<PAGE> 1
VANGUARD/
WELLESLEY INCOME
FUND
Annual Report - December 31, 1997
[PHOTO]
[THE VANGUARD GROUP LOGO]
<PAGE> 2
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--more than 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] [PHOTO]
John C. Bogle John J. Brennan
Chairman President
CONTENTS
<TABLE>
<S> <C>
A MESSAGE TO OUR SHAREHOLDERS . . . . . . . 1
THE MARKETS IN PERSPECTIVE . . . . . . . . 5
REPORT FROM THE ADVISER . . . . . . . . . . 7
PERFORMANCE SUMMARY . . . . . . . . . . . . 9
PORTFOLIO PROFILE . . . . . . . . . . . . . 10
FINANCIAL STATEMENTS . . . . . . . . . . . 14
REPORT OF INDEPENDENT ACCOUNTANTS . . . . . 24
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
Vanguard/Wellesley Income Fund earned +20.2% in 1997, a generous return made
possible by an excellent environment for bonds and an even better one for
stocks. The U.S. economy enjoyed strong economic growth and low unemployment,
combined, somewhat surprisingly, with decelerating inflation. Reflecting lower
interest rates, long-term corporate bonds provided a solid return of +13.5%,
and the stock market surged to an astonishing +33.4% advance.
The table at right compares the Fund's total return (capital change plus
reinvested dividends) with those of the average income fund and the unmanaged
Wellesley Composite Index, which mirrors our typical balance of 65% bonds and
35% high-yielding stocks. For the year, Wellesley's return topped those of both
the Index and--by a notably imposing margin--the average income-oriented mutual
fund.
<TABLE>
<CAPTION>
- --------------------------------------------------------
TOTAL RETURNS
YEAR ENDED
DECEMBER 31, 1997
- --------------------------------------------------------
<S> <C>
Vanguard/Wellesley Income Fund +20.2%
- --------------------------------------------------------
Average Income Fund +16.4%
- --------------------------------------------------------
Wellesley Composite Index* +19.4%
- --------------------------------------------------------
</TABLE>
*65% Lehman Long Corporate AA or Better Bond Index, 26% S&P/BARRA Value Index,
4.5% S&P Utilities Index, and 4.5% S&P Telephone Index.
The Fund's total return is based on net asset values of $20.51 per share
on December 31, 1996, and $21.86 per share on December 31, 1997, adjusted for
dividends totaling $1.20 per share paid from net investment income and
distributions totaling $1.445 per share from net realized capital gains.
Wellesley Income Fund's annualized yield as of December 31 was 5.3%.
FINANCIAL MARKETS IN BRIEF
Long-term interest rates rose through the first quarter of the year on
expectations that the economy's robust growth would cause inflation to
accelerate. The yield on the benchmark 30-year U.S. Treasury bond peaked at
7.17% in mid-April. Then, as the news on inflation got better rather than
worse, the yield turned downward, falling to 5.92% on December 31, 72 basis
points below the 6.64% level at which it began the year.
Short-term interest rates bottomed out in June then began rising,
apparently because of sales of short-term Treasuries by foreign central banks
and investors. At year-end 1997, the yield on three-month U.S. Treasury bills
was 5.35%, up just a bit from 5.17% when the year began. The spread between
yields on three-month T-bills and 30-year Treasury bonds was a slim 0.57
percentage point on December 31, 1997. Such a "flattening" of the yield curve
has more often than not been a precursor of a slowing economy.
On the stock side, the historic bull market that began in August 1982
continued in impressive fashion during 1997. The economy, corporate earnings,
and employment grew solidly, and consumer confidence strengthened. Yet interest
rates declined and inflation decelerated. In short, the domestic economic news
could not have been better.
The sole dark cloud--severe turmoil in Asian economies and
currencies--only briefly darkened the stock market's mood. After a sharp
decline in October--the Standard & Poor's 500 Composite Stock Price Index
tumbled -7% on October 27 alone--stocks resumed their climb. By the time the
year was over, the Index had produced its second-highest annual return (to
1995) in the past two decades.
1
<PAGE> 4
1997 PERFORMANCE OVERVIEW
Wellesley Income Fund's return of +20.2% fell between the terrific +33.4%
return of the stock market, as represented by the S&P 500 Index, and the fine
+13.5% return of the long-term corporate bond market. We were a bit closer to
the bond return because of the Fund's policy of emphasizing bonds. This
conservative stance tends to constrain Wellesley's advances during bullish
periods for the stock market, but it gives the Fund a more stable profile
during the inevitable down periods for stocks.
Wellesley's bond holdings returned +14.0% during the year, ahead of the
+13.5% return of the Lehman Brothers Long Corporate AA or Better Bond Index,
which is the bond portion of our composite benchmark. We were aided by the
bullish stance on bonds adopted by our investment adviser, Wellington
Management Company. The average duration of the Fund's bond segment, at 9.1
years, is slightly longer than that of the Lehman benchmark. (The longer a bond
fund's duration, the more its value rises when interest rates decline, and the
more its value falls when rates rise.)
Wellesley's stock holdings returned +32.8% in 1997, a bit shy of the
return on the S&P 500 Index, but ahead of the +30.7% return on the equity
segment of our composite benchmark. This segment is based on the S&P/BARRA
Value Index, the S&P Utilities Index, and the S&P Telephone Index, reflecting
our tilt toward income-producing stocks. The shortfall against the S&P 500 can
be largely attributed to the market's tilt toward growth stocks during the
year. The S&P 500 Index's growth component provided a return of +36.5% during
the year, well above the +30.0% return of its value component.
More than half of Wellesley's stock holdings were in the
financial-services and utilities sectors, respectively the best and third-best
performers within the S&P 500 Index in 1997. However, stocks we held in those
groups didn't perform as well as the financial-services and utilities stocks in
the S&P 500 Index. The Fund's industry concentrations were especially
advantageous during the final three months of the year, when turmoil in the
financial markets pushed up demand for financial and utility issues--sectors
that are sensitive to interest-rate changes. In addition, we held no stocks in
the technology or producer-durables sectors, two of the Index's
worst-performing sectors during the year.
We held an average of about 12% of our equity assets in the
market-lagging materials & processing sector--nearly twice the S&P 500 Index
weight. However, this negative was mostly offset by excellent stock picks in
the sector. A significant liability relative to the S&P 500 was a low
commitment to health-care stocks (4.7% for our Fund, 11.0% for the Index)
combined with poor stock selection in the sector.
The Fund's overall +3.8% advantage versus the average income-oriented
mutual fund was the result of the fine performance of our stocks combined with
the longer average maturities of our bond holdings compared to those of our
competitors. We hasten to add our customary warning about comparing Wellesley
Income Fund with this peer group over short periods. The income-fund group is a
varied bunch, and many funds within it pursue strategies that are far different
from Wellesley's.
We again achieved our objective of providing a high level of current
income. Our income dividends of $1.20 per share were 3.4% higher than our 1996
dividends of $1.16 per share. As noted above, the Fund's overall yield was
5.3%. The yield on its equities was 3.4%, more than twice the record-low 1.6%
yield of the S&P 500 Index.
2
<PAGE> 5
LONG-TERM PERFORMANCE OVERVIEW
As shown in the table below, over the past ten years Wellesley has outperformed
both its average peer and the composite index, a result that reflects both the
Fund's excellent investment management and our low costs. Based on our +13.3%
average annual return, which is 1.9 percentage points higher than that of our
peers, a $10,000 investment in Wellesley (with dividends and capital gains
distributions reinvested) would have grown over the decade to $34,983. This is
$5,547 more than the $29,436 that would have accumulated in the average income
fund. The "Vanguard advantage" is an impressive 55% of the initial investment.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED DECEMBER 31, 1997
-----------------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- -------------------------------------------------------------------------
<S> <C> <C>
Wellesley Income Fund +13.3% $34,983
- -------------------------------------------------------------------------
Average Income Fund +11.4% $29,436
- -------------------------------------------------------------------------
Wellesley Composite Index* +13.0% $33,806
- -------------------------------------------------------------------------
</TABLE>
*65% Lehman Long Corporate AA or Better Bond Index, 26% S&P/BARRA Value Index,
and 9% S&P Utilities Index through June 30, 1996, when the S&P Utilities
component was separated into the S&P Utilities Index and the S&P Telephone
Index.
