-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: keymaster@town.hall.org Originator-Key-Asymmetric: MFkwCgYEVQgBAQICAgADSwAwSAJBALeWW4xDV4i7+b6+UyPn5RtObb1cJ7VkACDq pKb9/DClgTKIm08lCfoilvi9Wl4SODbR1+1waHhiGmeZO8OdgLUCAwEAAQ== MIC-Info: RSA-MD5,RSA, PCA6OhKzD/alFIUDsxL68PlturjZOBJjR/YHWd4kAjRiKJ1t3S+l4YSjhgBed6zB 0sr3GbQeHGUQaOcvcUXfLw== 0000893220-94-000138.txt : 19940311 0000893220-94-000138.hdr.sgml : 19940311 ACCESSION NUMBER: 0000893220-94-000138 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19931230 FILED AS OF DATE: 19940310 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GEMINI II INC CENTRAL INDEX KEY: 0000759277 STANDARD INDUSTRIAL CLASSIFICATION: STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: N-30D SEC ACT: 40 SEC FILE NUMBER: 811-04168 FILM NUMBER: 94515412 BUSINESS ADDRESS: STREET 1: 1300 MORRIS DR STREET 2: P O BOX 2600 CITY: VALLEY FORGE STATE: PA ZIP: 19482 BUSINESS PHONE: 2156691000 N-30D 1 VANGUARDS ANNUAL REPORT FOR GEMINI II FUND 1 GEMINI II ANNUAL REPORT 1993 [COVER PHOTO -- SEE EDGAR APPENDIX] 2 A BRAVE NEW WORLD FOR INVESTING With the clarity of hindsight, we can now see that the past two decades composed one of the great cycles in the history of the financial markets, as reflected in the chart below. *During the 1973-1982 decade, the nominal total returns (capital change plus income) of stocks and bonds averaged only about +6% per year; cash reserves averaged more than +8% annually. However, high inflation rates, averaging 8.7% annually, devastated these nominal results. Real returns (nominal returns less the inflation rate) for each of these three major asset classes were actually negative. *During the 1983-1992 decade, quite the opposite situation prevailed. Nominal returns for stocks and bonds were close to their highest levels in history and forged well into double-digit territory. To make a good investment environment even better, inflation was tame (averaging 3.8% annually), and real returns were solidly positive. [A TALE OF TWO DECADES CHART -- SEE EDGAR APPENDIX] This sharp contrast provides us with perspective for the decade that will end in the year 2002. Some investors will fear a recurrence of the returns of the first decade, while others will hope for a recurrence of the second; most will likely anticipate something in between. Whatever the case, there are two essential elements involved in considering your investment program in the light of today's circumstances. First, the yield of each investment class at the start of a decade has had an important relationship to its future return. Yields were low when 1973 began, high when 1983 began, and are again low today. In fact, current income yields are remarkably close to the levels of 20 years ago, as shown in the following table.
Income Yields (January 1) ----------------------------------------------- 1973 1983 1994 - ---------------------------------------------------------------------------- STOCKS 2.7% 4.9% 2.7% BONDS 5.8 10.7 6.0 RESERVES 3.8 10.5 3.1 - ----------------------------------------------------------------------------
But there is a second important element to consider: inflation. It got progressively worse during most of the first decade, but got progressively better in the second
----------------------------------------------- 1973 1981 1993 - ---------------------------------------------------------------------------- INFLATION 3.4% 12.4% 2.7% - ----------------------------------------------------------------------------
Today's low yield levels suggest that more modest nominal returns are in prospect for the coming decade than in the 1980s; indeed, returns could gravitate (Please turn to inside back cover) GEMINI II SEEKS TO PROVIDE LONG-TERM CAPITAL GROWTH FOR ITS CAPITAL SHAREHOLDERS, AND CURRENT INCOME AND INCOME GROWTH FOR ITS INCOME SHAREHOLDERS. THE FUND INVESTS PRINCIPALLY IN COMMON STOCKS, SELECTED ON THE BASIS OF FUNDAMENTAL VALUE, THAT ARE EXPECTED TO CONTRIBUTE TO THE FUND'S DUAL INVESTMENT OBJECTIVES. THE FUND'S HOLDINGS ARE USUALLY CHARACTERIZED BY RELATIVELY LOW PRICE-EARNINGS RATIOS AND ABOVE-AVERAGE INCOME YIELDS. 3 CHAIRMAN'S LETTER [PHOTO OF JOHN C. BOGLE -- SEE EDGAR APPENDIX] FELLOW SHAREHOLDER: When I wrote to you one year ago, I noted, "1992 was a banner year for Gemini II. In a stock market that was up only modestly, the Fund's total return was +18.1%." Happily, I can repeat that message--indeed an even better one--this year. The return generated by Gemini II during 1993 was even larger, and totaled +21.6%. The following table compares our total return (capital change plus income) with our customary benchmark, the unmanaged Standard & Poor's 500 Composite Stock Price Index. The table reflects the results of the Fund as a whole; it is followed by a presentation of the financial results of our Capital Shares and our Income Shares.
