<PAGE> 1
VANGUARD
SELECTED VALUE
PORTFOLIO
Annual Report
October 31, 1997
[PHOTO]
1997
[THE VANGUARD GROUP LOGO]
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[GRAPHIC]
OUR CREW MAKES THE DIFFERENCE
Throughout our history, The Vanguard Group has received considerable attention
as the low-cost provider of mutual funds. While such accolades are gratifying,
we are most proud, not of our low operating expenses or the billions of dollars
we manage, but of our sterling reputation created by the Vanguard crew.
We recognize that it is our crew members--some 6,000 highly motivated men
and women--who form the cornerstone of our operations. As with any cornerstone,
we could not survive long--let alone prosper--without it. That's why we chose
this fiscal year's annual report to celebrate the spirit, enthusiasm, and
achievements of our crew. (We call those who work at Vanguard crew members, not
employees, because they operate as a team to accomplish our mission of serving
you, our clients.)
But while we prize the collective contributions of our crew, we also take
time to recognize the importance of the individual. Each calendar quarter, we
present our Award For Excellence to a handful of crew members who have
demonstrated particular excellence in the performance of their jobs and who
embody "The Vanguard Spirit." Our report cover shows only a few of the more than
300 crew members who have received this distinction since 1984.
They, along with the rest of our valiant crew, look forward to serving you
in the years ahead.
[PHOTO]
John C. Bogle John J. Brennan
Chairman President
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
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 3
[GRAPHIC]
FELLOW SHAREHOLDER,
Vanguard Selected Value Portfolio, lifted by the powerful bull market in U.S.
stocks, earned +30.9% for the fiscal year ended October 31, 1997, outpacing both
its average peer and its unmanaged index benchmark. It was a fine first full
year for the Portfolio.
The table at right compares the Portfolio's total return (capital change
plus reinvested dividends) for the year with those of the average
mid-capitalization equity mutual fund and the unmanaged Russell Midcap Index,
the standards against which we measure our performance.
<TABLE>
<CAPTION>
- -------------------------------------------------------
TOTAL RETURNS
FISCAL YEAR ENDED
OCTOBER 31, 1997
- -------------------------------------------------------
<S> <C>
Vanguard Selected Value Portfolio +30.9%
- -------------------------------------------------------
Average Mid-Cap Fund +22.8%
- -------------------------------------------------------
Russell Midcap Index +28.8%
- -------------------------------------------------------
</TABLE>
The Portfolio's return is based on an increase in its net asset value from
$10.07 per share on October 31, 1996, to $12.98 per share on October 31, 1997,
with the latter figure adjusted for a dividend of $0.06 per share paid from net
investment income and a distribution of $0.11 per share paid from net realized
capital gains.
FISCAL 1997 PERFORMANCE OVERVIEW
Despite taking a tumble in late October, the U.S. stock market--as represented
by the Standard & Poor's 500 Composite Stock Price Index--gained +32.1% during
the twelve months ended October 31. Mid- and small-cap stocks did almost as
well, a notable development as they had lagged far behind large-cap stocks in
the previous two years.
Economic conditions during the year were almost picture-perfect for equity
investors. Business activity and corporate profits continued to increase apace,
yet inflation decelerated and long-term interest rates declined. This positive
interest-rate environment, along with the splendid economic fundamentals,
elevated the already-high spirits of investors. But after reaching record
territory in early October, the stock market retreated late in the month, most
notably with a -7% plunge on Monday, October 27.
While the October slide (nearly 11% from high to low) was the sharpest
interim dip during the past twelve months, the stock market also experienced
monthly declines in December, March, and August. However, each drop was promptly
followed by a rebound, and the market averages at fiscal year-end were not far
off their historic highs.
The mid-cap market during the year was strongest within the category of
value stocks--those characterized by relatively low prices in relation to such
fundamental factors as earnings, book value, and dividends. For the twelve
months ended October 31, 1997, the Russell Midcap Value Index provided a return
of +32.5%, well ahead of returns of +24.6% for the Russell Midcap Growth Index.
