<PAGE> 1
VANGUARD
WELLESLEY
INCOME FUND
ANNUAL REPORT 1994
THE VANGUARD VOYAGE . . . STAYING THE COURSE
<PAGE> 2
THE VANGUARD VOYAGE. . . STAYING THE COURSE
WE ARE PRESENTLY OBSERVING TWO MILESTONES IN OUR HISTORY: (1) THE 20TH
ANNIVERSARY OF THE VANGUARD GROUP; AND (2) THE 65TH ANNIVERSARY YEAR OF
WELLINGTON FUND, THE OLDEST MUTUAL FUND ASSOCIATED WITH VANGUARD. WE CELEBRATE
THESE TWO EVENTS SINCE THEY HAVE INDELIBLY ALTERED THE MUTUAL FUND INDUSTRY--IN
OUR VIEW, FOR THE BETTER.
Wellington Fund--a pioneer in the mutual fund industry-began operations on June
30, 1929. Its first fifteen years were a struggle for survival in an industry
that was shaken to its roots by the Great Crash of 1929-1933. From an initial
base of $100,000, Wellington's assets had grown to but $27 million by the end
of World War II. The Vanguard Group was founded on September 24, 1974. Soon
thereafter, we assumed responsibility for the management of Wellington Fund and
ten associated funds, with assets aggregating $1.4 billion.
The years that followed the founding of The Vanguard Group were marked
by exceptional growth. Today, Wellington Fund, with assets of nearly $9
billion, remains one of the largest mutual funds in the nation. And Vanguard,
now managing 85 mutual fund portfolios, is entrusted with assets of $134
billion, and ranks as the second largest fund complex in the world.
Our durability in an era of change--and our longevity in an era of
challenge--didn't "just happen." What brought us to where we are today is what
we were when we began. Put another way, we set our original investment course
based on sound principles, and our corporate course based on a single focus:
serving solely the interests of our Fund shareholders.
FOUNDING INVESTMENT PRINCIPLES
The founding investment principles of Wellington Fund were, above all,
conservative. The Fund provided a broadly diversified portfolio at a time when
holding individual securities was the conventional strategy. It incurred no debt
in an era of high leverage that would soon come back to haunt less cautious
investors. And it was a "balanced" fund--in fact, Wellington is America's
oldest balanced fund--with holdings from each of the three basic financial
asset classes: cash reserves, bonds, and common stocks. In short, Wellington
Fund was a staid investment in an era of stock speculation that was to become,
almost within moments, an era of conservatism.
For Vanguard, these investment principles endure. "Balance" is still our
watchword, because the three basic financial asset classes have different--and
usually countervailing--investment characteristics. When it began, Wellington
Fund provided a balanced program in a single investment; in 1994, such a
balance is often achieved by a combination of Vanguard money market, bond, and
stock funds.
"Conservatism," too, remains our standard. Over the years, we have
tried to maintain the discipline to eschew offering funds that lack sound
financial principles, often based on marketplace fads that could not--and did
not--endure. Our conservatism applies not only to the funds we offer, but to
the instruments in which they invest. For example, we have steered clear of
exotic derivative securities with unpredictable investment characteristics.
Too many fund managers have been taken in by these highly risky instruments,
and their shareholders have paid a heavy price--except in cases where the
manager has "made the fund whole," when to do otherwise would have shocked
investors and impaired their confidence in the fund complex.
Speculation, it seems, comes and goes, albeit in different guises. But
the investment principles to which we have adhered since Wellington Fund began
in 1929 remain firm:
* We offer Funds with sound and durable investment objectives, designed
for long-term investors.
(please turn to inside back cover)
VANGUARD/WELLESLEY INCOME FUND SEEKS TO PROVIDE AS MUCH CURRENT INCOME
AS IS CONSISTENT WITH REASONABLE RISK, WHILE ALSO OFFERING THE POTENTIAL FOR
MODERATE CAPITAL GROWTH. NORMALLY, ABOUT 60% OF THE FUND'S ASSETS ARE INVESTED
IN FIXED-INCOME SECURITIES AND 40% IN COMMON STOCKS.
<PAGE> 3
CHAIRMAN'S LETTER
FELLOW SHAREHOLDER:
The year ended December 31, 1994, was a tough period for income funds.
The bond market took something of a drubbing, and the stock market barely held
its own. The results achieved by Wellesley Income Fund were, of course, affected
by these trends, and we closed the year with a return of -4.4%, only our second
negative return in the past twenty years.
This table compares the Fund's total return (capital change plus income)
with those of the two unmanaged indexes of the markets in which we invest: for
stocks, the Standard & Poor's 500 Composite Stock Price Index; and for bonds,
the Lehman Long-Term Corporate Bond Index. A hypothetical portfolio composed of
the two Indexes--reflecting the Fund's typical balance of 65% bonds and 35%
stocks--would have earned a total return of -3.3%, a bit better than the return
of the Fund.
<TABLE>
<CAPTION>
- ----------------------------------------------------------
Total Return
-----------------
Year Ended
December 31, 1994
- ----------------------------------------------------------
<S> <C>
WELLESLEY INCOME FUND -4.4%
- ----------------------------------------------------------
LEHMAN LONG-TERM CORPORATE BOND INDEX -5.8%
STANDARD & POOR'S 500 STOCK INDEX +1.3
- ----------------------------------------------------------
</TABLE>
The Fund's total return is based on net asset values of $19.24 per share on
December 31, 1993, and $17.05 on December 31, 1994, with the latter figure
adjusted to take into account the reinvestment of our four quarterly dividends
totaling $1.11 per share from net investment income and distributions totaling
$.24 per share from net realized capital gains. Wellesley's dividend yield at
year end was 7.1%.
THE FINANCIAL MARKETS IN 1994
Following a twelve-year bull market in bonds--including eight years of
"double-digit" gains--bonds faltered during 1994. The total return on the Lehman
Corporate Bond Index was -5.8% (-13.2% decline in price, partly offset by
interest income of +7.4%), as yields on long-term corporates rose from 7.3% to
8.6%. Yields on short-term and intermediate-term bonds also rose sharply;
however, because of their shorter maturities, price declines were much smaller.
The stock market treated investors more kindly during 1994, although the
rising rate environment was a major factor in dampening stock returns. Equities
encountered significant volatility during the year, but, on balance, the
Standard & Poor's 500 Index eased just a notch lower--from 466 at the outset to
459 at the year's conclusion, a decline of -1.5%. The inclusion of dividend
income of $13 brought the Index's total return into positive territory (+1.3%).
Despite this modest gain in the overall stock market, the returns on
higher-yielding stocks (as distinct from, say, growth stocks) were generally
negative, since their yields must compete directly with the yields available on
bonds.
A primary cause of the year's steep interest rate rise was investor
fears about a resurgence of inflation. So far, at least, the U.S. Consumer Price
Index gives little evidence of it. The CPI has risen just 2.7% over the past
twelve months, although more sensitive indicators--such as commodity prices and
producer prices--have been rising at higher rates.
In an effort to quell inflationary fears, the Federal Reserve acted to
"tighten" the money supply
[FIGURE 1]
<PAGE> 4
[FIGURE 2]
in order to slow economic growth and rein in potential future inflation. Fully
six rate increases--in February, March, April, May, August, and again in
November--combined to raise the Federal funds rate (at which banks borrow from
one another) from 3.00% to 5.50%. Still, the specter of inflation remains, and
further rate increases may well lie in prospect.
To add some perspective to the financial market cross-currents in 1994,
we present the chart above showing the cumulative returns on stocks and bonds
during the past five years--the first half (believe it or not!) of the decade of
the 1990s. Particularly striking is that the average annual total return on
bonds (+8.6%) was virtually identical to the return on stocks (+8.7%). As a
result, despite the "slings and arrows" of 1994, bond-oriented income funds such
as Wellesley gave a good account of themselves in terms of total return during
the five-year period, all the while assuming a lower-risk profile than an
all-stock portfolio.
As 1994 has now made obvious, there are times when bonds carry higher
risks than stocks. Nonetheless, there is some tendency for the two securities
markets to fluctuate independently (1990 was another good example). And it is
this tendency that continues to commend an income fund such as Wellesley as a
particularly suitable investment for long-term investors seeking a combination
of generous current income and the potential for modest capital growth with
reasonable risk.
WELLESLEY INCOME FUND IN 1994
Our total return of -4.4% was, as noted at the outset, a bit less than the
return of -3.3% for our corporate bond/stock index. The biggest factor in
shaping the Fund's return in 1994 was our exposure to interest rate risk. While
this risk exposure was marginally reduced late in 1993 by a selective shortening
of bond maturities, this more conservative position was simply overwhelmed by
the bond market's pervasive decline, and the returns on our bonds were
essentially the same as those on the bond index. On the other hand, our equity
position--designed to produce above-average yields--was heavily invested in some
of the most yield-sensitive securities of the equity market. These stocks
suffered equally with--and in some cases even more than--the bond market.
