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VANGUARD
WELLESLEY(R) INCOME
FUND
ANNUAL REPORT
DECEMBER 31, 1999
[SHIP GRAPHIC]
[A MEMBER OF THE VANGUARD GROUP LOGO]
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[PHOTO OF JOHN C. BOGLE]
JOHN C. BOGLE
FELLOW SHAREHOLDERS:
TWO ROADS DIVERGED IN A WOOD, AND I--I TOOK THE ONE LESS TRAVELED BY, AND THAT
HAS MADE ALL THE DIFFERENCE.
I can think of no better words than those of Robert Frost to begin this special
letter to our shareholders, who have placed such extraordinary trust in me and
in Vanguard over the past quarter century. When the firm was founded 25 years
ago, we deliberately took a new road to managing a mutual fund enterprise.
Instead of having the funds controlled by an outside management company with its
own financial interests, the Vanguard funds--there were only 11 of them
then--would be controlled by their own shareholders and operate solely in their
financial interests. The outcome of our unprecedented decision was by no means
certain. We described it then as "The Vanguard Experiment."
Well, I guess it's fair to say it's an experiment no more. During the
past 25 years, the assets we hold in stewardship for investors have grown from
$1 billion to more than $500 billion, and I believe that our reputation for
integrity, fair-dealing, and sound investment principles is second to none in
this industry. Our staggering growth--which I never sought--has come in
important part as a result of the simple investment ideas and basic human values
that are the foundation of my personal philosophy. I have every confidence that
they will long endure at Vanguard, for they are the right ideas and right
values, unshakable and eternal.
While Emerson believed that "an institution is the lengthened shadow of
one man," Vanguard today is far greater than any individual. The Vanguard crew
has splendidly implemented and enthusiastically supported our founding ideas and
values, and deserves the credit for a vital role in forging our success over the
years. It is a dedicated crew of fine human beings, working together in an
organization that is well prepared to press on regardless long after I am gone.
Creating and leading this enterprise has been an exhilarating run. Through it
all, I've taken the kudos and the blows alike, enjoying every moment to the
fullest, and even getting a second chance at life with a heart transplant nearly
four years ago. What more could a man ask?
While I shall no longer be serving on the Vanguard Board, I want to
assure you that I will remain vigorous and active in a newly created Vanguard
unit, researching the financial markets, writing, and speaking. I'll continue to
focus whatever intellectual power and ethical strength I possess on my mission
to assure that mutual fund investors everywhere receive a fair shake. In the
spirit of Robert Frost:
BUT I HAVE PROMISES TO KEEP, AND MILES TO GO BEFORE I SLEEP, AND MILES
TO GO BEFORE I SLEEP.
You have given me your loyalty and friendship over these long years,
and I deeply appreciate your thousands of letters of support. For my part, I
will continue to keep an eagle eye on your interests, for you deserve no less.
May God bless you all, always.
/S/
JCB
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CONTENTS
REPORT FROM THE CHAIRMAN 1
AFTER-TAX RETURNS REPORT 5
NOTICE TO SHAREHOLDERS 6
THE MARKETS IN PERSPECTIVE 7
REPORT FROM THE ADVISER 9
PERFORMANCE SUMMARY 11
FUND PROFILE 12
FINANCIAL STATEMENTS 16
REPORT OF INEPENDENT ACCOUNTANTS 26
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REPORT FROM THE CHAIRMAN
[PHOTO OF JOHN J. BRENNAN]
JOHN J. BRENNAN
Vanguard Wellesley Income Fund recorded a -4.1% return during 1999 as rising
interest rates sliced the prices of our bond holdings and hurt many of our
income-oriented, interest-rate-sensitive stocks. Our disappointing return
trailed both the 5.0% return of the average income fund and the -1.4% decline
for our unmanaged index benchmark.
The table at right presents the fund's total return (capital change
plus reinvested dividends) and those of its comparative standards. The Wellesley
Composite Index is constructed of market benchmarks weighted in proportion to
our typical investment mix of 65% bonds and 35% high-yielding stocks.
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TOTAL RETURNS
YEAR ENDED
DECEMBER 31, 1999
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Vanguard Wellesley Income Fund -4.1%
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Average Income Fund* 5.0%
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Wellesley Composite Index** -1.4%
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*Derived from data provided by Lipper Inc.
