for stocks over the past 75 years or so. We suggest that in making your investment plans, you assume no more than the long-term average return of about 11%. After all, if you make modest assumptions and the market exceeds them, the result is not bad: You'll merely get to your objectives sooner. IN SUMMARY The financial markets during the past 12 months certainly reinforced the importance of diversification. Just when it seemed that a single hot sector of the stock market was the only place to be, technology-related stocks swooned and value stocks came to the fore. And bonds--the asset class many investors forgot in the excitement of the bull market in stocks--posted solid results. Perhaps the one safe prediction for the next 12 months is that markets will continue to be quite unpredictable. But uncertainty and volatility--risk, to use a four-letter word--are constant companions for investors. A balanced investment program--a mix of short-term investments, bonds, and both value and growth stocks--can help you manage risk. Once you've built such a program in accordance with your objectives, time horizon, financial situation, and tolerance for market fluctuations, we recommend staying the course. Sincerely, /S/ JOHN J. BRENNAN November 13, 2000 JOHN J. BRENNAN Chairman and Chief Executive Officer 5 - -------------------------------------------------------------------------------- NOTICE TO SHAREHOLDERS: CHANGE IN OWNERSHIP FOR SANFORD C. BERNSTEIN & CO., INC. On June 20, 2000, Alliance Capital Management L.P. (Alliance Capital) announced that it had agreed to acquire Sanford C. Bernstein & Co., Inc. (Bernstein), one of the advisers to Vanguard Windsor Fund. The change in ownership is not expected to have any practical effect on the management or operations of your fund. However, your fund's advisory contract with Bernstein automatically terminated when the change in ownership occurred. This automatic termination is required by the Investment Company Act of 1940. Alliance Capital's acquisition of Bernstein became effective on October 2, 2000. Following the completion of that transaction, Bernstein's investment professionals, including those responsible for the management of your fund's assets, now provide investment management services through Sanford C. Bernstein & Co., LLC (Bernstein LLC), a subsidiary of Alliance Capital and Alliance Capital's Bernstein Investment Research and Management Unit. Accordingly, on September 14, 2000, your fund's board of trustees approved a new investment advisory contract with Bernstein LLC to take effect when the ownership change was completed. All of the key terms of the new contract, except for its commencement and termination dates, are the same as those in the previous contract. Your board believes that, like the previous advisory contract, the new advisory contract will enable the fund to obtain services of high quality at reasonable cost and that it is in the best interests of the fund and its shareholders. The board's unanimous vote to approve the new contract included all of the trustees who are not "interested persons" of the fund or of Bernstein LLC. In 1993, the Windsor Fund received permission from the U.S. Securities and Exchange Commission and the fund's shareholders for the trustees to enter into a new advisory agreement without the delay and expense of a shareholder vote. This special permission was made subject to several conditions, including the requirement that shareholders be notified of changes to the fund's investment advisory agreement. Bernstein LLC is located at 767 Fifth Avenue, New York, NY 10153. Bernstein LLC is registered as an investment adviser with the U.S. Securities and Exchange Commission. Bernstein began providing private investment advisory services in 1967 and has provided such services to both domestic and international investment portfolios for corporate, government, and union benefit plans; mutual funds; individuals; endowments; and foundations. As of June 30, 2000, Bernstein had total assets under management of approximately $82.7 billion. 6 ADVISER'S Report WELLINGTON MANAGEMENT COMPANY, LLP After appreciating a staggering 245% from the end of 1997 through the first quarter of 2000, the technology sector in the S&P 500 Index has finally undergone some correction, dropping about 25% in the final seven months of vanguard windsor fund's fiscal year ended October 31. Given our obvious underweighting in these mostly high-P/E stocks, which at their peak represented close to one-third of the market's value, this correction provided an improved backdrop for Windsor-style investing in the second half of the year. For the entire fiscal year, our outperformance of the S&P 500 Index was led by three sectors--energy, financials, and health care. In each of these, we were doubly blessed: Our portion of the fund was overweighted versus the index in a sector that outperformed the market and our holdings outpaced the sector average. And, believe it or not, our technology stocks--low-P/E tech stocks, to be sure--were up 30%, outperforming both the market as a whole and the average return from the tech sector. - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- A notable event that contributed importantly to performance for the year was the September announcement that Citigroup was acquiring Associates First Capital--our second-largest holding at the time--at a 53% premium. On the negative side of things, our long-distance telephone holdings--AT&T and WorldCom--were very poor performers. We still hold these stocks and believe that they have significant upside potential, although we've reduced our price targets for them due to significantly reduced earnings forecasts. The U.S. economy is transitioning from the too-high GDP growth rate of about 5.5% that we saw in 1999 and in the first half of 2000 to a more sustainable growth rate of 3.0% to 3.5% for the second half of the year and, we expect, for the next two or three years. We think that the odds are against this slowdown turning into a recession. The underlying productivity of the U.S. economy is strong, which should keep inflation well contained, and there are no broad inventory or other imbalances that might get us in trouble. When end demand slows, as it has lately, you do get inventory imbalances in individual sectors. However, in our modern economy such imbalances typically get recognized and dealt with in two or three quarters. 7 Importantly, we see real (inflation-adjusted) consumer spending growing 3.0% to 3.5% next year, about in line with real disposable income. And the consumer is, after all, about two-thirds of the economy. The increase in oil's price--from around $12 a barrel in early 1999 to around $35 now--has dampened consumer spending, but we expect the price to retrace its steps to the low $20s over the next 12 months, as OPEC's production now is clearly outstripping annualized demand. The recent decline in mortgage rates is another positive factor in the outlook for consumer spending, and we have already seen a bounce in home buying from spring and summer levels. While we see the economy in a positive light, the market is not so sure. This has created good value opportunities in cyclical stocks. Accordingly, we are somewhat overweighted in cyclical stocks--particularly Alcoa and other basic materials producers, retailers, specialty chemicals, and transportation. We are still considerably underweighted in both consumer nondurables and technology. Consumer nondurables have been poor performers for a year or two, and we don't see them outperforming the market given their still-high valuations, their low unit-volume growth, and the lack of their once-vaunted pricing power. And despite a 25% drop in tech stocks since March, the S&P's tech sector still sports a 32 price/earnings multiple based on estimates of next year's earnings. This is a high price relative to the 11% long-term growth rate for the information technology sector as a whole--especially if we are wrong about the economy and we wind up in a recession. In recessions, technology spending gets deferred, and tech stocks would be no fun at all. As it is, the group is being buffeted by decelerating growth in a number of technology sub-sectors-- a development that we envisioned in our report to you at midyear. Again, we do not forecast a recession. If we have one, it will be short and shallow. In any event, we think the prices of cyclicals, where we are overweighted, have factored in such a possibility better than tech prices have. We continue to invest your money in the longstanding Windsor tradition--emphasizing low-P/E stocks, staying price opportunistic on the buy side and price disciplined on the sell side, and being willing to sensibly concentrate--while keeping an eye on the ever-changing world of business and contemporary trends. Indeed, as tech stocks have weakened, we've used the opportunity to take starting positions in select tech stocks (Dell Computer and Hewlett-Packard, for example) at our kind of prices. Even so, we're still way underweighted in tech stocks overall. Other important new positions established in the latter half of the fiscal year include Staples, Cox Communications, and Petrobras, the big Brazilian oil company. We continue to forage--in our usual opportunistic and entrepreneurial fashion--for undervalued stocks with significant (30% or better) upside potential as we try to provide unusual returns to you, the shareholder. Charles T. Freeman, Portfolio Manager November 17, 2000 8 FUND PROFILE As of October 31, 2000 for Windsor Fund This Profile provides a snapshot of the fund's characteristics, compared where appropriate to both an unmanaged index that we consider a "best fit" for the fund and a broad market index. Key terms are defined on page 10. - --------------------------------------------------------------- PORTFOLIO CHARACTERISTICS WILSHIRE FUND BEST FIT* 5000 - --------------------------------------------------------------- Number of Stocks 175 740 6,768 Median Market Cap $8.9B $41.6B $46.1B Price/Earnings Ratio 15.0x 19.8x 29.8x Price/Book Ratio 2.2x 3.3x 4.5x Yield 1.6% 1.8% 1.1% Return on Equity 15.3% 20.8% 22.8% Earnings Growth Rate 12.2% 10.9% 16.8% Foreign Holdings 7.3% 0.0% 0.0% Turnover Rate 41% --- --- Expense Ratio 0.31% --- --- Cash Investments 0.6% --- --- - --------------------------------------------------------------- - -------------------------------------------- TEN LARGEST HOLDINGS (% of total net assets) Associates First Capital Corp. 5.4% (financial services) Alcoa Inc. 4.4 (aluminum) TJX Cos., Inc. 3.3 (retail) WorldCom, Inc. 3.1 (telecommunications) Citigroup, Inc. 2.9 (financial services) Pharmacia Corp. 2.8 (pharmaceuticals) Washington Mutual, Inc. 2.4 (savings & loan) CIGNA Corp. 2.1 (insurance) Air Products & Chemicals, Inc. 2.1 (chemicals) Eaton Corp. 1.7 (auto parts) - -------------------------------------------- Top Ten 30.2% - -------------------------------------------- - ---------------------------------------------- VOLATILITY MEASURES Wilshire Fund Best Fit* Fund 5000 - ---------------------------------------------- R-Squared 0.89 1.00 0.53 1.00 Beta 1.15 1.00 0.88 1.00 - ---------------------------------------------- - -------------------------------------------------------------------- SECTOR DIVERSIFICATION (% OF COMMON STOCKS) WILSHIRE FUND BEST FIT* 5000 - -------------------------------------------------------------------- Auto & Transportation 7.3% 3.1% 1.7% Consumer Discretionary 9.4 9.2 12.0 Consumer Staples 1.1 7.8 5.3 Financial Services 25.1 31.3 17.0 Health Care 6.5 8.6 12.4 Integrated Oils 5.7 7.2 3.1 Other Energy 3.6 2.5 2.6 Materials & Processing 19.6 3.8 2.5 Producer Durables 3.0 3.5 3.3 Technology 6.1 4.7 26.4 Utilities 11.0 15.7 8.7 Other 1.6 2.6 5.0 - -------------------------------------------------------------------- *Russell 1000 Value Index. - ------------------------------ INVESTMENT FOCUS MARKET CAP Medium STYLE Value - ------------------------------ [PICTURE OF COMPUTER] VISIT OUR WEBSITE WWW.VANGUARD.COM FOR REGULARLY UPDATED FUND INFORMATION. 9 GLOSSARY of Investment Terms BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the fund's "best fit" index benchmark and an overall market index. Each index is assigned a beta of 1.00. Compared with a given index, a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the index rose or fell by 10%. - -------------------------------------------------------------------------------- CASH INVESTMENTS. The percentage of a fund's net assets invested in "cash equivalents"--highly liquid, short-term, interest-bearing instruments. 