(The reverse was true among large-cap companies, where growth stocks fared
better than value stocks).
The Selected Value Portfolio's strong performance resulted from excellent
stock choices by our adviser, Barrow, Hanley, Mewhinney & Strauss. Producer
durable goods were the Portfolio's biggest industry concentration (representing
about 25% of our assets), and they generated a return of nearly +40%, far above
the +24% return of producer durables in the Russell Midcap Index. The
Portfolio's small position in consumer staples (less than 5% of assets) returned
more than 100% for the year, and our financial-services stocks (almost 10% of
assets during the year) produced a handsome +68% return.
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Partially offsetting these superb results were relatively poor results from
our selections in the auto & transportation sector, where our return of 12% was
30 percentage points behind that of the auto stocks in the Russell Midcap Index.
We also were hurt somewhat by our heavier position in materials & processing
(nearly 18% of assets versus 11% for the Index). This sector was the Index's
worst performer, with a return of "only" 16%.
Shareholders should understand that in a relatively concentrated portfolio
like ours, especially one operating outside the large-cap arena, the risks and
rewards of individual stocks tend to be rather high. Few mutual funds have, as
we do, more than 50% of assets in their twelve largest holdings. Shareholders
should expect wider divergence from our performance norms--peers and indexes
alike--than would characterize most mutual funds.
LIFETIME PERFORMANCE OVERVIEW
This kind of divergence has already been reflected in our record. The Selected
Value Portfolio got off to a rocky start, returning only +0.7% for the eight and
one-half months between its inception on February 15, 1996, and the end of
fiscal 1996. The solid turnaround in an excellent fiscal 1997, however, brought
our lifetime results close to our performance benchmarks, as shown in the table
at left. A $10,000 investment on the Portfolio's inception date would have grown
to $13,184 by October 31, 1997, or $155 less than an identical investment in our
average competitor and $766 short of the equivalent investment in the Russell
Midcap Index.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
TOTAL RETURNS
FEB. 15, 1996, TO OCT. 31, 1997
-------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- -------------------------------------------------------------------
<S> <C> <C>
Vanguard Selected Value Portfolio +17.6% $13,184
- -------------------------------------------------------------------
Average Mid-Cap Fund +18.4% $13,339
- -------------------------------------------------------------------
Russell Midcap Index +21.5% $13,950
- -------------------------------------------------------------------
</TABLE>
We would emphasize that the Portfolio's track record of less than two years
is too brief to judge its merits, but we are heartened by this year's results
and remain confident about the Portfolio's long-term strategy and our adviser's
ability to carry it out.
IN SUMMARY
After a year during which the stock market provided a return equivalent to
nearly three years' worth of those produced at its long-term average of nearly
11% annually, investors have every reason to be thankful for the market's
bounty. But the recent market volatility--punctuated by October's sudden
slide--should make everyone mindful of the risks of investing in stocks. The
danger of the breathtaking bull market in U.S. stocks, now in its 16th year, is
that it may have dulled investors' awareness of a simple fact of equity
investing: Prices can drop sharply and suddenly. And these declines are not
always quickly erased.
That said, the greatest risk is not investing in the first place. We
believe that a sound method for dealing with risk is to construct a balanced
investment program suited to your objectives, financial situation, tolerance for
risk, and time horizon. If you have such a program in place, you are prepared to
"stay the course" toward your investment goals.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
November 19, 1997
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[GRAPHIC]
THE MARKETS IN PERSPECTIVE
YEAR ENDED OCTOBER 31, 1997
U.S. EQUITY MARKETS
The 12-month period ended October 31, 1997, was exceptionally strong for stock
investors, although it wound up on a rather unpleasant note. Over the period,
large-capitalization stocks continued their advance, propelling the S&P 500
Index to a 32.1% gain. Small-cap stocks also fared well, as illustrated by the
29.3% increase of the Russell 2000 Index. These gains stood despite October's
volatile final week, when sharp declines in Asian stock markets led many
investors to question their expectations regarding the U.S. market. While the
domestic market dropped substantially--the Dow Jones Industrial Average fell 554
points, or 7.2%, on October 27--it then rebounded smartly over the next few
days. This quick recovery probably can be attributed to investors' recognition
that three major factors underlying the bull market of recent years were
unaffected by the turmoil in Asia. These factors are solid economic growth;
restrained inflation, at levels not experienced since the 1960s; and impressive
growth in corporate profits.