Our low expenses accounted for about half of our long-term advantage
over our competitors, while the rest was earned by our investment adviser. Our
expense ratio (annual expenses as a percentage of average net assets) totaled a
minuscule 0.31% in 1997, one-fourth of the 1.26% expense ratio charged by our
average peer. Costs matter, especially in an income-oriented fund, because
operating expenses directly reduce the income that a mutual fund passes through
to its shareholders.
Our performance edge over our composite index represents a significant
accomplishment, given that the index does not incur the real-world expenses
(for fund operations and securities transactions) that mutual funds must
assume.
We stress that the returns earned during the past decade were unusually
high. They encompass a ten-year period during which the U.S. stock market did
not experience a single serious downturn and the bond market was buoyed by
generally declining interest rates. Although financial markets are inherently
unpredictable, we believe it is safe to say that returns over the next decade
are virtually certain to be lower than those of the previous one.
IN SUMMARY
Returns from the U.S. stock market over the past three years--indeed, over the
past 15 years--have no precedent in American financial history. Long-term
bonds, too, have experienced a remarkable period as yields have generally
declined since the early 1980s. While as investors we have every reason to be
grateful for the bounty of the financial markets, we also have reason to regard
the future with some caution. Lengthy bull markets can breed complacency and
cause investors to discount the risks inherent in stocks and bonds. Make no
mistake, the markets will demonstrate these risks from time to time.
However, the greatest risk is failure to invest in the first place. We
believe that the best approach to dealing with risk is to hold a balanced
portfolio that includes stock funds, bond funds, and money market funds--a
belief that is at the core of Wellesley's
3
<PAGE> 6
investment philosophy. Investors who maintain such income-oriented
portfolios--allocated in accordance with their time horizon, financial
situation, and tolerance for market volatility--should be well-prepared to "stay
the course" toward their investment objectives, no matter what the future has in
store.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Chairman of the Board President
January 22, 1998
4
<PAGE> 7
The Markets In Perspective
Year Ended December 31, 1997
U.S. EQUITY MARKETS
Despite some year-end rockiness, 1997 again provided U.S. equity investors with
exceptional returns, as illustrated by the 33.4% advance of the S&P 500 Index.
Investors' mettle was tested several times, however, and most severely by the
upheavals that devastated a number of Asian markets in the fourth quarter.
Beginning in late October, the U.S. market grew increasingly volatile, a direct
result of investors' struggle to understand the nature and implications of
Asia's economic turmoil. By the end of the year, it appeared that a new
consensus was emerging, grounded in two basic beliefs: (1) that the collapse of
currencies in the Far East would help keep inflation tame in the United States
and (2) that slower growth in Asia would most likely lead to weaker corporate
profits over the next several years.
As the dust continued to settle, many investors sought havens
traditional in periods of high uncertainty: large-capitalization issues and
particularly the "defensive" sectors of the stock market, such as utilities,
consumer staples, and health care. The closing weeks of 1997 saw a broad
advance in these "safe" sectors, with utilities gaining 20.1% and consumer
staples 10.4% in the last quarter. By contrast, more economically sensitive
sectors were thrashed in the wake of the Asian crisis, with technology issues
falling 12.3% and producer durables down 9.0% over the three months. After
posting strong results in the third quarter, small-company stocks also suffered
in the fourth, falling 3.3%.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED DECEMBER 31, 1997
------------------------------------
1 YEAR 3 YEARS 5 YEARS
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 33.4% 31.2% 20.3%
Russell 2000 Index 22.4 22.3 16.4
MSCI EAFE Index 2.1 6.6 11.7
- ------------------------------------------------------------------------------
FIXED INCOME
Lehman Aggregate Bond Index 9.7% 10.4% 7.5%
Lehman 10-Year Municipal Bond Index 9.2 10.2 7.6
Salomon Brothers Three-Month
U.S. Treasury Bill Index 5.3 5.4 4.7
- ------------------------------------------------------------------------------
OTHER
Consumer Price Index 1.7% 2.5% 2.6%
- ------------------------------------------------------------------------------
</TABLE>
The year-end excitement did not detract from 1997's overall record as a
stellar year for U.S. stock investors. The best-performing sector was financial
services, which rose 46.9%. This sector benefited from a number of factors,
including the strength of the economy, the vibrant financial markets, and
merger activity. By contrast, the commodity-oriented materials & processing
sector posted a gain of "only" 12.3%--in itself more than a percentage point
above the long-term average return from common stocks. Small-cap stocks also
fared well overall, as illustrated by the 22.4% increase of the Russell 2000
Index. Small-company technology issues were the most glaring exception,
mustering a gain in 1997 of just 1.1%.
U.S. FIXED-INCOME MARKETS
In a year characterized by exceptionally low inflation, interest rates fell,
providing investors with very attractive total returns. The Lehman Aggregate
Bond Index, for example,
5
<PAGE> 8
posted a total return of 9.7% for 1997, comprising 7.2% in income return
and 2.5% in capital appreciation. The decline in rates can be attributed largely
to better-than-expected reports about the inflation rate. Early in the year,
economists were projecting a 2.9% increase in the Consumer Price Index (CPI)
during 1997. In March, the Federal Reserve grew sufficiently concerned to boost
interest rates by 0.25% in an effort to temper economic growth and thereby ward
off inflation. By year-end, however, the worries seemed to have been
unnecessary, as the actual CPI increase was a mere 1.7%--its smallest increase
since 1986.
The bond market gradually gathered strength during the year as investors
grew more confident that four seemingly strange bedfellows--strong economic
growth, reasonable inflation, low unemployment, and stable wage growth--would
continue to coexist peacefully. In the fourth quarter, the market also was
bolstered by the "flight to quality" among investors concerned about Asia's
problems. Overall, the longest-maturity issues benefited most from the decline
in interest rates. The yield on the 30-year U.S. Treasury bond closed the year
at 5.92%, compared with 6.64% on December 31, 1996. Falling rates flattened the
yield curve considerably: Only 0.57% separated the yield on Treasury bills from
that on the 30-year issue, down from a spread of 1.47% at the end of 1996.
The best-performing sector in 1997 was long-term Treasuries, as
illustrated by the 15.1% return of the Lehman Long U.S. Treasury Index.
Investors in lower-quality securities also fared well, with the Lehman High
Yield Bond Index generating a 12.8% gain. The strength of the economy, together
with the lack of inflationary pressure, created an ideal environment for junk
bonds.
INTERNATIONAL EQUITY MARKETS
Arguably, investors' greatest disappointments were in international
markets--and, of course, Asian markets in particular. During the year, the
Morgan Stanley Capital International (MSCI) Pacific Index declined by 25.7% in
U.S. dollar terms; the Index fell 20.7% in the fourth quarter alone. Among
individual markets, the fiscal year saw sharp declines (in U.S. dollar terms)
in Japan, down 23.6% (including a 19.7% drop in the fourth quarter); Thailand,
down 76.8%; and Malaysia, down 68.1%. The general slump in Asian markets began
in midsummer with currency devaluations by a number of countries.
By contrast, the European markets continued to provide U.S. investors
with solid returns, although they, too, stumbled in late October and
subsequently recovered. The MSCI Europe Index posted a gain of 23.7% for the 12
months. The robust character of the European markets reflected strong corporate
earnings and optimism that the European Monetary Union would provide a solid
framework for future fiscal responsibility and economic growth.
6
<PAGE> 9
REPORT FROM THE ADVISER
Vanguard/Wellesley Income Fund outperformed its unmanaged benchmark for 1997.
For the twelve months ended December 31, 1997, the Fund returned 20.2%, versus
19.4% for its benchmark. Wellesley's stock segment returned 32.8%, following
increases of 24.2% in 1996 and 37.1% in 1995. These equity returns are well
above historical averages and have allowed the Fund to enjoy respectable
returns over the last three years.
Throughout the year the Fund maintained its traditional allocation, with
60%-65% of assets invested in longer-term investment-grade bonds and 35%-40% in
dividend-paying equities. In general, the long average maturity of the Fund's
bonds and our meaningful weighting in high-yielding, interest-rate-sensitive
stocks make Wellesley's performance extremely sensitive to the direction of
long-term interest rates. The bond portfolio's return of 14.0% for 1997
bettered the 13.5% return for the Lehman Long Corporate AA or Better Index,
against which we measure that segment's performance. We increased the duration
of the bond portfolio throughout 1997, and at year-end it was slightly longer
than that of the Lehman index. This relatively longer duration helped
performance as long-term rates fell sharply during the last three months of
1997. A longer duration than the benchmark implies that the principal value of
the bond portfolio will change more dramatically with a change in interest
rates.