The best example of this dichotomy can be seen by looking at the returns
achieved by two distinctive market sectors: the utility group, which experienced
a negative total return of -10% for the year, and the technology group, which
enjoyed a positive return of +20%. Utility stocks, of course, provide very high
yields; technology stocks, low yields. Given the Fund's income objective, it had
fully 28% of its equity portfolio in the former group and no representation in
the latter. These two differences alone accounted for 3.5 percentage points of
the 3.6 point shortfall of our equity position relative to the Standard & Poor's
500 Stock Index. (Our equity return of -2.3% compared with +1.3% for the Index.)
The Fund's total return also fell a bit behind the -2.9% return of the
average income-oriented mutual fund, a shortfall of 1.5 percentage points.
However, as we noted last year--when we achieved a positive margin of +2.5
percentage points over our competitors--portfolios of income-oriented funds are
a sort of "mixed bag," and are difficult to evaluate relative to our "plain
vanilla" bond-stock strategy.
2
<PAGE> 5
[FIGURE 3]
<TABLE>
<CAPTION>
Average Annual Total Returns--Periods Ended December 31, 1994
- -------------------------------------------------------------
1 Year 5 Years 10 Years
- -------------------------------------------------------------
<S> <C> <C> <C>
WELLESLEY INCOME FUND -4.44% +8.47% +11.80%
AVERAGE INCOME FUND -2.92 +7.49 + 9.88
COMPOSITE INDEX* -3.29 +8.65 +12.52
LEHMAN BOND INDEX -5.76 +8.57 +11.47
</TABLE>
*Composite Index is 65% Lehman Corporate Bond Index and 35% Standard & Poor's
500 Index.
Note: Past performance is not predictive of future performance.
While other income funds, on average, maintain a bond position similar
to ours (64% and 61% of net assets, respectively), the quality of their bonds is
distinctly lower. We hold no bonds rated below "investment-grade," while the
average income fund holds fully 44% of its bond portfolio in lower-rated or
unrated bonds. Also, other income funds are more inclined to fill out the equity
portion of their portfolios with foreign and smaller capitalization stocks and
convertible bonds.
The strategies of most income funds, then, entail higher risks in bond
quality than we are willing to assume. As a result, it is not surprising that
their portfolios generate higher levels of gross income. Indeed, the average
income fund earns a gross yield of 7.9%, compared with 7.5% for Wellesley.
However, these funds are also much more expensive to hold--average annual
operating expense ratio of 1.06% versus 0.34% for our Fund--giving us a 0.72%
"natural" yield advantage, other factors held equal. As a result, Wellesley's
net yield of 7.1% for 1994 surpassed the competitors' average net yield of 6.9%.
When an investor can obtain a higher net yield on a higher quality portfolio, it
is a proposition worth carefully considering.
I should mention that I have already received letters from shareholders
asking why Wellesley Income Fund didn't simply replace its long-term bonds with
those of the short-term variety, and replace its utility stocks with technology
stocks. The answers are really two: 1) such a strategy would have been
inconsistent with the Fund's stated policies and objectives and, what is more,
would have reduced the Fund's dividend income by something like 40%; and 2)
hindsight, it is said, is "always 20/20," and forecasting the events of 1994
accurately and in advance is, in truth, beyond the ability of experienced and
amateur investors alike. There is no "bell" that rings to signal a coming
deterioration in the short-term market climate, nor, for that matter, is there a
bell that signals a coming improvement.
(continued)
3
<PAGE> 6
A TEN-YEAR REVIEW
It seems to me that investors should give only limited weight to a mutual fund's
results in any single year. And I would regard the modest shortfall in Wellesley
Income Fund's performance in 1994 as merely a "blip" in our remarkable long-term
record of success.
Relative to competitive funds, the record of Wellesley Income Fund is
clearly a superior one, as shown by the cumulative returns presented in the
chart on page 3. To summarize, during the past decade, our average annual total
return was +11.8%, compared with +9.9% for the average income fund. If that
annual margin sounds small, I assure you that, compounded over a decade, it is
anything but!
This summary table compares the ten-year results assuming an investment
of $10,000 on December 31, 1984, in both Wellesley Income Fund and the average
income fund, with all dividends and capital gains reinvested. On December 31,
1994, the investor in Wellesley Income Fund would have accumulated $30,520; the
investor in the average income fund, $25,650. This $4,870 of extra performance
is equivalent to 49%(!) of the initial $10,000 investment.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
Total Return
------------------------------------
Ten Years Ended December 31, 1994
------------------------------------
Annual Rate Final Value of Initial
of Return Investment of $10,000
- -------------------------------------------------------------------
<S> <C> <C>
WELLESLEY INCOME FUND +11.8% $30,520
AVERAGE INCOME FUND + 9.9 25,650
- -------------------------------------------------------------------
WELLESLEY ADVANTAGE + 1.9% $ 4,870
- -------------------------------------------------------------------
</TABLE>
It should go without saying that the returns reflected in the table are merely
history. The Fund's future returns--both on an absolute basis and relative to
our peer group--are unpredictable, and may be better or worse than those
illustrated.
I acknowledge that the chart on page 3 also reflects the shortfall
(averaging -0.7% annually) that Wellesley Income Fund has experienced relative
to our "composite index," comprising 65% bonds and 35% stocks. The most
important reason for this differential is that the Standard & Poor's 500 Index
includes both growth stocks and income stocks. However, given our basic
objectives, the Fund's equity position is limited to income stocks. Since the
returns on growth stocks were well above those earned on income-oriented stocks
during the past decade, we were distinctly disadvantaged relative to the Index.
I should also add that the bond and stock market indexes represent
very tough "bogeys" for all mutual funds to match. Market indexes are
theoretical constructs, operating in a "paper world" and completely free of the
"real world" expenses of fund operations, advisory fees, portfolio transaction
costs, and the "drag" of cash reserves. Of course, Wellesley's costs are
remarkably low, in part because we have negotiated sensibly low advisory fees
(about 0.07% of assets in 1994) with Wellington Management Company, and in part
because of the "at-cost" structure under which The Vanguard Group operates.
Given these low costs, our objective remains to outpace a similarly constructed
composite index over the long term.
IN SUMMARY
In my Chairman's letter one year ago, I called your special attention to the
fact that "all income funds . . . entail exposure to interest rate risk. That is
to say, both higher-yielding stocks and longer-term bonds have significant price
sensitivity to changes in interest rates. This sensitivity `paid off' for
Wellesley Income Fund in 1993, as rates fell sharply; but you should not ignore
the possibility--even, perhaps, the likelihood--of some retracement in interest
rates, and the commensurately negative impact on the Fund."
That situation, of course, is precisely what came to pass during 1994.
While it simply is not possible--for anyone--to accurately forecast the future
course of interest rates, I believe that with rates having risen so sharply over
the past year, the probabilities now favor better total returns for bonds in the
coming year. (There are no guarantees!)
Whatever the case may be, the Fund's return in 1994 should not unduly
disturb the shareholder who is holding Wellesley Income Fund for the long haul.
If our record since we began operations in 1970 proves anything, it surely
proves that the Fund has been a reliable and productive investment for long-term
investors who can (as they inevitably must) take short-term disappointments in
stride.
4
<PAGE> 7
So, we suggest that the best strategy for shareholders is to "stay the
course," come what may in the financial markets. For our part, we assure you
that we, too, will stay the course, holding fast to the conservative investment
principles and income orientation that have served our shareholders so well over
nearly a quarter century.