Among large-cap stocks, the best-performing sectors in fiscal 1997 were
technology and financial services, with increases of 51.1% and 41.4%,
respectively. The surge in technology reflects robust corporate spending on this
industry's products, particularly desktop computers, networking equipment, and
software. Consumer discretionary and cyclical stocks could be considered
laggards by contrast, despite their respective gains of 20.4% and 14.5%.
(Clearly the market has shown amazing growth when a 15%-20% advance over a
one-year period can be viewed as inadequate.)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED OCTOBER 31, 1997
-------------------------------
1 YEAR 3 YEARS 5 YEARS
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 32.1% 27.5% 19.9%
Russell 2000 Index 29.3 21.3 18.7
MSCI EAFE Index 4.9 5.1 12.1
- ------------------------------------------------------------------------------
FIXED INCOME
Lehman Aggregate Bond Index 8.9% 10.1% 7.5%
Lehman 10-Year Municipal Bond Index 8.7 9.4 7.8
Salomon Brothers Three-Month
U.S. Treasury Bill Index 5.2 5.4 4.6
- ------------------------------------------------------------------------------
OTHER
Consumer Price Index 2.1% 2.6% 2.6%
- ------------------------------------------------------------------------------
</TABLE>
While small-company stocks failed to match the outsized advance of the S&P
500 Index, their performance grew notably stronger in the second half of the
fiscal year. This was evident in both absolute and relative terms: During the
past six months, the Russell 2000 Index rose 27.3%, compared to 15.2% for the
S&P 500. The improved performance of smaller companies cannot be attributed to
any single factor, but is, rather, due to a combination of attractive valuations
and good earnings.
U.S. FIXED-INCOME MARKETS
Interest rates fell across the yield curve, rewarding fixed-income investors
with higher total returns. For example, the rates on 1-, 5-, 10-, and 30-year
Treasury issues decreased 0.06%, 0.35%, 0.51%, and 0.49%, respectively, during
the fiscal year. These declines reflected the continuing good news regarding
inflation and the relative dormancy of
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the Federal Reserve. The benefit to investors was illustrated by the 8.9% return
of the Lehman Brothers Aggregate Bond Index, the broadest measure of
investment-grade issues. Investors in lower-quality securities fared even
better, as shown by the 13.7% gain of the Lehman High Yield Bond Index. The
strength of the economy combined with the lack of inflationary pressure produced
an ideal environment for junk bonds.
INTERNATIONAL EQUITY MARKETS
The last quarter of the fiscal year proved to be horrible for investments in
Pacific markets, with declines both widespread and pronounced. The Morgan
Stanley Capital International (MSCI) Pacific Index declined by 21.4% in U.S.
dollar terms during the three months and was down 19.7% for the full fiscal
year. Among individual markets (also in U.S. dollar terms), Japan fell 18.4% for
the quarter and 18.1% for the 12 months, while the declines over the same
periods reached 34.3% and 17.5% in Hong Kong and 49.0% and 57.2% in Malaysia.
These markets suffered for a variety of reasons, but concern about future
economic growth was particularly significant.
By contrast, the European markets continued to provide U.S. investors with
solid returns, although they, too, stumbled in late October. The MSCI Europe
Index posted a gain of 26.0% for the 12 months despite a 4.9% decline in
October. The robust character of the European markets reflects strong earnings
and optimism that the growth will remain solid.