The 32.8% return for Wellesley's equities was ahead of the 30.7% return
on the equity portion of its composite benchmark, which is weighted 75% in the
S&P/BARRA Value Index, 12.5% in the S&P Utilities Index, and 12.5% in the S&P
Telephone Index. The stocks invested in the financial-services and utility
sectors contributed handsomely to performance this year. For more details,
please see the Message To Shareholders, beginning on page 1.
INVESTMENT OUTLOOK FOR 1998
Spreading economic and financial crises in Asia have caused us to lower growth
expectations for the U.S. economy in 1998. Real Gross Domestic Product is now
estimated to increase 2.3% on average in the year ahead, a reduction of
one-half percentage point from our prior forecast. We expect exports to Asia to
drop sharply, and we project that the rising U.S. dollar exchange rate will
translate both into a steady stream of lower-priced imports into this country
and market-share losses for industries that compete with imports. An extremely
competitive pricing environment will produce declining inflation. We expect the
Consumer Price Index to rise just 1.6% in 1998. Slower global growth, a strong
dollar, intense pricing pressure, and some inevitable upward movement in wage
rates will make it a very difficult year for corporate profits, which we now
expect to rise just marginally over the next four quarters.
INVESTMENT PHILOSOPHY
The Fund reflects a belief that relatively high current income and
moderate long-term growth in income and capital can be achieved without undue
risk by holding 60% to 65% of assets in fixed-income securities and the balance
in income-oriented common stocks. Consistent with this approach, the Funds
bond segment comprises intermediate- and long-term U.S. Treasury securities
and high-quality corporate bonds; its equity segment is dominated by stocks
with above-average dividend yields and strong potential for dividend increases.
7
<PAGE> 10
Slower U.S. growth, a strong dollar, and falling inflation rates will
end the speculation about a Federal Reserve tightening of monetary policy. Such
speculation dominated the capital markets for the first nine months of 1997.
Ultimately, we expect that the Fed's next move will be to lower short-term
interest rates later in the year.
We also now expect a budget surplus this year, a very positive factor
for the bond market. However, the fundamentals underlying 1998 will be much
more of a challenge to the U.S. equity market. Valuations remain historically
high, and the profit outlook has deteriorated. Nevertheless, lower long-term
interest rates and stable-to-lower short-term rates will be a positive
underpinning for stocks in 1998.
STRATEGY IN 1998
Our strategy remains consistent, and our allocation to stocks and bonds will
vary only marginally. The maturity of Wellesley's bonds will remain long-term,
with call protection to preserve the income stream. We purchase only
investment-grade, U.S.-dollar-denominated bonds, emphasizing those with
stable-to-improving credit fundamentals. As of December 31, approximately 86%
of the bond portfolio was rated "A" or better.
Our stock portfolio strategy is to purchase companies with above-market
yields across different industries. The average yield on our stocks, at 3.4%,
is 113% higher than the yield on the S&P 500 Index. We began increasing our
exposure to utilities because this sector benefits from declining interest
rates. Also, the fundamentals for this industry should improve as companies
consolidate. The primary reason for our selective sales of stocks is to dispose
of issues that reach our target prices.
The dominant theme guiding the Fund's investment strategy is our ongoing
obligation to shareholders to achieve an attractive absolute level of income by
holding high-quality securities. Our long-term goal is to increase Wellesley's
dividend by purchasing stocks of strong companies that can pass onto
shareholders higher dividends generated from rising earnings. Since we wrote to
you six months ago, the equities in our portfolio have had 21 dividend
increases. However, we note that we avoid stocks with ultrahigh dividends that
may not be sustainable over the longer term.
SUMMARY
If interest rates continue to decline, Wellesley should perform well versus
more aggressive bond and stock funds. We will continue to focus on maintaining
the Fund's charter and on trying to outperform the composite benchmark. Income
improvement remains an objective for 1998.
Earl E. McEvoy, Senior Vice President
John R. Ryan, Senior Vice President
Wellington Management Company, LLP
January 14, 1998
8
<PAGE> 11
PERFORMANCE SUMMARY
Wellesley Income Fund
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Fund. Note, too, that
both share price and return can fluctuate widely, so an investment in the Fund
could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: DECEMBER 31, 1977-DECEMBER 31, 1997
- ---------------------------------------------------------
WELLESLEY INCOME FUND COMPOSITE*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ---------------------------------------------------------
<S> <C> <C> <C> <C>
1978 -4.6% 8.2% 3.6% 2.2%
1979 -2.6 8.8 6.2 3.5
1980 0.9 11.0 11.9 9.4
1981 -3.1 11.8 8.7 -1.7
1982 10.1 13.2 23.3 36.3
1983 7.1 11.5 18.6 13.2
1984 4.9 11.7 16.6 13.8
1985 16.0 11.4 27.4 29.4
1986 9.2 9.1 18.3 19.9
1987 -8.1 6.2 -1.9 2.5
1988 4.7 8.9 13.6 13.7
1989 11.8 9.1 20.9 21.0
1990 -4.3 8.1 3.8 2.5
1991 12.9 8.7 21.6 20.5
1992 1.6 7.1 8.7 9.2
1993 8.2 6.4 14.6 14.6
1994 -10.2 5.8 -4.4 -4.6
1995 21.6 7.3 28.9 30.7
1996 3.3 6.1 9.4 6.8
1997 13.8 6.4 20.2 19.4
- ---------------------------------------------------------
</TABLE>
*65% Lehman Long-Term Corporate Bond Index and 35% S&P 500 Index through
December 31, 1985; 65% Lehman Long Corporate AA or Better Bond Index, 26%
S&P/BARRA Value Index, and 9% S&P Utilities Index through June 30, 1996, when
the S&P Utilities component was separated into the S&P Utilities Index and the
S&P Telephone Index.
See Financial Highlights table on page 21 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: DECEMBER 31, 1987-DECEMBER 31, 1997
- -----------------------------------------------------------------------------------------
VANGUARD/WELLINGTON AVERAGE BALANCED WELLINGTON COMPOSITE
FUND FUND INDEX S&P 500 INDEX
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1987 11 10000 10000 10000 10000
1988 02 11644 11234 11433 11736
1988 05 11421 11121 11181 11599
1988 08 11592 11270 11350 11675
1988 11 12103 11603 11928 12333
1989 02 12761 12121 12481 13131
1989 05 13789 13101 13725 14707
1989 08 14789 13970 14868 16256
1989 11 14521 13960 14988 16137
1990 02 14260 13576 14568 15613
1990 05 14931 14311 15592 17151
1990 08 13902 13511 14593 15446
1990 11 14136 13704 14952 15577
1991 02 15696 15132 16636 17904
1991 05 16553 15890 17548 19170
1991 08 16889 16336 18077 19597
1991 11 16512 16240 17829 18743
1992 02 17764 17614 19270 20759
1992 05 18333 17679 19603 21055
1992 08 18595 17835 20014 21148
1992 11 18988 18525 20660 22199
1993 02 19902 19194 21656 22968
1993 05 20656 19631 22053 23496
1993 08 21622 20479 23131 24358
1993 11 21574 20434 23091 24436
1994 02 21948 20892 23338 24878
1994 05 21688 20265 22662 24494
1994 08 22652 20861 23532 25688
1994 11 21396 20097 22720 24691
1995 02 23136 21141 24498 26707
1995 05 25372 22601 26890 29432
1995 08 26561 23770 28131 31190
1995 11 28393 24629 30218 33810
1996 02 29404 25506 31305 35965
1996 05 30104 26189 32016 37796
1996 08 30441 25964 31718 37029
1996 11 34430 28646 36210 43230
1997 02 35060 29159 37117 45374
1997 05 36683 30363 39103 48914
1997 08 38764 32130 41403 52081
1997 11 40832 34131 44048 55612
- -----------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1997
------------------------------------ FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Wellesley Income Fund 20.19% 13.18% 13.34% $34,983
Average Income Fund 16.38 11.45 11.40 29,436
Wellesley Composite Index* 19.41 12.75 12.95 33,806
Lehman Long Corporate AA or Better Bond Index 13.53 9.20 10.67 27,551
- ----------------------------------------------------------------------------------------------------------
</TABLE>
*65% Lehman Long Corporate AA or Better Bond Index, 26% S&P/BARRA Value Index,
and 9% S&P Utilities Index through June 30, 1996, when the S&P Utilities
component was separated into the S&P Utilities Index and the S&P Telephone
Index.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION ----------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Wellesley Income Fund 7/1/1970 20.19% 13.18% 5.97% 7.37% 13.34%
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE> 12
PORTFOLIO PROFILE
Wellesley Income Fund
This Profile provides a snapshot of the Fund's characteristics as of December
31, 1997, compared where appropriate to an unmanaged index. Key elements of
this Profile are defined on pages 12 and 13.