- ------------------------------------------------------------------------------------------ Total Return -------------- Year Ended December 31, 1993 - ------------------------------------------------------------------------------------------ GEMINI II +21.6% - ------------------------------------------------------------------------------------------ STANDARD & POOR'S 500 STOCK INDEX +10.1% - ------------------------------------------------------------------------------------------
The Fund's return takes into account the increase in our net asset value, dividends from net investment income, and Federal taxes accrued on net long-term capital gains realized during the year. *THE CAPITAL SHARES Gemini II's Capital Shares provided total capital appreciation of +23.1% for 1993. The net asset value of each share rose from $18.71 on December 31, 1992, to $22.10 on December 31, 1993, with the increase adjusted to include our accrual for Federal taxes on realized capital gains. During the year, the capital appreciation (excluding dividends) in the Standard & Poor's 500 Index was +7.1%. Thus, the return on our Capital Shares was in fact more than three times the capital return of this widely recognized Index, which depicts the performance of blue-chip stocks with very large market capitalizations. You will recall that the Capital Shares provided one-half of the Fund's assets at our initial public offering on February 15, 1985. Thus, their initial "capital leverage" ratio was 2.0 times. With appreciation in the Fund's net asset value over the years, this ratio has now fallen to 1.4, meaning that the Capital Shares' volatility--in both up and down markets--has been significantly reduced. Considering the significant contribution of income return to the Fund's total return in a given year, the full impact of the capital leverage in rising markets appears muted relative to the Fund's total return. *THE INCOME SHARES Gemini II's Income Shares received dividends totaling $1.66 per share from net investment income in 1993, with four quarterly dividends paid at the rate of $.25 per share and an "extra" dividend of $.66 per share at year-end. This so-called extra dividend is simply the amount by which our net investment income for the year exceeds the total of our quarterly payments. Our total dividend was the same in 1993 as it was in 1992, and only slightly above our total for 1991. (continued) 1 4 [CUMLATIVE PERFORMANCE: 1989-1993 GRAPH -- SEE EDGAR APPENDIX] Our ability to "hold the line" on, or even increase, net income is limited by the payments that the Fund must make for taxes on realized capital gains. These payments, of course, reduce the Fund's asset base, meaning that a smaller amount of assets is available on which to earn income. Since the Fund's inception, cumulative tax payments have been substantial, totaling $3.48 per share through 1992. The $.94 per share payment for 1993 brings the total to $4.42 per share, equivalent to 22% of our initial capital in 1985. While income growth in recent years has been slow, we need make no apologies for the Fund's dividend yield. Last year, our total investment portfolio provided a yield of 5.1% after expenses, nearly double the 2.7% dividend yield on the Standard & Poor's 500 Stock Index. Based on a net asset value of $9.33 at year-end, the yield on our Income Shares, benefiting from "income leverage," was 17.8%. *THE STOCK MARKET IN 1993 On an historical basis, 1993 was a good year for stocks. Indeed, the Standard & Poor's 500 Index provided a return of +10.1%, virtually identical with its long-term (since 1926) average annual total return of +10.3%. This 68-year historical span is by far the longest of any diversified stock market index. During the year, the market's returns accumulated gradually and with relative consistency, inch-by-inch, step-by-step, month-by-month. There were neither explosive rises nor plummeting declines. It is probably fair to say that such a steady course is the exception rather than the rule in market history. It remains a virtual certainty that most years will witness the kind of spasmodic market action--and hence the higher volatility and risk--that has been typical of the stock market in the past. The precipitating factor in the market's advance almost certainly was the decline in long-term interest rates. The yield on the long- term U.S. Treasury bond, which opened the year at 7.4%, fell to 6.4% by year-end, engendering a price gain of about +14%. This sharp rate decline seemed to be driven largely by two factors: (1) a stubbornly weak economic recovery that encouraged the Federal Reserve to make ample credit available; and (2) continuing evidence that inflation remained under control. The U.S. Consumer Price Index (CPI) increased 2.7% during 1993, down from 2.9% in 1992. As a result, despite the decline in interest rates, "real" yields (nominal yields less the inflation rate) on long-term bonds remain at healthy levels. Since one factor that investors consider in setting their asset allocations is the relative yield of stocks versus bonds, falling bond yields provided impetus to stock prices. During 1993, the dividend yield on stocks (as measured by the Standard & Poor's 500 Index) declined from 2.8% to 2.7%, enough, in and of itself, to add some +5% to the price of the stocks in the Index. This upward revaluation, when added to a dividend yield that is extremely low by historical standards, accounted for the lion's share of the +10.1% total return achieved by the Standard & Poor's 500 Index. What was most interesting about 1993 was the striking bias that the market exhibited toward "value" stocks--usually defined as those with above-average dividend yields and below-average price-earnings ratios--over "growth" stocks--those 2 5 that provide lower yields but presumably richer prospects for sustainable earnings growth. (The Standard & Poor's 500 Index is divided so that one-half of its total market capitalization is included in each category.) The disparity between the two groups' returns during 1993 was little short of astonishing: value stocks provided a return of +18.6%, while growth stocks provided a return of but +1.7%. I should note that, based on the historical record, such dichotomies are unlikely to persist. Indeed, as shown in the chart on page 2, value stocks lagged during the first three years, only to lead growth stocks for the final two years. For the full five-year period, the returns of the market segments have been fairly consistent--an annual return of +15.1% for the growth segment and +13.5% for the value segment. So, while we are pleased that value stocks--the core of Gemini II's investment philosophy--were "in the spotlight" during 1993, we caution that no market trend endures forever. *GEMINI II IN 1993 Achieving a total return of more than double that of the Standard & Poor's 500 Index speaks for itself. But we thought you might be interested in the "behind the scenes" reasons for the Fund's success. Two factors predominated: (1) The financial stocks (46% of equities at year-end) selected by John B. Neff, Gemini II's outstanding portfolio manager, provided excellent returns. (2) We held a far below-average representation in consumer [GEMINI II PERFORMANCE: FEBRUARY 15, 1985 TO DECEMBER 31, 1993 CHART -- SEE EDGAR APPENDIX] 3 6 staples stocks (3% of equities at year-end versus 20% for the Index), which provided many of the year's greatest disappointments. Their problems were largely manifested in the sharp price declines of drug stocks (engendered in part by fears about the Administration's health-care proposals) and of "name brand" stocks (for which brand loyalty no longer seems to preclude vigorous price competition). Our second performance standard is, of course, the average growth and income (value) mutual fund. Here, we were almost equally as successful as we were against the Standard & Poor's 500 Index, with our average competitor providing a total return of +11.2%. Typically, these competitors maintained a smaller weighting than our Fund in the financial stocks and a larger weighting in the consumer staples stocks. The competitive group funds also maintained a lower representation in the energy group, which performed well. I should note that the construction of the Gemini II portfolio differs substantially from that of the Standard & Poor's 500 Index (100% common stocks) or the average value fund (86% common stocks). While our portfolio relies heavily on common stocks (61% of net assets), it also includes a substantial representation in other "equity equivalents" (38%), held for both yield and growth potential. This table compares our portfolio's composition at year-end 1993 and one year ago:
- ---------------------------------------------------------------------------------------- Percentage of Net Assets ------------------------ December 31, ------------------------ 1993 1992 - ----------------------------------------------------------------------------------------- EQUITY EQUIVALENTS COMMON STOCKS 61% 60% CONVERTIBLE SECURITIES 28 22 LOWER-GRADE BONDS 10 8 - ------------------------------------------------------------------------------------------ SUBTOTAL 99% 90% - ------------------------------------------------------------------------------------------ RESERVE EQUIVALENTS U.S. TREASURY NOTES 3% 12% OTHER TEMPORARY INVESTMENTS 2 1 NET CASH -4 -3 - ------------------------------------------------------------------------------------------ SUBTOTAL 1% 10% - ------------------------------------------------------------------------------------------ TOTAL PORTFOLIO 100% 100% - ------------------------------------------------------------------------------------------
I should also call your attention to the Fund's heavy weighting in a relatively small number of securities. Our ten largest holdings account for 50% of our "equity" position. For most stock funds, that percentage would be about 25%. This limited diversification relative to other funds suggests a higher risk potential for Gemini II. It also suggests a higher return potential, as was realized in 1993. Our investment adviser's review of the year, prepared as usual by Mr. Neff, appears on page 6 of this Annual Report. I urge you to read it carefully; I am confident it will make for pleasant reading. *A LONGER-TERM VIEW Gemini II began operations on February 15, 1985, and will conclude its existence as a "closed-end" investment company on January 31, 1997, now- - -unbelievably to me--a mere three years away. In other words, fully three-quarters of our corporate lifetime is now history, and it is illuminating to review our record so far. This table presents our total returns since our inception compared with the returns of the average value (or growth and income) mutual fund and the Standard & Poor's 500 Index:
- ------------------------------------------------------------------------------------------ Total Return ------------ February 15, 1985, to December 31, 1993 - ------------------------------------------------------------------------------------------ Cumulative Annual Rate - ------------------------------------------------------------------------------------------ GEMINI II +248% +15.1% - ------------------------------------------------------------------------------------------ AVERAGE VALUE FUND +192% +12.9% STANDARD & POOR'S 500 INDEX +245 +15.0 - ------------------------------------------------------------------------------------------
I should note that these returns are well above historical norms. In no way should they be considered a prediction of future results. As our veteran shareholders know, Gemini II went through quite a "rough patch" in 1989 and 1990. Through December 31, 1990, our annual rate of return (+10.5%) was well short of that of the Standard & Poor's 500 Index (+14.7%). At that time, I expressed my confidence that Mr. Neff's "experience, judgment, and mental toughness should return the Fund to solid performance 4 7 relative to competitive norms." Our return now nicely exceeds that of our competitive group, and is, once again, greater--albeit by only a hair--than the return of the Standard & Poor's 500 Index. I count that as a great recovery. *PREMIUMS AND DISCOUNTS When Gemini II "matures" on January 31, 1997, the Capital Shares and the Income Shares will be "valued" at their actual net asset values on that date. Thus, for each class of shares, I want to call attention to the difference between its current net asset value and the price at which it trades on the New York Stock Exchange. Here are the figures:
- --------------------------------------------------------------------------------- December 31, 1993 - --------------------------------------------------------------------------------- Net Asset Market Value Price Difference - --------------------------------------------------------------------------------- CAPITAL SHARES $22.10 $19.875 -10.1% INCOME SHARES 9.33 11.750 +25.9 TOTAL $31.43 $31.625 + 0.6% - ---------------------------------------------------------------------------------
I call your special attention to the remarkable narrowing of the discount on the Capital Shares. One year ago, the Capital Shares sold in the market at a price of $14.875, a discount of -20%, or double what it is today. The Income Shares then sold at $12.00, a premium of +29%, about the same as today. Combining the two classes, the aggregate market price is virtually identical to their combined net asset values. As you know, both the discount on the Capital Shares and the premium on the Income Shares should continue to narrow as the Fund approaches its "maturity" date of January 31, 1997, when, in essence, the market price of each class will converge with its then current net asset value. Shareholders should bear this principle in mind in making their own evaluation of today's "fair market value" of both classes of shares. *LOOKING AHEAD The 1993 rise in the stock market is its eleventh in the past twelve years. The equity markets have come a long way since the end of 1981. Stock yields are near all-time historical lows and interest rates are at their lowest levels in two decades. So, it would be imprudent not to offer a word of caution about the stock market, which is surely due for its share of difficult bumps along the way during the next few years. What should Gemini II investors do in this environment? Because of our capital leverage, the Capital Shares of Gemini II are apt to be more volatile than the overall stock