Sincerely,
/s/ JOHN C. BOGLE
- -----------------
John C. Bogle
Chairman of the Board
January 16, 1995
AVERAGE ANNUAL TOTAL RETURNS--THE CURRENT YIELD QUOTED IN THE CHAIRMAN'S
LETTER IS CALCULATED IN ACCORDANCE WITH SEC GUIDELINES. THE AVERAGE ANNUAL TOTAL
RETURNS FOR THE FUND (PERIODS ENDED DECEMBER 31, 1994) ARE AS FOLLOWS:
<TABLE>
<CAPTION>
10 YEARS
-----------------------------
INCEPTION TOTAL INCOME CAPITAL
DATE 1 YEAR 5 YEARS RETURN RETURN RETURN
--------- ------ ------- ------ -------- -------
<S> <C> <C> <C> <C> <C> <C>
WELLESLEY INCOME FUND 7/1/70 -4.44% +8.47% +11.80% +7.98% +3.82%
</TABLE>
ALL OF THESE DATA REPRESENT PAST PERFORMANCE. THE INVESTMENT RETURN AND
PRINCIPAL VALUE OF AN INVESTMENT WILL FLUCTUATE SO THAT AN INVESTOR'S SHARES,
WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
5
<PAGE> 8
TOTAL INVESTMENT RETURN TABLE
The following table illustrates the results of a single share investment in
VANGUARD/WELLESLEY INCOME FUND since inception through December 31, 1994. During
the period illustrated, stock and bond prices fluctuated widely; these results
should not be considered a representation of the dividend income or capital gain
or loss that may be realized from an investment made in the Fund today.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
PERIOD PER SHARE DATA TOTAL INVESTMENT RETURN*
- ------------------------------------------------------------------------------------------------------------------------------------
Wellesley Income Fund Composite
Value With Income ----------------------------- Stock/Bond
Year Ended Net Asset Capital Gains Income Dividends & Capital Capital Income Total Index**
December 31 Value Distributions Dividends Gains Reinvested Return Return Return Total Return
<S> <C> <C> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------------
INITIAL (7/70) $11.66 -- -- $ 11.66 -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
1970 12.03 -- $ .46 12.49 + 3.2% + 3.9% + 7.1% +10.6%
- ------------------------------------------------------------------------------------------------------------------------------------
1971 12.56 $.38 .85 14.37 + 7.6 + 7.4 +15.0 +12.1
- ------------------------------------------------------------------------------------------------------------------------------------
1972 12.66 .26 .82 15.77 + 2.9 + 6.8 + 9.7 +11.4
- ------------------------------------------------------------------------------------------------------------------------------------
1973 11.40 -- .83 15.22 -10.0 + 6.5 - 3.5 - 4.4
- ------------------------------------------------------------------------------------------------------------------------------------
1974 9.84 -- .82 14.24 -13.7 + 7.3 - 6.4 -14.2
- ------------------------------------------------------------------------------------------------------------------------------------
1975 10.69 -- .82 16.73 + 8.6 + 8.9 +17.5 +24.4
- ------------------------------------------------------------------------------------------------------------------------------------
1976 12.23 -- .88 20.62 +14.4 + 8.9 +23.3 +22.0
- ------------------------------------------------------------------------------------------------------------------------------------
1977 11.81 -- .93 21.50 - 3.4 + 7.7 + 4.3 - 0.8
- ------------------------------------------------------------------------------------------------------------------------------------
1978 11.27 -- .96 22.28 - 4.6 + 8.2 + 3.6 + 2.2
- ------------------------------------------------------------------------------------------------------------------------------------
1979 10.98 -- 1.00 23.66 - 2.6 + 8.8 + 6.2 + 3.8
- ------------------------------------------------------------------------------------------------------------------------------------
1980 11.08 -- 1.14 26.47 + 0.9 +11.0 +11.9 + 9.7
- ------------------------------------------------------------------------------------------------------------------------------------
1981 10.74 -- 1.25 28.76 - 3.1 +11.8 + 8.7 - 1.8
- ------------------------------------------------------------------------------------------------------------------------------------
1982 11.82 -- 1.26 35.46 +10.1 +13.2 +23.3 +36.5
- ------------------------------------------------------------------------------------------------------------------------------------
1983 12.66 -- 1.31 42.06 + 7.1 +11.5 +18.6 +13.3
- ------------------------------------------------------------------------------------------------------------------------------------
1984 13.28 -- 1.37 49.06 + 4.9 +11.7 +16.6 +13.6
- ------------------------------------------------------------------------------------------------------------------------------------
1985 15.31 .10 1.38 62.51 +16.0 +11.4 +27.4 +29.3
- ------------------------------------------------------------------------------------------------------------------------------------
1986 16.27 .47 1.33 73.97 + 9.2 + 9.1 +18.3 +18.7
- ------------------------------------------------------------------------------------------------------------------------------------
1987 14.57 .38 1.04 72.55 - 8.1 + 6.2 - 1.9 + 2.8
- ------------------------------------------------------------------------------------------------------------------------------------
1988 15.26 -- 1.23 82.42 + 4.7 + 8.9 +13.6 +12.6
- ------------------------------------------------------------------------------------------------------------------------------------
1989 16.82 .24 1.31 99.67 +11.8 + 9.1 +20.9 +21.0
- ------------------------------------------------------------------------------------------------------------------------------------
1990 16.02 .08 1.30 103.42 - 4.3 + 8.1 + 3.8 + 3.1
- ------------------------------------------------------------------------------------------------------------------------------------
1991 18.08 -- 1.27 125.73 +12.9 + 8.7 +21.6 +24.3
- ------------------------------------------------------------------------------------------------------------------------------------
1992 18.16 .21 1.21 136.63 + 1.6 + 7.1 + 8.7 + 8.7
- ------------------------------------------------------------------------------------------------------------------------------------
1993 19.24 .40 1.14 156.65 + 8.2 + 6.4 +14.6 +12.4
- ------------------------------------------------------------------------------------------------------------------------------------
1994 17.05 .24 1.11 149.69 -10.2 + 5.8 - 4.4 - 3.3
- ------------------------------------------------------------------------------------------------------------------------------------
LIFETIME +1,184.1% +1,014.4%
- ------------------------------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURN +11.0% +10.3%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Adjusted to include reinvestment of income dividends and any capital gains
distributions for both the Fund and the Index.
**Composite index shown for comparative purposes is comprised of the Standard &
Poor's 500 Stock Index (35%) and Salomon Brothers High-Grade Bond Index (65%)
from June 30, 1970, through December 31, 1972, and Standard & Poor's 500 Stock
Index (35%) and Lehman Long-Term Corporate Bond Index (65%) thereafter.
Note: No adjustment has been made for income taxes payable by shareholders on
reinvested income dividends and capital gains distributions.
6
<PAGE> 9
REPORT FROM THE INVESTMENT ADVISER
In 1994, the Federal Reserve Board raised short-term interest rates six times
beginning in early February. One-year Treasury bill rates rose by more than 3.5
percentage points, while thirty-year Treasury bond yields increased by 1.5
percentage points. Because of this large increase in interest rates, Wellesley
Income Fund's total return (reflecting both the change in net asset value and
the distributions to shareholders) was negative for the calendar year, marking
only the second time in twenty years that this has occurred.
The performance of Wellesley Income Fund remains extremely sensitive to
the general direction of long-term interest rates. This is due largely to the
long average maturity of the Fund's bonds combined with our meaningful weighting
in high-yielding, interest- rate-sensitive stocks. Both the bond and stock
segments of the Wellesley portfolio had negative returns in 1994.
During 1994, the Fund maintained its traditional posture of 60% to 65%
of assets invested in longer-term bonds of investment-grade quality, and 35% to
40% of assets invested in dividend-paying equities. We do not anticipate a
change in that strategy going forward.
INVESTMENT OUTLOOK FOR 1995
The U.S. economy is still strong enough that we expect the Federal Reserve to
continue to raise short-term rates. We expect some moderation in economic growth
in 1995; however, we do expect inflation to rise moderately, as is typical in
the year following a peak in economic activity. We are forecasting that both GDP
growth and inflation will be above 3% for 1995.
Federal Reserve monetary policy and government fiscal policy are mapping
a course which is maintaining a balance between sustainable economic growth and
fairly stable prices, both of which we are currently experiencing. The markets
must be convinced that the Fed is committed to controlling inflation before
long-term interest rates will stabilize. We believe this will happen; thus, we
expect that long-term interest rates will remain in a trading range around the
current level of 8%.
We are cautious about the prospects for the stock market in 1995. The
stock market is in a race between higher earnings and higher interest rates.
Higher corporate earnings are currently supporting stock market valuations;
however, the rise in short-term interest rates threatens earnings growth, and,
at some level of short-term rates, stock prices will become vulnerable.
STRATEGY IN 1995
Our strategy remains consistent with that of previous years, despite the
performance decline we have experienced. The dominant theme guiding the
investment strategy for Wellesley Income Fund is our ongoing obligation to
shareholders to achieve an attractive absolute level of income with high-quality
securities. Our long-term goal is to achieve increases in Wellesley's dividend
by purchasing stocks of strong companies that are able to pass onto shareholders
higher dividends generated from rising earnings spurred by successful business
strategies. Since we wrote to you six months ago, the equity portfolio has had
19 companies announce dividend increases. We avoid investments in bonds rated
below investment-grade and in stocks with ultra-high dividends which may not be
sustainable over the longer term.