**65% Lehman Long Corporate AA or Better Index,
26% S&P 500/BARRA Value Index, 4.5% S&P Utilities
Index, and 4.5% S&P Telephone Index.
Our return is based on a decrease in net asset value from $22.12 per
share on December 31, 1998, to $18.85 per share on December 31, 1999, adjusted
for dividends totaling $1.12 per share paid from net investment income and
distributions totaling $1.245 per share paid from net realized capital gains. At
year-end, our annualized yield was 5.7%, up from 4.8% on December 31, 1998.
FINANCIAL MARKETS IN REVIEW
The U.S. economy's rapid growth during 1999--gross domestic product expanded by
around 4%--surprised the financial markets. For bond investors, it was an
unhappy surprise, as interest rates rose substantially. The uptrend in rates was
encouraged by Federal Reserve Board policymakers, who boosted short-term
interest rates in three steps by a total of 0.75 percentage point (75 basis
points).
Bond prices are, of course, tightly linked to interest rates, and
rising rates cause prices of existing bonds to fall. Interest rates rose across
all maturities in 1999, and prices dropped accordingly. The yield of the
benchmark 30-year U.S. Treasury bond stood at 6.48% on December 31, 138 basis
points above its 5.10% yield when the year began. Long-term bonds were hardest
hit by the rise in rates, as always, and their prices fell almost 15% during the
year. The total return of the Lehman Brothers Aggregate Bond Index, a broad
measure of the U.S. bond market, was -0.8%, as a price decline of -7.0% more
than offset interest income of 6.2%. Rates also rose on short-term money market
instruments, though not as much as for long-term securities. The yield of 90-day
Treasury bills increased 88 basis points during 1999 to 5.33% at year-end.
Somewhat surprisingly, rising interest rates merely slowed the stock
market's long bull market. Higher rates can depress stock prices by making bond
yields more attractive. Also, higher rates lessen the current value of projected
future earnings. But during 1999, investors decided that--at least for
fast-growing technology stocks--prospects for bigger corporate profits
outweighed the negative impact of higher rates.
The U.S. stock market in 1999 rode the technology wave to an
unprecedented fifth consecutive year of returns exceeding 20%. This performance
was something of a come-from-behind story. Stocks got off to a strong start
during the first four months
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of the year but struggled in the face of higher interest rates during most of
the summer and into the fall. Through September, the Wilshire 5000 Total Market
Index returned 4.6%. But technology stocks rallied, leading the market on an
upward tear over the final three months of 1999. The Wilshire 5000's full-year
return was a remarkable 23.8%, and the Standard & Poor's 500 Index, which is
dominated by large-capitalization stocks, returned 21.0%.
The rise for the major indexes in 1999 suggests a broad advance for the
market, but in fact it was a year of "haves" and "have nots"--a huge number of
stocks did not join in the market's ascent. Fully 60% of the stocks listed on
the New York Stock Exchange actually declined in price in 1999, and so did 48%
of the stocks listed on the Nasdaq market. (In fact, 36% of NYSE stocks and 31%
of Nasdaq issues fell by more than 20%.) The main "haves" were companies in the
technology sector--where stocks gained more than 70% for the year--along with
companies involved in wireless and cable telecommunications. The skyrocketing
technology group was responsible for growth stocks far outpacing value stocks;
within the S&P 500 Index, for example, growth stocks gained 28.2% while value
stocks were up 12.7%.
1999 PERFORMANCE OVERVIEW
Vanguard Wellesley Income Fund was hit hard by the rise in interest rates during
1999. We suffered from a double whammy--declines in both our bond and stock
holdings. Our bond segment, which accounts for 60% to 65% of our assets,
returned -5.3%, after expenses. While this was a poor absolute return, it was
ahead of the -7.0% return for the Lehman Long Corporate AA or Better Bond Index,
our fixed-income benchmark.
Our adviser, Wellington Management Company, expected higher interest
rates and reduced the interest rate sensitivity of the fund's bond portfolio as
the year progressed. This move mitigated, but could not avert, the damage done
by the rise in market rates. When compared with the average income fund,
Wellesley's bond segment has a longer average maturity and duration--and
therefore is more sensitive to changes in interest rates. This distinction works
in our favor during periods of stable or falling interest rates, as in 1998. But
it worked against us last year.