market. Due to our income leverage, our Income Shares will continue to provide higher yields than stocks in general. Your holdings in either class (or both) should be considered in the light of the exposure of your total investment portfolio to equities, bonds, and short-term reserves. Whatever course you choose, we recommend that you focus not on annual fluctuations in absolute and relative performance, but on the long term. Timing the markets is an inevitably fallible endeavor; therefore we believe that, provided your overall account is soundly balanced, "stay the course" is virtually always the best advice. Sincerely, /s/ JOHN C. BOGLE - ----------------- John C. Bogle Chairman of the Board January 25, 1994 Note: Mutual fund data from Lipper Analytical Services, Inc. 5 8 REPORT FROM THE INVESTMENT ADVISER For the third year in a row, your Fund not only bested the unmanaged S&P 500 Index handily, but it also turned in a good absolute result as well. These three stellar years were finally enough to give us a slight margin versus the Index over the life of the Fund. Even though improved, the total experience is not up to our usual standard, meaning, of course, that we are going to have to accomplish rather smartly in the last three years of Gemini II's closed-end life. Rest assured, we will give it our all, while at the same time continuing to be conscious of risk because we recognize not only the market's aggressive valuation but also the leverage of the Capital Shares as well. Particularly contributory to our good 1993 results were excellent gains in such disparate large positions as Columbia Healthcare (nee Humana), Telefonica, Ultramar, Aetna, and Commonwealth Edison, as well as journeyman appreciation in Bankers Trust, Chase Manhattan, and Phillips Petroleum. Additionally, a number of the convertible securities chipped in with substantial gains. This is particularly significant and gratifying because it goes right to the heart of what Gemini II is all about; namely, that meaningful appreciation can be garnered on securities which have very good yields. This in the face of the school which says yield is necessarily at the expense of appreciation. We think you can snare both even in the same security. The economy sustains its moderate growth with about a 2.5% advance in constant dollar GDP. General merchandise sales continue to labor for the most part, with the consumer still wary and seemingly motivated by either price or perceived style. On the other hand, "big ticket" sales are quite encouraging. Light duty truck sales continue to grow from an already ebullient level, but now passenger car sales have lifted nicely from a depressed level as, finally, the consumer's debt reduction has stopped and is now gently expanding. Additionally, housing starts are growing again. These are not the earmarks of a consumer in the bomb shelter as some media reports would suggest, but rather one who is gradually gaining confidence. To the degree we have absorbed, if not corrected, the excesses of overzealous expansion of commercial real estate and burgeoning consumer debt, the economy seems poised for continuing moderate growth, not only in 1994, but into 1995 and perhaps 1996 as well. We still think the market is a bit "long in the tooth" at almost 17 times 1994 estimated earnings and a 2.7% yield. This is particularly pertinent in that we don't visualize a breakout in earnings in a moderate growth environment. Additionally, what market happiness we have experienced in the last couple of years has been engendered importantly by a pronounced decline in interest rates that obviously will not be repeated. If anything, in our view, interest rates have seen their lows and could well retrace a bit as private credit demand picks up and inflation increases toward 3.5%-4.0%. We believe inflation will trend upward because the past year's very sharp price increases logged in natural gas, lumber, and scrap steel are precursors of what should happen in some other basic industrial commodities. Operating rates in these industries are quite close to effective capacity and are near potential price inflection points. This is because little new capacity is being added due to currently insufficient selling prices. In addition, the poor domestic grain crops experienced in 1993 will pressure these prices upward, not to mention the potential for world crude oil prices to move up. If all of this is close to the mark, the equity marketplace will be tough. However, we think any "indigestion" would be constructive, because it would remind market participants that there is risk in owning common stocks. In our judgment, this would be healthy and help improve the quality, integrity, and longevity of the market advance. Respectfully, John B. Neff, Managing Partner Charles T. Freeman, Senior Vice President Wellington Management Company January 26, 1994 6 9 [LOGO] STATEMENT OF NET ASSETS FINANCIAL STATEMENTS DECEMBER 31, 1993
Market Value Shares (000)+ - ---------------------------------------------------------------------------------------------- COMMON STOCKS (61.1%) - ---------------------------------------------------------------------------------------------- BANKS (19.2%) BankAmerica Corp. 130,267 $ 6,041 Bankers Trust New York Corp. 238,592 18,879 The Chase Manhattan Corp. 180,361 6,110 First Union Corp. 341,800 14,099 KeyCorp. 351,900 12,448 NationsBank, Inc. 82,200 4,028 Society Corp. 148,100 4,406 ---------- GROUP TOTAL 66,011 ---------- - ---------------------------------------------------------------------------------------------- CHEMICALS (1.7%) Lyondell Petrochemical Co. 272,400 5,788 ---------- - ---------------------------------------------------------------------------------------------- ELECTRIC UTILITIES (4.0%) Commonwealth Edison Co. 483,137 13,649 ---------- - ---------------------------------------------------------------------------------------------- INSURANCE (10.7%) Aetna Life & Casualty Co. 311,060 18,780 CIGNA Corp. 287,100 18,016 ---------- GROUP TOTAL 36,796 ---------- - ---------------------------------------------------------------------------------------------- MEDICAL (2.9%) Columbia Healthcare Corp. 288,009 9,576 *Humana, Inc. 24,900 439 ---------- GROUP TOTAL 10,015 ---------- - ---------------------------------------------------------------------------------------------- NON-FERROUS METALS (2.2%) Aluminum Co. of America 109,500 7,596 ---------- - ---------------------------------------------------------------------------------------------- OIL (9.5%) Pennzoil Co. 164,600 8,765 Phillips Petroleum Co. 150,300 4,359 USX-Marathon Group 867,100 14,307 Ultramar Corp. 203,400 5,161 ---------- GROUP TOTAL 32,592 ---------- - ---------------------------------------------------------------------------------------------- SAVINGS & LOAN (8.3%) H. F. Ahmanson & Co. 703,100 13,798 Great Western Financial Corp. 738,280 14,766 ---------- GROUP TOTAL 28,564 ---------- - ---------------------------------------------------------------------------------------------- STEEL (.6%) *Weirton Steel 299,100 1,907 ---------- - ---------------------------------------------------------------------------------------------- TELEPHONE (1.8%) Telefonica de Espana ADR 157,900 6,158 ---------- - ---------------------------------------------------------------------------------------------- OTHER (.2%) 820 - ---------------------------------------------------------------------------------------------- TOTAL COMMON STOCKS (Cost $187,366) 209,896 - ---------------------------------------------------------------------------------------------- CONVERTIBLE PREFERRED STOCKS (21.9%) - ---------------------------------------------------------------------------------------------- Advanced Micro Devices, Inc. $3.00 250,000 $11,813 Alumax, Inc. $4.00 10,000 985 Bethlehem Steel Corp. $2.50 86,400 2,354 $3.50 125,000 7,375 $5.00 93,600 4,961 Citicorp 10.75% 78,000 8,541 Cyprus Amax Mines $4.00 60,000 3,915 Kmart Corp. PERCS $3.41 330,000 14,561 (1)Kaiser Aluminum $.65 1,300,000 10,238 Sea Containers, Ltd. $4.00 109,900 5,550 UAL Corp. 6.25% 45,000 4,950 - ---------------------------------------------------------------------------------------------- TOTAL CONVERTIBLE PREFERRED STOCKS (Cost $66,722) 75,243 - ---------------------------------------------------------------------------------------------- BONDS (15.8%) - ---------------------------------------------------------------------------------------------- Face Amount CONVERTIBLE(6.0%) (000) ----------- Conner Peripherals 6.75%, 3/1/01 $ 3,750 3,263 6.5%, 3/1/02 2,000 1,800 Data General Corp. 7.75%, 6/1/01 5,750 5,549 Seagate Technology 6.75%, 5/1/12 11,000 9,955 ---------- GROUP TOTAL 20,567 ---------- - ---------------------------------------------------------------------------------------------- NON-CONVERTIBLE (9.8%) Chrysler Corp. 10.4%, 8/1/99 12,000 13,740 Geneva Steel 11.125%, 3/15/01 7,000 7,507 Quantum Chemical Corp. 12.5%, 3/15/99 8,000 8,493 13.0%, 3/15/04 3,500 3,778 ---------- GROUP TOTAL 33,518 ---------- - ---------------------------------------------------------------------------------------------- TOTAL BONDS (Cost $43,980) 54,085 - ---------------------------------------------------------------------------------------------- TEMPORARY INVESTMENTS (4.9%) - ---------------------------------------------------------------------------------------------- U.S. TREASURY NOTES (2.5%) 8.625%, 1/15/95 2,500 2,621 7.75%, 2/15/95 2,500 2,607 7.375%, 5/15/96 3,000 3,200 ---------- GROUP TOTAL 8,428 ---------- - ----------------------------------------------------------------------------------------------
7 10 [LOGO] STATEMENT OF NET ASSETS (continued)
Face Market Amount Value (000) (000)+ - ----------------------------------------------------------------------------------------------- COMMERCIAL PAPER (.6%) General Electric Capital Corp. 3.18%, 1/19/94 $2,000 $ 1,997 ----------- - ----------------------------------------------------------------------------------------------- REPURCHASE AGREEMENT (1.8%) Collateralized by U.S. Government Obligations in a Pooled Cash Account, 3.26%, 1/3/94 6,224 6,224 ----------- - ----------------------------------------------------------------------------------------------- TOTAL TEMPORARY INVESTMENTS (Cost $16,413) 16,649 - ----------------------------------------------------------------------------------------------- TOTAL INVESTMENTS (103.7%) (Cost $314,481) 355,873 - ----------------------------------------------------------------------------------------------- OTHER ASSETS AND LIABILITIES (-3.7%) - ----------------------------------------------------------------------------------------------- Other Assets--Notes D and F 10,940 Federal Income Tax Payable (10,265) Distribution Payable (7,208) Other Liabilities--Note F (6,055) ----------- (12,588) - ----------------------------------------------------------------------------------------------- NET ASSETS (100%) $343,285 =============================================================================================== +See Note A to Financial Statements. *Non-Income Producing Security. (1)Mandatory conversion June 30, 1996.
8 11 [LOGO] STATEMENT OF OPERATIONS
Year Ended December 31, 1993 (000) - ------------------------------------------------------------------------------------------- INVESTMENT INCOME INCOME Dividends $12,754 Interest 7,437 - ------------------------------------------------------------------------------------------- Total Income 20,191 - ------------------------------------------------------------------------------------------- EXPENSES Investment Advisory Fee--Note C Basic Fee $1,167 Performance Adjustment 255 1,422 -------- The Vanguard Group--Note D 431 Custodian's Fees 11 Taxes (other than income taxes) 27 Auditing Fees 9 Shareholders' Reports 105 Annual Meeting and Proxy Costs 21 Directors' Fees and Expenses 1 - ------------------------------------------------------------------------------------------- Total Expenses 2,027 - ------------------------------------------------------------------------------------------- Net Investment Income 18,164 =========================================================================================== REALIZED AND UNREALIZED GAIN ON INVESTMENTS Realized Net Gain on Investment Securities Sold--Note E 29,329 Change in Unrealized Appreciation (Depreciation)--Note E 17,951 - ------------------------------------------------------------------------------------------- Net Realized and Unrealized Gain on Investments $47,280 ===========================================================================================
9 12 [LOGO] STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
YEAR ENDED Year Ended DECEMBER 31, 1993 December 31, 1992 (000) (000) - ----------------------------------------------------------------------------------------------- INCOME AVAILABLE FOR DISTRIBUTION Balance, Beginning of Year $ 327 $ 472 Net Investment Income 18,164 18,092 Distributions to Income Shareholders ($1.66 and $1.67 per share, respectively) (18,128) (18,237) - ----------------------------------------------------------------------------------------------- Balance, End of Year $ 363 $ 327 - ----------------------------------------------------------------------------------------------- UNDISTRIBUTED CAPITAL GAINS Balance, Beginning of Year $79,344 $71,456 Realized Net Gain on Investment Securities Sold 29,329 12,786 Provision for Taxes on Capital Gains Retained (10,265) (4,024) Distributions to Capital Shareholders ($.08 per share) -- (874) - ----------------------------------------------------------------------------------------------- Balance, End of Year $98,408 $79,344 - ----------------------------------------------------------------------------------------------- UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES Beginning of Year $23,441 $ 4,812 End of Year 41,392 23,441 - ----------------------------------------------------------------------------------------------- Change in Unrealized Appreciation (Depreciation) $17,951 $18,629 - -----------------------------------------------------------------------------------------------
[LOGO] STATEMENT OF SHAREHOLDERS' EQUITY