<TABLE>
<CAPTION>
TOTAL FUND CHARACTERISTICS
- ----------------------------------------------------------
<S> <C>
Yield 5.3%
Turnover Rate 36%
Expense Ratio 0.31%
Cash Reserves 1.3%
</TABLE>
PORTFOLIO ASSET ALLOCATION
- ----------------------------------------------------------
CASH RESERVES 1%
STOCKS 36%
BONDS 63%
<TABLE>
<CAPTION>
TOTAL FUND VOLATILITY MEASURES
- ----------------------------------------------------------
WELLESLEY S&P 500
- ----------------------------------------------------------
<S> <C> <C>
R-Squared 0.58 1.00
Beta 0.46 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST STOCKS (% OF EQUITIES)
- -------------------------------------------------------
<S> <C>
Bell Atlantic Corp. 5.1%
First Union Corp. 5.0
J.C. Penney Co., Inc. 4.3
KeyCorp 4.3
Ford Motor Co. 3.7
Amoco Corp. 3.5
GTE Corp. 3.4
National City Corp. 3.3
Royal Dutch Petroleum Co. ADR 2.7
USX-Marathon Group 2.7
- -------------------------------------------------------
Top Ten 38.0%
- -------------------------------------------------------
Top Ten as % of Total Net Assets 13.8%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- ----------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1996 DECEMBER 31, 1997
------------------------------------------------------------
WELLESLEY WELLESLEY S&P 500
------------------------------------------------------------
<S> <C> <C> <C>
Auto & Transportation . . . . . . . . . . . . . . . . 5.1% 6.4% 3.5%
Consumer Discretionary . . . . . . . . . . . . . . . 3.0 7.3 9.8
Consumer Staples . . . . . . . . . . . . . . . . . . 4.6 5.8 11.5
Financial Services . . . . . . . . . . . . . . . . . 28.4 28.5 17.7
Health Care . . . . . . . . . . . . . . . . . . . . . 5.8 3.8 11.4
Integrated Oils . . . . . . . . . . . . . . . . . . . 16.0 13.8 7.2
Other Energy . . . . . . . . . . . . . . . . . . . . 0.0 0.0 1.4
Materials & Processing . . . . . . . . . . . . . . . 10.4 8.9 5.8
Producer Durables . . . . . . . . . . . . . . . . . . 0.0 0.0 4.0
Technology . . . . . . . . . . . . . . . . . . . . . 0.0 0.0 11.2
Utilities . . . . . . . . . . . . . . . . . . . . . . 23.1 23.9 10.6
Other . . . . . . . . . . . . . . . . . . . . . . . . 3.6 1.6 5.9
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
EQUITY CHARACTERISTICS
- ----------------------------------------------------------
WELLESLEY S&P 500
- ----------------------------------------------------------
<S> <C> <C>
Number of Stocks 70 500
Median Market Cap $15.6B $34.1B
Price/Earnings Ratio 18.4x 21.9x
Price/Book Ratio 2.8x 4.1x
Dividend Yield 3.4% 1.6%
Return on Equity 16.2% 20.4%
Earnings Growth Rate 12.2% 17.6%
Foreign Holdings 2.6% 1.9%
</TABLE>
EQUITY INVESTMENT FOCUS
- ----------------------------------------------------------
[GRAPH]
<TABLE>
<CAPTION>
FIXED-INCOME CHARACTERISTICS
- ----------------------------------------------------------
<S> <C>
Number of Bonds 187
Yield to Maturity 6.6%
Average Coupon 7.4%
Average Maturity 18.5 years
Average Quality Aa3
Average Duration 9.1 years
</TABLE>
FIXED-INCOME INVESTMENT FOCUS
- ----------------------------------------------------------
[GRAPH]
<TABLE>
<CAPTION>
DISTRIBUTION BY ISSUER (% OF BONDS)
- -------------------------------------------------------
<S> <C>
Asset-Backed 0.0%
Finance 20.8
Foreign 7.2
Industrial 32.2
Mortgage 0.0
U.S. Government and Agency 0.0
U.S. Treasury 18.7
Utilities 21.1
- -------------------------------------------------------
Total 100.0%
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTION BY CREDIT QUALITY (% OF BONDS)
- -------------------------------------------------------
<S> <C>
Aaa 24.8%
Aa 19.9
A 41.1
Baa 14.2
Ba 0.0
B 0.0
Not Rated 0.0
- -------------------------------------------------------
Total 100.0%
</TABLE>
11
<PAGE> 14
AVERAGE COUPON. The average interest rate paid on the securities held by a
portfolio. It is expressed as a percentage of face value.
AVERAGE DURATION. An estimate of how much a bond portfolio's share price will
fluctuate in response to a change in interest rates. To see how the price could
shift, multiply the portfolio's duration by the change in rates. If interest
rates rise by one percentage point, the share price of a portfolio with an
average duration of five years would decline by about 5%. If rates decrease by
a percentage point, the portfolio's share price would rise by 5%.
AVERAGE MATURITY. The average length of time until bonds held by a portfolio
reach maturity (or are called) and are repaid. In general, the longer the
average maturity, the more a portfolio's share price will fluctuate in response
to changes in market interest rates.
AVERAGE QUALITY. An indicator of credit risk, this figure is the average of the
ratings assigned to a portfolio's securities holdings by credit-rating
agencies. The agencies make their judgment after appraising an issuer's
ability to meet its obligations. Quality is graded on a scale, with Aaa or AAA
indicating the most creditworthy bond issuers and A-1 or MIG-1 indicating the
most creditworthy issuers of money market securities.
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a portfolio with a
beta of 1.20 would have seen its share price rise or fall by 12% when the
overall market rose or fell by 10%.
CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities. This
figure does not include cash invested in futures contracts to simulate stock or
bond investments.
DISTRIBUTION BY CREDIT QUALITY. This breakdown of a portfolio's securities by
credit rating can help in gauging the risk that returns could be affected by
defaults or other credit problems.
DISTRIBUTION BY ISSUER. A breakdown of a portfolio's holdings by type of issuer
or type of instrument.
DIVIDEND YIELD. The current, annualized rate of dividends paid on a share of
stock, divided by its current share price. For a portfolio, the weighted
average yield for stocks it holds.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a portfolio.
EQUITY 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).
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.
FIXED-INCOME INVESTMENT FOCUS. This grid indicates the focus of a portfolio in
terms of two attributes: average maturity (short, medium, or long) and average
credit quality (high, medium, or low).
FOREIGN HOLDINGS. The percentage of a portfolio's net assets represented by
stocks or American Depositary Receipts of companies based outside the United
States.
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 BONDS. An indicator of diversification. The more separate issues a
portfolio holds, the less susceptible it is to a price decline stemming from
the problems of a particular issue.
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.
12
<PAGE> 15
PORTFOLIO ASSET ALLOCATION. This chart shows the distribution, by type of
asset, of the Fund's holdings.
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.
R-SQUARED. A measure of how much of a portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio's returns bore no
relationship to the market's returns, its R-squared would be 0.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a 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 equity assets that a portfolio has
invested in its ten largest equity holdings. As this percentage rises, returns
are likely to be more volatile because they are 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.
YIELD TO MATURITY. The rate of return an investor would receive if the
securities held by a portfolio were held to their maturity dates.
13
<PAGE> 16
FINANCIAL STATEMENTS
December 31, 1997
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, 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 Fund's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the Fund
to arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the Fund's net assets on both a dollar and
per-share basis. Because all income and any realized gains must be distributed
to shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the Fund had available to distribute to shareholders as income dividends
or capital gains as of the statement date. Any Accumulated Net Realized Losses,
and any cumulative excess of distributions over net income or net realized
gains, will appear as negative balances. Unrealized Appreciation (Depreciation)
is the difference between the market value of the Fund's investments and their
cost, and reflects the gains (losses) that would be realized if the Fund were
to sell all of its investments at their statement-date values.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
WELLESLEY INCOME FUND (000) (000)
- ----------------------------------------------------------------------------
CORPORATE BONDS (46.2%)
- ----------------------------------------------------------------------------
<S> <C> <C>
FINANCE (13.0%)
ABN AMRO Bank NV
(Chicago Branch)
7.55%, 6/28/2006 $25,000 $ 26,784
Allstate Corp.