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. - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- 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 market in general, as measured by the fund's "best fit" index benchmark and by an overall market index. If a fund's total returns were precisely synchronized with an index's returns, its R-squared would be 1.00. If the fund's returns bore no relationship to the index'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. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of trading activity during the past year. 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. - -------------------------------------------------------------------------------- 10 PERFORMANCE SUMMARY for 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, 1990-October 31, 2000 WINDSOR FUND RUSSELL 1000 VALUE INDEX 1991 44.7 32.9 1992 9.3 10.7 1993 28.3 25.2 1994 6.3 0.8 1995 17.8 24.7 1996 23.2 23.7 1997 27.0 33.2 1998 -0.8 14.8 1999 13.7 16.5 2000 11.6 5.5 - -------------------------------------------------------------------------------- See Financial Highlights table on page 19 for dividend and capital gains information for the past five years. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CUMULATIVE PERFORMANCE OCTOBER 31, 1990-OCTOBER 31, 2000 WINDSOR AVERAGE RUSSELL 1000 WILSHIRE S&P 500 FUND MULTI-CAP VALUE 5000 INDEX INDEX VALUE FUND* INDEX 199010 10000 10000 10000 10000 10000 199101 12228 11555 11459 11562 11420 199104 13564 12645 12494 12865 12562 199107 13938 13077 12933 13395 13087 199110 14469 13519 13289 13860 13350 199201 14962 14216 13685 14751 14011 199204 15840 14506 14412 14789 14325 199207 16390 14787 14949 15166 14760 199210 15815 14848 14706 15202 14679 199301 18001 15951 16002 16310 15493 199304 18469 16253 16835 16332 15648 199307 19393 16749 17749 16916 16049 199310 20288 17748 18406 17902 16872 199401 21581 18436 19064 18488 17488 199404 20134 17560 18067 17432 16480 199407 21294 17808 18394 17646 16877 199410 21576 18397 18549 18356 17524 199501 20711 18046 18559 18300 17581 199504 22857 19677 20339 20019 19359 199507 25482 21524 22230 22239 21283 199510 25417 22165 23128 23062 22158 199601 27194 24001 25686 25108 24378 199604 28922 25085 26421 26464 25208 199607 28171 24206 25762 25508 24810 199610 31304 26738 28617 28118 27497 199701 35471 29346 31769 31252 30800 199704 35551 29229 32382 31131 31543 199707 41597 34654 38340 37538 37745 199710 39767 34438 38113 36990 36327 199801 40712 35400 40381 39123 39089 199804 46782 39386 46041 44600 44497 199807 42618 37294 45129 43961 45024 199810 39455 36091 43764 42484 44315 199901 40961 38855 47740 49829 51788 199904 48136 41217 52528 52172 54207 199907 46842 41389 51893 52018 54120 199910 44878 40321 50997 53385 55691 200001 42738 39515 49185 56994 57146 200004 46060 41085 50491 58554 59697 200007 46306 40930 49300 57832 58978 200010 50084 44732 53805 57709 59083 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED OCTOBER 31, 2000 FINAL VALUE ------------------------------- OF A $10,000 1 YEAR 5 YEARS 10 YEARS INVESTMENT - -------------------------------------------------------------------------------- Windsor Fund 11.60% 14.53% 17.48% $50,084 Average Multi-Cap Value Fund* 10.94 15.08 16.16 44,732 Russell 1000 Value Index 5.52 18.40 18.33 53,805 Wilshire 5000 Index 8.10 20.14 19.16 57,709 S&P 500 Index 6.09 21.67 19.44 59,083 - -------------------------------------------------------------------------------- *Derived from data provided by Lipper Inc. - -------------------------------------------------------------------------------- 11 A REPORT on Your Fund's After-Tax Returns This table presents pre-tax and after-tax returns for your fund and an appropriate peer group of mutual funds. The after-tax returns represent the fund's past results only and cannot be used to predict future tax efficiency. If you own the fund in a tax-deferred account such as an individual retirement account or a 401(k), this information does not apply to you. Such accounts are not subject to current taxes. Income taxes can have a considerable impact on a fund's return--an important consideration for investors who own mutual funds in taxable accounts. While the pre-tax return is most often used to tally a fund's performance, the fund's after-tax return, which accounts for taxes on distributions of capital gains and income dividends, is an important measure of the return that many investors actually received. PRE-TAX AND AFTER-TAX PERIODS ENDED OCTOBER 31, 2000 AVERAGE ANNUAL TOTAL RETURNS ONE YEAR FIVE YEARS TEN YEARS ----------------------------------------------------- PRE-TAX AFTER-TAX PRE-TAX AFTER-TAX PRE-TAX AFTER-TAX - -------------------------------------------------------------------------------- Vanguard Windsor Fund 11.6% 7.8% 14.5% 10.7% 17.5% 13.8% Average Mid-Cap Value Fund* 17.0 14.1 14.7 11.4 16.1 13.5 - -------------------------------------------------------------------------------- *Based on data from Morningstar, Inc. Elsewhere in this report, returns for comparable funds are derived from data provided by Lipper Inc., which may differ somewhat. The after-tax return calculations use the top federal income tax rates in effect at the time of each distribution. The tax burden would be less, and the after-tax return higher, for those in lower tax brackets. We must stress that because many interrelated factors affect how tax-friendly a fund may be, it's very difficult to predict tax efficiency. A fund's tax efficiency can be influenced by its turnover rate, the types of securities it holds, the accounting practices it uses when selling shares, and the net cash flow it receives. Finally, it's important to understand that our calculation does not reflect the tax effect of your own investment activities. Specifically, you may incur additional capital gains taxes--thereby lowering your after-tax return--if you decide to sell all or some of your shares. - -------------------------------------------------------------------------------- A NOTE ABOUT OUR CALCULATIONS: Pre-tax total returns assume that all distributions received (income dividends, short-term capital gains, and long-term capital gains) are reinvested in new shares, while our after-tax returns assume that distributions are reduced by any taxes owed on them before reinvestment. When calculating the taxes due, we used the highest individual federal income tax rates at the time of the distributions. Those rates are currently 39.6% for dividends and short-term capital gains and 20% for long-term capital gains. State and local income taxes were not considered. The competitive group returns provided by Morningstar are calculated in a manner consistent with that used for Vanguard funds. [PICTURE OF COMPUTER] You can use Vanguard's online after-tax return calculator at www.vanguard.com/?aftertax to customize the calculation of your after-tax return. 12 FINANCIAL STATEMENTS October 31, 2000 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 (97.5%)(1) - -------------------------------------------------------------------------------- AUTO & TRANSPORTATION (7.1%) (2) Eaton Corp. 4,026,800 274,074 Canadian National Railway Co. 5,692,100 179,301 *(2) Continental Airlines, Inc. Class B 2,560,800 134,442 Compagnie Generale des Etablissements Michelin Class B 4,000,586 115,636 Delta Air Lines, Inc. 1,498,722 70,815 Burlington Northern Santa Fe Corp. 1,949,000 51,770 Union Pacific Corp. 1,072,300 50,264 Delphi Automotive Systems Corp. 2,937,059 46,075 CSX Corp. 1,619,900 41,004 *(2) America West Holdings Corp. Class B 3,484,500 34,627 Dana Corp. 1,550,200 34,395 Genuine Parts Co. 1,486,500 31,681 Norfolk Southern Corp. 1,923,600 27,171 Ford Motor Co. 1,011,843 26,434 Southwest Airlines Co. 307,000 8,750 --------- 1,126,439 --------- - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- CONSUMER DISCRETIONARY (9.2%) (2) TJX Cos., Inc. 19,511,200 531,680 * Staples, Inc. 14,076,300 200,587 *(2) Republic Services, Inc. 10,574,800 142,099 May Department Stores Co. 4,676,100 122,748 (2) Ross Stores, Inc. 8,625,000 113,742 Target Corp. 2,901,000 80,140 * Jones Apparel Group, Inc. 2,341,400 65,120 Newell Rubbermaid, Inc. 2,054,600 39,423 * Federated Department Stores, Inc. 1,100,300 35,829 Gannett Co., Inc. 500,000 29,000 VF Corp. 994,300 27,157 Whirlpool Corp. 619,800 26,961 Sears, Roebuck & Co. 841,800 25,027 Leggett & Platt, Inc. 1,200,700 19,661 Dillard's Inc. 616,900 6,477 --------- 1,465,651 --------- CONSUMER STAPLES (1.1%) Philip Morris Cos., Inc. 2,502,900 91,669 ConAgra Foods, Inc. 2,395,800 51,210 Tyson Foods, Inc. 1,812,600 20,278 SuperValu Inc. 942,100 14,485 --------- 177,642 --------- 13 - -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR FUND SHARES (000) - -------------------------------------------------------------------------------- FINANCIAL SERVICES (24.4%) Associates First Capital Corp. Class A 22,995,700 853,715 Citigroup, Inc. 8,744,400 460,174 Washington Mutual, Inc. 8,743,864 384,730 CIGNA Corp. 2,782,500 339,326 Golden West Financial Corp. 4,745,300 266,033 (2) Dime Bancorp, Inc. 7,771,300 189,911 U.S. Bancorp 4,971,400 120,246 (2) Liberty Property Trust REIT 4,324,100 114,318 Bank of America Corp. 2,313,500 111,193 PartnerRe Ltd. 1,860,500 101,397 Bank One Corp. 2,220,900 81,063 The Chubb Corp. 907,500 76,627 FleetBoston Financial Corp. 2,009,530 76,362 UnionBanCal Corp. 3,292,900 69,151 First Union Corp. 1,944,300 58,937 MBIA, Inc. 803,800 58,426 American International Group, Inc. 574,350 56,286 KeyCorp 2,167,600 53,513 Charter One Financial 2,266,740 51,993 American General Corp. 637,000 51,279 National City Corp. 2,185,700 46,719 AMBAC Financial Group Inc. 579,900 46,283 TCF Financial Corp. 1,104,100 44,647 (2) IPC Holdings Ltd. 2,006,000 40,904 Torchmark Corp. 1,061,800 35,371 Summit Bancorp 873,700 32,764 Fannie Mae 344,600 26,534 Morgan Stanley Dean Witter & Co. 276,000 22,166 Regions Financial Corp. 509,450 12,004 Old Republic International Corp. 383,800 9,979 Horace Mann Educators Corp. 257,300 4,326 --------- 3,896,377 --------- HEALTH CARE (6.3%) Pharmacia Corp. 8,132,904 447,310 Aetna Inc. 3,752,000 216,913 Aventis SA ADR 1,919,550 138,328 * Foundation Health Systems Class A 6,028,660 121,704 Johnson & Johnson 402,100 37,043 Merck & Co., Inc. 200,000 17,988 * Pacificare Health Systems, Inc. 1,336,200 13,947 Bergen Brunswig Corp. Class A 1,017,100 9,218 Aventis SA Class A 99,671 7,181 --------- 1,009,632 --------- - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- INTEGRATED OILS (5.5%) USX-Marathon Group 6,397,700 173,937 * Petroleo Brasileiro ADR 5,268,100 153,104 Exxon Mobil Corp. 1,647,104 146,901 Phillips Petroleum Co. 1,105,400 68,258 Shell Transport & Trading Co. ADR 1,302,300 64,057 Texaco Inc. 1,060,700 62,648 Petro Canada 2,535,800 53,252 Occidental Petroleum Corp. 2,623,200 52,136 Conoco Inc. Class B 1,831,300 49,788 Amerada Hess Corp. 666,700 41,335 Repsol-YPF, SA ADR 1,000,000 15,938 --------- 881,354 --------- OTHER ENERGY (3.6%) Anadarko Petroleum Corp. 2,178,001 139,501 * Anderson Exploration Ltd. 6,774,134 124,196 (2) Ultramar Diamond Shamrock Corp. 4,547,400 119,369 Devon Energy Corp. 1,658,426 83,585 Valero Energy Corp. 2,401,300 79,393 Ashland, Inc. 607,000 19,879 --------- 565,923 --------- MATERIALS & PROCESSING (19.1%) Alcoa Inc. 24,555,468 704,435 Air Products & Chemicals, Inc. 8,831,200 329,514 (2) Engelhard Corp. 11,454,200 239,106 E.I. du Pont de Nemours & Co. 3,200,000 145,200 Rohm & Haas Co. 4,805,400 144,462 Willamette Industries, Inc. 3,898,100 141,550 Abitibi-Consolidated, Inc. 15,176,789 132,797 Jefferson Smurfit Group PLC ADR 6,918,641 125,400 * Smurfit-Stone Container Corp. 9,126,750 123,211 *(2) Packaging Corp. of America 5,406,500 79,408 Praxair, Inc. 2,008,200 74,805 Lyondell Chemical Co. 4,603,203 66,171 International Paper Co. 1,597,281 58,500 Dow Chemical Co. 1,854,900 56,806 Fort James Corp. 1,650,800 54,373 Pechiney SA ADR A 2,861,128 51,500 Lafarge Corp. 2,587,700 48,843 Georgia Pacific Group 1,502,900 40,390 Alcan Aluminium Ltd. 1,265,600 39,946 Sonoco Products Co. 1,942,300 37,511 The Mead Corp. 1,185,000 34,291 Sherwin-Williams Co. 1,543,300 33,470 AK Steel Corp. 3,318,652 30,698 14 - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- *(2) Kaiser Aluminum & Chemical Corp. 6,048,434 30,620 Nucor Corp. 863,400 29,949 Temple-Inland Inc. 607,800 27,199 * American Standard Cos., Inc. 591,400 27,131 (2) Century Aluminum Co. 2,000,000 17,500 Cabot Corp. 771,300 16,969 Great Lakes Chemical Corp. 485,000 16,187 Phosphate Resources Partners LP 4,018,800 16,075 Boise Cascade Corp. 473,900 13,595 Crown Cork & Seal Co., Inc. 1,398,300 12,759 * Albany International Corp. 1,017,555 10,939 * Cabot Microelectronics Corp. 216,329 9,559 * Owens-Illinois, Inc. 1,303,800 7,741 Ryerson Tull, Inc. 969,446 7,271 * Burlington Industries, Inc. 2,383,700 2,980 Archer-Daniels-Midland Co. 189,935 2,089 Owens Corning 615,500 846 --------- 3,041,796 --------- PRODUCER DURABLES (3.0%) Alcatel SA ADR 1,681,551 104,887 *(2) Toll Brothers, Inc. 3,029,166 98,448 (2) Kaufman & Broad Home Corp. 2,098,600 62,433 CNH Global NV 4,362,600 42,263 Cooper Industries, Inc. 1,103,600 42,213 The BFGoodrich Co. 971,200 39,759 (2) MDC Holdings, Inc. 1,156,300 31,654 *(2) Beazer Homes USA, Inc. 860,464 23,985 Centex Corp. 464,900 17,201 Thomas & Betts Corp. 648,600 9,810 --------- 472,653 --------- TECHNOLOGY (5.9%) *(2) Arrow Electronics, Inc. 7,899,300 252,778 International Business Machines Corp. 1,867,100 183,909 * Dell Computer Corp. 6,000,000 177,000 Hewlett-Packard Co. 3,300,000 153,244 Avnet, Inc. 2,027,000 54,476 *(2) General Semiconductor, Inc. 3,468,600 39,672 * Quantum Corp.