After experiencing a "correction" that endured for five quarters,
utility stocks, many of which have declined in value by more than 30% from their
peaks in September 1993, are now modestly attractive on a relative valuation
basis. Based on this cautiously optimistic view of utility stocks, we were net
buyers of utilities for the first time in over two years. Wellesley's utility
holdings increased to 28% of total fund equities from 27% at the end of June
1994.
Another sector that we added to significantly was the energy sector.
This sector has come under pressure as short-term commodity price weakness has
masked an improving long-term fundamental picture. Rising global economic growth
is causing an increase in demand for both oil and gas. While there are enough
uncertainties in the near term (e.g., Iraq's inevitable return to the world
markets) to keep us from quickly building our overweighting, we will continue to
add to our positions on further market weakness.
The majority of Wellesley's stocks are New York Stock Exchange-listed
issues and generally have above-average yields. The average yield on our stocks
7
<PAGE> 10
is currently 80% higher than the yield on the average stock in the marketplace.
Our primary focus is securities of U.S.-based companies, so we are pleased that,
given the devaluation of the peso, we did not own stocks or bonds of any Mexican
companies.
The Fund's bond portfolio will continue to have a long average maturity
and excellent call protection, which should lend sustainability to the Fund's
income stream, even though these bonds are subject to price fluctuations in the
short-term. Our bond holdings currently have an average maturity of 16 years, an
average coupon of 7.3%, and an average quality rating of "Aa." Eighty-eight
percent of the bond portfolio's assets are rated "A" or better. Over the long
term, we believe that high-quality, long-term bonds with call protection will
provide reasonably attractive real returns.
SUMMARY
Following the large increase in rates last year (and thus the Fund's negative
total return), we believe that 1995 will be more positive for shareholders
primarily because we expect long-term interest rates to stabilize in coming
months. The same investment disciplines utilized for Wellesley Income Fund over
the past two decades will continue to be followed in 1995.
We have the utmost confidence in the Fund's consistent investment
approach, which stresses securities of high-quality companies with attractive
yields. Over the long term, shareholders should achieve satisfactory rewards as
long as inflation is reasonably contained and long-term interest rates do not
rise sharply.
Respectfully,
Earl E. McEvoy
Senior Vice President
John R. Ryan
Senior Vice President
Wellington Management Company
January 11, 1995
8
<PAGE> 11
FINANCIAL STATEMENTS
December 31, 1994
STATEMENT OF NET ASSETS
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- ------------------------------------------------------
<S> <C> <C>
CORPORATE BONDS (39.9%)
- ------------------------------------------------------
ASSET-BACKED SECURITIES (2.0%)
American Express Trust
7.15%, 8/15/99 $25,000 $ 24,051
Discover Card
6.25%, 8/16/00 20,000 18,900
6.80%, 6/16/00 25,000 24,078
General Motors Acceptance Corp.
6.30%, 6/15/99 31,316 30,591
NationsBank Corp.
6.00%, 12/15/05 20,000 17,187
---------
GROUP TOTAL 114,807
---------
- ------------------------------------------------------
BANKS & FINANCE (9.0%)
Allstate Corp.
7.50%, 6/15/13 20,000 17,293
BankAmerica Corp.
7.50%, 10/15/02 10,000 9,347
Bank of Boston
6.625%, 12/1/05 15,000 12,645
6.875%, 7/15/03 15,000 13,340
Bank of New York
7.875%, 11/15/02 15,000 14,329
Boatmen's Banchares, Inc.
7.625%, 10/1/04 10,000 9,367
British Telecom Finance
9.625%, 2/15/19 5,000 5,270
Chase Manhattan Corp.
6.50%, 8/1/05 15,000 12,662
Chemical Bank
8.625%, 5/1/02 20,000 19,986
Comerica, Inc.
7.125%, 12/1/13 15,000 12,779
8.375%, 7/15/24 5,000 4,646
CoreStates Capital
6.625%, 3/15/05 20,000 17,081
First Bank System
6.625%, 5/15/03 10,000 8,853
First Chicago Corp.
6.375%, 1/30/09 5,000 4,007
7.625%, 1/15/03 15,000 14,117
First Union Corp.
6.00%, 10/30/08 15,000 11,513
Fleet Financial Group
6.875%, 3/1/03 30,000 26,808
7.625%, 12/1/99 15,000 14,494
Ford Motor Credit Corp.
5.625%, 12/15/98 20,000 18,109
General Motors Acceptance Corp.
7.00%, 9/15/02 30,000 26,841
International Bank for
Reconstruction & Development
8.25%, 9/1/16 15,000 14,851
8.625%, 10/15/16 20,000 20,405
J. P. Morgan & Co., Inc.
5.75%, 10/15/08 20,000 15,416
6.25%, 1/15/09 20,000 16,390
Morgan Guaranty Trust
7.375%, 2/1/02 20,000 18,888
NBD Bank
6.25%, 8/15/03 20,000 17,264
National City Cleveland Bank
6.50%, 5/1/03 10,000 8,810
NationsBank Corp.
7.75%, 8/15/04 15,000 14,088
Norwest Corp.
6.00%, 3/15/00 15,000 13,534
6.65%, 10/15/23 10,000 7,861
Norwest Financial Corp.
7.95%, 5/15/02 10,000 9,737
Republic New York Corp.
5.875%, 10/15/08 15,000 11,611
State Street Bank & Trust Co.
5.95%, 9/15/03 5,000 4,221
Suntrust Banks
6.125%, 2/15/04 20,000 17,059
7.375%, 7/1/02 16,000 15,086
Wachovia Corp.
6.375%, 4/15/03 20,000 17,500
Wells Fargo & Co.
6.125%, 11/1/03 15,000 12,716
---------
GROUP TOTAL 508,924
---------
- ------------------------------------------------------
INDUSTRIAL (13.0%)
Alcan Aluminium Ltd.
9.625%, 7/15/19 7,000 7,139
Aluminum Co. of America
5.75%, 2/1/01 20,000 17,617
Amoco Canada Petroleum Co.
6.75%, 9/1/23 25,000 20,171
Archer-Daniels-Midland
8.375%, 4/15/17 5,000 4,962
Bristol-Meyers Squibb Co.
7.15%, 6/15/23 25,000 21,813
British Petroleum Co.
7.875%, 5/15/02 20,000 19,552
Burlington Resources
7.15%, 5/1/99 10,000 9,567
Chevron Corp.
9.375%, 6/1/16 10,000 10,328
</TABLE>
9
<PAGE> 12
STATEMENT OF NET ASSETS (continued)
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- -------------------------------------------------------
<S> <C> <C>
Coastal Corp.
8.125%, 9/15/02 $10,000 $ 9,457
9.75%, 8/1/03 11,275 11,700
10.00%, 2/1/01 27,000 27,998
Coca-Cola Co.
6.00%, 7/15/03 10,000 8,657
Coca-Cola Enterprises, Inc.
7.875%, 2/1/02 10,000 9,732
Crown Cork & Seal Co., Inc.
8.00%, 4/15/23 15,000 13,513
E.I. du Pont de Nemours & Co.
8.125%, 3/15/04 9,900 9,835
8.25%, 1/15/22 30,000 28,848
Eastman Chemical
7.25%, 1/15/24 25,000 20,761
Eaton Corp.
7.625%, 4/1/24 10,000 8,895
Enron Corp.
7.00%, 8/15/23 10,000 7,982
Ford Motor Co.
8.875%, 1/15/22 10,000 10,099
General Motors Corp.
9.40%, 7/15/21 20,000 20,764
Georgia Pacific Corp.
9.50%, 5/15/22 10,000 10,028
Gillette Co.
5.75%, 10/15/05 20,000 16,632
6.25%, 8/15/03 10,000 8,771
International Paper Co.
7.625%, 1/15/07 15,000 13,997
Johnson & Johnson
6.73%, 11/15/23 20,000 16,450
Johnson Controls
8.20%, 6/15/24 6,000 5,624
Knight-Ridder, Inc.
8.50%, 9/1/01 10,000 9,979
Lockheed Corp.
6.75%, 3/15/03 7,000 6,202
McDonalds Corp.
7.375%, 7/15/33 7,500 6,474
Mobil Corp.
8.625%, 8/15/21 20,000 20,326
9.17%, 2/29/00 7,353 7,515
Monsanto Co.
6.00%, 7/1/00 18,750 16,646
8.13%, 12/15/06 5,000 4,843
Northrop-Grumman
9.375%, 10/15/24 15,000 14,859
PPG Industries, Inc.
9.00%, 5/1/21 10,000 10,339
J.C. Penney Co., Inc.
9.75%, 6/15/21 20,000 21,569
Philips Electronics
7.75%, 4/15/04 10,000 9,429
Phillips Petroleum Co.