7.50%, 6/15/2013 20,000 21,472
Ambac, Inc.
7.50%, 5/1/2023 5,500 5,908
American Re Corp.
7.45%, 12/15/2026 33,000 35,583
Banc One Corp.
7.75%, 7/15/2025 50,000 55,224
8.00%, 4/29/2027 15,000 17,067
BankBoston Corp.
6.625%, 12/1/2005 15,000 15,106
6.875%, 7/15/2003 15,000 15,344
Boatmen's Bancshares Inc.
7.625%, 10/1/2004 10,000 10,643
CIGNA Corp.
7.875%, 5/15/2027 25,000 27,125
Citicorp
6.65%, 12/15/2010 MTN 25,000 25,335
7.125%, 9/1/2005 15,000 15,593
7.625%, 5/1/2005 10,000 10,668
Comerica, Inc.
7.125%, 12/1/2013 15,000 15,271
CoreStates Capital Corp.
6.625%, 3/15/2005 20,000 20,181
Fifth Third Bank
6.75%, 7/15/2005 25,000 25,395
First Bank N.A.
7.55%, 6/15/2004 8,000 8,473
First Bank System Inc.
6.625%, 5/15/2003 10,000 10,113
7.625%, 5/1/2005 7,500 7,997
First Chicago Corp.
7.625%, 1/15/2003 15,000 15,851
First Union Corp.
6.00%, 10/30/2008 15,000 14,316
7.50%, 4/15/2035 11,000 12,539
Fleet Financial Group, Inc.
6.875%, 3/1/2003 30,000 30,622
General Electric Global
Insurance Holdings
7.00%, 2/15/2026 60,000 62,604
General Electric Capital Services
7.50%, 8/21/2035 14,000 15,793
General Electric Capital Corp
8.125%, 5/15/2012 10,000 11,588
GMAC
7.00%, 9/15/2002 30,000 30,906
John Hancock
7.375%, 2/15/2024 25,000 26,189
Liberty Mutual Insurance Co.
8.50%, 5/15/2025 25,300 29,286
Lumbermens Mutual Casualty
9.15%, 7/1/2026 45,000 52,045
MBIA Inc.
7.00%, 12/15/2025 19,500 20,219
Metropolitan Life Insurance Co.
7.80%, 11/1/2025 25,000 26,801
J.P. Morgan & Co., Inc.
5.75%, 10/15/2008 20,000 18,797
6.25%, 1/15/2009 20,000 19,465
NBD Bank N.A.
6.25%, 8/15/2003 20,000 19,973
</TABLE>
14
<PAGE> 17
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- ----------------------------------------------------------------------------
<S> <C> <C>
National City Bank Pennsylvania
7.25%, 10/21/2011 $22,000 $ 23,085
National City Cleveland Bank
6.50%, 5/1/2003 10,000 10,066
National City Corp.
7.20%, 5/15/2005 20,000 20,792
NationsBank Corp.
7.25%, 10/15/2025 20,000 20,919
7.75%, 8/15/2004 20,000 21,426
Republic New York Corp.
5.875%, 10/15/2008 15,000 14,286
SunTrust Banks, Inc.
6.00%, 2/15/2026 25,000 24,517
6.125%, 2/15/2004 20,000 19,781
Travelers Property Casualty Corp.
7.75%, 4/15/2026 9,540 10,445
Wachovia Corp.
6.375%, 4/15/2003 20,000 20,146
6.605%, 10/1/2025 30,000 30,992
------------
992,731
------------
INDUSTRIAL (20.1%)
Air Products & Chemicals, Inc.
7.375%, 5/1/2005 15,000 15,939
8.75%, 4/15/2021 12,550 15,480
Baxter International, Inc.
7.65%, 2/1/2027 25,000 27,758
Bristol-Myers Squibb Co.
6.80%, 11/15/2026 40,000 41,626
Browning-Ferris Industries, Inc.
6.375%, 1/15/2008 15,000 14,760
Burlington Northern Santa Fe Corp.
6.375%, 12/15/2005 12,500 12,398
6.875%, 12/1/2027 25,000 25,154
CPC International, Inc.
6.15%, 1/15/2006 20,000 19,804
7.25%, 12/15/2026 30,000 32,192
CSX Corp.
7.95%, 5/1/2027 30,000 33,864
Chrysler Corp.
7.45%, 3/1/2027 25,000 26,926
The Walt Disney Co.
6.75%, 3/30/2006 15,000 15,411
E.I. du Pont de Nemours & Co.
6.75%, 9/1/2007 25,000 25,738
Eastman Chemical Co.
7.25%, 1/15/2024 25,000 25,970
7.60%, 2/1/2027 15,000 16,197
Eaton Corp.
6.50%, 6/1/2025 10,000 10,285
7.625%, 4/1/2024 10,000 11,033
Fluor Corp.
6.95%, 3/1/2007 20,000 20,758
Ford Motor Co.
7.50%, 8/1/2026 20,000 21,683
8.875%, 1/15/2022 20,000 24,723
General Motors Corp.
7.40%, 9/1/2025 30,000 31,930
9.40%, 7/15/2021 20,000 25,901
Georgia-Pacific Corp.
8.625%, 4/30/2025 10,000 10,912
Gillette Co.
5.75%, 10/15/2005 20,000 19,462
6.25%, 8/15/2003 10,000 10,071
Hershey Foods Corp.
6.95%, 3/1/2007 13,000 13,603
Hubbell Inc.
6.625%, 10/1/2005 10,000 10,208
International Business
Machines Corp.
7.00%, 10/30/2025 60,000 62,126
International Paper Co.
7.625%, 1/15/2007 15,000 15,975
Johnson & Johnson
6.73%, 11/15/2023 15,000 15,667
Johnson Controls, Inc.
8.20%, 6/15/2024 6,000 6,502
Eli Lilly & Co.
7.125%, 6/1/2025 50,000 53,329
Lockheed Corp.
6.75%, 3/15/2003 7,000 7,148
McDonald's Corp.
7.05%, 11/15/2025 23,300 23,316
7.375%, 7/15/2033 8,500 8,746
Mead Corp.
7.35%, 3/1/2017 10,350 11,015
Merck & Co.
6.30%, 1/1/2026 30,000 29,898
Mobil Corp.
8.625%, 8/15/2021 20,000 25,083
Monsanto Co.
6.75%, 12/15/2027 25,000 25,092
8.20%, 4/15/2025 20,000 22,047
Motorola, Inc.
7.50%, 5/15/2025 50,000 55,482
New York Times Co.
8.25%, 3/15/2025 26,000 29,146
News America Holdings Inc.
8.00%, 10/17/2016 50,000 53,507
Norfolk Southern Corp.
7.80%, 5/15/2027 15,000 16,840
Northrop Grumman Corp.
9.375%, 10/15/2024 15,000 17,720
PPG Industries, Inc.
6.875%, 2/15/2012 10,200 10,630
9.00%, 5/1/2021 15,000 18,985
J.C. Penney Co., Inc.
7.95%, 4/1/2017 15,000 16,754
Phelps Dodge Corp.
7.125%, 11/1/2027 12,500 12,744
Phillips Petroleum Co.
9.375%, 2/15/2011 10,000 12,363
Praxair, Inc.
6.75%, 3/1/2003 25,000 25,427
Procter & Gamble Co.
6.45%, 1/15/2026 24,000 23,766
Procter & Gamble Co. ESOP
(2) 9.36%, 1/1/2021 30,000 38,820
Raytheon Co.
7.20%, 8/15/2027 25,000 26,147
7.375%, 7/15/2025 25,000 25,144
</TABLE>
15
<PAGE> 18
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
WELLESLEY INCOME FUND (000) (000)
- ----------------------------------------------------------------------------
<S> <C> <C>
Rohm & Haas Co.
(2) 9.80%, 4/15/2020 $10,000 $ 12,703
E.W. Scripps Co.
6.625%, 10/15/2007 20,000 20,343
Tenneco Inc.
7.625%, 6/15/2017 30,000 32,302
7.875%, 4/15/2027 20,000 22,337
Texaco Capital Inc.
8.625%, 4/1/2032 30,000 37,586
Tribune Co.
6.875%, 11/1/2006 20,000 20,588
Ultramar Diamond Shamrock
7.20%, 10/15/2017 25,000 25,575
Union Pacific Corp.