-DLT & Storage Systems 2,168,300 32,525 * Adaptec, Inc. 1,658,700 26,228 * Litton Industries, Inc. 279,900 14,537 * Ingram Micro, Inc. 732,500 12,498 --------- 946,867 --------- UTILITIES (10.7%) * WorldCom, Inc. 20,720,339 492,108 * Cox Communications, Inc. Class A 5,709,300 251,566 - -------------------------------------------------------------------------------- MARKET VALUE* SHARES (000) - -------------------------------------------------------------------------------- AT&T Corp. 8,253,116 191,369 * Adelphia Communications Corp. Class A 5,252,400 174,314 * Comcast Corp. Special Class A 2,592,500 105,644 Xcel Energy, Inc. 2,116,215 54,096 PG&E Corp. 1,919,100 51,696 Ameren Corp. 1,272,300 50,574 American Electric Power Co., Inc. 1,213,400 50,356 Consolidated Edison Inc. 1,376,000 48,418 SBC Communications Inc. 837,720 48,326 FirstEnergy Corp. 1,704,100 44,094 Cinergy Corp. 1,334,900 40,881 GPU, Inc. 993,600 32,851 Verizon Communications 533,442 30,840 * Comcast Corp. Class A 705,500 28,308 BellSouth Corp. 174,300 8,421 --------- 1,703,862 --------- MISCELLANEOUS (1.6%) 248,828 --------- - -------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $14,084,858) 15,537,024 - -------------------------------------------------------------------------------- CONVERTIBLE PREFERRED STOCK (0.2%) - -------------------------------------------------------------------------------- Kaufman & Broad Home Corp. 8.25% Cvt. Pfd. (COST $23,120) 3,163,700 28,473 - -------------------------------------------------------------------------------- Face Amount (000) - -------------------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (2.9%)(1) - -------------------------------------------------------------------------------- FEDERAL HOME LOAN MORTGAGE CORP. (3) 6.54%, 1/25/2001 15,000 14,769 FEDERAL NATIONAL MORTGAGE ASSN. (3) 6.49%, 11/2/2000 3,000 2,999 REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 6.56%, 11/1/2000 397,452 397,452 6.58%, 11/1/2000--Note G 45,758 45,758 - -------------------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $460,982) 460,978 - -------------------------------------------------------------------------------- TOTAL INVESTMENTS (100.6%) (Cost $14,568,960) 16,026,475 - -------------------------------------------------------------------------------- 15 - -------------------------------------------------------------------------------- MARKET VALUE* WINDSOR FUND (000) - -------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-0.6%) - -------------------------------------------------------------------------------- Other Assets--Note C 84,624 Liabilities--Note G (176,314) --------- (91,690) --------- - -------------------------------------------------------------------------------- NET ASSETS (100%) - -------------------------------------------------------------------------------- Applicable to 969,289,774 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $15,934,785 ================================================================================ NET ASSET VALUE PER SHARE $16.44 ================================================================================ * See Note A in Notes to Financial Statements. * Non-income-producing security. (1) 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 99.2% and 1.2%, respectively, of net assets. See Note F in Notes to Financial Statements. (2) 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 $2,570,770,000. (3) Securities with an aggregate value of $17,768,000 have been segregated as initial margin for open futures contracts. ADR --American Depositary Receipt. REIT --Real Estate Investment Trust. - -------------------------------------------------------------------------------- AMOUNT PER (000) SHARE - -------------------------------------------------------------------------------- AT OCTOBER 31, 2000, NET ASSETS CONSISTED OF: - -------------------------------------------------------------------------------- Paid in Capital--Note E $12,624,337 $13.03 Undistributed Net Investment Income 80,408 .08 Accumulated Net Realized Gains--Note E 1,781,994 1.84 Unrealized Appreciation (Depreciation)--Note F Investment Securities 1,457,515 1.50 Futures Contracts (9,469) (.01) - -------------------------------------------------------------------------------- NET ASSETS $15,934,785 $16.44 ================================================================================ 16 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 YEAR ENDED OCTOBER 31, 2000 (000) - -------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 290,584 Interest 27,075 Security Lending 1,712 - -------------------------------------------------------------------------------- Total Income 319,371 - -------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B Basic Fee 20,781 Performance Adjustment (12,827) The Vanguard Group--Note C Management and Administrative 37,757 Marketing and Distribution 1,633 Custodian Fees 275 Auditing Fees 19 Shareholders' Reports 346 Trustees' Fees and Expenses 20 - -------------------------------------------------------------------------------- Total Expenses 48,004 Expenses Paid Indirectly--Note D (2,777) - -------------------------------------------------------------------------------- Net Expenses 45,227 - -------------------------------------------------------------------------------- NET INVESTMENT INCOME 274,144 - -------------------------------------------------------------------------------- REALIZED NET GAIN Investment Securities Sold* 1,994,887 Futures Contracts 18,907 - -------------------------------------------------------------------------------- REALIZED NET GAIN 2,013,794 - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities (605,604) Futures Contracts (15,737) - -------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (621,341) - -------------------------------------------------------------------------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $1,666,597 ================================================================================ *Dividend income and realized net gain from affiliated companies were $34,184,000 and $7,097,000, respectively. 17 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 YEAR ENDED OCTOBER 31, --------------------------- 2000 1999 (000) (000) - -------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 274,144 $ 277,607 Realized Net Gain 2,013,794 1,940,531 Change in Unrealized Appreciation (Depreciation) (621,341) 42,819 - -------------------------------------------------------------------------------- Net Increase in Net Assets Resulting from Operations 1,666,597 2,260,957 - -------------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income (287,257) (255,285) Realized Capital Gain (1,869,353) (1,341,486) - -------------------------------------------------------------------------------- Total Distributions (2,156,610) (1,596,771) - -------------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS1 Issued 932,126 1,402,297 Issued in Lieu of Cash Distributions 2,025,871 1,504,748 Redeemed (3,356,921) (5,102,907) - -------------------------------------------------------------------------------- Net Decrease from Capital Share Transactions (398,924) (2,195,862) - -------------------------------------------------------------------------------- Total Decrease (888,937) (1,531,676) - -------------------------------------------------------------------------------- NET ASSETS Beginning of Year 16,823,722 18,355,398 - -------------------------------------------------------------------------------- End of Year $15,934,785 $16,823,722 ================================================================================ 1Shares Issued (Redeemed) Issued 61,020 82,191 Issued in Lieu of Cash Distributions 135,718 100,940 Redeemed (222,437) (311,166) - -------------------------------------------------------------------------------- Net Decrease in Shares Outstanding (25,699) (128,035) ================================================================================ 18 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 THROUGHOUT EACH YEAR 2000 1999 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, BEGINNING OF YEAR $16.91 $16.34 $19.55 $16.99 $15.55 - ------------------------------------------------------------------------------------------------------------ INVESTMENT OPERATIONS Net Investment Income .28 .27 .23 .36 .43 Net Realized and Unrealized Gain (Loss)on Investments 1.44 1.77 (.32) 3.94 2.85 - ------------------------------------------------------------------------------------------------------------ Total from Investment Operations 1.72 2.04 (.09) 4.30 3.28 - ------------------------------------------------------------------------------------------------------------ DISTRIBUTIONS Dividends from Net Investment Income (.29) (.24) (.24) (.41) (.46) Distributions from Realized Capital Gains (1.90) (1.23) (2.88) (1.33) (1.38) - ------------------------------------------------------------------------------------------------------------ Total Distributions (2.19) (1.47) (3.12) (1.74) (1.84) - ------------------------------------------------------------------------------------------------------------ NET ASSET VALUE, END OF YEAR $16.44 $16.91 $16.34 $19.55 $16.99 ============================================================================================================ Total Return 11.60% 13.74% -0.78% 27.04% 23.16% ============================================================================================================ Ratios/Supplemental Data Net Assets, End of Year (Millions) $15,935 $16,824 $18,355 $20,678 $15,841 Ratio of Total Expenses to Average Net Assets 0.31% 0.28% 0.27% 0.27% 0.31% Ratio of Net Investment Income to Average Net Assets 1.75% 1.56% 1.31% 1.89% 2.75% Portfolio Turnover Rate 41% 56% 48% 61% 34% ============================================================================================================
19 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 U.S. 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., LLC, 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. 20 The basic fee of Sanford C. Bernstein & Co., LLC, is subject to quarterly adjustments based on performance relative to the Russell 1000 Value Index. For the year ended October 31, 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 $12,827,000 (0.08%) based on performance. The Vanguard Group manages the cash reserves of the fund on an at-cost basis. 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 October 31, 2000, the fund had contributed capital of $2,914,000 to Vanguard (included in Other Assets), representing 0.02% of net assets and 2.9% 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 year ended October 31, 2000, directed brokerage and custodian fee offset arrangements reduced expenses by $2,670,000 and $107,000, respectively. The total expense reduction represented an effective annual rate of 0.02% of the fund's average net assets. E. During the year ended October 31, 2000, the fund purchased $6,269,347,000 of investment securities and sold $8,552,278,000 of investment securities, other than temporary cash investments. The fund used a tax accounting practice to treat a portion of the price of capital shares redeemed during the year as distributions from realized capital gains. Accordingly, the fund has reclassified $221,667,000 from accumulated net realized gains to paid in capital. F. At October 31, 2000, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $1,457,515,000, consisting of unrealized gains of $3,270,144,000 on securities that had risen in value since their purchase and $1,812,629,000 in unrealized losses on securities that had fallen in value since their purchase. At October 31, 2000, the aggregate settlement value of open futures contracts expiring in December 2000 and the related unrealized depreciation were: - -------------------------------------------------------------------------------- (000) ---------------------------- AGGREGATE NUMBER OF SETTLEMENT UNREALIZED FUTURES CONTRACTS LONG CONTRACTS VALUE DEPRECIATION - -------------------------------------------------------------------------------- S&P 500 Index 695 $250,235 $(8,475) S&P MidCap 400 Index 104 27,105 (994) - -------------------------------------------------------------------------------- Unrealized depreciation on open futures contracts is required to be treated as realized loss for tax purposes. G. The market value of securities on loan to broker/dealers at October 31, 2000, was $44,340,000, for which the fund held cash collateral of $45,758,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. 