9.375%, 2/15/11 10,000 10,428
Praxair Inc.
6.75%, 3/1/03 25,000 22,254
Procter & Gamble Co.
9.36%, 1/1/21 30,000 32,364
Rohm & Haas Co.
9.80%, 4/15/20 10,000 11,128
Shell Oil Co.
6.625%, 7/1/99 15,000 14,178
Tele-Communications, Inc.
9.25%, 1/15/23 20,000 18,136
Tenneco, Inc.
7.875%, 10/1/02 20,000 19,007
Texaco, Inc.
8.625%, 4/1/32 30,000 29,817
United Parcel Service
8.375%, 4/1/20 10,000 10,025
Unocal Corp.
8.75%, 8/15/01 10,000 10,104
WMX Technologies
6.375%, 12/1/03 20,000 17,423
Wal-Mart Stores Inc.
5.875%, 10/15/05 25,000 20,542
6.50%, 6/1/03 10,000 8,862
Whirlpool Corp.
9.00%, 3/1/03 10,000 10,283
Witco Chemical Corp.
6.60%, 4/1/03 5,000 4,479
---------
GROUP TOTAL 738,103
---------
- -------------------------------------------------------
TRANSPORTATION (.3%)
AMR Corp. Cvt.
6.125%, 11/1/24 8,200 6,560
Hertz Corp.
6.00%, 2/1/01 15,000 13,245
---------
GROUP TOTAL 19,805
---------
- -------------------------------------------------------
UTILITY (15.6%)
AT&T Corp.
6.75%, 4/1/04 10,000 9,022
7.125%, 1/15/02 33,750 31,846
8.625%, 12/1/31 40,000 39,111
Arizona Public Service Co.
6.625%, 3/1/04 10,000 8,729
9.50%, 4/15/21 10,000 10,191
Baltimore Gas & Electric Co.
7.25%, 7/1/02 15,000 14,037
8.375%, 8/15/01 10,000 10,024
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- -------------------------------------------------------
<S> <C> <C>
BellSouth Telecommunications
6.25%, 5/15/03 $12,000 $10,587
8.25%, 7/1/32 35,000 32,940
Carolina Power & Light Co.
6.875%, 8/15/23 10,000 8,025
Carolina Telephone &
Telegraph Co.
5.75%, 8/15/00 5,000 4,426
Central Illinois Public Service
6.375%, 4/1/03 4,000 3,559
Chesapeake & Potomac
Telephone Co., MD
7.15%, 5/1/23 20,000 17,180
Chesapeake & Potomac
Telephone Co., VA
7.875%, 1/15/22 15,000 14,488
Commonwealth Edison Co.
7.00%, 7/1/05 10,000 8,689
7.375%, 9/15/02 15,000 13,782
Consolidated Edison Co.
6.375%, 4/1/03 20,000 17,653
Duke Power Co.
5.875%, 6/1/01 16,900 14,852
7.00%, 7/1/33 10,000 8,195
Florida Power & Light Co.
5.375%, 4/1/00 12,500 11,008
GTE Florida Inc.
6.31%, 12/15/02 20,000 17,725
Houston Lighting & Power Co.
7.50%, 7/1/23 20,000 17,319
Illinois Bell Telephone Co.
6.625%, 2/1/25 10,000 8,021
7.25%, 3/15/24 20,000 16,962
Illinois Power Co.
5.625%, 4/15/00 10,000 8,776
6.50%, 8/1/03 10,000 8,759
7.50%, 7/15/25 10,000 8,330
Iowa-Illinois Gas & Electric Co.
6.95%, 10/15/25 5,000 4,063
Kansas Gas & Electric Co.
6.50%, 8/1/05 6,500 5,595
Kentucky Utilities
7.92%, 5/15/07 5,000 4,789
MCI Communications Corp.
7.125%, 1/20/00 15,000 14,282
7.50%, 8/20/04 15,000 14,209
Michigan Bell Telephone Co.
7.50%, 2/15/23 35,000 31,575
Michigan Consolidated Gas
8.25%, 5/1/14 3,200 3,134
Mountain States Telephone Co.
9.50%, 5/1/00 1,500 1,572
New England Telephone Co.
6.875%, 10/1/23 15,000 12,271
9.00%, 8/1/31 10,000 10,130
New Jersey Bell Telephone Co.
8.00%, 6/1/22 35,000 33,366
New York Telephone Co.
6.50%, 3/1/05 30,000 26,036
Niagara Mohawk Power Co.
6.875%, 3/1/01 8,500 7,529
6.875%, 4/1/03 8,000 6,869
Northern States Power Co.
6.375%, 4/1/03 8,000 7,105
Ohio Bell Telephone Co.
6.125%, 5/15/03 15,000 13,180
Pacific Bell Telephone Co.
7.00%, 7/15/04 5,000 4,577
7.125%, 3/15/26 25,000 20,851
7.25%, 7/1/02 10,000 9,413
Pacific Gas & Electric Co.
8.25%, 11/1/22 25,000 23,483
8.875%, 7/1/24 10,000 9,945
PECO Energy Corp.
6.50%, 5/1/03 30,000 26,349
Pennsylvania Power & Light Co.
6.50%, 4/1/05 15,000 12,952
6.75%, 10/1/23 9,000 7,133
Public Service Co. of Colorado
7.25%, 1/1/24 10,000 8,446
Southern California Edison Co.
6.25%, 6/15/03 6,050 5,300
8.875%, 6/1/24 10,000 9,701
Southern California Gas Co.
6.875%, 11/1/25 15,000 12,121
Southwestern Bell Telephone Co.
7.25%, 7/15/25 15,000 12,729
Southwestern Public Service Co.
7.25%, 7/15/04 10,000 9,272
8.20%, 12/1/22 10,000 9,487
Texas Utilities Co.
6.75%, 7/1/05 10,000 8,755
8.00%, 6/1/02 10,000 9,558
9.75%, 5/1/21 10,000 10,385
Union Electric Co.
6.75%, 10/15/99 7,250 6,798
6.875%, 8/1/04 10,000 9,118
U.S. West Communications
7.50%, 6/15/23 45,000 39,087
Virginia Electric & Power Co.
5.875%, 4/1/00 13,000 11,684
6.00%, 8/1/02 10,000 8,702
6.75%, 10/1/23 20,000 16,169
</TABLE>
11
<PAGE> 14
STATEMENT OF NET ASSETS (continued)
<TABLE>
<CAPTION>
Face Market
Amount Value
(000) (000)+
- -------------------------------------------------------
<S> <C> <C>
Wisconsin Gas Co.
6.60%, 9/15/13 $ 2,500 $ 2,094
Wisconsin Public Service Co.
7.30%, 10/1/02 5,000 4,698
8.80%, 9/1/21 5,000 5,000
-----------
GROUP TOTAL 883,748
-----------
- -------------------------------------------------------
TOTAL CORPORATE BONDS
(Cost $2,480,708) 2,265,387
- -------------------------------------------------------
U.S. GOVERNMENT & AGENCY
OBLIGATIONS (20.9%)
- -------------------------------------------------------
Federal Home Loan Mortgage
Corp.
8.14%, 9/29/04 25,000 24,306
Federal National Mortgage Assn.
6.00%, 9/1/01 1,306 1,255
6.625%, 4/10/03 25,000 22,516
7.00%, 12/1/07-1/1/08 22,868 21,654
7.50%, 6/1/19-1/1/23 7,662 7,233
8.50%, 12/1/97-3/1/98 1,554 1,558
Government National Mortgage
Assn.