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[GRAPHIC]
REPORT FROM THE ADVISER
For the six- and twelve-month periods ended October 31, 1997, Vanguard Selected
Value Portfolio earned 22.5% and 30.9%, respectively. These results exceeded the
Russell Midcap Index returns of 20.6% and 28.8% for the same periods. For the
full fiscal year, the Portfolio outperformed the average mid-capitalization
stock fund by 8.1 percentage points (30.9% versus 22.8%). We are pleased with
these results.
MARKET OVERVIEW
The superior relative performance of the mid-cap market in the second half of
the year--reflected in the Russell benchmark's 20.6% return versus the 15.2%
return on the S&P 500 Index--accelerated in the fourth quarter.
Higher-than-expected earnings, moderately decelerating inflation, and lower
interest rates continued to push stock prices higher. The S&P 500 Index returned
32.1% for the fiscal year, despite a downturn late in the period. The Russell
Midcap Index increased 28.8% for the year, and in the final three months of the
period it eked out a 0.5% return versus a downturn of 3.8% in the S&P 500
Index. The relatively strong performance by the mid-cap segment of the market
was a long time in coming, but was not a surprise. As we have maintained in our
previous reports to you, relative value is overwhelmingly in favor of the
mid-cap market. We believe that the gains in the mid-cap market relative to
large-cap stocks were not a result of a few earnings disappointments or a
meaningful multiple contraction among the large-cap blue chips. We conclude that
the mid-cap market's premium performance during the second half of the fiscal
year was the result of superior earnings growth and some modest gains in
price/earnings multiples relative to large-cap stocks.
Even though the Russell Midcap Index strongly outperformed the S&P 500
Index during the July-September quarter (by a larger margin than in any
three-month period during the past decade), mid-cap stocks still have a decided
edge over large-cap stocks in relative valuations. Therefore, we believe that
the recent outperformance by mid-cap stocks is a trend that has only just begun
and that will be long-term, though we doubt that it will be uninterrupted.
PORTFOLIO REVIEW
We made only one new purchase--Atlas Air--during the final quarter of the fiscal
year. Atlas Air is a cargo carrier that provides reliable, worldwide,
airport-to-airport transportation services to major international airlines under
fixed-rate, long-term contracts. The company offers its customers cost savings
of up to 40% over what it costs the airlines to provide the cargo capacity
themselves. Atlas Air's workforce is productive and flexible, and economies are
created in maintenance and insurance. Atlas Air, which flies only Boeing 747-200
aircraft, had leased five planes formerly used by other cargo carriers. These
five aircraft have had excessively high maintenance costs, which led to
operating losses. As a result, shares of Atlas Air have declined during the past
12 months from
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<PAGE> 8
a high of $64 to a low of $22. We see value here, primarily because the five
planes are being returned to the lessor in 1998. Thus, the losses generated by
these planes are truly one-time in nature. Furthermore, Atlas Air's earnings
excluding these planes are strong and, when considered alone, justify our
purchase. We have known several members of management since the 1970s (they are
alumni of Texas Air), and note their substantial purchases of shares as a
confirmation of our investment thesis.
The earnings and stock price of Canandaigua Brands, a longtime holding of
the Portfolio, are soaring. As we expected, the grape harvest is huge this year.
Grape prices in California are falling, and this has begun to favorably affect
Canandaigua's profit margins. We expect that the supply of grapes will continue
to swell in coming years as vines planted during a shortage several years ago
begin to mature. Unit sales growth is very impressive (up over 12% in the latest
quarter), with Corona Beer (which Canandaigua imports from Mexico), high-quality
wines, and spirits leading the way. Canandaigua's stock has more than doubled
from its lows and still, according to our analysis, remains undervalued.