21 REPORT of Independent Accountants To the Shareholders and Trustees of Vanguard Windsor Fund In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard Windsor Fund (the "Fund") at October 31, 2000, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at October 31, 2000 by correspondence with the custodian and brokers, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania November 29, 2000 - -------------------------------------------------------------------------------- SPECIAL 2000 TAX INFORMATION (UNAUDITED) FOR VANGUARD WINDSOR FUND This information for the fiscal year ended October 31, 2000, is included pursuant to provisions of the Internal Revenue Code. The fund distributed $1,687,633,000 as capital gain dividends (from net long-term capital gains) to shareholders during the fiscal year, all of which is designated as a 20% rate gain distribution. For corporate shareholders, 86.4% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction. 22 THE VANGUARD(R) Family of Funds STOCK FUNDS 500 Index Fund Calvert Social Index(TM) Fund Capital Opportunity Fund Convertible Securities Fund Developed Markets Index 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 Equity Fund Growth Index Fund Health Care Fund Institutional Developed Markets Index 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 Strategic Equity 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 U.S. Value 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 Inflation-Protected Securities 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 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. 23 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. Six of Vanguard's seven 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. The year in which the trustee joined the Vanguard board is noted in parentheses. TRUSTEES JOHN J. BRENNAN (1987) Chairman of the Board, Chief Executive Officer, and Director/Trustee of The Vanguard Group, Inc., and of 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 & Johnson*Merck 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 Argentaria, Gestion, BKF Capital, The Jeffrey Co., NeuVis, Inc., 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. JAMES O. WELCH, JR. (1971) Retired Chairman of Nabisco Brands, Inc. (Food Products); retired Vice Chairman and Director of RJR Nabisco (Food and Tobacco Products); Director of TECO Energy, Inc., and Kmart Corp. J. LAWRENCE WILSON (1985) Retired Chairman and Chief Executive Officer 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. GREGORY BARTON, Legal Department. ROBERT A. DISTEFANO, Information Technology. JAMES H. GATELY, Direct Investor Services. 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. - -------------------------------------------------------------------------------- JOHN C. BOGLE Founder; Chairman and Chief Executive, 1974-1996. [SHIP] [THE VANGUARD GROUP LOGO] Post Office Box 2600 Valley Forge, PA 19482-2600 ABOUT OUR COVER Our cover art evokes both Vanguard's rich past and the course we've set for the future--our determination to provide superior investment performance and top-notch service. The image is based on two works: a painting titled The First Journey of 'Victory,' by the English artist W.L. Wyllie (1851-1931), and a sculpture of a compass rose on Vanguard's campus near Valley Forge, Pennsylvania. 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, 500, S&P MidCap 400, and S&P SmallCap 600 are trademarks of The McGraw-Hill Companies, Inc. All other index names may contain trademarks and are the exclusive property of their respective owners. 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. (C)2000 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q220 122000 Vanguard Windsor(TM)II Fund Annual Report October 31, 2000 OUR REPORTS TO THE OWNERS At Vanguard, we regard our investors not as mere customers but as owners of the enterprise. For that's exactly what a mutual fund shareholder is--part owner of an investment company. In our reports to you on how the company is doing, we have tried to convey information without hyperbole and in the context of broad market trends and relevant benchmarks. We've introduced several changes to this year's annual reports to make them even more useful. Among the changes: **Larger type and redesigned graphics to make the reports easier to read. **An at-a-glance summary of key points about fund performance and the financial markets. **A table--included for many funds--in which the investment adviser highlights significant changes in holdings. **Comparisons of fund performance and characteristics against both a broad market index and a "best fit" benchmark. We hope you'll find that these changes make the reports even more accessible and informative. SUMMARY * Vanguard Windsor II Fund posted a 7.2% return, just ahead of its average peer. * Value stocks outperformed growth stocks during the second half of fiscal 2000. * Windsor II's concentration in the financial services, utilities, and "other energy" sectors contributed to the fund's turnaround in performance. CONTENTS 1 Letter from the Chairman 6 Notice to Shareholders 7 Adviser's Report 10 Fund Profile 11 Glossary of Investment Terms 12 Performance Summary 13 Report on After-Tax Returns 14 Financial Statements 24 Report of Independent Accountants LETTER from the Chairman Fellow Shareholders, Long-neglected value stocks came back in favor during a volatile 12 months in the financial markets, propelling vanguard windsor ii fund to a fiscal-year return of 7.2%, which outpaced the returns of our two value-focused comparative standards. 2000 TOTAL RETURNS FISCAL YEAR ENDED OCTOBER 31 - -------------------------------------------------------------- Vanguard Windsor II Fund 7.2% Average Large-Cap Value Fund* 7.1 Russell 1000 Value Index 5.5 Wilshire 5000 Index 8.1 - -------------------------------------------------------------- *Derived from data provided by Lipper Inc. The adjacent table pre-sents the total returns (capital change plus reinvested dividends) for the 12 months ended October 31, 2000, for the fund, its average peer, and the unmanaged Russell 1000 Value Index, the benchmark we consider the best fit for Windsor II, as well as the Wilshire 5000 Total Market Index, a proxy for the overall U.S. stock market. The fund's return is based on a change in net asset value from $29.03 per share on October 31, 1999, to $27.58 per share on October 31, 2000, and is adjusted for dividends totaling $0.67 per share paid from net investment income and a distribution of $2.50 per share paid from net realized capital gains. If you own Vanguard Windsor II Fund in a taxable account, you may wish to review our report on the fund's after-tax returns on page 13. FINANCIAL MARKETS IN REVIEW The U.S. stock market began the fiscal year like a skyrocket, as investors exhibited extreme enthusiasm for technology-related stocks. In the first two months of the period, the broad market gained more than 11%. Fueling the increase were favorable MARKET BAROMETER Average Annual Total Returns Periods Ended October 31, 2000 One Three Five Year Years Years - ---------------------------------------------------------------------------- STOCKS S&P 500 Index (Large-caps) 6.1% 17.6% 21.7% Russell 2000 Index (Small-caps) 17.4 5.9 12.4 Wilshire 5000 Index (Entire market) 8.1 16.0 20.1 MSCI EAFE Index (International) -2.7 9.7 8.9 - ---------------------------------------------------------------------------- BONDS Lehman Aggregate Bond Index (Entire market) 7.3% 5.7% 6.3% Lehman 10 Year Municipal Bond Index 8.2 5.0 5.7 Salomon Smith Barney 3-Month U.S. Treasury Bill Index 5.7 5.2 5.2 ============================================================================ CPI Consumer Price Index 3.4% 2.5% 2.5% - ---------------------------------------------------------------------------- 1 economic data: Production rose rapidly, unemployment fell below 4% of the workforce, long-term interest rates declined, and inflation was well-behaved, save for a rise in energy prices. But as the period progressed, the effects of higher short-term interest rates--engineered by the Federal Reserve Board to slow the economy and forestall inflation--began to show. Data suggested that the economy's expansion was decelerating to a moderate pace. And, despite solid increases in corporate earnings, doubts grew that companies could sustain the growth pace amid a slowing economy. Investors seemed to grow wary of the lofty prices of many tech stocks in relation to their earnings and other fundamentals. Value stocks--those issues characterized by relatively low prices in relation to earnings, book value, and dividends-- generally benefited from the market's increased emphasis on current earnings. The result was a significant split between first- and second-half results for growth and value stocks, as the table above shows. TOTAL RETURNS OCT. 31, 1999, TO APR. 30, 2000 TO FISCAL APR. 30, 2000 OCT. 31, 2000 2000 - -------------------------------------------------------------------------- Russell 1000 Growth Index 18.7% -7.9% 9.3% Russell 1000 Value Index -1.0 6.6 5.5 - -------------------------------------------------------------------------- For the full 12 months, the overall market, as measured by the Wilshire 5000 Index, returned 8.1%--a decent result but one below the double-digit gains investors have seen in recent years. For a change, small- and mid- capitalization stocks outpaced their large-cap counterparts: The small-cap Russell 2000 Index returned 17.4% for the 12 months, 11.3 percentage points ahead of the return of the large-cap S&P 500 Index, which accounts for roughly three-fourths of the market value of U.S. stocks. The year saw huge variations in returns of various industry groups. Higher oil and natural gas prices helped the oil exploration and services companies in the "other energy" group to a 49% return, making this the top-performing sector within the S&P 500 Index. Other strong sectors included producer durables (+31%), health care (+16%), and financial services (+15%). Technology, a standout during the first half of the year, fell during the second half but still provided a 12-month return of 15%. The year's big losers were telephone companies, which weighed down the utilities group (-15%), and retailers, apparel makers, and other firms in the consumer discretionary sector (-13%). THE FIXED INCOME MARKETS Short-term interest rates rose substantially during the fiscal year, with the yield of 3-month U.S. Treasury bills rising 1.3 percentage points. The 2 increase essentially matched the 1.25-point increase in the federal funds rate, accomplished in four steps by the Federal Reserve. Yields were relatively flat, on balance, for most longer-term securities, however. A rising federal budget surplus shrank the supply of U.S. Treasury securities, and their yields declined slightly for the fiscal year: The 30-year Treasury's yield fell from 6.16% to 5.79%. Yields on 10-year Treasuries fell by about a quarter-point. In general, bonds turned in solid results during the 12 months. The Lehman Aggregate Bond Index, a proxy for taxable investment-grade bonds, returned 7.3%, outpacing the S&P 500 Index. Mortgage-backed securities and high-quality corporate bonds performed well, benefiting from investors' shift toward high-quality bonds and away from speculative issues. The prices of high-yield bonds fell by more than 10% on average, and the Lehman High Yield Index returned -1.6%. FISCAL 2000 PERFORMANCE OVERVIEW What a difference a year makes. In fiscal 1999, the Windsor II Fund lagged its benchmarks. The fund performed poorly in an environment that punished value investing. Fiscal 2000 began in a similar fashion, but the trend reversed suddenly during the spring. Windsor II earned 25.2% in the last eight months of the period, regaining ground it lost early on and ending with a 12-month return of 7.2%. Although our return was only slightly ahead of the result of our average peer, we arrived at the same destination via very different routes. Our average peer built a big lead early in the fiscal year, but returned 11.7% in the last eight months, less than half of Windsor II's gain during the same period. - -------------------------------------------------------------------------------- Windsor II gained 25.2% in the last eight months, making up for a poor beginning to the fiscal year. - -------------------------------------------------------------------------------- Three sectors played major roles in the fund's turnaround. The