6.50%, 6/15/08-12/15/24 392,326 341,765
7.00%, 4/15/17-5/15/24 129,492 117,028
7.50%, 5/15/16-8/15/22 61,777 58,057
8.00%, 3/15/02-6/15/22 29,693 28,875
Tennessee Valley Authority
6.125%, 7/15/03 16,400 14,319
7.75%, 12/15/22 25,000 23,252
8.625%, 11/15/29 40,000 39,691
U.S. Treasury Bonds
7.125%, 2/15/23 100,000 91,000
7.25%, 5/15/16 225,000 208,055
8.125%, 8/15/19 100,000 101,328
U.S. Treasury Note
5.75%, 8/15/03 100,000 86,906
- -------------------------------------------------------
TOTAL U.S. GOVERNMENT & AGENCY
OBLIGATIONS
(Cost $1,260,004) 1,188,798
- -------------------------------------------------------
<CAPTION>
Market
Value
Shares (000)+
- -------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (36.3%)
- -------------------------------------------------------
CONSUMER (1.6%)
Flowers Industries, Inc. 1,639,400 $ 29,714
Kimberly-Clark Corp. 730,000 36,865
Universal Corp. 1,159,600 23,047
---------
GROUP TOTAL 89,626
---------
- -------------------------------------------------------
ENERGY (6.8%)
Atlantic Richfield Co. 518,000 52,707
Chevron Corp. 600,000 26,775
Dresser Industries, Inc. 683,200 12,895
Exxon Corp. 467,700 28,413
Mobil Corp. 886,900 74,721
Royal Dutch Petroleum Co. 659,500 70,896
Sun Co., Inc. 504,100 14,493
Texaco, Inc. 1,404,200 84,076
USX-Marathon Group 1,429,000 23,400
---------
GROUP TOTAL 388,376
---------
- -------------------------------------------------------
FINANCE (7.6%)
Aetna Life & Casualty Co. 139,500 6,574
Banc One Corp. 600,000 15,225
BankAmerica 1,540,000 60,830
Bankers Trust New York Corp. 1,026,500 56,842
Boatmen's Bancshares, Inc. 1,454,000 39,440
Comerica, Inc. 489,000 11,919
CoreStates Financial Corp. 3,208,600 83,424
First Security Corp. 267,000 6,074
First Union Corp. 486,200 20,116
Keycorp 2,029,050 50,726
J.P. Morgan & Co., Inc. 819,644 45,900
PNC Bank Corp. 1,656,800 35,000
---------
GROUP TOTAL 432,070
---------
- -------------------------------------------------------
HEALTHCARE (1.6%)
Baxter International, Inc. 845,200 23,877
Bristol-Myers Squibb Co. 877,000 50,756
Upjohn Co. 553,000 17,005
---------
GROUP TOTAL 91,638
---------
- -------------------------------------------------------
INDUSTRIAL (4.2%)
Dow Chemical Co. 347,000 23,336
E.I. du Pont de Nemours & Co. 1,004,400 56,498
Eastman Kodak Co. 604,800 28,879
Ford Motor Co. 200,000 5,600
Minnesota Mining
& Manufacturing Co. 536,400 28,630
Tenneco, Inc. 450,000 19,125
Union Camp Corp. 972,900 45,848
Witco Chemical Corp. 1,234,600 30,402
---------
GROUP TOTAL 238,318
---------
- -------------------------------------------------------
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
Market
Value
Shares (000)+
- ---------------------------------------------------------
<S> <C> <C>
REAL ESTATE INVESTMENT TRUSTS
(2.7%)
Bay Apartment Communities,
Inc. 316,200 $ 6,364
CBL & Associates Properties,
Inc. 805,500 16,613
Colonial Properties 415,000 9,338
Duke Realty Investments 519,700 14,682
Equity Residential Properties
Trust 308,200 9,246
General Growth Properties 486,800 11,014
(1)Home Properties of New York 425,000 8,341
JP Realty Inc. 110,500 2,321
Paragon Group, Inc. 390,000 7,410
Post Properties, Inc. 382,800 12,058
Roc Communities, Inc. 407,600 8,560
Simon Property Group 314,200 7,619
Spieker Properties 507,400 10,338
(1)Town & Country Trust 947,000 13,495
Urban Shopping Centers 532,800 10,589
Wellsford Residential
Property Trust 265,200 5,569
----------
GROUP TOTAL 153,557
----------
- ---------------------------------------------------------
RETAIL (.9%)
Kmart Corp. 450,000 5,850
J.C. Penney Co., Inc. 1,020,000 45,518
----------
GROUP TOTAL 51,368
----------
- ---------------------------------------------------------
TRANSPORTATION (.5%)
Union Pacific Corp. 650,000 29,656
----------
- ---------------------------------------------------------
UTILITY (10.4%)
BCE, Inc. 1,286,200 41,319
Cinergy Corp. 887,972 20,756
Consolidated Edison Co.
of New York 527,400 13,581
DQE Inc. 804,700 23,839
Detroit Edison Co. 1,238,200 32,348
Entergy Corp. 524,000 11,463
Equitable Resources, Inc. 106,400 2,886
GTE Corp. 1,021,800 31,037
General Public Utilities Corp. 717,400 18,832
Houston Industries, Inc. 249,700 8,896
* Metrogas ADS 665,000 6,733
Montana Power Co. 516,100 11,870
National Fuel & Gas Co. 283,700 7,234
Niagara Mohawk Power Corp. 912,500 13,003
NICOR, Inc. 862,100 19,613
Nova Scotia Power 595,000 4,720
NYNEX Corp. 1,431,772 52,618
Pacific Enterprises 485,000 10,306
Pacific Gas & Electric Co. 1,930,200 47,049
Pacific Telesis Group 490,000 13,965
Pacificorp 256,800 4,655
PECO Energy Corp. 387,200 9,486
Pennsylvania Power & Light Co. 563,000 10,697
Public Service Co. of Colorado 349,900 10,278
Questar Corp. 212,100 5,833
Rochester Gas & Electric Corp. 531,600 11,097
Royal PTT 577,600 19,422
SCE Corp. 1,398,000 20,446
Sierra Pacific Resources 744,300 14,049
Southern Co. 1,476,000 29,520
Texas Utilities Co. 378,857 12,123
Unicom Corp. 1,067,207 25,613
US West Corp. 655,249 23,343
----------
GROUP TOTAL 588,630
----------
- ---------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $2,080,921) 2,063,239
- ---------------------------------------------------------
CONVERTIBLE PREFERRED
STOCKS (1.1%)
- ---------------------------------------------------------
H.F. Ahmanson 6.0% 516,000 20,511
Boise Cascade $1.58 169,700 3,988
Reynolds Metals $3.31 267,600 12,945
Santa Fe Energy 8.25% 1,041,300 8,851
Sears, Roebuck & Co.
PERCS $3.75 147,400 8,181
Storage Technology $3.50 78,300 5,128
- ---------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED
STOCKS (Cost $62,583) 59,604
- ---------------------------------------------------------
TEMPORARY CASH INVESTMENT
- ---------------------------------------------------------
<CAPTION>
Face
Amount
(000)
------
<S> <C> <C>
REPURCHASE AGREEMENT
Collateralized by U.S.
Government Obligations in
a Pooled Cash Account
5.90%, 1/3/95
(Cost $90) $90 90
- ---------------------------------------------------------
TOTAL INVESTMENTS (98.2%)
(Cost $5,884,306) 5,577,118
- ---------------------------------------------------------
OTHER ASSETS AND LIABILITIES (1.8%)
- ---------------------------------------------------------
Other Assets--Notes C and F 175,176
Liabilities--Note F (71,667)
----------
103,509
- ---------------------------------------------------------
</TABLE>
13
<PAGE> 16
STATEMENT OF NET ASSETS (continued)
<TABLE>
<CAPTION>
Market
Value
(000)+
- ---------------------------------------------------------
<S> <C>
NET ASSETS (100%)
- ---------------------------------------------------------
Applicable to 333,156,619 outstanding
$.10 par value shares
(authorized 400,000,000 shares) $5,680,627
- ---------------------------------------------------------
NET ASSET VALUE PER SHARE $17.05
=========================================================
</TABLE>
+ See Note A to Financial Statements.
* Non-Income Producing Security.
(1)Considered an affiliated company as the Fund owns more than 5% of the
outstanding voting securities of the company.