The level of interest rates also can affect stock prices. Wellesley
Income Fund's heavy commitment to financial-services and electric-utility
stocks, which tend to be sensitive to changing interest rates, hurt our results
in 1999. As a group, our stocks had a negative return of -2.7% during the year,
while the stock portion of our composite index benchmark earned 9.3%.
Electric utilities had a money-losing year across the board--our
utility holdings were down -9.2%. Financial stocks within the S&P 500 Index
gained only 5.0% as a group, and ours actually declined due to disappointing
earnings reports from some large holdings, such as National City and Wachovia.
We also were hurt badly by poor results for several large retailing and consumer
products companies we owned, including J.C. Penney, H.J. Heinz, and Philip
Morris. And our lack of technology stocks, a group that offers few
dividend-paying issues, was a big handicap. On the other hand, we saw a payoff
from our big commitment to energy stocks (nearly 20% of assets during 1999).
Even though this group lagged the overall market slightly, our oil stocks gained
a bit more than 25% over the year.
As a result of its continuous analysis of Wellesley Income Fund, the
Board of Trustees has approved a change in the benchmark for the fund's bond
segment, effective April 1, 2000. The new benchmark, the Lehman Corporate A or
Better Index, maintains a shorter duration (5.5 years) than the old benchmark
(9.1 years).
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As the fund's holdings change to reflect the new benchmark, the
emphasis of our fixed-income portfolio will shift to intermediate-term bonds
with an average quality rating of A or better. We don't expect the shift to
significantly affect long-term returns, but it should reduce by roughly 30% the
fluctuations in our bond segment's price in response to a given change in
interest rates. The bond portfolio's interest rate sensitivity will be in line
with that of peer funds, most of which emphasize intermediate-term bonds. By
including A-rated bonds in the universe from which our adviser may select
securities, we significantly expand the number of high-quality investment-grade
bonds available for the fund, thus increasing the adviser's flexibility. The
change to the Lehman Corporate A or Better Index is discussed in more detail in
the note on page 6.
Although the rise in interest rates during 1999 reduced the fund's net
asset value, Wellesley's 5.7% annualized yield at year-end was nearly a full
percentage point higher than a year earlier. For long-term investors who take
advantage of the power of compounding, higher yields are good news: At a 4.8%
annual rate, an investment doubles in about 15 years, while at 5.7%, it doubles
in about 12.5 years.
LONG-TERM PERFORMANCE OVERVIEW
Despite a tough year in 1999, Wellesley Income Fund's long-term record is good,
both on an absolute basis and in relation to peers. In the table below, we
present a decade's returns for Wellesley and our benchmarks, showing how a
hypothetical $10,000 investment in each would have grown, assuming the
reinvestment of income dividends and capital gains distributions. Wellesley's
average annual return of 10.6% during the 1990s was 0.7 percentage point higher
than the 9.9% return for the average income fund. Although that margin may seem
slim, its impact is widened by compounding: Over a decade, it resulted in a
$1,626 advantage for Wellesley in the value of the hypothetical $10,000
investments.The source of our advantage during the 1990s can be summed up in two
words: low costs. Wellesley Income Fund's expense ratio (operating expenses as a
percentage of average net assets) was 0.30%, or $3.00 per $1,000 in assets,
about one-quarter of the 1.18%--$11.80 per $1,000 in assets--charged by the
average income fund. Vanguard's low costs and sound investment management by
Wellington Management Company combined to create good value for our
shareholders.
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TOTAL RETURNS
TEN YEARS ENDED DECEMBER 31, 1999
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AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RETURN INITIAL INVESTMENT
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Vanguard Wellesley Income Fund 10.6% $27,299
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Average Income Fund 9.9% $25,673
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Wellesley Composite Index* 10.7% $27,596
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*65% Lehman Long Corporate AA or Better Index, 26% S&P 500/BARRA
Value Index, 4.5% S&P Utilities Index, and 4.5% S&P Telephone
Index.