As we begin the new fiscal year, the Portfolio owns 26 stocks, with more
than 44% of total net assets in the ten largest holdings. Our average stock
sells at a price/earnings ratio (based on consensus estimates of 1998 earnings)
equal to about 72% of the P/E ratio of the Russell Midcap Index and at a
price/book value equal to only 67% of the Index's. Yet we expect our stocks to
grow at a comparable rate to the stocks in the Index. We believe that the
combination of depressed valuation and improving profitability continues to
offer attractive return potential and relatively low levels of risk for the
Portfolio.
Barrow, Hanley, Mewhinney & Strauss, Inc.
November 13, 1997
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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[GRAPHIC]
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: FEBRUARY 15, 1996-OCTOBER 31, 1997
- ------------------------------------------------------
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%
1997 30.2 0.7 30.9 28.8
- ------------------------------------------------------
</TABLE>
*Russell Midcap Index.
See Financial Highlights table on page 14 for dividend and capital gains
information since the Portfolio's inception.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: FEBRUARY 15, 1996-OCTOBER 31, 1997
- ---------------------------------------------------------------
SELECTED LIPPER MID RUSSELL MIDCAP
VALUE PORTFOLIO CAP FUNDS INDEX
<S> <C> <C> <C> <C>
2/15/96 10000 10000 10000
1996 04 10630 10701 10422
1996 07 9490 9818 9775
1996 10 10070 10863 10833
1997 01 11051 11652 11801
1997 04 10767 10819 11563
1997 07 13336 13256 13881
1997 10 13184 13339 13950
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED OCTOBER 31, 1997
------------------------------- FINAL VALUE OF A
1 YEAR SINCE INCEPTION $10,000 INVESTMENT
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Selected Value Portfolio 30.92% 17.58% $13,184
Average Mid-Cap Fund 22.80 18.39 13,339
Russell Midcap Index 28.77 21.53 13,950
- -----------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1997*
- -------------------------------------------------------------------------------
SINCE INCEPTION
INCEPTION --------------------------
DATE 1 YEAR CAPITAL INCOME TOTAL
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Selected Value Portfolio 2/15/1996 40.09% 22.23% 0.41% 22.64%
- -------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
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[GRAPHIC]
PORTFOLIO PROFILE
SELECTED VALUE PORTFOLIO
This Profile provides a snapshot of the Portfolio's characteristics as of
October 31, 1997, compared where appropriate to an unmanaged index. Key elements
of this Profile are defined on page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- -------------------------------------------
SELECTED RUSSELL
VALUE MIDCAP
- -------------------------------------------
<S> <C> <C>
Number of Stocks 26 780
Median Market Cap $0.9B $4.2B
Price/Earnings Ratio 18.9x 19.8x
Price/Book Ratio 2.8x 3.0x
Yield 0.7% 1.6%
Return on Equity 11.4% 15.5%
Earnings Growth Rate 11.1% 16.4%
Foreign Holdings 0% --
Turnover Rate 32% --
Expense Ratio 0.74% --
Cash Reserves 6.3% --
</TABLE>
INVESTMENT FOCUS
- -------------------------------------------
[GRAPHIC]
<TABLE>
<CAPTION>
TEN LARGEST STOCKS (% OF TOTAL NET ASSETS)
- ------------------------------------------
<S> <C>
Canandaigua Brands, Inc. 5.4%
Silicon Valley Group, Inc. 5.1
Mentor Graphics Corp. 5.0
Raychem Corp. 4.7
Valassis Communications, Inc. 4.7
Ferro Corp. 4.2
Kirby Corp. 4.0
Atlas Air, Inc. 3.8
Lear Corp. 3.8
Vastar Resources, Inc. 3.7
- ------------------------------------------
Top Ten Total 44.4%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- --------------------------------------------------------------------------------
OCTOBER 31, 1996 OCTOBER 31, 1997
---------------- ------------------------------
SELECTED VALUE SELECTED VALUE RUSSELL MIDCAP
------------------------------------------------
<S> <C> <C> <C>
Auto & Transportation......... 9.5% 16.1% 3.8%
Consumer Discretionary........ 18.1 14.4 16.7
Consumer Staples.............. 4.5 5.8 4.7
Financial Services............ 10.8 7.4 21.0
Health Care................... 7.2 7.4 6.1
Integrated Oils............... 0.0 0.0 1.2
Other Energy.................. 0.0 4.0 6.3
Materials & Processing........ 18.3 19.0 10.2
Producer Durables............. 28.4 20.5 4.9
Technology.................... 3.2 5.4 9.5
Utilities..................... 0.0 0.0 12.5
Other......................... 0.0 0.0 3.1
- --------------------------------------------------------------------------------
</TABLE>
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CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing investments--after
adjusting for cash held in collateral for futures contracts.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a portfolio.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FOREIGN HOLDINGS. The percentage of a portfolio's net assets represented by
stocks or American Depository Receipts of companies based outside the United
States.