7.00%, 2/1/2016 30,000 30,071
United Parcel Service
8.375%, 4/1/2020 10,000 12,193
Weyerhaeuser Co.
8.50%, 1/15/2025 10,000 11,939
Whirlpool Corp.
9.00%, 3/1/2003 10,000 11,132
Witco Corp.
6.875%, 2/1/2026 15,000 15,034
Worthington Industries, Inc.
6.70%, 12/1/2009 15,500 15,683
7.125%, 5/15/2006 20,000 21,024
------------
1,537,715
------------
UTILITIES (13.1%)
AT&T Corp.
7.125%, 1/15/2002 20,000 20,761
Arizona Public Service Co.
6.625%, 3/1/2004 10,000 10,099
Baltimore Gas & Electric Co.
7.25%, 7/1/2002 15,000 15,578
BellSouth Telecommunications
6.25%, 5/15/2003 12,000 12,069
7.00%, 10/1/2025 10,000 10,523
8.25%, 7/1/2032 35,000 38,103
Carolina Power & Light Co.
6.875%, 8/15/2023 10,000 9,821
Chesapeake & Potomac
Telephone Co. (MD)
7.15%, 5/1/2023 20,000 20,481
Chesapeake & Potomac
Telephone Co. (VA)
7.875%, 1/15/2022 16,000 18,238
Cincinnati Gas & Electric Co.
6.90%, 6/1/2025 9,500 9,911
7.20%, 10/1/2023 15,100 15,229
Coastal Corp.
7.75%, 10/15/2035 10,000 10,882
Consolidated Edison Co. of
New York, Inc.
6.375%, 4/1/2003 20,000 20,138
Duke Energy Corp.
7.00%, 7/1/2033 30,000 29,899
El Paso Natural Gas Co.
7.50%, 11/15/2026 25,000 26,680
Enron Corp.
6.875%, 10/15/2007 20,000 20,396
7.00%, 8/15/2023 10,000 9,625
GTE California Inc.
6.70%, 9/1/2009 25,000 25,269
GTE Southwest, Inc.
6.00%, 1/15/2006 10,000 9,711
Houston Lighting & Power Co.
7.50%, 7/1/2023 20,000 20,634
Illinois Bell Telephone Co.
6.625%, 2/1/2025 13,575 13,046
7.25%, 3/15/2024 20,000 20,530
Illinois Power Co.
6.50%, 8/1/2003 10,000 9,987
Indiana Bell Telephone Co., Inc.
7.30%, 8/15/2026 23,000 24,975
Kentucky Utilities Co.
7.92%, 5/15/2007 5,000 5,549
MCI Communications Corp.
7.50%, 8/20/2004 15,000 15,772
Michigan Bell Telephone Co.
7.50%, 2/15/2023 35,000 36,433
7.85%, 1/15/2022 21,100 24,183
New Jersey Bell Telephone Co.
8.00%, 6/1/2022 40,000 46,601
New York Telephone Co.
6.50%, 3/1/2005 30,000 30,229
Northern States Power Co.
6.375%, 4/1/2003 8,000 8,080
7.125%, 7/1/2025 30,000 31,686
Ohio Bell Telephone Co.
6.125%, 5/15/2003 15,000 14,968
Oklahoma Gas & Electric
7.30%, 10/15/2025 15,000 15,591
Pacific Bell
7.125%, 3/15/2026 25,000 26,414
PacifiCorp MTN
6.625%, 6/1/2007 10,000 10,118
6.71%, 1/15/2026 12,500 12,289
Pennsylvania Power & Light Co.
6.50%, 4/1/2005 15,000 15,116
6.75%, 10/1/2023 9,000 8,633
PECO Energy Co.
6.50%, 5/1/2003 30,000 30,212
Southern California Edison Co.
6.25%, 6/15/2003 6,050 6,052
Southern California Gas Co.
6.875%, 11/1/2025 15,000 14,634
Southwestern Bell Telephone Co.
7.20%, 10/15/2026 32,500 33,312
7.25%, 7/15/2025 37,500 38,286
Southwestern Public Service Co.
7.25%, 7/15/2004 10,000 10,509
Tennessee Gas Pipeline Co.
7.50%, 4/1/2017 25,000 26,675
Texas Utilities Electric Co.
6.75%, 7/1/2005 10,000 10,169
Union Electric Co.
6.875%, 8/1/2004 10,000 10,312
U S WEST Capital Funding, Inc.
7.30%, 1/15/2007 25,000 25,926
U S WEST Communications Group
7.50%, 6/15/2023 45,000 46,692
</TABLE>
16
<PAGE> 19
<TABLE>
- ----------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- ----------------------------------------------------------------------------
<S> <C> <C>
Virginia Electric & Power Co.
6.75%, 10/1/2023 $20,000 $ 19,414
Wisconsin Public Service Co.
7.30%, 10/1/2002 6,700 7,049
------------
1,003,489
------------
- ----------------------------------------------------------------------------
TOTAL CORPORATE BONDS
(COST $3,340,282) 3,533,935
- ----------------------------------------------------------------------------
FOREIGN BONDS (U.S. DOLLAR DENOMINATED)(4.5%)
- ----------------------------------------------------------------------------
Amoco Canada Petroleum Co.
6.75%, 9/1/2023 25,000 24,620
BHP Finance USA Ltd.
6.69%, 3/1/2006 10,000 10,045
Province of British Columbia
6.50%, 1/15/2026 35,000 35,198
Husky Oil Ltd.
7.55%, 11/15/2016 20,000 20,764
Republic of Italy Global Bond
6.875%, 9/27/2023 10,000 10,470
Province of Manitoba
6.125%, 1/19/2004 7,000 6,984
8.875%, 9/15/2021 24,041 30,906
Province of Ontario
6.00%, 2/21/2006 25,000 24,620
7.75%, 6/4/2002 15,000 15,961
Petro-Canada
7.875%, 6/15/2026 11,840 13,373
Province of Quebec
7.50%, 7/15/2023 50,000 53,919
Saga Petroleum ASA
7.25%, 9/23/2027 25,000 25,691
Province of Saskatchewan
8.50%, 7/15/2022 19,000 23,367
Talisman Energy, Inc.