Over the past decade, we fell just a tenth of a point short of our
index benchmark's return. Of course, we cannot outdo the composite index when it
comes to cost, since the index is a theoretical construct that has no operating
or transaction costs at all. Yet our low costs give us a fighting chance to beat
the index, and we aim to do so in the years ahead.
The double-digit return that Wellesley Income Fund earned during the
past ten years reflects a golden decade for financial assets. It was well above
the long-term historical average of about 8% for our target asset mix of 65%
bonds and 35% stocks. This was principally due to the fantastic stock market
returns experienced during the period. The U.S. stock market, as measured by the
Wilshire 5000 Index, produced an average annual return of 17.6% during the
1990s, more than 1 1/2 times the average return of about 11% achieved by
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stocks since 1925. The S&P 500/BARRA Value Index, a better benchmark for the
kinds of stocks owned by Wellesley, returned an average of 15.4% annually during
the decade.
In part, the big returns of the past decade reflect the underlying
growth in the U.S. economy and in corporate profits. But another part of the
gains can be traced to growing optimism about stocks and less fear of their
risks. These changes in perception are reflected in the extraordinary rise in
the average stock's price/earnings ratio--from about 16 as the decade of the
1990s began to an unprecedented 33 when it ended. No one knows whether or how
investor perceptions will change. But we note that the moods of markets, like
the moods of the millions of individuals who make up the markets, can shift
dramatically.
In constructing long-term plans, you should realize that financial
markets will go through bad times as well as good times. It's prudent to adopt
realistic assumptions about future returns. We don't believe it is realistic to
expect the next decade to be as rewarding as the past one. This isn't a forecast
of doom. If inflation remains in the neighborhood of 3% annually, it would take
stock returns of only 8% to 9% a year to provide decent inflation-adjusted
returns of 5% to 6%. If long-term bond returns approximate their current
yields--and that's the best guess to make--the current yields of nearly 6.5% on
long-term U.S. Treasury securities translate into a real return of nearly 4
percentage points over recent inflation rates.
IN SUMMARY
Although financial markets are fickle, the fundamentals of sound investing are
not. Vanguard believes the foundation of an investment program starts with
consideration of your investment time horizon, goals, financial situation, and
tolerance for market fluctuations. The next step is to construct a diversified
portfolio of bonds, stocks, and short-term reserves that allow you to
participate in the long-term rewards of investing while being prepared for the
ever-present risks. Such a balanced approach is what Vanguard Wellesley Income
Fund is all about.
/s/
John J. Brennan
Chairman and Chief Executive Officer
January 18, 2000
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A NOTE OF THANKS TO OUR FOUNDER
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As you may have read on the inside cover of our report, our founder, John C.
Bogle, retired on December 31, 1999, as Senior Chairman of our Board after
nearly 25 years of devoted service to Vanguard and our shareholders. Vanguard
investors have Jack to thank for creating a truly mutual mutual fund company
that operates solely in the interest of its fund shareholders. And mutual fund
investors everywhere have benefited from his energetic efforts to improve this
industry. Finally, on a personal note, I am forever grateful to Jack for giving
me the opportunity to join this great company in 1982.
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A REPORT ON YOUR FUND'S AFTER-TAX RETURNS
Beginning with this annual report, Vanguard is pleased to provide a review of
Wellesley Income Fund's after-tax performance. The figures on this page
demonstrate the considerable impact that federal income taxes can have on a
fund's return--an important consideration for investors who own mutual funds in
taxable accounts. While the pretax return is most often used to tally a fund's
performance, the fund's after-tax return, which accounts for taxes on
distributions of capital gains and income dividends, is a better representation
of the return that many investors actually received. If you own Wellesley Income
Fund in a tax-deferred account such as an individual retirement account or a
401(k), this information does not apply to you. Such accounts are not subject to
current taxes.
The table below presents the pretax and after-tax returns for your fund
and an appropriate peer group of mutual funds. Two things to keep in mind:
o The after-tax return calculations use the top federal income tax
rates in effect at the time of each distribution. The tax burden, therefore,
would be somewhat less, and the after-tax return somewhat more, for those in
lower tax brackets.
o The peer funds' returns are provided by Morningstar, Inc. (Elsewhere
in this report, returns for comparable mutual funds are derived from data
provided by Lipper Inc., which differ somewhat.)