Investment Focus. This grid indicates the focus of a portfolio in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. The midpoint of market capitalization (market price x shares
outstanding) of the stocks in a 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 it is and the more likely to perform in line with
the overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a portfolio, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a portfolio, the weighted average P/E of the
stocks it holds. P/E is an indicator of market expectations about corporate
prospects; the higher the P/E, the greater the expectations for a company's
future growth.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a portfolio, the weighted average return
on equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a portfolio's common stocks that come
from each of the major industry groups that compose the stock market.
TEN LARGEST STOCKS. The percentage of net assets that a portfolio has invested
in its ten largest holdings. (The average for stock mutual funds is about 30%).
As this percentage rises, a portfolio's returns are likely to be more volatile,
since its return is more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year.
Portfolios with high turnover rates incur higher transaction costs and are more
likely to distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a portfolio's income from interest and dividends. The
yield, expressed as a percentage of the portfolio's net asset value, is based on
income earned over the past 30 days and is annualized, or projected forward for
the coming year. The index yield is based on the current annualized rate of
dividends paid on stocks in the index.
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[GRAPHIC]
FINANCIAL STATEMENTS
OCTOBER 31, 1997
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)
- ----------------------------------------------------------------------
COMMON STOCKS (93.7%)
- ----------------------------------------------------------------------
<S> <C> <C>
AUTO & TRANSPORTATION (15.1%)
- - Atlas Air, Inc. 263,000 $ 7,265
- - Kirby Corp. 388,300 7,669
- - Lear Corp. 150,300 7,224
Polaris Industries, Inc. 212,900 6,480
---------
28,638
---------
CONSUMER DISCRETIONARY (13.5%)
Dillard's Inc. 125,300 4,808
Heilig-Meyers Co. 205,200 2,745
Smith & Nephew PLC 2,253,300 6,584
Sturm, Ruger & Co., Inc. 137,400 2,585
- - Valassis Communications, Inc. 300,600 8,868
---------
25,590
---------
CONSUMER STAPLES (5.4%)
- - Canandaigua Brands, Inc. 206,400 10,243
---------
ENERGY (3.7%)
Vastar Resources, Inc. 175,400 7,082
---------
FINANCIAL SERVICES (6.9%)
- - First Federal Financial Corp. 176,000 6,160
Pacific Century Financial Corp. 137,800 6,942
---------
13,102
---------
HEALTH CARE (6.9%)
- - Coventry Corp. 450,000 6,272
- - Magellan Health Services, Inc. 238,000 6,857
---------
13,129
---------
MATERIALS & PROCESSING (17.8%)
Ferro Corp. 212,900 7,970
H.B. Fuller Co. 137,800 6,442
- - International Specialty
Products, Inc. 423,800 6,331
Quanex Corp. 250,500 6,920
RPM Inc. (Ohio) 325,700 6,107
---------
33,770
---------
PRODUCER DURABLES (19.4%)
Harnischfeger Industries Inc. 175,400 6,906
Raychem Corp. 99,100 8,975
- - Silicon Valley Group, Inc. 339,400 9,673
Snap-On Inc. 144,000 6,192
Stewart & Stevenson
Services, Inc. 235,600 5,124
---------
36,870
---------
TECHNOLOGY (5.0%)
- - Mentor Graphics Corp. 881,800 9,534
---------
- ----------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $156,634) 177,958
- ----------------------------------------------------------------------
FACE
AMOUNT
(000)
- ----------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (7.2%)
- ----------------------------------------------------------------------
Repurchase Agreement
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.66%, 11/3/97
(COST $13,724) $13,724 13,724
- ----------------------------------------------------------------------
TOTAL INVESTMENTS (100.9%)
(COST $170,358) 191,682
- ----------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
MARKET
VALUE*
(000)
- ----------------------------------------------------------------------
<S> <C>
OTHER ASSETS AND LIABILITIES (-0.9%)
- ----------------------------------------------------------------------
Other Assets--Notes C and F $ 2,458
Liabilities--Note F (4,228)
---------
(1,770)
- ----------------------------------------------------------------------
NET ASSETS (100.0%)
- ----------------------------------------------------------------------
Applicable to 14,626,612 outstanding
$.001 par value shares
(authorized 250,000,000 shares) $189,912
======================================================================
NET ASSET VALUE PER SHARE $12.98
======================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