fund had more than one-quarter of its assets in financial services companies. While those holdings fared poorly initially, they returned 27.8% in the fiscal second half. In the "other energy" sector--the market's best performer during fiscal 2000 due to rising oil and natural gas prices--Windsor II's stake of about 10% was more than triple the sector weighting in the Russell 1000 Value Index. In the utilities sector, our holdings of electric companies performed well even as telephone companies slumped badly. One notable shortcoming during the period was the fund's stock selections in the consumer discretionary sector, which is home to many retailing and restaurant stocks that were hurt by tough competition and concerns about a possible slowdown in consumer spending. We recognize that Windsor II Fund's strong performance over the past eight months was overdue in the eyes of our shareholders, and we thank you for your patience during the preceding months, when value stocks were decidedly out of favor and our performance was well below par. 3 We note that many individuals who gave in to the temptation to alter their investment allocations in pursuit of hot growth stocks paid a heavy price. Consider that the largest flows of cash into technology-related mutual funds and the largest outflows of cash from value funds like Windsor II occurred in February and March 2000. The timing of these flows couldn't have been worse. TOTAL ASSETS MANAGED OCTOBER 31, 2000 $ MILLION PERCENTAGE - -------------------------------------------------------------------------- Barrow, Hanley, Mewhinney & Strauss, Inc. $14,723 62% Equinox Capital Management, Inc. 3,682 15 Tukman Capital Management, Inc. 3,233 13 Vanguard Quantitative Equity Group 1,442 6 Cash Investments* 990 4 - -------------------------------------------------------------------------- Total $24,070 100% - -------------------------------------------------------------------------- *This cash is invested by The Vanguard Group in equity index futures to simulate investment in stocks; each adviser also maintains a modest cash position. That said, we don't pretend to know what the market has in store next, but we continue to believe that long-term investors are well-advised to maintain exposure to both value stocks and growth stocks. As fiscal 2000 demonstrated, market leadership can switch suddenly and decisively from growth to value and back again. As you know, the fund's assets are divided among four managers. The table at left shows the allocation among managers as of the end of the fiscal year. For further details on the fund's performance and holdings, please see the Adviser's Report on page 7. LONG-TERM PERFORMANCE OVERVIEW A single year's performance hardly provides an adequate picture of a fund's merits. We've always believed a long-term view is important. The table below shows that a hypothetical $10,000 investment a decade ago in Windsor II would have grown to $50,395, or about $1,400 more than a similar investment in the average large-cap value fund. However, during the past decade the fund lagged both the Russell 1000 Value and the Wilshire 5000 Indexes. As a total market benchmark, the Wilshire 5000 also includes growth stocks, which were the market's leaders in recent years. Of course, indexes have a big advantage over real-world funds because they are theoretical constructs that do not incur the actual operating and transaction costs that funds must bear. TOTAL RETURNS TEN YEARS ENDED OCTOBER 31, 2000 AVERAGE FINAL VALUE OF ANNUAL A $10,000 RETURN INITIAL INVESTMENT - ------------------------------------------------------------------------- Vanguard Windsor II Fund 17.6% $50,395 Average Large-Cap Value Fund 17.2 49,016 Russell 1000 Value Index 18.3 53,805 Wilshire 5000 Index 19.2 57,709 - ------------------------------------------------------------------------- Nevertheless, our fund's expense 4 ratio (average expenses as a percentage of average net assets) of 0.37% is a fraction of the average peer's 1.28%, according to data from Lipper Inc. This gap may seem inconsequential, but we assure you that over time it is extremely important, giving our advisers a head start each year in their quest to provide superior returns. Over time, costs matter, since operating expenses and transaction costs reduce the returns that a fund passes on to its shareholders. While we hope to improve our relative returns versus competitors and our index benchmark in the future, we doubt that either the fund or the market will be able to match the absolute returns seen during the past ten years. The stock market's performance during the 1990-2000 decade was one of its best ever; returns were far above the 11% to 12% annual average for stocks over the past 75 years or so. Therefore, we caution against extrapolating the remarkable returns of the past decade into your investment plans. If you make modest assumptions and the market exceeds them, you'll merely get to your objectives sooner. IN SUMMARY The financial markets during the past 12 months certainly reinforced the importance of diversification. Just as it seemed that a single hot sector of the stock market was the only place to be, technology-related stocks swooned and value stocks came to the fore. And bonds--the asset class many investors forgot in the excitement of the bull market in stocks--posted solid results. Perhaps the one safe prediction for the next 12 months is that markets will continue to be quite unpredictable. But uncertainty and volatility--risk, to use a four-letter word--are constant companions for investors. A balanced investment program--a mix of short-term investments, bonds, and both value and growth stocks--can help you manage risk. Once you've built such a program in accordance with your objectives, time horizon, financial situation, and tolerance for market fluctuations, we recommend staying the course. Sincerely, /S/ JOHN J. BRENNAN November 13, 2000 JOHN J. BRENNAN Chairman and Chief Executive Officer 5 - -------------------------------------------------------------------------------- NOTICE OF CHANGE IN OWNERSHIP FOR BARROW, HANLEY, MEWHINNEY & STRAUSS, INC. In July 2000, Old Mutual plc agreed to acquire United Asset Management Corporation (UAM), the parent company of Barrow, Hanley, Mewhinney & Strauss, Inc. (BHMS), an investment adviser for Vanguard Windsor II Fund. UAM will continue to own BHMS, and the change in the parent company's ownership is not expected to have any practical effect on the fund. There will be no change in BHMS's role as the fund's investment adviser, in the personnel who advise the fund, or in the fees charged to the fund. However, as is required by the Investment Company Act of 1940, your fund's advisory contract with BHMS automatically terminated with the change in ownership. Accordingly, on September 14, 2000, your fund's board of trustees approved a new investment advisory contract with BHMS that took effect when the ownership of BHMS's parent company officially changed in early October. All of the terms of the new contract, except for its commencement and termination dates, are the same as those in the previous contract. Your board believes that, similar to the previous contract, the new advisory contract will enable the fund to obtain services of high quality at reasonable cost and that the new contract is in the best interests of the fund and its shareholders. (In 1993, your fund received permission from the U.S. Securities and Exchange Commission and from its shareholders for the trustees to enter into a new advisory agreement without the delay and expense of a shareholder vote. This special permission was made subject to several conditions, including the requirement that shareholders be notified of changes to the fund's investment advisory agreement.) In July, Old Mutual plc announced the terms of a tender offer under which it would acquire all of UAM's outstanding shares. The directors of UAM recommended that its shareholders accept Old Mutual's offer, and UAM tendered all of its shares. The acquisition became effective on October 5, 2000. BHMS, which is registered as an investment adviser with the Securities and Exchange Commission, is located at One McKinney Plaza, 3232 McKinney Avenue, 15th Floor, Dallas, Texas 75204. UAM began providing investment advisory services in December 1980. Today the principal operating subsidiaries of UAM manage both domestic and international investment portfolios for corporate, government, and union benefit plans; mutual funds; individuals; endowments; and foundations. Together with its subsidiaries, UAM manages or advises approximately $195 billion in assets. 6 ADVISER'S Report BARROW, HANLEY, MEWHINNEY & STRAUSS, INC. VANGUARD WINDSOR II FUND had a 7.2% return for the fiscal year ended October 31, consisting of a poor -3.4% return for the first half-year and an excellent 10.9% gain for the second six months. These results were less a reflection of the manager's competence than an illustration of the madness of the moment, something whose equal we are unlikely to see again. THE INVESTMENT ENVIRONMENT The past fiscal year should be viewed as having two distinct and nearly equal parts. Investors' attention, and the market's performance, were focused on one sector--technology--to an extreme degree. A lack of tech stocks in the fund hurt our performance through February; that same near-absence of tech names dramatically helped performance thereafter. Even though shareholders were clamoring for exposure to this area, most stocks were priced too high, given our assessment of their growth potential. Rather than join the parade, we held our ground. Although prices in the sector have fallen--dramatically, in many cases--we still believe that most of the very large names are far too pricey to justify purchase. Early in the fiscal year, talk about "new economy" and "old economy" was in every newspaper and magazine article, and yet there is but one economy. The real economy focuses on profit opportunities. - -------------------------------------------------------------------------------- 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 returns. - -------------------------------------------------------------------------------- OUR SUCCESSES Our electric utility holdings have been the fund's top contributors lately, with names like Entergy, Reliant Energy, and American Electric Power providing leadership. We believe the future for these and other electric utilities can be bright despite the uncertainties of deregulation. During the second half of the fiscal year, our better-performing stocks included Washington Mutual, Allstate, and John Hancock. These stocks' returns were influenced to some degree by declining interest rates, but even more by a significant improvement in investors' assessments of their business prospects. We feel that these and other holdings are underappreciated and continue to bear promise. Other top contributors for the fiscal second half included Phillips Petroleum and Philip Morris. Significant increases in Phillips Petroleum's revenues from oil and gas pushed that stock up. Philip Morris benefited from a growing perception that tobacco litigation was not a fatal threat. 