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[PHOTO]
VANGUARD
SELECTED VALUE
PORTFOLIO
Annual Report
October 31, 1996
THE VANGUARD GROUP: LINKING TRADITION AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our
course toward the twenty-first century. Our Report cover reflects that blending
of tradition and innovation, of past, present, and future.
The montage includes a bronze medallion with a likeness of our namesake, HMS
Vanguard (Lord Nelson's flagship at The Battle of the Nile); a clock built
circa 1816 in Scotland, featuring a portrait of Nelson (who is also shown,
accepting a surrender, in a detail from a nineteenth-century engraving); and
several views of our recently completed campus, which is steeped in nautical
imagery--from our buildings named after Nelson's warships (Victory, Majestic,
and Goliath are three shown), to our artwork and ornamental compass rose.
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[PHOTO]
VANGUARD HAS ALWAYS STRIVED TO BE THE STANDARD-BEARER for mutual fund
disclosure, going well beyond the "letter of the law" in our shareholder
communications. During the past year, we raised the standard once again by
rewriting and reformatting our Fund prospectuses. They are designed to ensure
that prospective investors fully understand, before they make an investment,
each Fund's investment strategies, risks, and costs. In that spirit, we have
redesigned our Annual Reports to shareholders, which provide a comprehensive
discussion and analysis of the year's results in the context of each Fund's
investment objectives and policies. Since Vanguard has long been recognized for
the quality and content of these Fund Reports, our overriding objective was to
maintain the character of the previous Reports, while adding information to
assist shareholders in understanding the investment characteristics of their
Fund.
THE NEW FUND REPORTS INCLUDE A MESSAGE TO SHAREHOLDERS from Chairman John C.
Bogle and President John J. Brennan. This Message continues to provide a candid
assessment of the Fund's performance relative to an appropriate unmanaged
market benchmark and a peer group of mutual funds with similar investment
policies. It also reviews the principal factors contributing to--and detracting
from--the returns earned by the Fund. To help you evaluate your Fund's
current-year performance, the Message includes a discussion of the Fund's
long-term investment results, as well as a look ahead to the prospects for the
coming year. A recap of the financial markets, which had been included as part
of the Chairman's letter, now appears in The Markets In Perspective. This
overview covers the world's financial markets, putting the results of the
Fund's strategy in a global perspective.
THE PORTFOLIO PROFILE REPRESENTS AN ADDITION TO OUR FUND REPORTS. In this day
and age, many investors use detailed statistical information to evaluate their
mutual fund holdings, and our new Portfolio Profile furnishes shareholders with
comprehensive data on key characteristics--sector diversification, volatility,
top-ten holdings, among others--that ultimately define how a Fund is likely to
perform in various market environments. For this information to be used
effectively, we include a brief description of the profiled characteristics.
The Report From The Adviser (for our traditionally managed Funds) now covers
specific topics that we have defined as being the important ones for the
adviser to address--and we do our best to ensure that this Report is written in
the same simple and candid manner that characterizes all Vanguard
communications. Finally, each Adviser's Report will include an inset reminder
of the adviser's basic investment philosophy.
WE TRUST THAT THIS REDESIGNED FUND REPORT will continue to meet your need for a
fair, candid, and clear presentation of your Fund's investment results and a
thorough portfolio review. We welcome any comments that you might have at any
time regarding these Reports.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
3
Report From
The Adviser
5
Performance
Summary
7
Portfolio
Profile
8
Financial
Statements
10
Report Of
Independent
Accountants
16
Directors And
Officers
INSIDE BACK COVER
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[PHOTO]
John C. Bogle
[PHOTO]
John J. Brennan
FELLOW SHAREHOLDER,
Our first Annual Report on Vanguard Selected Value Portfolio covers
the eight and one-half months since the Portfolio's inception on February 15,
1996. During this period, which was a bullish time for the U.S. stock market,
your Portfolio earned only a modest positive return.
While it would be, to say the least, premature to make any judgments
about the Portfolio's performance during such a brief period, we acknowledge
that the Portfolio's early record leaves something to be desired. Its return
trails by more than seven percentage points the returns of both its benchmark
index and the average mid-capitalization stock mutual fund. The table at right
compares the Portfolio's total return (capital change plus reinvested
dividends) since inception with those of the average mid-cap mutual fund and
the unmanaged Russell Midcap Stock Index, the standards against which we
measure our performance.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
TOTAL RETURN
FEBRUARY 15 TO
OCTOBER 31, 1996
- ---------------------------------------------------------------
<S> <C>
Vanguard Selected Value Portfolio +0.7%
- ---------------------------------------------------------------
Average Mid-Cap Fund +8.6%
- ---------------------------------------------------------------
Russell Midcap Stock Index +8.3%
- ---------------------------------------------------------------
</TABLE>
The Portfolio's return is based on an increase in net asset value
from $10.00 per share at the Portfolio's inception on February 15, 1996, to
$10.07 per share on October 31, 1996. Included in this latter value is $.04 per
share of accrued net investment income, which will be included in the income
dividend to be distributed at the end of calendar 1996.