- -Non-Income-Producing Security.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ----------------------------------------------------------------------
<S> <C> <C>
AT OCTOBER 31, 1997, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------------
Paid in Capital $161,259 $11.02
Undistributed Net
Investment Income 543 .04
Accumulated Net Realized Gains 6,786 .46
Unrealized Appreciation--Note E 21,324 1.46
- ----------------------------------------------------------------------
NET ASSETS $189,912 $12.98
======================================================================
</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
YEAR ENDED OCTOBER 31, 1997
(000)
- ----------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 1,300
Interest 454
--------
Total Income 1,754
--------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 517
Performance Adjustment (93)
The Vanguard Group--Note C
Management and Administrative 441
Marketing and Distribution 31
Taxes (other than income taxes) 9
Custodian Fees 11
Auditing Fees 9
Shareholders' Reports 41
Annual Meeting and Proxy Costs 1
--------
Total Expenses 967
- ----------------------------------------------------------------------------------------
NET INVESTMENT INCOME 787
- ----------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 6,810
- ----------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 22,843
- ----------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $30,440
========================================================================================
</TABLE>
12
<PAGE> 15
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Portfolio's total net assets changed during the two
most recent reporting periods. The Operations section summarizes information
that is detailed in the Statement of Operations. The amounts shown as
Distributions to shareholders from the 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
-------------------------------
YEAR ENDED FEB. 15* TO
OCT. 31, 1997 OCT. 31, 1996
(000) (000)
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 787 $ 324
Realized Net Gain 6,810 1,018
Change in Unrealized Appreciation (Depreciation) 22,843 (1,519)
-------------------------------
Net Increase (Decrease) in Net Assets Resulting from Operations 30,440 (177)
-------------------------------
DISTRIBUTIONS
Net Investment Income (568) --
Realized Capital Gain (1,042) --
-------------------------------
Total Distributions (1,610) --
-------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 106,636 108,104
Issued in Lieu of Cash Distributions 1,544 --
Redeemed (39,764) (15,361)
-------------------------------
Net Increase from Capital Share Transactions 68,416 92,743
- -------------------------------------------------------------------------------------------------------------------
Total Increase 97,246 92,566
- -------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period--Note G 92,666 100
-------------------------------
End of Period $ 189,912 $ 92,666
===================================================================================================================
(1)Shares Issued (Redeemed)
Issued 8,742 10,732
Issued in Lieu of Cash Distributions 143 --
Redeemed (3,458) (1,542)
-------------------------------
Net Increase in Shares Outstanding 5,427 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. These data will help you assess: the variability of the Portfolio's net
income and total returns from year to year; the relative contributions of net
income and capital gains to the Portfolio's total return; how much it costs to
operate the Portfolio; and the extent to which the Portfolio tends to distribute
capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in the
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
-------------------------------
YEAR ENDED FEB. 15* TO
FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD OCT. 31, 1997 OCT. 31, 1996
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $10.07 $10.00
- ----------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .06 .04
Net Realized and Unrealized Gain (Loss) on Investments 3.02 .03
-------------------------------
Total from Investment Operations 3.08 .07
-------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.06) --
Distributions from Realized Capital Gains (.11) --
-------------------------------
Total Distributions (.17) --
- ----------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $12.98 $10.07
====================================================================================================
TOTAL RETURN 30.92% 0.70%
====================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $190 $93
Ratio of Total Expenses to Average Net Assets 0.74% 0.75%**
Ratio of Net Investment Income to Average Net Assets 0.60% 0.75%**
Portfolio Turnover Rate 32% 25%