December 31, 1993 (000) - ----------------------------------------------------------------------------------------------- Income Shares, $1.00 Par Value--Redeemable at $9.30 per Share on January 31, 1997: Authorized 15,000,000 Shares; Issued and Outstanding 10,920,550 Shares $ 10,920* Capital Surplus 90,641* Income Available for Distribution 363 - ----------------------------------------------------------------------------------------------- 101,924 - ----------------------------------------------------------------------------------------------- Capital Shares, $1.00 Par Value; Authorized 15,000,000 Shares; Issued and Outstanding 10,920,550 Shares 10,920* Capital Surplus 90,641* Undistributed Capital Gains 98,408 Unrealized Appreciation of Investment Securities 41,392 - ---------------------------------------------------------------------------------------------- 241,361 - ---------------------------------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY $343,285 - ----------------------------------------------------------------------------------------------
*No change during year. 10 13 [LOGO] FINANCIAL HIGHLIGHTS
Year Ended December 31, --------------------------------------------- For a Share Outstanding Throughout Each Year 1993 1992 1991 1990 1989 - -------------------------------------------------------------------------------------------------- INCOME SHARES Net Asset Value, Beginning of Year $ 9.33 $ 9.34 $ 9.34 $ 9.37 $ 9.38 Net Investment Income 1.66 1.66 1.65 1.63 1.58 Distributions from Net Investment Income (1.66) (1.67) (1.65) (1.66) (1.59) - -------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF YEAR $ 9.33 $ 9.33 $ 9.34 $ 9.34 $ 9.37 ================================================================================================== CAPITAL SHARES Net Asset Value, Beginning of Year $18.71 $16.28 $11.51 $17.44 $16.56 Realized Net Gain on Investments 2.69 1.17 1.7 7.38 1.14 Distributions from Realized Capital Gains -- (.08) (.22) (.11) (.19) Provision for Taxes on Capital Gains Retained (.94) (.37) (.53) (.09) (.33) Unrealized Appreciation (Depreciation) 1.64 1.71 3.75 (6.11) .26 - -------------------------------------------------------------------------------------------------- NET ASSET VALUE, END OF YEAR $22.10 $18.71 $16.28 $11.51 $17.44 ==================================================================================================
[LOGO] SUMMARY OF QUARTERLY RESULTS OF OPERATIONS
Amounts in Thousands and Per Share (Unaudited) ----------------------------------------------------------------------- Three Months Ended - ---------------------------------------------------------------------------------------------------------- March 31, 1993 June 30, 1993 September 30, 1993 December 31, 1993 ----------------- ------------- ------------------ ----------------- Net Investment Income $ 4,332 $ .40 $4,311 $.39 $ 4,621 $ .42 $ 4,900 $ .45 Net Realized Gain (Loss) and Change in Unrealized Appreciation (Depreciation) $ 23,032 $2.11 $5,742 $.53 $21,301 $1.95 $(2,795) $ (.26) - ----------------------------------------------------------------------------------------------------------
March 31, 1992 June 30, 1992 September 30, 1992 December 31, 1992 ----------------- ------------- ------------------ ----------------- Net Investment Income $ 4,591 $ .42 $4,528 $.42 $ 4,604 $ .42 $ 4,369 $ .40 Net Realized Gain (Loss) and Change in Unrealized Appreciation (Depreciation) $ 4,883 $ .45 $9,693 $.89 $(4,452) $ (.41) $21,291 $1.95 - ----------------------------------------------------------------------------------------------------------
11 14 [LOGO] NOTES TO FINANCIAL STATEMENTS Gemini II is registered under the Investment Company Act of 1940 as a diversified closed-end investment company. Certain of the Fund's investments are in corporate debt instruments; the issuers' abilities to meet these obligations may be affected by economic developments in their respective industries. *A. The following significant accounting policies are in conformity with generally accepted accounting principles for investment companies. Such policies are consistently followed by the Fund in the preparation of financial statements. 1. SECURITY VALUATION: Securities listed on an exchange are valued at the latest quoted sales prices as of 4:00 PM on the valuation date; securities not traded are valued at the mean of the latest quoted bid and asked prices. Securities not listed are valued at the latest quoted bid prices. Temporary investments are valued at amortized cost which approximates market value, except for U.S. Treasury Notes maturing in 1995-1996 which are valued at the latest quoted bid prices. Such U.S. Treasury Notes have been classified as temporary investments as the Fund's investment adviser does not intend to hold these securities until maturity. 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. Realized net long-term gains, if any, on security transactions are retained and applicable taxes thereon are accrued at the end of the Fund's fiscal year (see Note B). 3. REPURCHASE AGREEMENTS: The Fund, along with other members of The Vanguard Group of Investment Companies, transfers uninvested cash balances into a Pooled Cash Account, the daily aggregate of which is invested in repurchase agreements secured by U.S. Government obligations. Securities pledged as collateral for repurchase agreements are held by the Fund's custodian bank until maturity of each repurchase agreement. Provisions of the agreement ensure that the market value of this collateral is sufficient in the event of default; however, in the event of default or bankruptcy by the other party to the agreement, realization and/or retention of the collateral may be subject to legal proceedings. 4. OTHER: Security transactions are accounted for on the date the securities are purchased or sold. Costs used in determining realized gains and losses on the sale of investment securities are those of specific securities sold. Dividend income and distributions to shareholders are recorded on the ex-dividend date. Discounts and premiums on debt securities purchased are amortized to interest income over the lives of the respective securities. *B. Income Shareholders are entitled to receive as distributions the higher of $.80 per share (annually) or all of the net investment income available for distribution. Income distributions to Capital Shareholders are prohibited as long as any Income Shares remain outstanding. Capital Shareholders are entitled to any net realized short-term gains on investment securities annually. *C. Under the terms of a contract expiring January 31, 1995, the Fund pays Wellington Management Company a basic investment advisory fee calculated at an annual percentage rate of average net assets of the Fund. The basic fee thus computed is subject to quarterly adjustments based on performance relative to the Standard & Poor's 500 Stock Index. For the year ended December 31, 1993, the investment advisory fee represents an effective annual base rate of .34 of 1% of average net assets before an increase of $255,000 (.08 of 1%) based on performance. 