PERFORMANCE OVERVIEW
In the eight and one-half months covered by this Report, the stock market
flourished in an environment of moderate economic growth and low inflation.
When the Selected Value Portfolio began operations in mid-February, interest
rates were rising sharply, as the U.S. economy showed surprising signs of
strength, causing anxiety among investors about a pickup in inflation. By early
July, long-term interest rates peaked at 7.2%, more than a percentage point
above the levels prevailing at the time of the Portfolio's inception. As summer
waned, however, so did concerns about inflation, and interest rates reversed
course. By October 31, interest rates had receded, closing the period at 6.6%,
so that the price of long-term U.S. Treasury bonds was down about -6% for the
eight and one-half months.
The broad stock market's advance during this period was steady, with
the Standard & Poor's 500 Composite Stock Price Index providing positive
returns in every month but July, when there was a sharp setback. At first, the
Selected Value Portfolio participated fully in the market's advance, as its net
asset value increased +7.8% from its beginning just four months earlier.
However, while the overall stock market rebounded fairly quickly--and
fully--from the sharp decline in July, the Portfolio regained only a small part
of the ground it lost.
The explanation for our underperformance is simple: some of our
adviser's stock selections performed poorly, as the improved operating results
did not materialize as
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expected. In general, the market sectors our adviser emphasized were about
neutral in their impact on our performance.
Our Portfolio and other mid-capitalization stock funds were at a
slight disadvantage during the period because of the market's bias toward
large-cap stocks over small- and mid-cap stocks and toward growth stocks over
value stocks. Returns on these two conventional market pairings tend to
converge over longer periods but often diverge over shorter periods. Since our
Fund's inception, large-cap stocks outperformed mid-cap stocks by about 1.7
percentage points; growth stocks earned an edge of about 1.1 percentage points
over value stocks.
While our market-lagging performance is certainly not pleasing, it is
not surprising to see a divergence between the Portfolio's return and that of
the market. As we stated in our Semi-Annual Report, the Selected Value
Portfolio is subject not only "to the inevitable downturns that are part and
parcel of investing in the stock market" but also to "the incremental risk
associated with our strategy of keeping the Portfolio's holdings concentrated
among 30 to 40 stocks." Because of this portfolio concentration (we held only
26 stocks at fiscal year end) and our strategy of investing in out-of-favor
stocks of companies in challenging special situations, the Portfolio may at
times significantly lag the market averages. Over time, however, we expect it
will also enjoy periods when its performance exceeds that of the market. We
remain confident in the investment strategy of the Portfolio and the ability of
our adviser to execute this strategy, and we thank you, as a charter
shareholder in the Selected Value Portfolio, for your confidence in Vanguard.
We trust that you share our view that, in the final analysis, it is only the
long run that matters.
IN SUMMARY
The U.S. stock market has been on the rise--with only a few brief setbacks--for
nearly 15 years. So, it seems appropriate to note that the ever-present risks
of investing in stocks may be higher now than for some time. Vanguard Selected
Value Portfolio is fully exposed to those risks and, we reiterate, to the
additional risk of investing in a relatively concentrated group of stocks. The
sailing, in short, will not always be smooth. Nevertheless, we believe the
Portfolio can be a sensible part of a balanced investment portfolio of stock
funds, bond funds, and money market funds. Further, we believe that investors
who "stay the course" with balanced portfolios consistent with their own
financial objectives have little to fear from rough seas in the financial
markets.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
Chairman of the Board President
November 15, 1996
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THE MARKETS IN PERSPECTIVE: FISCAL YEAR ENDED OCTOBER 31, 1996
[PHOTO]
U.S. EQUITY MARKETS
The past twelve months were truly rewarding for common-stock investors in the
United States, particularly those who emphasized larger companies. As noted in
the table, the Standard & Poor's 500 Composite Stock Price Index gained 24.1%
for the fiscal year, while the Russell 2000 Small Stock Index posted a 16.6%
advance. The strong absolute returns can be attributed primarily to solid
earnings growth, continued low inflation, and the expectation on the part of
investors that this environment will prevail over the near term.
Among larger-capitalization issues, the best performing sector was
financial, with a 39.0% advance. Leading this group were banks and brokerage
firms. Banks benefited from the relative stability of economic growth--which
could be expected to result in both growing demand for loans and low default
rates; brokerage firms continued to reap the benefits of positive equity
markets. Energy issues also posted very strong results (33.1%), reflecting the
pronounced increase in oil prices from $17.98 per barrel to $23.35 during the
past twelve months.