For shareholders in the highest tax bracket, Wellesley's pretax total
return of -4.1% for the 12 months ended December 31, 1999, was reduced by taxes
to -7.4%, a difference of 3.3 percentage points. In comparison, the average
return for Morningstar's "domestic hybrid" category was 8.8% before taxes and
6.5% after taxes, a difference of 2.3 percentage points. The average fund in
this category holds a larger percentage of assets in stocks, which have helped
to boost pretax returns and also tend to be more tax-efficient than bonds, which
derive most of their returns from income, not capital gains.
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<CAPTION>
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AVERAGE ANNUAL RETURNS: PRETAX AND AFTER-TAX
PERIODS ENDED DECEMBER 31, 1999
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1 YEAR 5 YEARS 10 YEARS
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PRETAX AFTER-TAX PRETAX AFTER-TAX PRETAX AFTER-TAX
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<S> <C> <C> <C> <C> <C> <C>
Wellesley Income Fund -4.1% -7.4% 12.7% 9.1% 10.6% 7.4%
Average Domestic
Hybrid Fund* 8.8 6.5 15.6 12.7 11.4 8.8
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*Based on data from Morningstar, Inc.
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Over the past ten years, Wellesley Income Fund's pretax return of 10.6%
per year was reduced by an average of 3.2 percentage points. The average pretax
return for domestic hybrid funds was 11.4%. Taxes reduced that return by 2.6
percentage points.
We stress that because many interrelated factors affect how
tax-friendly a fund may be, it's very difficult to predict tax efficiency. A
fund's tax efficiency can be influenced by its turnover rate, the types of
securities it holds, the accounting practices it uses when selling shares, and
the net cash flow it receives.
Finally, it's important to understand that our calculation does not
reflect the effect of your own investment activities. Specifically, you may
incur additional capital gains taxes--thereby lowering your after-tax return--if
you decide to sell all or some of your shares.
A NOTE ABOUT OUR CALCULATIONS: Pretax total returns assume that all
distributions received (income dividends, short-term capital gains, and
long-term capital gains) are reinvested in new shares, while our after-tax
returns assume that distributions are reduced by any taxes owed on them before
reinvestment. When calculating the taxes due, we used the highest individual
federal income tax rates at the time of the distributions. Those rates are
currently 39.6% for dividends and short-term capital gains and 20% for long-term
capital gains. State and local income taxes were not considered. The competitive
group returns provided by Morningstar are calculated in a manner consistent with
that used for Vanguard funds.
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NOTICE TO SHAREHOLDERS
CHANGE IN BOND BENCHMARK
The Board of Trustees of Vanguard Wellesley Income Fund has approved a change in
the investment benchmark for the bond segment of the fund, effective April 1,
2000. The benchmark will change from the Lehman Brothers Long Corporate AA or
Better Bond Index to the Lehman Brothers Corporate A or Better Bond Index, which
represents a much larger universe of high-quality bonds. Although the fund's
prospectus permits investments in this larger universe of bonds, the fund has
not previously exercised this flexibility.
As the fund broadens its bond holdings to reflect the new benchmark,
shareholders should benefit over the long term from reduced volatility in the
fund's net asset value.
In actively managing the fund, Wellington Management Company strives to
keep key characteristics of the bond portfolio--such as credit quality, average
maturity, and average duration--consistent with a bond benchmark. The fund's
current benchmark is significantly more sensitive to changes in interest rates
than the new benchmark. As a result, the fund has been much more sensitive to
changes in interest rates than most other balanced mutual funds. For example,
the average duration of the current benchmark is 9.1 years, versus 5.5 years for
the new benchmark. This means that a change of one percentage point in interest
rates would cause a change of approximately 9.1% in the market value of the
current benchmark and a change of about 5.5% in the value of the new benchmark.
The second key reason for the change is that the current benchmark
constrains the fund's bond investments to a shrinking segment of the
investment-grade market and limits the adviser's ability to purchase new issues,
which often have attractive yields relative to bonds trading in the secondary
market. Since 1973, the percentage of the investment-grade corporate bond market
rated AA or higher has dropped from 58% to 24%. An even more dramatic reduction
has occurred in the proportion of newly issued bonds rated AA or better. During
1999, only about 10% of investment-grade issues with a maturity of 6 years or
more carried a credit rating of AA or higher. By contrast, A-rated bonds
accounted for more than 40% of new issues. As of year-end 1999, 239 corporate
bond issues had ratings of AA or better, while approximately 2,400 had ratings
of A or better.