7 OUR SHORTFALLS Retailers, including Kmart and Sears, were weak, reflecting disappointing sales. It seems to us that inflation in energy prices must affect demand for consumer products. These issues are quite cheap and should rebound. Newell Rubbermaid is having problems passing along increased costs in its petroleum-based feedstocks. Service Corp. International's stock has reacted to financial fears that we regard as unfounded. The company is profitable and, although the funeral business is changing, it is a necessary industry. Once tax-loss selling comes to an end, the stock should rebound. In the oil-services sector, Halliburton has been weak due to a very slow flow of new orders in its marine construction division. This division probably will be sold, leaving the company much less subject to the oil industry's ups and downs. We are confident that 2001 will be a positive year for the entire energy industry. THE FUND'S POSITIONING Your fund is significantly overweighted, compared with any relevant market index, in two sectors: energy and electric utilities. We believe that after a long period of underinvestment on new production capacity in both areas, meaningful price increases are in store. Eventually, we'll see a dramatic change in infrastructure spending to increase supplies. Only then would we expect to see excess capacity in these industries. Windsor II continues to have very little exposure to the technology, telecommunications, and media sectors, whereas many indexes and portfolios have weightings of 10% to 30% in these industries. We see a real potential for excess capacity in these areas of the economy, as they have had large increases in investment in the past five years. If we are right, the very high relative and absolute prices of these stocks could create an opportunity for capital loss. The fund has a significant position in financial services, which is generally in line with our benchmarks. It is important to know that the fund's holdings have a weighted price/earnings ratio of 19.8, based on trailing 12-month earnings, which is only two-thirds of the P/E of the overall market, as measured by the Wilshire 5000 Index. At some point, investors will again care about dividends, and this fund has a significant yield advantage over most equity portfolios. James P. Barrow, Portfolio Manager November 10, 2000 8 PORTFOLIO CHANGES FISCAL YEAR ENDED OCTOBER 31, 2000 COMMENTS - -------------------------------------------------------------------------------- ADDITIONS Conoco Class A* Bought this domestic oil stock with cash from sales of some oil-services stocks. - -------------------------------------------------------------------------------- Emerson Electric Good company, cheap stock. - -------------------------------------------------------------------------------- Watson Pharmaceuticals* Dynamic company that had a falling stock price. - -------------------------------------------------------------------------------- Bristol-Myers Squibb Stock became cheap due to worries about expiring patents. - -------------------------------------------------------------------------------- Newell Rubbermaid Added to holdings after price fell on earnings shortfall. ================================================================================ REDUCTIONS Citigroup Stock seems ahead of itself. - -------------------------------------------------------------------------------- Ford Motor Earnings are peaking as autos are at the top of their cycle. - -------------------------------------------------------------------------------- Washington Mutual Reduced a large holding. - -------------------------------------------------------------------------------- Baker Hughes Reduced a large holding. - -------------------------------------------------------------------------------- Phillips Petroleum Reduced a large holding. - -------------------------------------------------------------------------------- SBC Communications Reduced a large holding. - -------------------------------------------------------------------------------- *New holding in portfolio. SEE PAGE 14 FOR A COMPLETE LISTING OF THE FUND'S HOLDINGS. 9 FUND PROFILE As of October 31, 2000 for Windsor II Fund This Profile provides a snapshot of the fund's characteristics, compared where appropriate to both an unmanaged index that we consider a "best fit" for the fund and a broad market index. Key terms are defined on page 11. - ------------------------------------------------------------------------- PORTFOLIO CHARACTERISTICS WILSHIRE FUND BEST FIT* 5000 - ------------------------------------------------------------------------- Number of Stocks 272 740 6,768 Median Market Cap $29.6B $41.6B $46.1B Price/Earnings Ratio 19.8x 19.8x 29.8x Price/Book Ratio 3.0x 3.3x 4.5x Yield 2.1% 1.8% 1.1% Return on Equity 19.6% 20.8% 22.8% Earnings Growth Rate 9.7% 10.9% 16.8% Foreign Holdings 4.3% 0.0% 0.0% Turnover Rate 26% -- -- Expense Ratio 0.37% -- -- Cash Investments 2.6% -- -- - ------------------------------------------------------------------------- - -------------------------------------------- TEN LARGEST HOLDINGS (% of total net assets) Allstate Corp. (insurance) 3.0% Entergy Corp. (electrical utilities) 2.6 Philip Morris Cos., Inc. (tobacco) 2.6 American Electric Power Co., Inc. (electrical utilities) 2.5 Phillips Petroleum Co. (oil) 2.4 BP Amoco PLC ADR (oil) 2.3 Washington Mutual, Inc. (savings & loan) 2.3 SBC Communications Inc. (telecommunications) 2.2 Schlumberger Ltd. (oil) 2.1 Citigroup, Inc. (financial services) 2.1 - ------------------------------------------- Top Ten 24.1% - ------------------------------------------- - ---------------------------------------------------- VOLATILITY MEASURES WILSHIRE FUND BEST FIT* FUND 5000 R-Squared 0.93 1.00 0.41 1.00 Beta 0.99 1.00 0.66 1.00 - ---------------------------------------------------- - ---------------------------------------------------------- SECTOR DIVERSIFICATION (% OF COMMON STOCKS) WILSHIRE FUND BEST FIT* 5000 Auto & Transportation 0.7% 3.1% 1.7% Consumer Discretionary 11.8 9.2 12.0 Consumer Staples 8.9 7.8 5.3 Financial Services 26.5 31.3 17.0 Health Care 5.3 8.6 12.4 Integrated Oils 9.5 7.2 3.1 Other Energy 8.9 2.5 2.6 Materials & Processing 4.0 3.8 2.5 Producer Durables 1.5 3.5 3.3 Technology 3.1 4.7 26.4 Utilities 15.4 15.7 8.7 Other 4.4 2.6 5.0 - ---------------------------------------------------------- *Russell 1000 Value Index. - ------------------------ INVESTMENT FOCUS MARKET CAP Large STYLE Value - ------------------------ [PICTURE OF COMPUTER] VISIT OUR WEBSITE WWW.VANGUARD.COM FOR REGULARLY UPDATED FUND INFORMATION 10 GLOSSARY of Investment Terms BETA. A measure of the magnitude of a fund's past share-price fluctuations in relation to the ups and downs of the fund's "best fit" index benchmark and an overall market index. Each index is assigned a beta of 1.00. Compared with a given index, a fund with a beta of 1.20 would have seen its share price rise or fall by 12% when the index rose or fell by 10%. - -------------------------------------------------------------------------------- CASH INVESTMENTS. 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. - -------------------------------------------------------------------------------- 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. - -------------------------------------------------------------------------------- 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 market in general, as measured by the fund's "best fit" index benchmark and by an overall market index. If a fund's total returns were precisely synchronized with an index's returns, its R-squared would be 1.00. If the fund's returns bore no relationship to the index'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. - -------------------------------------------------------------------------------- TURNOVER RATE. An indication of trading activity during the past year. 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. - -------------------------------------------------------------------------------- 11 PERFORMANCE SUMMARY for 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 (%) October 31, 1990-October 31, 2000 WINDSOR FUND RUSSELL 1000 VALUE INDEX 1991 36.6 32.9 1992 12.5 10.7 1993 19.5 25.2 1994 2.2 0.8 1995 23.1 24.7 1996 27.2 23.7 1997 31.3 33.2 1998 16.5 14.8 1999 4.6 16.5 2000 7.2 5.5 - -------------------------------------------------------------------------------- See Financial Highlights table on page 21 for dividend and capital gains information for the past five years. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CUMULATIVE PERFORMANCE OCTOBER 31, 1990-OCTOBER 31, 2000 WINDSOR AVERAGE RUSSELL WILSHIRE S&P 500 II FUND LARGE-CAP 1000 VALUE 5000 INDEX INDEX VALUE FUND* INDEX 199010 10000 10000 10000 10000 10000 199101 11795 11629 11459 11562 11420 199104 13062 12665 12494 12865 12562 199107 13534 13105 12933 13395 13087 199110 13661 13504 13289 13860 13350 199201 14281 14185 13685 14751 14011 199204 14803 14446 14412 14789 14325 199207 15447 14683 14949 15166 14760 199210 15369 14644 14706 15202 14679 199301 16392 15592 16002 16310 15493 199304 16795 15906 16835 16332 15648 199307 17509 16288 17749 16916 16049 199310 18367 17271 18406 17902 16872 199401 18864 17906 19064 18488 17488 199404 17890 16969 18067 17432 16480 199407 18298 17212 18394 17646 16877 199410 18774 17754 18549 18356 17524 199501 18657 17655 18559 18300 17581 199504 20492 19299 20339 20019 19359 199507 22060 20921 22230 22239 21283 199510 23108 21666 23128 23062 22158 199601 25941 23704 25686 25108 24378 199604 27044 24587 26421 26464 25208 199607 26563 23965 25762 25508 24810 199610 29387 26482 28617 28118 27497 199701 32534 29303 31769 31252 30800 199704 32886 29671 32382 31131 31543 199707 38722 35022 38340 37538 37745 199710 38577 34021 38113 36990 36327 199801 40618 35910 40381 39123 39089 199804 47002 40160 46041 44600 44497 199807 45830 39341 45129 43961 45024 199810 44948 38910 43764 42484 44315 199901 48251 43577 47740 49829 51788 199904 52710 46092 52528 52172 54207 199907 50678 45557 51893 52018 54120 199910 47003 45762 50997 53385 55691 200001 43548 45634 49185 56994 57146 200004 45426 47212 50491 58554 59697 200007 45718 46267 49300 57832 58978 200010 50395 49016 53805 57709 59083 - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS PERIODS ENDED OCTOBER 31, 2000 FINAL VALUE ------------------------------- OF A $10,000 1 YEAR 5 YEARS 10 YEARS INVESTMENT - -------------------------------------------------------------------------------- Windsor II Fund 7.22% 16.88% 17.55% $50,395 Average Large-Cap Value Fund* 7.11 17.74 17.23 49,016 Russell 1000 Value Index 5.52 18.40 18.33 53,805 Wilshire 5000 Index 8.10 20.14 19.16 57,709 S&P 500 Index 6.09 21.67 19.44 59,083 - -------------------------------------------------------------------------------- *Derived from data provided by Lipper Inc. - -------------------------------------------------------------------------------- 12 A REPORT on Your Fund's After-Tax Returns This table presents pre-tax and after-tax returns for your fund and an appropriate peer group of mutual funds. The after-tax returns represent the fund's past results only and should not be used to predict future tax efficiency. If you own the fund in a tax-deferred account such as an individual retirement account or a 401(k), this information does not apply to you. Such accounts are not subject to current taxes. Income taxes can have a considerable impact on a fund's return--an important consideration for investors who own mutual funds in taxable accounts. While the pre-tax return is most often used to tally a fund's performance, the fund's after-tax return, which accounts for taxes on distributions of capital gains and income dividends, is an important measure of the return that many investors actually received. PRE-TAX AND AFTER-TAX PERIODS ENDED OCTOBER 31, 2000 AVERAGE ANNUAL TOTAL RETURNS ONE YEAR FIVE YEARS TEN YEARS ----------------------------------------------------- PRE-TAX AFTER-TAX PRE-TAX AFTER-TAX PRE-TAX AFTER-TAX - -------------------------------------------------------------------------------- Vanguard Windsor II Fund 7.2% 3.9% 16.9% 13.8% 17.6% 14.9% Average Large Value Fund* 7.6 5.5 15.4 12.6 16.0 13.3 - -------------------------------------------------------------------------------- *Based on data from Morningstar, Inc. Elsewhere in this report, returns for comparable funds are derived from data provided by Lipper Inc., which may differ somewhat. The after-tax return calculations use the top federal income tax rates in effect at the time of each distribution. The tax burden would be less, and the after-tax return higher, for those in lower tax brackets. We must stress that because many interrelated factors affect how tax-friendly a fund may be, it is very difficult to predict tax efficiency. A fund's tax efficiency can be influenced by its turnover rate, the types of securities it holds, the accounting practices it uses, and the net cash flow it receives. Finally, it's important to understand that our calculation does not reflect the tax effect of your own investment activities. Specifically, you may incur additional capital gains taxes--thereby lowering your after-tax return--if you decide to sell all or some of your shares. - -------------------------------------------------------------------------------- A NOTE ABOUT OUR CALCULATIONS: Pre-tax total returns assume that all distributions received (income dividends, short-term capital gains, and long-term capital gains) are reinvested in new shares, while our after-tax returns assume that distributions are reduced by any taxes owed on them before reinvestment. When calculating the taxes due, we used the highest individual federal income tax rates at the time of the distributions. Those rates are currently 39.6% for dividends and short-term capital gains and 20% for long-term capital gains. State and local income taxes were not considered. The competitive group returns provided by Morningstar are calculated in a manner consistent with that used for Vanguard funds. [PICTURE OF COMPUTER] You can use Vanguard's online after-tax return calculator at www.vanguard.com/?aftertax to customize the calculation of your after-tax return. 