Technology issues probably exhibited the greatest disparity of any
sector. The best performers were generally larger companies with dominant
positions in their industries; many of these firms rose 30% or more compared to
16.9%, in aggregate, for the technology holdings in the S&P 500 Index. By
contrast, technology was the worst-performing sector within the Russell 2000
Index, with a scant 2.9% return over the fiscal year.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED OCTOBER 31, 1996
-------------------------------------------
1 YEAR 3 YEARS 5 YEARS
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Equity
S&P 500 Index 24.1% 17.7% 15.5%
Russell 2000 Index 16.6 11.2 14.8
MSCI-EAFE Index 10.8 6.9 8.0
- ---------------------------------------------------------------------------------------
Fixed-Income
Lehman Aggregate Bond Index 5.9% 5.6% 7.7%
Lehman 10-Year Municipal
Bond Index 5.0 5.2 7.7
Salomon 90-Day U.S. Treasury Bills 5.3 5.0 4.4
- ---------------------------------------------------------------------------------------
Other
Consumer Price Index 3.0% 2.8% 2.9%
- ---------------------------------------------------------------------------------------
</TABLE>
In sum, investors displayed a strong preference for companies with
"predictable" earnings streams. One unusual note: the price/earnings ratio of
the S&P 500 Index rose 17% (from 15.8 to 18.5) during the last twelve months,
despite a rise in interest rates. In general, the P/E ratio moves inversely
with interest rates.
U.S. FIXED-INCOME MARKETS
While U.S. stock investors relished their solid gains, bond investors were not
so fortunate. Interest rates, as reflected in the 30-year U.S. Treasury yield,
fell from 6.33% on October 31, 1995, to 5.95% two months later. At that time,
analysts anticipated an environment of slow economic growth and harbored almost
no concern about potential increases in inflation. Underscoring that view, the
Federal Reserve Board's Open Market Committee cut both the discount rate and
the Federal funds rate by 0.25% in late January.
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Economic data soon suggested a different scenario--one characterized
by accelerating economic activity. A range of indicators pointed toward more
rapid growth than anticipated, but none concerned the bond market as much as
the ongoing increases in employment. In many analysts' view, continued job
growth would probably lead to higher wage rates, which might not be offset by
improvements in productivity. The net result would be higher inflation, the
bane of bond investors. Such concerns caused the 30-year U.S. Treasury yield to
climb to 7.19% in early July. From that point forward, interest rates declined,
although in an erratic pattern, leaving the long-term Treasury yield at 6.64%
by the end of October.
Three categories of bonds did benefit their investors, at least on a
relative basis, over the past year: short-maturity portfolios, low-quality
issues, and municipals. Short-maturity investors saw a small increase in rates
(0.18% for the 3-year U.S. Treasury bond). Owners of junk bonds earned
positive returns as lower-quality, higher-yielding issues generally fare well
during periods of steady growth; a modest increase in inflation can be
beneficial to junk-bond issuers (the Lehman High Yield Bond Index gained
11.1%). Municipal bonds, freed from investor worries over the proposed "flat
tax," performed exceptionally well and, to some extent, seemed immune to the
inflation concerns of the taxable market. In fact, the yield on the benchmark
30-year municipal fell -0.05% during the twelve months, while the yield on the
comparable-maturity U.S. Treasury issue rose 0.31%.
INTERNATIONAL EQUITY MARKETS
Investments in non-U.S. equity markets fared quite well over the fiscal year,
with one major exception: Japan. For the past twelve months, the Morgan Stanley
Capital International-Europe, Australasia, Far East Index (which covers all
major markets outside North America) posted a total return of 10.8% in dollars,
after a 5.1% increase in the value of the U.S. dollar over foreign currencies.
Nearly all of this return was generated in the European markets, where the
dollar return was 17.9% compared to 3.5% for the Pacific Basin. Aside from
Japan (-0.7% in dollars) and Singapore (-3.1%), markets in the Pacific Basin
provided very strong returns, as evidenced by Hong Kong (28.0%) and Australia
(18.3%).
The variation in returns across and within regions can be attributed
to differing environments and expectations for growth and inflation. In Europe,
many governments focused on the deficit-spending guidelines mandated by the
Maastricht Treaty for the conversion to a common European currency unit (the
ECU). The Treaty stipulated that deficit spending not exceed defined
levels--with the idea that restraint would keep inflation to reasonable levels.
Over the past year, many governments reaffirmed their commitments to the ECU
and cut spending accordingly. Investors took this as an indication that
inflation would remain modest and economic growth tepid. The result was a
strong boost to high-quality growth stocks across Europe.
The Japanese market continues to suffer because the long-anticipated
economic recovery has yet to materialize in a meaningful way. Despite some
positive signs, such as improving corporate profits, the Japanese economy
continues to perform in a lack-luster fashion.