EFFECT ON CREDIT QUALITY, YIELD, AND RETURNS
After the benchmark change is implemented, the average credit quality for
Wellesley Income Fund's bond segment will be reduced slightly, although it will
remain high, solidly within the investment-grade category. As of December 31,
1999, the yield of the existing benchmark, the Lehman Long Corporate AA or
Better Index, was 0.26% higher than the yield of the new benchmark, the Lehman
Corporate A or Better Index. However, because of its greater price volatility
and the narrower universe of bonds within it, the existing benchmark does not
necessarily lead to a superior long-term return. The Board believes that the
benefit from reduced interest rate risk due to the benchmark change far
outweighs the modest reduction in yield and any reduction in total return
potential.
ADVISORY CONTRACT
Wellington Management Company's compensation as investment adviser is tied to
the fund's investment performance relative to that of the benchmark.
Accordingly, the fund's advisory contract will be amended to adopt the new
benchmark for determining compensation after April 1, 2000. All other terms of
the advisory contract will remain the same.
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THE MARKETS IN PERSPECTIVE
YEAR ENDED DECEMBER 31, 1999
A global expansion in economic activity bolstered stocks at home and abroad
during 1999. The muscular U.S. economy provided a good bit of the oomph, but it
got an assist from solid growth in Asian, European, and Latin American economies
that had slumped in 1997 and 1998.
Interest rates increased significantly--causing bond prices to fall--as
both investors and monetary policymakers grew concerned that economic growth was
so vigorous that it would cause inflation to accelerate.
U.S. STOCK MARKETS
The booming economy and growing corporate profits provided plenty of fuel for
stock prices during 1999. However, higher interest rates restrained the rise,
especially for financial-services and electric utility stocks regarded as
interest rate sensitive.
U.S. economic output increased at an inflation adjusted rate of about
4%--a very rapid pace for such a large, mature economy. Analysts estimated that
corporate profits would grow by 14% in 1999 and again in 2000. Consumer
spending, which accounts for roughly two-thirds of economic activity, was
strong. People felt prosperous, thanks to the long bull market, plentiful jobs,
and rising incomes. (After-tax personal income grew by more than 5% in 1999, and
unemployment at year-end was at a three-decade low of 4.1% of the workforce.)
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AVERAGE ANNUAL RETURNS
PERIODS ENDED DECEMBER 31, 1999
--------------------------------
1 YEAR 3 YEARS 5 YEARS
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STOCKS
S&P 500 Index 21.0% 27.6% 28.6%
Russell 2000 Index 21.3 13.1 16.7
Wilshire 5000 Index 23.8 26.1 27.1
MSCI EAFE Index 27.3 16.1 13.2
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BONDS
Lehman Aggregate Bond Index -0.8% 5.7% 7.7%
Lehman 10 Year Municipal Bond Index -1.3 4.8 7.1
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 4.7 5.0 5.2
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OTHER
Consumer Price Index 2.7% 2.0% 2.4%
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The stock market, as measured by the Wilshire 5000 Index, gained 23.8%,
with more than three-quarters of the gain coming in the final quarter of 1999.
For the first time in several years, smaller stocks outpaced
large-capitalization issues. The S&P 500 Index, which is dominated by large-cap
stocks and accounts for more than three-quarters of the U.S. stock market's
total value, gained 21.0% during the year; the rest of the market gained 35.4%.
Hidden in the market averages was an amazing divergence in stock
performance. Prices soared for most technology-related stocks, but performance
was pedestrian, at best, for most other issues. Indeed, three-fifths of stocks
on the New York Stock Exchange fell in 1999. The technology sector of the S&P
500 Index gained 74%, and the producer-durables sector, driven by huge gains for
some makers of telecommunications and technology gear, was up 49%. These results
were in stark contrast to the declines suffered by food and beverage companies
in the consumer-staples sector (-16%) and by many companies in the health-care
group (-10%).