13 FINANCIAL STATEMENTS October 31, 2000 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 (93.1%)(1) - -------------------------------------------------------------------- AUTO & TRANSPORTATION (0.7%) General Motors Corp. 1,963,068 $ 121,956 Ford Motor Co. 451,453 11,794 Delta Air Lines, Inc. 123,800 5,850 Burlington Northern Santa Fe Corp. 200,800 5,334 PACCAR, Inc. 105,500 4,438 TRW, Inc. 96,700 4,061 * Navistar International Corp. 121,600 4,020 Union Pacific Corp. 71,000 3,328 * Continental Airlines, Inc. Class B 19,800 1,040 Delphi Automotive Systems Corp. 50,400 791 * Northwest Airlines Corp. Class A 19,000 542 Kansas City Southern Industries, Inc. 11,500 100 ------------ $ 163,254 ------------ CONSUMER DISCRETIONARY (11.0%) Waste Management, Inc. 24,746,597 494,932 Sears, Roebuck & Co. 12,742,100 378,823 *(2)Kmart Corp. 39,811,200 236,379 Gannett Co., Inc. 3,791,100 219,884 Wal-Mart Stores, Inc. 4,314,800 195,784 * Cendant Corp. 13,650,200 163,802 Newell Rubbermaid, Inc. 8,479,200 162,695 The Walt Disney Co. 4,253,832 152,340 Target Corp. 5,090,000 140,611 Tribune Co. 3,105,500 115,098 * AT&T Corp.-Liberty Media Class A 5,250,000 94,500 Kimberly-Clark Corp. 1,295,000 85,470 J.C. Penney Co., Inc. 5,646,800 65,997 *(2)Service Corp. International 24,745,700 57,224 McDonald's Corp. 254,800 7,899 Eastman Kodak Co. 132,800 5,959 Darden Restaurants Inc. 227,300 5,114 * Toys R Us, Inc. 274,500 4,718 * Convergys Corp. 105,000 4,574 R.R. Donnelley & Sons Co. 187,300 4,027 Reader's Digest Assn., Inc. Class A 103,900 3,812 Hasbro, Inc. 349,700 3,759 * Viacom Inc. Class B 65,991 3,753 * Outback Steakhouse 128,300 3,657 Galileo International, Inc. 175,800 3,472 Wendy's International, Inc. 151,200 3,289 Whirlpool Corp. 74,000 3,219 * Mandalay Resort Group 146,300 3,045 * AutoNation, Inc. 447,100 3,018 * Clear Channel Communications, Inc. 38,100 2,288 14 - ---------------------------------------------------------------------- MARKET VALUE* SHARES (000) - ---------------------------------------------------------------------- * AutoZone Inc. 81,400 $ 2,183 Time Warner, Inc. 28,500 2,163 May Department Stores Co. 74,037 1,943 * Jones Apparel Group, Inc. 62,300 1,733 Circuit City Stores, Inc. 121,900 1,615 * International Game Technology 31,000 1,135 Gillette Co. 19,400 677 * Tricon Global Restaurants, Inc. 21,300 639 Hertz Corp. Class A 16,400 539 Harcourt General, Inc. 7,700 432 VF Corp. 14,300 391 ------------ $2,642,592 ------------ CONSUMER STAPLES (8.3%) Philip Morris Cos., Inc. 16,906,400 619,197 Anheuser-Busch Cos., Inc. 8,416,800 385,069 Procter & Gamble Co. 4,498,800 321,383 Imperial Tobacco Group ADR 14,840,000 289,380 PepsiCo, Inc. 3,643,300 176,472 H.J. Heinz Co. 2,536,900 106,391 Sara Lee Corp. 2,380,900 51,338 The Coca-Cola Co. 104,600 6,315 Ralston Purina Group 213,400 5,175 IBP, Inc. 249,700 5,134 R.J. Reynolds Tobacco Holdings, Inc. 140,200 5,012 Brown-Forman Corp. Class B 80,700 4,913 Nabisco Holdings Corp. Class A 74,400 4,022 Nabisco Group Holdings Corp. 105,000 3,032 SuperValu Inc. 157,000 2,414 McCormick & Co., Inc. 71,200 2,256 Tyson Foods, Inc. 195,500 2,187 * Safeway, Inc. 30,800 1,684 ------------ $1,991,374 ------------ FINANCIAL SERVICES (24.7%) Allstate Corp. 18,172,344 731,437 Washington Mutual, Inc. 12,397,230 545,478 Citigroup, Inc. 9,691,239 510,001 Bank of America Corp. 9,828,612 472,388 American International Group, Inc. 4,676,241 458,272 Bank One Corp. 11,435,605 417,400 The Chase Manhattan Corp. 7,988,084 363,458 First Union Corp. 11,213,402 339,906 Wells Fargo & Co. 7,061,300 327,026 Fannie Mae 4,215,700 324,609 Aon Corp. 6,736,062 279,126 * John Hancock Financial Services, Inc. 7,512,300 237,576 American General Corp. 2,128,600 171,352 PNC Financial Services Group 2,381,022 159,231 Morgan Stanley Dean Witter & Co. 1,614,300 129,648 U.S. Bancorp 4,324,900 104,609 J.P. Morgan & Co., Inc. 614,100 101,634 National City Corp. 961,500 20,552 American Express Co. 236,700 14,202 Conseco Inc. 2,024,000 14,042 Merrill Lynch & Co., Inc. 189,800 13,286 The Bank of New York Co., Inc. 181,600 10,453 Mellon Financial Corp. 197,900 9,549 CIGNA Corp. 77,600 9,463 FleetBoston Financial Corp. 230,584 8,762 Freddie Mac 126,300 7,578 Marsh & McLennan Cos., Inc. 49,300 6,446 St. Paul Cos., Inc. 122,200 6,263 MGIC Investment Corp. 91,700 6,247 Golden West Financial Corp. 109,800 6,156 Nationwide Financial Services, Inc. 118,600 5,767 Loews Corp. 63,000 5,729 Bear Stearns Co., Inc. 94,100 5,705 SouthTrust Corp. 173,300 5,611 Dime Bancorp, Inc. 218,400 5,337 First Data Corp. 104,200 5,223 The Hartford Financial Services Group Inc. 69,400 5,166 Golden State Bancorp Inc. 196,700 5,139 Countrywide Credit Industries, Inc. 135,555 5,075 A.G. Edwards & Sons, Inc. 97,950 4,971 The PMI Group Inc. 66,350 4,902 Hibernia Corp. Class A 365,800 4,367 Compass Bancshares Inc. 223,400 4,063 Heller Financial, Inc. 138,800 4,060 Deluxe Corp. 174,500 3,937 State Street Corp. 31,400 3,917 UnionBanCal Corp. 185,790 3,902 Dow Jones & Co., Inc. 66,000 3,886 Northern Trust Corp. 45,000 3,842 Huntington Bancshares Inc. 211,860 3,045 First Virginia Banks, Inc. 70,500 2,917 Equity Residential Properties Trust REIT 59,000 2,777 The Goldman Sachs Group, Inc. 24,900 2,485 Associates First Capital Corp. 66,500 2,469 GATX Corp. 58,400 2,456 Stilwell Financial, Inc. 46,000 2,061 * CNA Financial Corp. 54,700 1,997 Associated Banc-Corp. 82,940 1,996 Duke Realty Investments, Inc. REIT 80,100 1,897 Lehman Brothers Holdings, Inc. 29,400 1,896 Equity Office Properties Trust REIT 61,900 1,865 Archstone Communities Trust REIT 66,400 1,565 ProLogis Trust REIT 70,900 1,489 Mercantile Bankshares Corp. 37,300 1,403 15 - ---------------------------------------------------------------------- MARKET VALUE* WINDSOR II FUND SHARES (000) - ---------------------------------------------------------------------- Public Storage, Inc. REIT 61,800 $ 1,391 Commerce Bancshares, Inc. 36,603 1,315 Household International, Inc. 26,000 1,308 Automatic Data Processing, Inc. 17,800 1,163 * DST Systems, Inc. 15,400 949 Simon Property Group, Inc. REIT 40,800 910 SunTrust Banks, Inc. 16,700 815 Comdisco, Inc. 64,600 795 Spieker Properties, Inc. REIT 12,800 709 M & T Bank Corp. 14,000 703 MBNA Corp. 17,100 642 Firstar Corp. 23,600 465 Erie Indemnity Co. Class A 5,700 159 Charter One Financial 2,415 55 ------------ $5,940,446 ------------ HEALTH CARE (4.9%) Bristol-Myers Squibb Co. 6,402,300 390,140 American Home Products Corp. 4,129,500 262,223 * Watson Pharmaceuticals, Inc. 2,987,000 186,874 HCA-The Healthcare Co. 3,563,500 142,317 Johnson & Johnson 1,527,500 140,721 Merck & Co., Inc. 269,400 24,229 Abbott Laboratories 282,300 14,909 UnitedHealth Group Inc. 74,300 8,127 Tenet Healthcare Corp. 165,000 6,487 Baxter International, Inc. 45,000 3,698 * Chiron Corp. 69,100 2,993 C.R. Bard, Inc. 48,500 2,031 Pharmacia Corp. 35,272 1,940 DENTSPLY International Inc. 52,400 1,818 ------------ $1,188,507 ------------ INTEGRATED OILS (8.8%) Phillips Petroleum Co. 9,484,400 585,662 BP Amoco PLC ADR 11,098,572 565,334 Occidental Petroleum Corp. 18,342,300 364,553 (2)Conoco Inc. Class A 9,900,000 255,544 Exxon Mobil Corp. 1,955,928 174,444 Unocal Corp. 4,222,600 144,096 Chevron Corp. 157,300 12,918 Texaco Inc. 145,200 8,576 Kerr-McGee Corp. 77,600 5,068 (2)Conoco Inc. Class B 135,900 3,695 Amerada Hess Corp. 53,700 3,329 ------------ $2,123,219 ------------ OTHER ENERGY (8.2%) Schlumberger Ltd. 6,775,600 515,793 Baker Hughes, Inc. 14,796,000 508,612 Halliburton Co. 11,555,700 428,283 Williams Cos., Inc. 6,191,546 258,884 Enron Corp. 1,723,100 141,402 Transocean Sedco Forex Inc. 2,232,631 118,329 Apache Corp. 81,200 4,491 Ultramar Diamond Shamrock Corp. 145,700 3,825 EOG Resources, Inc. 81,700 3,217 Anadarko Petroleum Corp. 15,424 988 ------------ $1,983,824 ------------ MATERIALS & PROCESSING (3.7%) (2)Fort James Corp. 13,072,100 430,562 Dow Chemical Co. 4,372,400 133,905 (2)Millennium Chemicals, Inc. 7,368,142 118,811 Hanson PLC ADR 3,995,350 104,878 (2)Crompton Corp. 6,238,569 49,909 E.I. du Pont de Nemours & Co. 172,387 7,822 Archer-Daniels-Midland Co. 605,850 6,664 Praxair, Inc. 129,000 4,805 * American Standard Cos., Inc. 103,900 4,766 Boise Cascade Corp. 148,600 4,263 The Timber Co. 143,900 4,074 Engelhard Corp. 190,100 3,968 Lafarge Corp. 171,800 3,243 Eastman Chemical Co. 74,500 3,194 Fluor Corp. 77,200 2,702 Johns Manville Corp. 220,000 2,021 Alcoa Inc. 70,400 2,020 Temple-Inland Inc. 32,000 1,432 Westvaco Corp. 18,500 527 International Paper Co. 9,600 352 ------------ $ 889,918 ------------ PRODUCER DURABLES (1.4%) Emerson Electric Co. 4,091,000 300,433 The Boeing Co. 205,500 13,935 Northrop Grumman Corp. 61,700 5,183 Cooper Industries, Inc. 134,400 5,141 United Technologies Corp. 72,396 5,054 Pitney Bowes, Inc. 121,300 3,601 Caterpillar, Inc. 49,200 1,725 ------------ $ 335,072 ------------ TECHNOLOGY (2.9%) International Business Machines Corp. 2,275,000 224,088 Electronic Data Systems Corp. 3,619,300 169,881 Intel Corp. 2,573,000 115,785 Compaq Computer Corp. 3,261,500 99,182 * Microsoft Corp. 527,000 36,297 Hewlett-Packard Co. 246,200 11,433 * Seagate Technology Inc. 92,700 6,477 Motorola, Inc. 227,000 5,661 * Intuit, Inc. 81,000 4,976 * KEMET Corp. 142,500 3,972 Rockwell International Corp. 84,700 3,330 AVX Corp. 102,200 2,925 * Advanced Micro Devices, Inc. 127,000 2,873 * Computer Sciences Corp. 41,100 2,589 * Apple Computer, Inc. 104,600 2,046 16 - ---------------------------------------------------------------------- MARKET VALUE* SHARES (000) - ---------------------------------------------------------------------- * American Management Systems, Inc. 23,400 $ 506 * 3Com Corp. 13,900 247 ------------ $ 692,268 ------------ UTILITIES (14.3%) (2)Entergy Corp. 16,284,200 623,888 American Electric Power Co., Inc. 14,726,060 611,131 SBC Communications Inc. 9,130,047 526,690 Verizon Communications 7,702,654 445,310 Reliant Energy, Inc. 10,594,900 437,702 (2)FirstEnergy Corp. 12,083,777 312,668 Xcel Energy, Inc. 4,214,500 107,733 Public Service Enterprise Group, Inc. 2,445,400 101,484 * WorldCom, Inc. 4,041,172 95,978 AT&T Corp. 4,010,745 92,999 BellSouth Corp. 439,800 21,248 * Comcast Corp. Special Class A 157,000 6,398 TXU Corp. 167,200 6,197 Exelon Corp. 100,450 6,040 PPL Corp. 132,688 5,465 GPU, Inc. 155,200 5,131 DTE Energy Co. 142,000 5,130 Telephone & Data Systems, Inc. 46,100 4,864 Sprint Corp. 177,180 4,518 * Qwest Communications International Inc. 92,511 4,498 * XO Communications Inc. 119,500 4,031 Duke Energy Corp. 46,300 4,002 Cinergy Corp. 121,000 3,706 Pinnacle West Capital Corp. 76,700 3,332 * U.S. Cellular Corp. 50,500 3,232 Sempra Energy 154,900 3,204 Ameren Corp. 79,700 3,168 Edison International 102,100 2,438 CP&L, Inc. 50,600 2,040 PG&E Corp. 72,600 1,956 ALLTEL Corp. 30,200 1,946 Kinder Morgan, Inc. 30,000 1,157 Southern Co. 12,400 364 * Level 3 Communications, Inc. 3,300 157 ------------ $3,459,805 ------------ OTHER (4.2%) General Electric Co. 6,569,200 360,074 Honeywell International Inc. 6,025,362 324,240 (2)ITT Industries, Inc. 8,916,800 290,353 Minnesota Mining & Manufacturing Co. 101,600 9,817 Fortune Brands, Inc. 201,300 5,926 Johnson Controls, Inc. 89,800 5,354 * Thermo Electron Corp. 154,700 4,486 * FMC Corp. 38,800 2,949 Crane Co. 34,200 896 ------------ $1,004,095 ------------ - ---------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $17,799,055) $22,414,374 - ---------------------------------------------------------------------- Face Amount (000) - ---------------------------------------------------------------------- TEMPORARY CASH INVESTMENTS (7.3%)(1) - ---------------------------------------------------------------------- FEDERAL HOME LOAN MORTGAGE CORP. (3)6.54%, 1/25/2001 $ 25,000 $ 24,615 FEDERAL NATIONAL MORTGAGE ASSN. (3)6.54%, 1/24/2001 35,000 $ 34,474 REPURCHASE AGREEMENTS Collateralized by U.S. Government Obligations in a Pooled Cash Account 6.56%, 11/1/2000 1,698,345 $1,698,345 6.58%, 11/1/2000--Note G 4,120 4,120 - ---------------------------------------------------------------------- TOTAL TEMPORARY CASH INVESTMENTS (Cost $1,761,564) $1,761,554 - ---------------------------------------------------------------------- TOTAL INVESTMENTS (100.4%) (Cost $19,560,619) $24,175,928 - ---------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-0.4%) - ---------------------------------------------------------------------- Other Assets--Note C 216,763 Liabilities--Note G (322,786) ------------ (106,023) ` ------------ - ---------------------------------------------------------------------- NET ASSETS (100%) - ---------------------------------------------------------------------- Applicable to 872,618,430 outstanding $.001 par value shares of beneficial interest (unlimited authorization) $24,069,905 ====================================================================== NET ASSET VALUE PER SHARE $27.58 ====================================================================== *See Note A in Notes to Financial Statements. *Non-income-producing security. (1)The fund invests a portion of its cash 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 97.4% and 3.0%, respectively, of net assets. See Note F in Notes to Financial Statements. (2)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 $2,379,033,000. (3)Securities with an aggregate value of $59,089,000 have been segregated as initial margin for open futures contracts. ADR--American Depositary Receipt. REIT--Real Estate Investment Trust. 