4
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REPORT FROM THE ADVISER
[PHOTO]
During the second half of our first fiscal year, Vanguard Selected
Value Portfolio declined in value by -5.3%, compared to total returns of 3.9%
for the Russell Midcap Stock Index and 1.6% for the average mid-capitalization
stock fund. This reduced the total return for the Portfolio's first eight and
one-half months of operations to 0.7% versus 8.3% for the Index and 8.6% for
the average mid-cap stock fund.
Needless to say, as advisers and shareholders, we are not pleased.
However, we recognize that the concentrated, event-driven nature of our
investment philosophy has always led to a lack of correlation with both the
market and our competitive fund group. The effect has been--and will continue
to be--substantial leads and substantial lags for the Portfolio relative to our
benchmarks. Our task during the lagging periods is to redouble our efforts to
capitalize on the very situations that have caused us to fall behind. This will
produce, when we are correct, greater rewards and a lower level of portfolio
risk. Although, historically, periods of lagging performance have always been
followed by periods of superior performance, we have never managed to get used
to the subpar periods. For more specific details about the Portfolio's
performance, please see the Message To Shareholders on pages 1 and 2.
In the February 15 to October 31 period, the median return from the
stocks in our portfolio (meaning half of the stocks did better and half worse)
was 3.3%, 4.4% behind the market. The problem for us, as it has been in other
difficult periods, was that a few negative, company-specific events occurred
simultaneously. Interestingly, and again as usual, the culprits were new
investments.
While we try not to be early, we often are. In each case, we expected
that an undervalued company had reached a bottom, but it had not. Needless to
say, we have traveled the country, visiting the companies in which we have
invested, checking the numbers and modifying the forecasts. And in each
instance, we have concluded that short-term adversity has presented us with a
long-term opportunity and we have bought more.
The difficult stocks included Mentor Graphics, which pre-announced
very disappointing third-quarter earnings. Mentor has proprietary technology, a
pristine balance sheet, strong free cash flow, and, we believe, a very bright
future. Earnings visibility is, as usual, the critical issue here.
Heilig-Meyers, a small-town furniture retailer, had lower growth in sales due
in part to last year's excellent sales (which makes for tough comparisons) and
in part to hurricane-disrupted sales in North Carolina and Puerto Rico. Sales,
credit trends, and profit margins should improve from here. If the company
returns to the margins it has consistently earned in the past, earnings should
triple. Canandaigua Wine was hurt by high prices stemming from a poor grape
harvest in California. Nothing cures high prices better than high prices, and
the supply of grapes is expected to materially increase between 1997 and 2000.
The earnings benefit from lower grape costs and the company's internal
efficiencies should be very large.
INVESTMENT PHILOSOPHY
The adviser believes that superior long-term investment results can be obtained
by emphasizing medium-size companies with reasonable financial strength whose
stocks are out of favor and undervalued by the market, often because of special
situations that have temporarily depressed profits.
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We are not only happy with our purchases of these three companies--we
feel very positive about the Portfolio overall, despite our view that economic
and market conditions are likely to produce a restrained environment for common
stocks. In positioning the Portfolio, we never become involved in "top down" or
economic sector weightings, believing that the "special situation" aspect of
each of our stocks is the critical consideration. Still, we keep an eye on the
Portfolio's sector positions. In general, our current investments are more
heavily concentrated in areas sensitive to spending on capital goods and
consumer durable goods, with less emphasis on the energy, financial, and
technology sectors. Our belief is that industry, sector, and economic effects
are likely to be, for the most part, temporary influences on share prices.
Nevertheless, a continuation of the recent pattern of modest, consistent
economic growth will, we expect, have a positive effect on the realization of
individual stock values and on the performance of the Portfolio.
As we begin the new fiscal year, the Portfolio comprises 26 stocks,
with about 44% of total net assets concentrated in our ten largest holdings.
Our average stock's price/earnings ratio is at about 68% of the average P/E
ratio for the Russell Midcap Stock Index. Our average stock's price/book ratio
is 54% of the Index's. And yet our average stock is expected to grow at a rate
comparable to that of companies represented in the Index. We believe that this
combination of depressed valuation and improving profitability continues to
offer attractive return potential and relatively low levels of portfolio risk.
Barrow, Hanley, Mewhinney & Strauss, Inc.
November 8, 1996
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PERFORMANCE SUMMARY: SELECTED VALUE PORTFOLIO
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Portfolio. Note, too,
that both share price and return can fluctuate widely so that an investment in
the Portfolio could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: 2/15/96-10/31/96
- -------------------------------------------------------------------------------
SELECTED VALUE PORTFOLIO RUSSELL INDEX*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1996 0.7% 0.0% 0.7% 8.3%
- -------------------------------------------------------------------------------
</TABLE>
*Russell Midcap Stock Index.