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Investors seemed bedazzled by the prospects for growth in revenue and
profits among tech stocks, but less interested in the actual profits for nontech
companies. Remarkably, the average S&P 500 stock without earnings gained 36.5%
in 1999, while the average stock with earnings rose 11.5%. There is general
agreement that growth in Internet commerce, computers, software, wireless
communications, and other key tech sectors will be stupendous. However, there is
much disagreement about whether profits will grow so impressively, given the
intense competition. During 1999, optimists clearly ruled.
U.S. BOND MARKETS
The pickup in worldwide economic activity buoyed stock prices but depressed bond
prices. Interest rates, which move in the opposite direction from bond prices,
rose sharply. The rate increase stemmed from increased borrowing by corporations
and individuals and from investors' fears that a sizzling economy was bound to
send inflation soaring.
The inflation evidence was ambiguous. Price increases were greater in
1999 than in 1998 at both the wholesale and consumer levels. Wholesale prices
rose 3.0%, the biggest gain since 1990. And the Consumer Price Index advanced
2.7% in 1999 after a gain of just 1.6% in 1998. However, energy prices, which
plunged in 1998 and shot up in 1999, skewed the figures in both periods. At the
consumer level, the "core rate" of inflation, which excludes food and energy
prices, was up just 1.9% in 1999, the smallest increase in 35 years.
At midyear, the Federal Reserve Board, aiming to cool the economy a bit
to head off price pressures, began raising short-term interest rates. In all,
the Fed pushed up rates by 0.75 percentage point in three quarter-point steps.
The bond market anticipated the Fed--interest rates began rising sharply in
February--and at year-end the yield of 30-year U.S. Treasury bonds was up 1.38
percentage points (138 basis points) to 6.48%. The 10-year Treasury note--a
benchmark for mortgage lenders--rose 179 basis points, from 4.65% to 6.44%.
Short-term rates didn't rise as far; 3-month Treasury bill yields were up 88
basis points to 5.33% at year-end.
Price declines, as usual, were greatest for long-term bonds and least
for short-term bonds. The overall market, as measured by the Lehman Aggregate
Bond Index, which has an intermediate-term average maturity, posted a -0.8%
total return in 1999. Short-term bonds generally provided returns of 2% to 3%.
Long-term bonds suffered significant price declines, and the Lehman Long
Government/Corporate Index recorded a -7.7% total return.
INTERNATIONAL STOCK MARKETS
Bullishness among stock investors was an international phenomenon in 1999. The
biggest gains came in Pacific-region and emerging markets that had suffered most
from economic slumps and currency crises during 1997 and 1998.
Overall, the Morgan Stanley Capital International Europe, Australasia,
Far East (EAFE) Index of major developed markets produced a 27.3% return for
U.S. dollar-based investors. The MSCI Pacific Free Index gained an astounding
56.4% for U.S. investors, as a strong rise in the Japanese yen against the U.S.
dollar tacked on about 12.5 percentage points to a 43.9% return in local
currencies. In Europe, currency fluctuations had the opposite effect: European
currencies, including the new 11-nation common currency, the euro, mostly fell
against the dollar, and the 30.3% return in local currencies was nearly halved
to 15.8% in U.S. dollars.
Emerging markets managed a stunning turnaround, as the Select Emerging
Markets Free Index rose 60.9% in U.S.-dollar terms after having plummeted -18.4%
in 1998 and -16.4% in 1997.
8
<PAGE>
REPORT FROM THE ADVISER
Vanguard Wellesley Income Fund underperformed its unmanaged benchmark during
1999, returning -4.1% versus the -1.4% decline of the composite index weighted
to reflect our usual allocation of 65% bonds and 35% stocks.
The fund's stock segment returned -2.7% for the year, a disappointing
contrast to its previous increases of 15.6% in 1998, 32.8% in 1997, and 24.2% in
1996. The stock portfolio's return also was well behind the 9.3% gain for the
equity portion of our index benchmark, which is weighted 75% in the S&P
500/BARRA Value Index, 12.5% in the S&P Utilities Index, and 12.5% in the S&P
Telephone Index. We lagged this standard primarily because we hold
higher-yielding stocks than those in the composite benchmark, and the market's
best performers in 1999 were stocks that paid little or no dividends. Among
sectors our largest area of underperformance was technology, where Wellesley had
no representation because few tech stocks can meet our income-oriented charter.