12 15 *D. The Vanguard Group, Inc. furnishes at cost corporate management and administration, transfer agency, marketing, and distribution services. The costs of such services are allocated to the Fund under methods approved by the Board of Directors. At December 31, 1993, the Fund had contributed capital of $58,000 to Vanguard (included in Other Assets), representing .3% of Vanguard's capitalization. The Fund's directors and officers are also directors and officers of Vanguard. *E. During the year ended December 31, 1993, the Fund made purchases of $131,428,000 and sales of $114,371,000 of investment securities other than U.S. Government securities and temporary cash investments. Sales of U.S. Government securities were $28,748,000. At December 31, 1993, unrealized appreciation for financial reporting and Federal income tax purposes aggregated $41,392,000 of which $54,179,000 related to appreciated securities and $12,787,000 related to depreciated securities. *F. The market value of securities on loan to broker/dealers at December 31, 1993, was $2,789,000 for which the Fund had received cash collateral of $2,824,000. 13 16 [LOGO] REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders and Board of Directors Gemini II In our opinion, the accompanying statements of net assets and shareholders' equity and the related statements of operations and of changes in shareholders' equity and the financial highlights present fairly, in all material respects, the financial position of Gemini II (the "Fund") at December 31, 1993, the results of its operations, the changes in its shareholders' equity and the financial highlights for each of the respective periods presented, in conformity with generally accepted accounting principles. 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 generally accepted auditing standards 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 by correspondence with the custodian and brokers and the application of alternative auditing procedures where confirmations from brokers were not received, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE Thirty South Seventeenth Street Philadelphia, Pennsylvania 19103 January 31, 1994 14 17 [LOGO] IMPORTANT TAX NOTES CAPITAL SHAREHOLDERS: Gemini II Capital Shares, of course, receive all capital appreciation (or depreciation) from the Fund's investments, including any net capital gains that are realized from the sale of portfolio securities. The net realized long-term capital gains are retained in the value of the Capital Shares rather than being distributed to shareholders. According to provisions of the Internal Revenue Code, the Fund pays Federal income tax on these net realized long-term capital gains at the corporate capital gains tax rate, and the amount of this tax is deducted from the net asset value of the Capital Shares at year-end. As a result of this procedure, there are three important tax steps which you, as a Capital Shareholder, should take: 1) You should report on your 1993 personal income tax return the net long-term capital gains realized by your Fund during the year. 2) You should take credit for the Federal taxes paid by the Fund on these realized gains. Since the effective personal capital gains tax rate cannot exceed 28%, no inequity is created since you receive full credit for the tax paid by the Fund. 3) You should increase the tax cost basis of your Capital Shares by the amount of the after-tax gains. This is the difference between the amount of net capital gains realized and the tax paid on these gains by the Fund (see the table to the right). Federal tax Form 2439, which you should receive by March 1, 1994, provides for your account the specific amounts of realized capital gains and corresponding taxes paid as discussed in 1) and 2) above. Enclosed with this Form are specific instructions on how to record this information for tax purposes, but please feel free to contact us if you have any questions regarding taxes and your Gemini II Capital Shares. IF YOUR SHARES ARE HELD FOR YOU IN A NOMINEE REGISTRATION AND YOU HAVE NOT AS YET RECEIVED TAX FORM 2439, YOU SHOULD CONTACT YOUR BANK OR BROKER TO OBTAIN THE FORM. A copy must be filed with your Federal income tax return. The table below shows: the amount of net realized capital gains per Capital Share; the Federal taxes paid on your behalf; the Fund's capital gains tax rate; and the amount by which your cost per share should be increased for fiscal years 1985 through 1993.
- ----------------------------------------------------------------------------------------------------- Realized Long-Term Capital Gains Per Capital Share - ----------------------------------------------------------------------------------------------------- 1985 1986 1987 1988 1989 1990 1991 1992 1993 - ----------------------------------------------------------------------------------------------------- Realized long-term capital gains $.21 $2.66 $3.14 $.86 $.97 $.27 $1.56 $1.08 $2.69 Federal capital gains taxes paid .06 .74 1.07 .29 .33 .09 .53 .37 .94 (Tax rate in effect) (28%) (28%) (34%) (34%) (34%) (34%) (34%) (34%) (35%) Net amount by which your cost should be increased .15 1.92 2.07 .57 .64 .18 1.03 .71 1.75 - -----------------------------------------------------------------------------------------------------
INCOME SHAREHOLDERS: Additional Tax Information--For possible use in the preparation of your state income tax return: 5.49% of your 1993 income was derived from direct U.S. Government obligations. Corporate shareholders should note that 67.6% of the 1993 income qualifies for the intercorporate dividends received deduction. 15 18 [LOGO] DIRECTORS AND OFFICERS JOHN C. BOGLE, Chairman and Chief Executive Officer Chairman and Director of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. JOHN J. BRENNAN, President President and Director of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. ROBERT E. CAWTHORN, Chairman and Chief Executive Officer of Rhone-Poulenc Rorer Inc.; Director of Sun Company, Inc. and Immune Response Corporation; Trustee of the Universal Health Realty Income Trust. BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea Company, Alco Standard Corp., Raytheon Company, Knight-Ridder, Inc., and Massachusetts Mutual Life Insurance Co. BRUCE K. MACLAURY, President of The Brookings Institution; Director of Dayton Hudson Corporation, American Express Bank Ltd., The St. Paul Companies, Inc., and Scott Paper Company. BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton University; Director of Prudential Insurance Co. of America, Amdahl Corporation, Baker Fentress & Co., and The Southern New England Telephone Company. ALFRED M. RANKIN, JR., President and Chief Executive Officer of NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Company, and The Standard Products Company. JOHN C. SAWHILL, President and Chief Executive Officer of The Nature Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and President of New York University; Director of Pacific Gas and Electric Company and NACCO Industries. J. LAWRENCE WILSON, Chairman and Director of Rohm & Haas Company; Director of Cummins Engine Company; Trustee of Vanderbilt University and the Culver Educational Foundation. OTHER FUND OFFICERS RICHARD F. HYLAND, Treasurer; Treasurer of The Vanguard Group, Inc., and of each of the investment companies in The Vanguard Group. RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The Vanguard Group, Inc.; Secretary of each of the investment companies in The Vanguard Group. KAREN E. WEST, CONTROLLER; Vice President of The Vanguard Group, Inc.; Controller of each of the investment companies in The Vanguard Group. OTHER VANGUARD GROUP OFFICERS