See Financial Highlights table on page 14 for dividend and capital gains
information since the Portfolio's inception.
CUMULATIVE PERFORMANCE: 2/15/96-10/31/96
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
SELECTED VALUE AVERAGE MID-CAP RUSSELL MIDCAP
PORTFOLIO FUND STOCK INDEX
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
February 1996 10,000 10,000 10,000
April 1996 10,630 10,701 10,422
July 1996 9,490 9,818 9,775
October 1996 10,070 10,863 10,833
- -------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
TOTAL RETURNS FINAL VALUE OF A
SINCE INCEPTION $10,000 INVESTMENT
- -------------------------------------------------------------------------------
<S> <C> <C>
SELECTED VALUE PORTFOLIO 0.70% $10,070
AVERAGE MID-CAP FUND 8.63 10,863
RUSSELL MIDCAP STOCK INDEX 8.33 10,833
- -------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
SINCE INCEPTION TOTAL RETURNS: PERIOD ENDED 9/30/96*
- --------------------------------------------------------------------------------------------------
SINCE INCEPTION
INCEPTION ------------------------------------
DATE CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Selected Value Portfolio 2/15/96 -0.60% 0.0% -0.60%
- --------------------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this total return information through the
latest calendar quarter as well as for the Portfolio's fiscal year end.
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PORTFOLIO PROFILE: SELECTED VALUE PORTFOLIO
OCTOBER 31, 1996
The Profile provides a snapshot of the Portfolio's characteristics, where
appropriate, compared to an unmanaged index. Key elements of this Profile are
defined on page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- ---------------------------------------------------------------------
SELECTED RUSSELL
VALUE INDEX*
- ---------------------------------------------------------------------
<S> <C> <C>
Number of Stocks 26 789
Median Market Cap $0.7B $3.3B
Price/Earnings Ratio 16.8x 18.2x
Price/Book Ratio 2.2x 2.7x
Yield 0.6% 1.8%
Return on Equity 11.1% 15.2%
Earnings Growth Rate 1.3% 15.5%
Foreign Holdings 9.3% --
Turnover Rate 25% --
Expense Ratio** 0.75% --
Cash Reserves 5.5% --
</TABLE>
*Russell Midcap Stock Index.
**Annualized.
INVESTMENT FOCUS
- --------------------------------------------------------------------
[FIGURE 2]
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- --------------------------------------------------------------------
<S> <C>
Quanex Corp. 5.0%
Harnischfeger Industries Inc. 4.9
Kirby Corp. 4.8
H.B. Fuller Co. 4.7
Valassis Communication 4.7
First Federal Financial Corp. 4.2
Canandaigua Wine Co., Inc. Class A 4.2
International Specialty Products, Inc. 4.0
Lear Corp. 3.9
Heilig-Meyers Co. 3.8
- --------------------------------------------------------------------
Top Ten 44.2%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- -------------------------------------------------------------------------------------
OCTOBER 31, 1996 OCTOBER 31, 1996
----------------------------------------
SELECTED VALUE S&P 500
----------------------------------------
<S> <C> <C>
Basic Materials . . . . . . . . . . . . . . 14.6% 6.3%
Capital Goods & Construction . . . . . . . . 20.4 8.6
Consumer Cyclical . . . . . . . . . . . . . 24.7 12.7
Consumer Staples . . . . . . . . . . . . . . 4.4 12.3
Energy . . . . . . . . . . . . . . . . . . . 0.0 9.6
Financial . . . . . . . . . . . . . . . . . 10.4 14.8
Health Care . . . . . . . . . . . . . . . . 13.5 10.4
Technology . . . . . . . . . . . . . . . . . 6.9 12.1
Transport & Services . . . . . . . . . . . . 5.1 1.4
Utilities . . . . . . . . . . . . . . . . . 0.0 9.7
Miscellaneous . . . . . . . . . . . . . . . 0.0 2.1
- -------------------------------------------------------------------------------------
</TABLE>
8
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[PHOTO]
CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing investments.
EARNINGS GROWTH RATE. The annual average rate of growth in earnings over the
past five years for the stocks now in a portfolio.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors. The average expense ratio for a stock mutual fund was
1.34% in 1995.
FOREIGN HOLDINGS. The percentage of a portfolio's investments represented by
stocks or American Depository Receipts (ADRs) of companies based outside the
United States.
INVESTMENT FOCUS. This grid indicates a portfolio's characteristics in terms of
market capitalization and relative valuation (growth, value, or a blend). For
instance, if the upper right box of the grid is shaded, it indicates that a
portfolio emphasizes large capitalization growth stocks.
MEDIAN MARKET CAP. The midpoint of market capitalization (market price x shares
outstanding) of stocks in the portfolio. Half the stocks in the portfolio have
higher market capitalizations and half lower.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified, and the more likely it is to perform in line with
the overall stock market.