<TABLE>
<CAPTION>
- ---------------------------------------------------------
AT DECEMBER 31, 1994,
NET ASSETS CONSISTED OF:
- ---------------------------------------------------------
Amount Per
(000) Share
---------- -------
<S> <C> <C>
Paid in Capital $5,989,939 $17.98
Undistributed Net
Investment Income 13,070 .04
Accumulated Net
Realized Losses--Note E (15,194) (.05)
Unrealized Depreciation
of Investments--Note D (307,188) (.92)
- ---------------------------------------------------------
NET ASSETS $5,680,627 $17.05
- ---------------------------------------------------------
</TABLE>
14
<PAGE> 17
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended
December 31, 1994
(000)
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
INVESTMENT INCOME
INCOME
Dividends................................................ $ 116,710
Interest................................................. 273,776
- --------------------------------------------------------------------------------------------------
Total Income...................................... 390,486
- --------------------------------------------------------------------------------------------------
EXPENSES
Investment Advisory Fee--Note B.......................... 4,457
The Vanguard Group--Note C
Management and Administrative......................... $13,437
Marketing and Distribution............................ 1,283 14,720
------- ----------
Taxes (other than income taxes).......................... 476
Custodian's Fees......................................... 220
Auditing Fees............................................ 20
Shareholders' Reports.................................... 232
Annual Meeting and Proxy Costs........................... 129
Directors' Fees and Expenses............................. 33
- --------------------------------------------------------------------------------------------------
Total Expenses.................................... 20,287
- --------------------------------------------------------------------------------------------------
Net Investment Income.......................... 370,199
- --------------------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT
SECURITIES SOLD ........................................... 46,034
- --------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION
(DEPRECIATION) OF INVESTMENT SECURITIES ................... (696,906)
- --------------------------------------------------------------------------------------------------
Net Decrease in Net Assets Resulting from
Operations .................................. $(280,673)
==================================================================================================
</TABLE>
15
<PAGE> 18
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED Year Ended
DECEMBER 31, 1994 December 31, 1993
(000) (000)
- --------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income.................................... $ 370,199 $ 271,526
Realized Net Gain ....................................... 46,034 134,114
Change in Unrealized Appreciation (Depreciation) ........ (696,906) 158,024
- --------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Net Assets
Resulting from Operations......................... (280,673) 563,664
- --------------------------------------------------------------------------------------------------
DISTRIBUTIONS (1)
Net Investment Income.................................... (368,591) (287,169)
Realized Net Gain........................................ (78,686) (118,442)
- --------------------------------------------------------------------------------------------------
Total Distributions................................. (447,277) (405,611)
- --------------------------------------------------------------------------------------------------
NET EQUALIZATION CREDITS--Note A............................ 617 18,650
- --------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (2)
Issued --Regular........................................ 1,065,849 1,962,428
--In Lieu of Cash Distributions.................. 379,611 347,422
--Exchange....................................... 497,331 1,047,944
Redeemed--Regular........................................ (732,681) (317,119)
--Exchange....................................... (813,628) (383,596)
- --------------------------------------------------------------------------------------------------
Net Increase from Capital Share Transactions........ 396,482 2,657,079
- --------------------------------------------------------------------------------------------------
Total Increase (Decrease)........................... (330,851) 2,833,782
- --------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year........................................ 6,011,478 3,177,696
- --------------------------------------------------------------------------------------------------
End of Year (3).......................................... $5,680,627 $6,011,478
==================================================================================================
(1) Distributions Per Share
Net Investment Income................................. $1.11 $1.14
Realized Net Gain..................................... $ .24 $ .40
- --------------------------------------------------------------------------------------------------
(2) Shares Issued and Redeemed
Issued................................................ 85,297 155,647
Issued in Lieu of Cash Distributions.................. 21,438 18,033
Redeemed.............................................. (86,104) (36,146)
- --------------------------------------------------------------------------------------------------
20,631 137,534
- --------------------------------------------------------------------------------------------------
(3) Undistributed Net Investment Income .................. $ 13,070 $ 10,845
- --------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE> 19
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------
For a Share Outstanding Throughout Each Year 1994 1993 1992 1991 1990
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR ........ $19.24 $18.16 $18.08 $16.02 $16.82
INVESTMENT OPERATIONS
Net Investment Income ................... 1.11 1.14 1.21 1.27 1.30
Net Realized and Unrealized Gain (Loss)
on Investments......................... (1.95) 1.48 .29 2.06 (.72)
TOTAL FROM INVESTMENT OPERATIONS ... (.84) 2.62 1.50 3.33 .58
- --------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income..... (1.11) (1.14) (1.21) (1.27) (1.30)
Distributions from Realized Capital Gains (.24) (.40) (.21) -- (.08)
TOTAL DISTRIBUTIONS ................ (1.35) (1.54) (1.42) (1.27) (1.38)
- --------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR .............. $17.05 $19.24 $18.16 $18.08 $16.02
==================================================================================================
TOTAL RETURN ............................... -4.44% +14.65% +8.67% +21.57% +3.76%
- --------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
- ------------------------
Net Assets, End of Year (Millions).......... $5,681 $6,011 $3,178 $1,934 $1,022
Ratio of Expenses to Average Net Assets..... .34% .33% .35% .40% .45%
Ratio of Net Investment Income to
Average Net Assets....................... 6.16% 5.79% 6.50% 7.08% 7.77%
Portfolio Turnover Rates:
Common Stocks............................ 32% 26% 16% 19% 12%
Bonds.................................... 31% 18% 24% 34% 23%
- --------------------------------------------------------------------------------------------------
</TABLE>
NOTES TO FINANCIAL STATEMENTS
Vanguard/Wellesley Income Fund is registered under the Investment Company Act of
1940 as a diversified open-end investment company. Certain of the Fund's
investments are in long-term corporate debt instruments; the issuers' abilities
to meet these obligations may be affected by economic developments in their
respective industries.
A. The following significant accounting policies are in conformity with
generally accepted accounting principles for investment companies. Such policies
are consistently followed by the Fund in the preparation of financial
statements.
1. SECURITY VALUATION: Common stocks listed on an exchange are valued at the
latest quoted sales prices as of the close of the New York Stock Exchange
(generally 4:00 PM) on the valuation date; such securities not traded are valued
at the mean of the latest quoted bid and asked prices; those securities not
listed are valued at the latest quoted bid prices. Bonds are valued utilizing
the latest bid prices and on the basis of a matrix system (which considers such
factors as security prices, yields, maturities and ratings), both as furnished
by independent pricing services. Temporary cash investments are valued at cost
which approximates market value.
2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for Federal income taxes is required in the financial
statements.
17
<PAGE> 20
NOTES TO FINANCIAL STATEMENTS (continued)
3. EQUALIZATION: The Fund follows the accounting practice known as
"equalization," under which a portion of the price of capital shares issued and
redeemed, equivalent to undistributed net investment income per share on the
date of the transaction, is credited or charged to undistributed income. As a
result, undistributed income per share is unaffected by Fund share sales or
redemptions.
4. REPURCHASE AGREEMENTS: The Fund, along with other members of The Vanguard
Group of Investment Companies, transfers uninvested cash balances into a Pooled
Cash Account, the daily aggregate of which is invested in repurchase agreements
secured by U.S. Government obligations. Securities pledged as collateral for
repurchase agreements are held by the Fund's custodian bank until maturity of
each repurchase agreement. Provisions of each agreement ensure that the market
value of this collateral is sufficient in the event of default; however, in the
event of default or bankruptcy by the other party to the agreement, realization
and/or retention of the collateral may be subject to legal proceedings.
5. OTHER: Security transactions are accounted for on the date the securities are
purchased or sold. Costs used in determining realized gains and losses on the
sale of investment securities are those of specific securities sold. Dividend
income and distributions to shareholders are recorded on the ex-dividend date.
Discounts and premiums on debt securities purchased are amortized to interest
income over the lives of the respective securities.
B. Under the terms of a contract expiring April 30, 1995, the Fund pays
Wellington Management Company an investment advisory fee calculated at an annual
percentage rate of average net assets of the fund. For the year ended December
31, 1994, the investment advisory fee represents an effective annual rate of .07
of 1% of average net assets.
C. The Vanguard Group, Inc. furnishes at cost corporate management,
administrative, marketing and distribution services. The costs of such services
are allocated to the Fund under methods approved by the Board of Directors. At
December 31, 1994, the Fund had contributed capital of $890,000 to Vanguard
(included in Other Assets), representing 4.4% of Vanguard's capitalization. The
Fund's directors and officers are also directors and officers of Vanguard.
Vanguard has requested the Fund's investment adviser to direct certain portfolio
trades, subject to obtaining the best price and execution, to brokers who have
agreed to rebate or credit to the Fund a portion of the commissions generated.
Such rebates or credits are used solely to reduce the Fund's administrative
expenses. For the year ended December 31, 1994, directed brokerage arrangements
reduced the Fund's expenses by $574,000 (.01 of 1% of average net assets).
D. During the year ended December 31, 1994, the Fund made purchases of
$1,451,642,000 and sales of $1,229,638,000 of investment securities other than
U.S. Government securities and temporary cash investments. Purchases and sales
of U.S. Government obligations were $882,929,000 and $685,180,000, respectively.
At December 31, 1994, unrealized depreciation for financial reporting and
Federal income tax purposes aggregated $307,188,000, of which $134,634,000
related to appreciated securities and $441,822,000 related to depreciated
securities.
E. Capital gain distributions are determined on a tax basis and may differ from
realized capital gains for financial reporting purposes depending on the timing
of the realization of gains. For Federal tax purposes, capital gains required to
be distributed in December 1994 included net gains realized through October 31,
1994. Subsequently the Fund realized capital losses of $16,810,000 which are
available to offset future net capital gains.
F. The market value of securities on loan to broker/dealers at December 31,
1994, was $112,518,000, for which the Fund had received as collateral cash of
$24,387,000 and U.S. Treasury securities with a market value of $90,871,000.