JEREMY G. DUFFIELD Senior Vice President Planning & Development JAMES H. GATELY Senior Vice President Institutional IAN A. MACKINNON Senior Vice President Fixed Income Group VINCENT S. MCCORMACK Senior Vice President Operations RALPH K. PACKARD Senior Vice President Chief Financial Officer 16 19 (Continued from inside front cover) toward those of the 1970s. However, the current level of inflation suggests that future real returns may prove to be satisfactory. Looking forward, the main risks to the investor are two: (1) that yields on financial assets will rise sharply, reducing the prices of stocks and bonds alike; and (2) that inflation, presently at moderate levels, will accelerate. SOME COURSES OF ACTION What, if any, present action should be taken by investors to deal with these two major risks? Should your allocation of assets among stock funds, bond funds, and money market funds be adjusted? Here are some reasonable courses of action to consider: * For long-term investors who have built a substantial balanced portfolio of stock, bond, and money market funds, stay the course. Even if withdrawing from the stock market proves to be justified, the next decision--when to return--will one day be required. "Being right twice" is no mean challenge. * For long-term investors gradually accumulating assets for, say, retirement, stay your present course. Continue to invest regularly. By doing so, you buy more shares of a mutual fund when its price falls, and fewer shares when its price rises, virtually assuring a reasonable average cost. * For risk-averse investors who are highly confident that stock prices are "too high," make only marginal--not "all or nothing"--changes in your portfolio balance. Given the perils of predicting the future, any changes should be limited to, say, 15 percentage points. That is, if your normal portfolio allocation is 60% in stock funds, it might be reduced to 45%; if 85%, to 70%. * For investors who simply must have more income, never lose sight of the added principal risk involved in shifting from money market funds to bond funds. Long-term bond funds provide a generous and durable income stream, but their prices are highly volatile. Short-term and intermediate-term bond funds offer a "middle way" of increasing income with more modest risk to principal. * For investors who are tempted to find an "easy way" to higher returns, never forget that risk and reward go hand in hand. Precipitously replacing certificates of deposit with broad-based common stock funds verges on the irrational. Funds investing in other securities markets--emerging nations, international stocks and bonds, and small U.S. companies--carry their own special risks. Generally, limit such alternative investments to, say, 20% of your total portfolio. For all investors, be prepared for sharp interim swings in stock and bond prices. The central tenet of investing is "prices fluctuate," and sensible long-term investors simply must take such fluctuations in their stride. Successful investing is as much a function of your own discipline and equanimity as it is of the returns available in the securities markets. THREE ESSENTIAL PRINCIPLES As we confront the brave new world of investing that may well lie ahead in the coming decade--and it is important to think in decade-length terms--we would underscore three caveats: 1. Have "rational expectations" for future returns. At prices prevailing today, it seems highly unlikely that the returns enjoyed by investors in the past decade will be repeated in the coming decade. 2. Maintain a balanced portfolio consisting of stock, bond, and money market funds. Each asset class has its own risk and reward characteristics. By allocating your resources among the three asset classes according to your own requirements, you can build a portfolio providing appropriate elements of capital appreciation, capital conservation, and current income. 3. In balancing risk against reward, be sure to consider cost. Many mutual funds carry hefty sales charges or high expense ratios, or both. Other factors held equal, expenses reduce returns, dollar for dollar. Put another way, high-cost funds must select investments with higher prospective gross returns--which entail higher risks--to match the net returns earned by low-cost funds. This brief Annual Report essay can provide only an elementary look at the challenges investors face today. History can give us perspective, but it cannot give us performance. Famed British economist Lord Keynes had it right when he said, "the inevitable never happens. It is the unexpected always." 20 THE VANGUARD FAMILY OF FUNDS MONEY MARKET FUNDS Vanguard Money Market Reserves TAX-EXEMPT MONEY MARKET FUNDS Vanguard Municipal Bond Fund Money Market Portfolio Vanguard State Tax-Free Funds Money Market Portfolios (CA, NJ, OH, PA) TAX-EXEMPT INCOME FUNDS Vanguard Municipal Bond Fund Vanguard State Tax-Free Funds Insured Long-Term Portfolios (CA, FL, NJ, NY, OH, PA) FIXED INCOME FUNDS Vanguard Admiral Funds Vanguard Bond Index Fund Vanguard Fixed Income Securities Fund Vanguard Preferred Stock Fund BALANCED FUNDS Vanguard Asset Allocation Fund Vanguard Balanced Index Fund Vanguard STAR Fund Vanguard/Wellesley Income Fund Vanguard/Wellington Fund EQUITY FUNDS GROWTH AND INCOME FUNDS Vanguard Convertible Securities Fund Vanguard Equity Income Fund Vanguard Index Trust Vanguard Quantitative Portfolios Vanguard/Trustees' Equity Fund U.S. Portfolio Vanguard/Windsor Fund Vanguard/Windsor II GROWTH FUNDS Vanguard/Morgan Growth Fund Vanguard/PRIMECAP Fund Vanguard U.S. Growth Portfolio AGGRESSIVE GROWTH FUNDS Vanguard Explorer Fund Vanguard Small Capitalization Stock Fund Vanguard Specialized Portfolios INTERNATIONAL FUNDS Vanguard International Equity Index Fund Vanguard International Growth Portfolio Vanguard/Trustees' Equity Fund International Portfolio [LOGO -- SEE EDGAR APPENDIX] Vanguard Financial Center * Valley Forge, Pennsylvania 19482 New Account Information 1-(800) 662-7447 Shareholder Account Services: 1-(800) 662-2739 This Report has been prepared for shareholders and may be distributed to others only if preceded or accompanied by a current prospectus. All Funds in the Vanguard Family are offered by prospectus only. Q340-12/93 21 EDGAR Appendix This appendix describes components of the printed version of this report that do not translate into a format acceptable to the EDGAR system. The cover of the printed version of this report features the flags of The United States of America and Vanguard flying from a halyard. A bar chart called "A Tale of Two Decades" appears on the inside front cover. This chart illustrates Average Annual Total Return, in nominal and real terms, of Stocks, Bonds and Reserves (U.S. Treasury bills) for the two decades since 1973. A running head featuring the Vanguard flag logo appears at the top of pages one through 16. A photograph of John C. Bogle appears at the upper-right of page one. A line chart illustrating cumulative performance of Standard & Poor's 500 Growth Index compared to Standard & Poor's Value Index for the fiscal years 1989 through 1993 appear on page 2. A chart illustrating income shares and capital shares performance for years 1985-1993. -----END PRIVACY-ENHANCED MESSAGE-----