PRICE/BOOK RATIO. The share price of a stock, divided by its net worth, or book
value, per share. For a portfolio, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. 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. For a portfolio, the weighted average P/E of the
stocks it holds.
RETURN ON EQUITY. The rate of return generated by a company during the past
year for each dollar of shareholder's equity (net income for the year /
shareholder's equity). For a portfolio, the weighted average return on equity
for the companies represented in the portfolio.
SECTOR DIVERSIFICATION. The percentage of a portfolio's common stocks invested
in each of the major industry classifications that compose the stock market.
TEN LARGEST HOLDINGS. Indicates the percentage of a portfolio's total net
assets in its ten largest stocks (the average for stock mutual funds is about
25%). As this percentage rises, a portfolio's returns are likely to be more
volatile, since its return is more dependent on a few companies.
TURNOVER RATE. Indicates trading activity during the past year. Portfolios with
high turnover rates incur higher transaction costs and are more likely to
realize and distribute capital gains (which are taxable to investors). The
average turnover rate for stock mutual funds is about 80%.
YIELD. A snapshot of a portfolio's income from interest and dividends. The
yield, expressed as a percentage of the portfolio's net asset value, is based
on income earned by the portfolio over the past 30 days and is annualized, or
projected forward for the coming year.
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[PHOTO]
FINANCIAL STATEMENTS
OCTOBER 31, 1996
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Portfolio's holdings, including
each security's market value on the last day of the reporting period.
Securities are grouped and subtotaled by asset type (common stocks, preferred
stocks, bonds, etc.) and by industry sector. Other assets are added to, and
liabilities are subtracted from, the value of Total Investments to calculate
the Portfolio's Net Assets. Finally, Net Assets are divided by the outstanding
shares of the Portfolio 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 Portfolio'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 Portfolio had available to distribute to shareholders as income
dividends or capital gains as of the statement date. Any Accumulated Net
Realized Losses, and any cumulative excess of distributions over net income or
net realized gains, will appear as negative balances. Unrealized Appreciation
(Depreciation) is the difference between the market value of the Portfolio's
investments and their cost, and reflects the gains (losses) that would be
realized if the Portfolio were to sell all of its investments at their
statement-date values.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
MARKET
VALUE*
SELECTED VALUE PORTFOLIO SHARES (000)
- ------------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (94.5%)
- ------------------------------------------------------------------------
BASIC MATERIALS (13.8%)
H.B. Fuller Co. 106,100 $ 4,377
- - International Specialty
Products, Inc. 342,900 3,729
Quanex Corp. 163,300 4,654
------------
12,760
------------
CAPITAL GOODS & CONSTRUCTION (19.2%)
Harnischfeger Industries Inc. 113,500 4,540
Keystone International, Inc. 179,600 3,233
Raychem Corp. 43,600 3,406
Stewart & Stevenson
Services, Inc. 163,300 3,429
Thomas & Betts Corp. 76,100 3,225
------------
17,833
------------
CONSUMER CYCLICAL (23.4%)
Dillard Department Stores Class A 81,600 2,591
Heilig-Meyers Co. 267,900 3,483
- - Lear Corp. 98,000 3,626
- - Lechters Corp. 498,000 2,303
Snap-On Inc. 85,700 2,753
Sturm, Ruger & Co., Inc. 137,400 2,576
- - Valassis Communication 239,800 4,316
------------
21,648
CONSUMER STAPLES (4.2%)
- - Canandaigua Wine Co., Inc.
Class A 171,400 3,856
------------
FINANCIAL (9.9%)
American States Financial Corp. 100,100 2,365
Bancorp Hawaii, Inc. 73,500 2,912
- - First Federal Financial Corp. 176,000 3,872
------------
9,149
------------
HEALTH CARE (12.7%)
Astra AB ADR 65,300 2,996
- - Magellan Health Services Corp. 171,400 3,149
Novo-Nordisk AS ADR 65,600 2,731
Smith & Nephew PLC 957,200 2,922
------------
11,798
------------
TECHNOLOGY (6.5%)
- - Mentor Graphics Corp. 318,400 2,667
- - Silicon Valley Group, Inc. 204,100 3,393
------------
6,060
------------
TRANSPORT & SERVICES (4.8%)
- - Kirby Corp. 228,600 4,458
------------
- ------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $89,081) 87,562
- ------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
- ------------------------------------------------------------------------
<S> <C> <C>
TEMPORARY CASH INVESTMENT (6.8%)
- ------------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled Cash Account
5.58%, 11/1/96
(Cost $6,296) $6,296 6,296
- ------------------------------------------------------------------------
TOTAL INVESTMENTS (101.3%)
(Cost $95,377) 93,858
- ------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
MARKET
VALUE*
(000)
- ------------------------------------------------------------------------
<S> <C>
OTHER ASSETS AND LIABILITIES (-1.3%)
- ------------------------------------------------------------------------
Other Assets--Note C $ 444
Liabilities (1,636)
------------
(1,192)
- ------------------------------------------------------------------------
NET ASSETS (100%)
- ------------------------------------------------------------------------
Applicable to 9,199,745 outstanding
$.001 par value shares
(authorized 250,000,000 shares) $92,666
========================================================================
NET ASSET VALUE PER SHARE $10.07
========================================================================
*See Note A in Notes To Financial Statements.