7.125%, 6/1/2007 20,000 20,605
7.25%, 10/15/2027 25,000 25,851
- ----------------------------------------------------------------------------
TOTAL FOREIGN BONDS
(COST $328,156) 342,374
- ----------------------------------------------------------------------------
U.S. GOVERNMENT AND AGENCY OBLIGATIONS (11.6%)
- ----------------------------------------------------------------------------
U.S. Treasury Bonds
6.25%, 8/15/2023 250,000 257,690
7.25%, 5/15/2016 250,000 284,705
12.00%, 8/15/2013 130,000 191,599
U.S. Treasury Notes
6.25%, 8/31/2002 100,000 102,087
6.875%, 5/15/2006 50,000 53,507
- ----------------------------------------------------------------------------
TOTAL U.S. GOVERNMENT AND AGENCY OBLIGATIONS
(COST $819,727) 889,588
- ----------------------------------------------------------------------------
<CAPTION>
- ----------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ----------------------------------------------------------------------------
COMMON STOCKS (36.4%)
- ----------------------------------------------------------------------------
<S> <C> <C>
AUTO & TRANSPORTATION (2.3%)
Chrysler Corp. 1,246,200 $ 43,851
Ford Motor Co. 2,129,900 103,700
Union Pacific Corp. 510,000 31,843
------------
179,394
------------
CONSUMER DISCRETIONARY (2.7%)
Eastman Kodak Co. 916,000 55,704
May Department Stores Co. 540,000 28,451
J.C. Penney Co., Inc. 1,992,600 120,179
------------
204,334
------------
CONSUMER STAPLES (2.1%)
Flowers Industries, Inc. 2,901,600 59,664
Gallaher Group PLC ADR 1,207,100 25,802
H.J. Heinz Co. 650,800 33,069
Philip Morris Cos., Inc. 475,000 21,523
Universal Corp. 521,900 21,463
------------
161,521
------------
FINANCIAL SERVICES (10.4%)
Alexandria Real Estate
Equities, Inc. REIT 279,100 8,809
BankAmerica Corp. 540,000 39,420
Brandywine Realty Trust REIT 332,000 8,342
CBL & Associates Properties,
Inc. REIT 1,050,400 25,932
Camden Property Trust REIT 920,172 28,525
Chateau Communities, Inc. REIT 89,869 2,831
(1) Colonial Properties Trust REIT 1,139,900 34,339
Felcor Suite Hotels, Inc. REIT 420,000 14,910
First Union Corp. 2,720,400 139,421
General Growth Properties
Inc. REIT 802,600 28,994
Highwood Properties, Inc. REIT 325,000 12,086
IPC Holdings Ltd. 309,300 9,898
JP Realty Inc. REIT 250,000 6,484
KeyCorp 1,679,050 118,898
Kimco Realty Corp. REIT 218,700 7,709
The Macerich Co. REIT 719,100 20,494
Mid Ocean Ltd. 179,900 9,760
National City Corp. 1,405,000 92,379
Nationwide Health
Properties, Inc. REIT 616,000 15,708
PNC Bank Corp. 456,800 26,066
Summit Bancorp. 900,000 47,925
Sun Communities, Inc. REIT 320,600 11,522
Urban Shopping Centers,
Inc. REIT 617,000 21,518
Wachovia Corp. 766,900 62,215
------------
794,185
------------
HEALTH CARE (1.4%)
Baxter International, Inc. 1,047,700 52,843
Pharmacia & Upjohn, Inc. 1,448,500 53,051
------------
105,894
------------
INTEGRATED OILS (5.0%)
Amoco Corp. 1,135,000 96,617
Atlantic Richfield Co. 736,000 58,972
Equitable Resources, Inc. 1,125,000 39,797
Royal Dutch Petroleum Co. ADR 1,398,000 75,754
Texaco Inc. 733,400 39,879
USX-Marathon Group 2,188,200 73,852
------------
384,871
------------
</TABLE>
17
<PAGE> 20
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
MARKET
VALUE*
WELLESLEY INCOME FUND SHARES (000)
- ----------------------------------------------------------------------------
<S> <C> <C>
MATERIALS & PROCESSING (3.3%)
BOC Group PLC ADR 800,000 $ 26,350
Consolidated Papers 251,600 13,429
Dow Chemical Co. 360,000 36,540
Eastman Chemical Co. 633,400 37,727
- - Georgia Pacific Timber Group 500,000 11,344
Kimberly-Clark Corp. 971,500 47,907
Union Camp Corp. 203,500 10,925
Weyerhaeuser Co. 579,600 28,437
Witco Chemical Corp. 886,400 36,176
------------
248,835
------------
UTILITIES (8.7%)
Bell Atlantic Corp. 1,553,200 141,341
BellSouth Corp. 422,000 23,764
Central & South West Corp. 2,162,300 58,517
Consolidated Edison Co. of
New York, Inc. 527,400 21,623
DQE Inc. 1,357,050 47,666
DTE Energy Co. 1,238,200 42,950
Duke Energy Corp. 724,000 40,092
GPU, Inc. 1,130,400 47,618
GTE Corp. 1,787,700 93,407
MCN Corp. 291,200 11,757
New England Electric System 479,000 20,477
NICOR, Inc. 582,300 24,566
Questar Corp. 570,000 25,436
SBC Communications Inc. 82,000 6,006
Southern Co. 1,260,000 32,603
Texas Utilities Co. 200,000 8,312
U S WEST Communications
Group 405,000 18,276
------------
664,411
------------
OTHER (0.5%)
Cooper Industries, Inc. 824,400 40,396
------------
- ----------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $1,888,395) 2,783,841
- ----------------------------------------------------------------------------
FACE
AMOUNT
(000)
- ----------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (2.2%)
- ----------------------------------------------------------------------------
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
6.54%, 1/2/1998 $106,739 106,739
6.50%, 1/2/1998---Note F 63,809 63,809
- ----------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $170,548) 170,548
- ----------------------------------------------------------------------------
TOTAL INVESTMENTS (100.9%)
(COST $6,547,108) 7,720,286
- ----------------------------------------------------------------------------
MARKET
VALUE*
(000)
- ----------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.9%)
- ----------------------------------------------------------------------------
Other Assets--Note C $ 112,521
Liabilities--Note F (186,907)
------------
(74,386)
- ----------------------------------------------------------------------------
NET ASSETS (100%)
- ----------------------------------------------------------------------------
Applicable to 349,691,084 outstanding
$.10 par value shares
(authorized 450,000,000 shares) $7,645,900
============================================================================
NET ASSET VALUE PER SHARE $21.86
============================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
-Non-Income-Producing Security. New issue that has not paid a dividend as of
December 31, 1997.
(1)Considered an affiliated company as the Fund owns more than 5% of the
outstanding voting securities of such company. The total market value of
investments in affiliated companies was $34,339,000.
(2)The average maturity is shorter than the final maturity shown due to
scheduled interim principal payments.
ADR--American Depositary Receipt.
MTN--Medium-Term Note.
REIT--Real Estate Investment Trust.
<TABLE>
<CAPTION>
- ------------------------------------------------------------
AT DECEMBER 31, 1997, NET ASSETS CONSISTED OF:
- ------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ------------------------------------------------------------
<S> <C> <C>
Paid in Capital--Note A $6,393,432 $18.28
Overdistributed Net
Investment Income--
Notes A and D (3,967) (.01)
Accumulated Net
Realized Gains--Note D 83,257 .24
Unrealized Appreciation--
Note E 1,173,178 3.35
- ------------------------------------------------------------
NET ASSETS $7,645,900 $21.86
============================================================
</TABLE>
18
<PAGE> 21
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Fund during the
reporting period, and details the operating expenses charged to the Fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
WELLESLEY INCOME FUND
YEAR ENDED DECEMBER 31, 1997
(000)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends* $ 93,961
Interest 318,667
----------------
Total Income 412,628
----------------
EXPENSES
Investment Advisory Fee--Note B
Basic Fee 3,646
Performance Adjustment 718
The Vanguard Group--Note C
Management and Administrative 15,331
Marketing and Distribution 1,431
Taxes (other than income taxes) 534
Custodian Fees 103
Auditing Fees 15
Shareholders' Reports 247
Annual Meeting and Proxy Costs 71
Directors' Fees and Expenses 17
----------------
Total Expenses 22,113
Expenses Paid Indirectly--Note C (590)
----------------
Net Expenses 21,523
- ---------------------------------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME 391,105
- ---------------------------------------------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD* 512,072
- ---------------------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 425,482
- ---------------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $1,328,659
===========================================================================================================================
</TABLE>
*Dividend income and realized net gain from affiliated companies were
$1,929,000 and $1,352,000, respectively.
19
<PAGE> 22
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Fund's total net assets changed during the two
most recent reporting periods. The Operations section summarizes information
detailed in the Statement of Operations. The amounts shown as Distributions to
shareholders from the Fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined
on a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in
the Fund, either by purchasing shares or by reinvesting distributions, as well
as the amounts redeemed. The corresponding numbers of Shares Issued and
Redeemed are shown at the end of the Statement.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
Wellesley Income Fund
YEAR ENDED DECEMBER 31,
-------------------------------------
1997 1996
(000) (000)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 391,105 $ 403,091
Realized Net Gain 512,072 258,042
Change in Unrealized Appreciation (Depreciation) 425,482 (41,888)
-----------------------------------
Net Increase in Net Assets Resulting from Operations 1,328,659 619,245
-----------------------------------
DISTRIBUTIONS
Net Investment Income (395,073) (398,277)
Realized Capital Gain (476,586) (202,715)
-----------------------------------
Total Distributions (871,659) (600,992)
-----------------------------------
NET EQUALIZATION CHARGES--Note A -- (4,740)
-----------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 803,337 912,255
Issued in Lieu of Cash Distributions 759,182 519,028
Redeemed (1,386,341) (1,612,810)
-----------------------------------
Net Increase (Decrease) from Capital Share Transactions 176,178 (181,527)
- ---------------------------------------------------------------------------------------------------------------------------
Total Increase (Decrease) 633,178 (168,014)
- ---------------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 7,012,722 7,180,736
-----------------------------------
End of Year $7,645,900 $7,012,722
===========================================================================================================================
(1)Shares Issued (Redeemed)
Issued 37,413 45,503
Issued in Lieu of Cash Distributions 35,385 25,898
Redeemed (65,083) (80,687)
-----------------------------------
Net Increase (Decrease) in Shares Outstanding 7,715 (9,286)
===========================================================================================================================
</TABLE>
20
<PAGE> 23
FINANCIAL HIGHLIGHTS
This table summarizes the Fund's investment results and distributions to
shareholders on a per-share basis. It also presents the Fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the Fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the Fund's total return; how much it costs to operate the
Fund; and the extent to which the Fund tends to distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in
the Fund for one year. Finally, the table lists the Fund's Average Commission
Rate Paid, a disclosure required by the Securities and Exchange Commission
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>
- ---------------------------------------------------------------------------------------------------------------------------
Wellesley Income Fund
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $20.51 $20.44 $17.05 $19.24 $18.16
- ---------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income 1.190 1.17 1.13 1.11 1.14
Net Realized and Unrealized Gain (Loss) on Investments 2.805 .66 3.68 (1.95) 1.48
-------------------------------------------------------------
Total from Investment Operations 3.995 1.83 4.81 (.84) 2.62
-------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (1.200) (1.16) (1.14) (1.11) (1.14)
Distributions from Realized Capital Gains (1.445) (.60) (.28) (.24) (.40)
-------------------------------------------------------------
Total Distributions (2.645) (1.76) (1.42) (1.35) (1.54)
- ---------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $21.86 $20.51 $20.44 $17.05 $19.24
===========================================================================================================================
TOTAL RETURN 20.19% 9.42% 28.91% -4.44% 14.65%
===========================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $7,646 $7,013 $7,181 $5,681 $6,011
Ratio of Total Expenses to Average Net Assets 0.31% 0.31% 0.35% 0.34% 0.33%
Ratio of Net Investment Income to Average Net Assets 5.47% 5.74% 5.96% 6.16% 5.79%
Portfolio Turnover Rate 36% 26% 32% 32% 21%
Average Commission Rate Paid $.0598 $.0585 N/A N/A N/A
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
21
<PAGE> 24
NOTES TO FINANCIAL STATEMENTS
Vanguard/Wellesley Income Fund is registered under the Investment Company Act
of 1940 as a diversified open-end investment company, or mutual fund. 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 conform to generally
accepted accounting principles for mutual funds. The Fund 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. Bonds are valued using the latest bid
prices or using valuations based on a matrix system (which considers such
factors as security prices, yields, maturities, and ratings), both as furnished
by independent pricing services. 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.