17 - ----------------------------------------------------------------------- AMOUNT PER WINDSOR II FUND (000) SHARE - ----------------------------------------------------------------------- AT OCTOBER 31, 2000, NET ASSETS CONSISTED OF: - ----------------------------------------------------------------------- Paid in Capital--Note E $18,212,531 $20.87 Undistributed Net Investment Income 158,735 .18 Accumulated Net Realized Gains--Note E 1,135,931 1.30 Unrealized Appreciation (Depreciation)--Note F Investment Securities 4,615,309 5.29 Futures Contracts (52,601) (.06) - ----------------------------------------------------------------------- NET ASSETS $24,069,905 $27.58 ======================================================================= 18 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 YEAR ENDED OCTOBER 31, 2000 (000) - ------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends* $ 563,303 Interest 99,399 Security Lending 1,786 - ------------------------------------------------------------------------------- Total Income 664,488 - ------------------------------------------------------------------------------- EXPENSES Investment Advisory Fees--Note B Basic Fee 30,354 Performance Adjustment (6,281) The Vanguard Group--Note C Management and Administrative 62,100 Marketing and Distribution 3,412 Custodian Fees 85 Auditing Fees 28 Shareholders' Reports 760 Trustees' Fees and Expenses 34 - ------------------------------------------------------------------------------- Total Expenses 90,492 Expenses Paid Indirectly--Note D (3,825) - ------------------------------------------------------------------------------- Net Expenses 86,667 - ------------------------------------------------------------------------------- NET INVESTMENT INCOME 577,821 - ------------------------------------------------------------------------------- REALIZED NET GAIN Investment Securities Sold* 1,389,813 Futures Contracts 84,282 - ------------------------------------------------------------------------------- REALIZED NET GAIN 1,474,095 - ------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) Investment Securities (793,181) Futures Contracts (71,695) - ------------------------------------------------------------------------------- CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (864,876) - ------------------------------------------------------------------------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $1,187,040 =============================================================================== *Dividend income and realized net loss from affiliated companies were $137,047,000 and $(802,507,000), respectively. 19 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 YEAR ENDED OCTOBER 31, ------------------------- 2000 1999 (000) (000) - ----------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS OPERATIONS Net Investment Income $ 577,821 $ 670,002 Realized Net Gain 1,474,095 2,600,015 Change in Unrealized Appreciation (Depreciation) (864,876) (1,931,112) - ----------------------------------------------------------------------------- Net Increase in Net Assets Resulting from Operations 1,187,040 1,338,905 - ----------------------------------------------------------------------------- DISTRIBUTIONS Net Investment Income (642,217) (741,695) Realized Capital Gain (2,514,938) (2,559,664) - ----------------------------------------------------------------------------- Total Distributions (3,157,155) (3,301,359) - ----------------------------------------------------------------------------- CAPITAL SHARE TRANSACTIONS1 Issued 2,976,235 6,123,676 Issued in Lieu of Cash Distributions 3,004,773 3,148,067 Redeemed (10,481,817) (6,407,121) - ----------------------------------------------------------------------------- Net Increase (Decrease) from Capital Share Transactions (4,500,809) 2,864,622 - ----------------------------------------------------------------------------- Total Increase (Decrease) (6,470,924) 902,168 - ----------------------------------------------------------------------------- NET ASSETS Beginning of Year 30,540,829 29,638,661 - ----------------------------------------------------------------------------- End of Year $24,069,905 $30,540,829 ============================================================================= 1Shares Issued (Redeemed) Issued 118,060 198,010 Issued in Lieu of Cash Distributions 120,577 109,009 Redeemed (417,883) (209,049) - ----------------------------------------------------------------------------- Net Increase (Decrease) in Shares Outstanding (179,246) 97,970 ============================================================================= 20 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 THROUGHOUT EACH YEAR 2000 1999 1998 1997 1996 - --------------------------------------------------------------------------------------------------------- NET ASSET VALUE, BEGINNING OF YEAR $29.03 $31.07 $29.36 $24.04 $20.06 - --------------------------------------------------------------------------------------------------------- INVESTMENT OPERATIONS Net Investment Income .64 .64 .65 .64 .62 Net Realized and Unrealized Gain (Loss) on Investments 1.08 .73 3.91 6.47 4.63 - --------------------------------------------------------------------------------------------------------- Total from Investment Operations 1.72 1.37 4.56 7.11 5.25 - --------------------------------------------------------------------------------------------------------- DISTRIBUTIONS Dividends from Net Investment Income (.67) (.74) (.66) (.63) (.58) Distributions from Realized Capital Gains (2.50) (2.67) (2.19) (1.16) (.69) - --------------------------------------------------------------------------------------------------------- Total Distributions (3.17) (3.41) (2.85) (1.79) (1.27) - --------------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF YEAR $27.58 $29.03 $31.07 $29.36 $24.04 ========================================================================================================= TOTAL RETURN 7.22% 4.57% 16.51% 31.27% 27.17% ========================================================================================================= RATIOS/SUPPLEMENTAL DATA Net Assets, End of Year (Millions) $24,070 $30,541 $29,639 $22,568 $14,758 Ratio of Total Expenses to Average Net Assets 0.37% 0.37% 0.41% 0.37% 0.39% Ratio of Net Investment Income to Average Net Assets 2.36% 2.08% 2.16% 2.49% 2.92% Portfolio Turnover Rate 26% 26% 31% 30% 32% =========================================================================================================
21 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 U.S. 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 22 for Tukman Capital Management, Inc., are subject to quarterly adjustments based on performance relative to the S&P 500 Index. 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 $414,000 for the year ended October 31, 2000. For the year ended October 31, 2000, the aggregate investment advisory fee represented an effective annual basic rate of 0.12% of average net assets before a decrease of $6,281,000 (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 October 31, 2000, the fund had contributed capital of $4,415,000 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 year ended October 31, 2000, these arrangements reduced the fund's expenses by $3,825,000 (an annual rate of 0.02% of average net assets). E. During the year ended October 31, 2000, the fund purchased $5,822,673,000 of investment securities and sold $12,599,936,000 of investment securities, other than temporary cash investments. The fund used a tax accounting practice to treat a portion of the price of capital shares redeemed during the year as distributions from realized capital gains. Accordingly, the fund has reclassified $321,828,000 from accumulated net realized gains to paid in capital. F. At October 31, 2000, net unrealized appreciation of investment securities for financial reporting and federal income tax purposes was $4,615,309,000, consisting of unrealized gains of $6,923,211,000 on securities that had risen in value since their purchase and $2,307,902,000 in unrealized losses on securities that had fallen in value since their purchase. At October 31, 2000, the aggregate settlement value of open futures contracts expiring in December 2000 and the related unrealized depreciation were: - -------------------------------------------------------------------------------- (000) ----------------------- AGGREGATE NUMBER OF SETTLEMENT UNREALIZED FUTURES CONTRACTS LONG CONTRACTS VALUE DEPRECIATION - -------------------------------------------------------------------------------- S&P 500 Index 2,686 $967,094 $(48,977) S&P MidCap 400 Index 275 71,672 (3,624) - -------------------------------------------------------------------------------- Unrealized depreciation on open futures contracts is required to be treated as realized loss for tax purposes. G. The market value of securities on loan to broker/dealers at October 31, 2000, was $3,999,000 for which the fund held cash collateral of $4,120,000. The fund invests cash collateral received in repurchase agreements, and records a liability for the return of the collateral, during the period the securities are on loan. 23 REPORT of Independent Accountants To the Shareholders and Trustees of Vanguard Windsor II Fund In our opinion, the accompanying statement of net assets and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Vanguard Windsor II Fund (the "Fund") at October 31, 2000, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at October 31, 2000 by correspondence with the custodian and brokers, provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP Philadelphia, Pennsylvania November 29, 2000 - -------------------------------------------------------------------------------- SPECIAL 2000 TAX INFORMATION (UNAUDITED) FOR VANGUARD WINDSOR II FUND This information for the fiscal year ended October 31, 2000, is included pursuant to provisions of the Internal Revenue Code. The fund distributed $2,439,406,000 as capital gain dividends (from net long-term capital gains) to shareholders during the fiscal year, all of which is designated as a 20% rate gain distribution. For corporate shareholders, 92.8% of investment income (dividend income plus short-term gains, if any) qualifies for the dividends-received deduction. 24 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. Six of Vanguard's seven 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. The year in which the trustee joined the Vanguard board is noted in parentheses. - -------------------------------------------------------------------------------- TRUSTEES JOHN J. BRENNAN (1987) Chairman of the Board, Chief Executive Officer, and Director/Trustee of The Vanguard Group, Inc., and of 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 & Johnson*Merck 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 Argentaria, Gestion, BKF Capital, The Jeffrey Co., NeuVis, Inc., 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. JAMES O. WELCH, JR. (1971) Retired Chairman of Nabisco Brands, Inc. (Food Products); retired Vice Chairman and Director of RJR Nabisco (Food and Tobacco Products); Director of TECO Energy, Inc., and Kmart Corp. J. LAWRENCE WILSON (1985) Retired Chairman and Chief Executive Officer 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, Direct Investor Services. 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. - -------------------------------------------------------------------------------- JOHN C. BOGLE Founder; Chairman and Chief Executive, 1974-1996. [SHIP] [THE VANGUARD GROUP LOGO] Post Office Box 2600 Valley Forge, PA 19482-2600 ABOUT OUR COVER Our cover art evokes both Vanguard's rich past and the course we've set for the future--our determination to provide superior investment performance and top-notch service. The image is based on two works: a painting titled The First Journey of 'Victory,' by the English artist W.L. Wyllie (1851-1931), and a sculpture of a compass rose on Vanguard's campus near Valley Forge, Pennsylvania. 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, 500, S&P MidCap 400, and S&P SmallCap 600 are trademarks of The McGraw-Hill Companies, Inc. All other index names may contain trademarks and are the exclusive property of their respective owners. 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. (C)2000 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor. Q730 122000 -----END PRIVACY-ENHANCED MESSAGE-----