- -Non-Income Producing Security.
ADR--American Depository Receipt.
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
AT OCTOBER 31, 1996, NET ASSETS CONSISTED OF:
- ------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $92,843 $10.09
Undistributed Net
Investment Income 324 .04
Accumulated Net
Realized Gains 1,018 .11
Unrealized Depreciation--Note E (1,519) (.17)
- ------------------------------------------------------------------------
NET ASSETS $92,666 $10.07
========================================================================
</TABLE>
11
<PAGE> 14
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Portfolio
during the reporting period, and details the operating expenses charged to the
Portfolio. 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.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
SELECTED VALUE PORTFOLIO
FEB. 15* TO
OCT. 31, 1996
(000)
- ---------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 437
Interest 218
------------
Total Income 655
------------
EXPENSES
Investment Advisory Fees--Note B 190
The Vanguard Group--Note C
Management and Administrative 115
Marketing and Distribution 4
Taxes (other than income taxes) 3
Custodian Fees 5
Auditing Fees 4
Shareholders' Reports 8
Annual Meeting and Proxy Costs 2
------------
Total Expenses 331
- ---------------------------------------------------------------------------
NET INVESTMENT INCOME 324
- ---------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 1,018
- ---------------------------------------------------------------------------
UNREALIZED DEPRECIATION OF INVESTMENT SECURITIES (1,519)
- ---------------------------------------------------------------------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (177)
===========================================================================
</TABLE>
*Commencement of operations.
12
<PAGE> 15
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Portfolio's total net assets changed during the
reporting period. The Operations section summarizes information that is
detailed in the Statement of Operations. The amounts shown as Distributions to
shareholders from the Portfolio'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 Portfolio, 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.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
SELECTED VALUE PORTFOLIO
FEB. 15* TO
OCT. 31, 1996
(000)
- ---------------------------------------------------------------------------
<S> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 324
Realized Net Gain 1,018
Unrealized Depreciation (1,519)
------------
Net Decrease in Net Assets Resulting from Operations (177)
------------
DISTRIBUTIONS
Net Investment Income --
Realized Capital Gain --
------------
Total Distributions --
------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 108,104
Issued in Lieu of Cash Distributions --
Redeemed (15,361)
------------
Net Increase from Capital Share Transactions 92,743
- ---------------------------------------------------------------------------
Total Increase 92,566
- ---------------------------------------------------------------------------
NET ASSETS
Beginning of Period--Note F 100
------------
End of Period $92,666
===========================================================================
(1)Shares Issued (Redeemed)
Issued 10,732
Issued in Lieu of Cash Distributions --
Redeemed (1,542)
------------
Net Increase in Shares Outstanding 9,190
===========================================================================
</TABLE>
*Commencement of operations.
13
<PAGE> 16
FINANCIAL HIGHLIGHTS
This table summarizes the Portfolio's investment results and distributions to
shareholders on a per-share basis. It also presents the Portfolio's Total
Return and shows net investment income and expenses as percentages of average
net assets. 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 Portfolio for one year. Finally, the table lists the Portfolio's
Average Commission Rate Paid, a disclosure required by the SEC beginning in
1996. This rate is calculated by dividing total commissions paid on portfolio
securities by the total number of shares purchased and sold on which
commissions were charged.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
SELECTED VALUE PORTFOLIO
FEB. 15* TO
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD OCT. 31, 1996
- ---------------------------------------------------------------------------
<S> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $10.00
- ---------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .04
Net Realized and Unrealized Gain (Loss) on Investments .03
------------
Total from Investment Operations .07
------------
DISTRIBUTIONS
Dividends from Net Investment Income --
Distributions from Realized Capital Gains --
------------
Total Distributions --
- ---------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $10.07
===========================================================================
TOTAL RETURN 0.70%
===========================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $93
Ratio of Total Expenses to Average Net Assets 0.75%**
Ratio of Net Investment Income to Average Net Assets 0.75%**
Portfolio Turnover Rate 25%
Average Commission Rate Paid $.0537
- ---------------------------------------------------------------------------
</TABLE>
*Commencement of operations.
**Annualized.
14
<PAGE> 17
NOTES TO FINANCIAL STATEMENTS
Vanguard Selected Value Portfolio 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 with generally
accepted accounting principles for mutual funds. The Portfolio consistently
follows such policies in preparing its financial statements.