3. EQUALIZATION: Prior to January 1, 1997, the Fund followed 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, was credited or
charged to undistributed income. As a result, undistributed income per share
was unaffected by capital share transactions. As of January 1, 1997, the Fund
has discontinued equalization accounting and has reclassified accumulated net
equalization credits of $50,574,000 from undistributed net income to paid in
capital. This reclassification has no effect on the Fund's net assets, results
of operations, or net asset value per share.
4. REPURCHASE AGREEMENTS: The Fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other
party to the agreement, retention of the collateral may be subject to legal
proceedings.
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold. Premiums and discounts on debt
securities purchased are amortized and accreted, respectively, to interest
income over the lives of the respective securities.
B. Wellington Management Company, LLP provides investment advisory services
to the Fund 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 a combined index comprising the Lehman Brothers Long Corporate AA or
Better Bond Index, the S&P/BARRA Value Index, the S&P Utilities Index, and the
S&P Telephone Index. For the year ended December 31, 1997, the advisory fee
represented an effective annual basic rate of 0.05% of the Fund's average net
assets before an increase of $718,000 (0.01%) based on performance.
22
<PAGE> 25
C. The Vanguard Group furnishes at cost corporate management,
administrative, marketing, and distribution services. The costs of such
services are allocated to the Fund under methods approved by the Board of
Directors. At December 31, 1997, the Fund had contributed capital of
$506,000 to Vanguard (included in Other Assets), representing 2.5% of
Vanguard's capitalization. The Fund's Directors and officers are also
Directors and officers of Vanguard.
Vanguard has asked 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 to the Fund part of the commissions generated. Such
rebates are used solely to reduce the Fund's administrative expenses. For the
year ended December 31, 1997, these arrangements reduced the Fund's expenses by
$590,000 (0.01% of average net assets).
D. During the year ended December 31, 1997, the Fund purchased $1,908,028,000
of investment securities and sold $1,850,678,000 of investment securities, other
than U.S. government securities and temporary cash investments. Purchases and
sales of U.S. government securities were $623,403,000 and $894,263,000,
respectively. Gains of $38,549,000 on securities held for less than one year are
treated as ordinary income for tax purposes and have been included in income
dividends to shareholders; accordingly, such gains have been reclassified from
accumulated net realized gains to undistributed net investment income.
E. At December 31, 1997, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $1,173,178,000,
consisting of unrealized gains of $1,184,997,000 on securities that had risen in
value since their purchase and $11,819,000 in unrealized losses on securities
that had fallen in value since their purchase.
F. The market value of securities on loan to brokers/dealers at December 31,
1997, was $341,409,000, for which the Fund held cash collateral of $63,809,000
and U.S. Treasury securities with a market value of $286,001,000. Cash
collateral received is invested in repurchase agreements. Security loans are
required to be secured at all times by collateral at least equal to the market
value of securities loaned; 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.
23
<PAGE> 26
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors of
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, 1997, the results
of its operations for the year then ended, the changes in its net assets for
each of the two years in the period then ended and the financial highlights for
each of the five years in the period then ended, in conformity with 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 at December 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
February 6, 1998
SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR VANGUARD/WELLESLEY INCOME FUND
This information for the fiscal year ended December 31, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Fund designates $452,055,000 as capital gain dividends (from net
long-term capital gains), of which $383,623,000 was distributed to
shareholders in December 1997 and $68,432,000 will be distributed in March
1998. Of the $452,055,000 capital gain dividends, the Fund designates
$212,733,000 as a 20% rate gain distribution.
For corporate shareholders, 19.3% of investment income (dividend
income plus short-term gains, if any) qualifies for the dividends-received
deduction.
24
<PAGE> 27
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> 28
VANGUARD FAMILY OF FUNDS
STOCK FUNDS
Convertible Securities Fund
Equity Income Fund
Explorer Fund
Growth and Income Portfolio
Horizon Fund
Aggressive Growth Portfolio
Capital Opportunity Portfolio
Global Equity Portfolio
Index Trust
500 Portfolio
Extended Market Portfolio
Growth Portfolio
Small Capitalization Stock
Portfolio
Total Stock Market Portfolio
Value Portfolio
Institutional Index Fund
International Equity Index Fund
Emerging Markets Portfolio
European Portfolio
Pacific Portfolio
International Growth Portfolio
International Value Portfolio
Morgan Growth Fund
PRIMECAP Fund
Selected Value Portfolio
Specialized Portfolios
Energy Portfolio
Gold & Precious Metals
Portfolio
Health Care Portfolio
REIT Index Portfolio
Utilities Income Portfolio
Tax-Managed Fund
Capital Appreciation
Portfolio
Growth and Income Portfolio
Total International Portfolio
Trustees' Equity Fund
U.S. Portfolio
U.S. Growth Portfolio
Windsor Fund
Windsor II
BALANCED FUNDS
Asset Allocation Fund
Balanced Index Fund
Horizon Fund
Global Asset Allocation
Portfolio
LifeStrategy Portfolios
Conservative Growth
Portfolio
Growth Portfolio
Income Portfolio
Moderate Growth Portfolio
STAR Portfolio
Tax-Managed Fund
Balanced Portfolio
Wellesley Income Fund
Wellington Fund
BOND FUNDS
Admiral Funds
Intermediate-Term U.S.
Treasury Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term U.S. Treasury
Portfolio
Bond Index Fund
Intermediate-Term Bond
Portfolio
Long-Term Bond Portfolio
Short-Term Bond Portfolio
Total Bond Market Portfolio
Fixed Income Securities Fund
GNMA Portfolio
High Yield Corporate Portfolio
Intermediate-Term Corporate
Portfolio
Intermediate-Term U.S.
Treasury Portfolio
Long-Term Corporate
Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term Corporate
Portfolio
Short-Term Federal Portfolio
Short-Term U.S. Treasury
Portfolio
Municipal Bond Fund
High-Yield Portfolio
Insured Long-Term Portfolio
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Limited-Term Portfolio
Long-Term Portfolio
Short-Term Portfolio
Preferred Stock Fund
State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
MONEY MARKET FUNDS
Admiral Funds
U.S. Treasury Money Market
Portfolio
Money Market Reserves
Federal Portfolio
Prime Portfolio
Municipal Bond Fund
Money Market Portfolio
Treasury Money Market Portfolio
State Tax-Free Funds
(CA, NJ, NY, OH, PA)
Q270-12/1997
(C) 1998 Vanguard Marketing
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Valley Forge, Pennsylvania 19482
FUND INFORMATION
1-800-662-7447
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1-800-662-2739
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1-800-523-1036
www.vanguard.com
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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.