Average Commission Rate Paid $.0569 $.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 to 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 continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. REPURCHASE AGREEMENTS: The 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. Barrow, Hanley, Mewhinney & Strauss, Inc., provides investment advisory
services to the Portfolio for a fee calculated at an annual percentage rate of
average net assets. The basic fee is subject to quarterly adjustments based on
performance relative to the Russell Midcap Index. For the year ended October 31,
1997, the advisory fee represented an effective annual basic rate of 0.40% of
the Portfolio's average net assets before a decrease of $93,000 (an annual rate
of 0.07%) based on performance.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the Portfolio under methods approved by the Board of Directors. At October
31, 1997, the Portfolio had contributed capital of $13,000 to Vanguard (included
in Other Assets), representing 0.06% of Vanguard's capitalization. The
Portfolio's Directors and officers are also Directors and officers of Vanguard.
D. During the year ended October 31, 1997, the Portfolio purchased $99,919,000
of investment securities and sold $39,176,000 of investment securities, other
than temporary cash investments.
E. At October 31, 1997, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $21,324,000,
consisting of unrealized gains of $23,475,000 on securities that had risen in
value since their purchase and $2,151,000 in unrealized losses on securities
that had fallen in value since their purchase.
F. The market value of securities on loan to broker/dealers at October 31,
1997, was $1,762,000, for which the Portfolio was fully collateralized.
G. 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
[GRAPHIC]
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, 1997, the
results of its operations for the year then ended, and the changes in its net
assets and the financial highlights for the year then ended and 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 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 at October
31, 1997 by correspondence with the custodian and the application of alternative
auditing procedures where securities purchased had not been settled, provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
December 3, 1997
SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR VANGUARD SELECTED VALUE PORTFOLIO
This information for the fiscal year ended October 31, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Portfolio designates $3,444,000 as capital gain dividends (from net
long-term capital gains), all of which is designated as a 20% rate gain
distribution, which will be distributed in December 1997.
For corporate shareholders, 27.5% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
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.
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.; Managing Director
of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun
Company, Inc., and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions, Inc.,
Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance Co., and
Ladies Professional Golf Association; Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
BURTON G. MALKIEL
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Amdahl Corp., Baker Fentress & Co., The
Jeffrey Co., and Southern New England Telecommunications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., and
NACCO Industries.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co., and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND
Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
KAREN E. WEST
Controller; Principal of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM MCNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R),"
and "500" are trademarks of The McGraw-Hill Companies, Inc.
Frank Russell Company is the owner of trademarks and copyrights relating
to the Russell Indexes. "Wilshire 4500" and "Wilshire 5000" are
trademarks of Wilshire Associates.
<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 Growth and Income Portfolio
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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 International Value 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 Treasury Money Market Portfolio
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, NY, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds (CA, FL, NJ, NY, OH, PA)
Q9340-10/97 y (C) 1997 Vanguard Marketing Corporation, Distributor
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
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1-800-523-1036
http://www.vanguard.com
[email protected]
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
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