1. SECURITY VALUATION: Securities listed on an exchange 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. Securities not listed on an exchange are
valued at the latest quoted bid prices. Temporary cash investments are valued
at cost, which approximates market value.
2. FEDERAL INCOME TAXES: The Portfolio intends 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 Portfolio, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. Government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other
party to the agreement, retention of the collateral may be subject to legal
proceedings.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Under a contract that expires January 31, 1998, the Portfolio pays Barrow,
Hanley, Mewhinney & Strauss, Inc., an investment advisory fee calculated at an
annual percentage rate of average net assets. For the period ended October 31,
1996, the advisory fee represented an effective annual rate of 0.40% of the
Portfolio's average net assets.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the Portfolio under methods approved by the Board of Directors. At October
31, 1996, the Portfolio had contributed capital of $8,000 to Vanguard (included
in Other Assets), representing 0.04% of Vanguard's capitalization. The
Portfolio's directors and officers are also directors and officers of Vanguard.
D. During the period ended October 31, 1996, the Portfolio purchased
$101,188,000 of investment securities and sold $13,124,000 of investment
securities, not counting U.S. Government securities and temporary cash
investments.
E. At October 31, 1996, net unrealized depreciation of investment securities
for financial reporting and Federal income tax purposes was $1,519,000,
consisting of unrealized gains of $6,327,000 on securities that had risen in
value since their purchase and $7,846,000 in unrealized losses on securities
that had fallen in value since their purchase.
F. The Portfolio was organized on November 27, 1995, and its operations up to
February 15, 1996, were limited to the sale and issuance of 10,000 shares of
its common stock to an officer of the Portfolio's investment adviser.
15
<PAGE> 18
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors of
Vanguard Selected Value Portfolio
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 Selected Value Portfolio (the "Portfolio") at October 31, 1996, and
the results of its operations, the changes in its net assets and the financial
highlights for the period February 15, 1996 (commencement of operations)
through October 31, 1996, in conformity with generally accepted accounting
principles. These financial statements and financial highlights (hereafter
referred to as "financial statements") are the responsibility of the
Portfolio's management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit 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 audit, which included
confirmation of securities at October 31, 1996 by correspondence with the
custodian and brokers and the application of alternative auditing procedures
where confirmations from brokers were not received, provides a reasonable basis
for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
December 2, 1996
SPECIAL 1996 TAX INFORMATION (UNAUDITED)
VANGUARD SELECTED VALUE PORTFOLIO
This information for the fiscal year ended October 31, 1996, is included
pursuant to provisions of the Internal Revenue Code.
For corporate shareholders, 30.2% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
All comparative mutual fund data are from Lipper Analytical Services, Inc. or
Morningstar unless otherwise noted.
16
<PAGE> 19
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director of The Vanguard Group, Inc.
and of each of the investment companies in The Vanguard Group; Director of
Chris-Craft Industries, Inc.
JOHN J. BRENNAN, President, Chief Executive Officer, and Director of The
Vanguard Group, Inc. and of each of the investment companies in The Vanguard
Group.
ROBERT E. CAWTHORN, Chairman Emeritus and Director of Rhone-Poulenc Rorer Inc.;
Director of Sun Company, Inc. and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea Co.,
Alco Standard Corp., Raytheon Co., Knight-Ridder, Inc., and Massachusetts
Mutual Life Insurance Co.
BRUCE K. MACLAURY, President Emeritus of The Brookings Institution; Director of
American Express Bank Ltd., The St. Paul Companies, Inc., and National
Steel Corp.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl Corp.,
Baker Fentress & Co., The Jeffrey Co., and Southern New England
Communications Co.
ALFRED M. RANKIN, JR., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Co.,
and The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and
President of New York University; Director of Pacific Gas and Electric
Co., Procter & Gamble Co., and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc. and
Kmart Corp.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas Co.;
Director of Cummins Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
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.
RICHARD F. HYLAND, Treasurer; Principal of The Vanguard Group, Inc.; Treasurer
of each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller; Principal of The Vanguard Group, Inc.; Controller of
each of the investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President, Information Technology.
JAMES H. GATELY, Senior Vice President, Individual Investor Group.
IAN A. MACKINNON, Senior Vice President, Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President, Institutional.
RALPH K. PACKARD, Senior Vice President and Chief Financial Officer.
[VANGUARD LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
[email protected] http://www.vanguard.com
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.
<PAGE> 20
THE VANGUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard Selected Value Portfolio
Vanguard/Trustees' Equity-U.S. Portfolio
Vanguard Convertible Securities Fund
BALANCED FUNDS
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LifeStrategy Portfolios
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity-International Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Admiral Funds
INCOME FUNDS
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
Q9340-10/96
[PHOTO]