18
<PAGE> 21
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
Vanguard/Wellesley Income Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard/Wellesley Income Fund (the "Fund") at December 31, 1994, the results of
its operations, the changes in its net assets and the financial highlights for
each of the respective periods presented, in conformity with generally accepted
accounting principles. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities by correspondence with the custodian and brokers and
the application of alternative auditing procedures where confirmations from
brokers were not received, provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
February 1, 1995
SPECIAL TAX INFORMATION
SPECIAL 1994 TAX INFORMATION (UNAUDITED)
FOR VANGUARD/WELLESLEY INCOME FUND, INC.
Corporate shareholders should note that for the fiscal year ended
December 31, 1994, 29.7% of the Fund's investment income (i.e., dividend income
plus short-term capital gains, if any) qualifies for the intercorporate
dividends received deduction.
19
<PAGE> 22
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman and Chief Executive Officer Chairman and Director of The
Vanguard Group, Inc., and of each of the investment companies in The Vanguard
Group.
JOHN J. BRENNAN, President
President and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Chairman of Rhone-Poulenc Rorer Inc.; Director of
Sun Company, Inc.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea
Company, Alco Standard Corp., Raytheon Company, Knight-Ridder, Inc., and
Massachusetts Mutual Life Insurance Co.
BRUCE K. MACLAURY, President of The Brookings Institution; Director of
American Express Bank Ltd., The St. Paul Companies, Inc., and Scott Paper
Company.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics,
Princeton University; Director of Prudential Insurance Co. of America, Amdahl
Corporation, Baker Fentress & Co., The Jeffrey Co., and Southern New England
Communications Company.
ALFRED M. RANKIN, JR., Chairman, President, and
Chief Executive Officer of NACCO Industries, Inc.; Director of NACCO Industries,
The BFGoodrich Company, Reliance Electric Company, and The Standard Products
Company.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and
President of New York University; Director of Pacific Gas and Electric Company
and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas
Company; Director of Cummins Engine Company; Trustee of Vanderbilt University
and the Culver Educational Foundation.
OTHER FUND OFFICERS
RICHARD F. HYLAND, Treasurer; Treasurer of The Vanguard Group, Inc., and of each
of the investment companies in The Vanguard Group.
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies in The
Vanguard Group.
KAREN E. WEST, Controller; Vice President of The Vanguard Group, Inc.;
Controller of each of the investment companies in The Vanguard Group.
OTHER VANGUARD GROUP OFFICERS
JEREMY G. DUFFIELD VINCENT S. MCCORMACK
Senior Vice President Senior Vice President
Planning & Development Operations
JAMES H. GATELY RALPH K. PACKARD
Senior Vice President Senior Vice President
Institutional Chief Financial Officer
IAN A. MACKINNON
Senior Vice President
Fixed Income Group
20
<PAGE> 23
THE VANGUARD VOYAGE . . . STAYING THE COURSE
(continued from inside front cover)
* We set specific standards for each Fund's investment policies and principles.
* We adhere to the highest standards of investment quality, consistent
with each Fund's objectives.
* We offer candor in our Fund descriptions (including full disclosure of
risk) to prospective investors, and in our description to shareholders
of each Fund's success (or, sometimes, lack of the same).
These principles make at least as much sense today as they did in 1929,
perhaps even more. For we live in an era when many fund organizations have
become asset-gathering machines, capitalizing on past performance that is
unrepeatable and investment fads that today, as yesterday, will come and go. The
new marketing policy is too often "if investors want it, we'll sell it to
them." But our principle remains "if it makes sound investment sense, we'll
offer it, even if it takes years to attract substantial assets."
FOUNDING CORPORATE VALUES
With the founding of The Vanguard Group in 1974, a new concept of values was
brought to bear on mutual fund management. Unlike other fund organizations,
Vanguard alone is structured to serve only its Funds' shareholders. Vanguard's
corporate structure places not the fund management company, but the fund
shareholders, "at the top" of the organizational chart. Vanguard Fund
shareholders are literally the owners of the firm and are entitled to all of
the benefits that, at other fund firms, accrue to the owners of the management
company.
Because of this unique structure, Vanguard has become best known for its
low costs, which we believe are just as essential a consideration in investing
in mutual funds as risk potential and total return. We call this relationship
between risk, return, and cost the "eternal triangle" of mutual fund investing.
We take special pride in our position as (by far) the lowest-cost
provider of financial services in the world. Under our "no-load" offering
structure, shareholders begin their Vanguard investment program with $1,000 of
assets (not, say, $950) for each $1,000 investment. Then, under our "at-cost"
operating structure, each $1,000 is managed for only about $3 per year; our
competitors may charge three, four, or even five times that amount.
In all, Vanguard has distinguished itself by providing Funds with
sound and durable goals to investors with long-term time horizons, and doing
so at the fairest financial terms available. We believe that the unique
Vanguard structure "promotes a healthy and viable mutual fund complex within
which each Fund can better prosper; enables the Funds to realize substantial
savings from advisory fee reductions; promotes savings from economies of
scale; and provides the Funds with direct and conflict-free control over
distribution functions." We are not alone in this belief. Indeed, the
quotation is taken verbatim from the unanimous decision of the U.S.
Securities and Exchange Commission when, in 1981, it approved our application
for the structure under which we operate today.
A CLOSING THOUGHT
We are proud of what Wellington Fund, the other Vanguard Funds, and The
Vanguard Group have come to represent, and we are grateful for the success and
growth with which we have been blessed. We are an industry leader, and, as a
competitor observed a few years ago, we are "the standard by which all fund
organizations are judged."
In battle terms, "the vanguard" is the first wave of troops or ships,
and Vanguard surely is in the first wave of the battle for investment
survival. As we look behind us, however, the "second wave" is not in sight. No
fund organization has followed our lead, leaving ours a lonely course. No
matter. We have an organization that places the interests of our Fund
shareholders first. We have Funds that shall endure the vicissitudes of the
future. Come what may, we intend to "stay the course," and we shall do our very
best to continue to deserve your confidence and loyalty. We hope that you will
stay the course with us.
<PAGE> 24
THE VANGUARD FAMILY OF FUNDS
FIXED INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Admiral Funds
U.S. Treasury Money Market Portfolio
Vanguard Money Market Reserves
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Money Market Portfolio
Vanguard State Tax-Free Funds
Money Market Portfolios (CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
Insured Longer-Term Portfolios
(CA, FL, NJ, NY, OH, PA)
INCOME FUNDS
Vanguard Admiral Funds
Vanguard Fixed Income Securities Fund
Vanguard Preferred Stock Fund
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard Convertible Securities Fund
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard/Trustees' Equity Fund
U.S. Portfolio
Vanguard/Windsor Fund
Vanguard/Windsor II
BALANCED FUNDS
Vanguard Asset Allocation Fund
Vanguard STAR Fund
Vanguard/Wellesley Income Fund
Vanguard/Wellington Fund
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity Fund
International Portfolio
INDEX FUNDS
Vanguard Index Trust
Total Stock Market Portfolio
500 Portfolio
Extended Market Portfolio
Growth Portfolio
Value Portfolio
Small Capitalization Stock Portfolio
Vanguard International Equity Index Fund
European Portfolio
Pacific Portfolio
Emerging Markets Portfolio
Vanguard Bond Index Fund
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
[LOGO]
<TABLE>
<S> <C>
Vanguard Financial Center Valley Forge, Pennsylvania 19482
New Account Information: 1-(800) 662-7447 Shareholder Account Services: 1-(800) 662-2739
</TABLE>
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.
Q270-12/94
<PAGE> 25
EDGAR APPENDIX
This appendix describes the components of the printed version of this
report that do not translate into a format acceptable to the EDGAR system.
The front cover of the printed version of this report features the
Vanguard ship in the crashing sea.
A small picture of a rear view of the Vanguard ship crashing through
the sea appears at the top of the inside covers of the report.
A running head featuring a sextant appears on pages one through five.
A photograph of John C. Bogle appears at the lower-right of page one.
A Cumulative Performance line chart depicting the Indexed Value of the
Lehman Long-Term Corporate Bond Index and the Standard & Poor's 500 Stock
Index for the fiscal years 1990 to 1994 appears at the upper-left of page two.
A Cumulative Performance line chart for the period December 31, 1984,
to December 31, 1994, including average annual total returns, appears on page
three.
A running head featuring a lantern appears on page six.
A running head featuring a map and telescope appears on pages seven and
eight.
A running head featuring a log book and pen appears on pages nine
through nineteen.
A running head featuring a compass appears on page twenty.
At the bottom of the back cover there appears a triangle with the sides
labeled "Risk," "Cost," and "Return."
A seagull in flight is featured at the top of the outside back cover of
the report.