The bond segment's net return of -5.3% for the year was ahead of the
- -7.0% return for the Lehman Long Corporate AA or Better Index, against which we
have measured our performance. Nonetheless, our bond segment had one of its
worst years ever in absolute terms, a painful reminder of what happens to the
prices of long-term bonds when interest rates rise sharply. During the year, we
reduced the interest rate risk of the Wellesley bond portfolio by shortening its
duration meaningfully. This shorter duration should help performance relative to
the index if long-term rates continue to rise. Our shorter duration implies
that, with a given change in interest rates, the bond segment's prinicipal value
will change less than that of the index. We emphasize, however, that our
absolute performance will be hurt if rates continue to rise.
The fund maintained its traditional allocation, with 60%-65% of assets
invested in investment-grade bonds and 35%-40% invested in dividend-paying
equities. As events in 1999 proved, Wellesley's performance generally is
extremely sensitive to the direction of long-term interest rates. This
sensitivity is due to the long average maturity of the fund's bond holdings and
to our meaningful commitment to high-yielding, interest-rate-sensitive stocks.
THE OUTLOOK FOR THE FIRST HALF OF 2000
The economy remains on solid footing, supported by strong gains in consumption,
accelerating exports, and continued strength in business investment, especially
in technology products. Inflation-adjusted GDP (gross domestic product) is
expected to grow more slowly than it did in 1999, when the growth rate was about
4%. The outlook for consumer spending remains very positive because of good
fundamentals: Steady job growth, rising incomes, and increasing wealth are all
fueling the best spending gains in nearly 15 years. Confidence is at high levels
last seen in the late 1960s. There are concerns about whether the good news can
continue and whether the high level of consumer spending is sustainable.
However, even though consumer debt levels are high, we do not foresee a sharp
slowdown in consumption.
- --------------------------------------------------------------------------------
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 fund's 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.
- --------------------------------------------------------------------------------
9
<PAGE>
We expect the federal funds rate--the short-term interest rate directly
controlled by the Federal Reserve Board--to increase several times by mid-year.
This tightening by the Fed will keep the bond market--and possibly the stock
market--off-balance.
Operating profits for S&P 500 Index companies grew 21% in the third
quarter of 1999 from year-earlier levels--the best quarterly gain since 1995.
For 1999 as a whole, operating earnings, when reports are in, will be up by
nearly 13%. The underpinnings for sustained, strong profit advances in 2000 are
solid: robust U.S. demand, accelerating export business, rebounding sales abroad
for U.S. multinationals, only modest labor cost increases, and aggressive
technology-induced cost-cutting. We expect earnings to rise about 13% for S&P
500 companies this year and believe that any surprises are likely to be on the
higher end. This is a more optimistic view than the consensus, which calls for
profit growth of 7% to 8%. We expect analysts to steadily raise earnings
forecasts in 2000.
OUR STRATEGY IN 2000
Our strategy for the fund is consistent with prior periods. Because we see a
more positive outlook for stocks than for bonds, we have raised the fund's stock
allocation to its maximum of 40% of assets. The increase in our stock allocation
from 36% at the beginning of 1999 to 40% now is a substantial move, given our
allocation guideline of 35% to 40%. We will continue to shorten the duration of
the fund's bond portfolio to reduce its vulnerability to rising interest rates
and its overall volatility. We emphasize bonds with call protection to provide a
consistent income stream. We purchase only investment-grade,
U.S.-dollar-denominated bonds, and we emphasize those issues with stable or
improving credit fundamentals.
In selecting stocks, we continue to purchase shares with above-average
dividend yields from companies representing a diversified group of industries.
When we sell stocks, it is usually because their prices have approached our
target prices or because a company is experiencing deteriorating fundamentals.
Most of Wellesley's stocks are New York Stock Exchange-listed issues
and most have above-average yields. The average dividend yield on our stocks is
3.7%, which is 236% higher than the current, historically low 1.1% yield on the
S&P 500 Index.
The dominant factor guiding the fund's investment strategy is our
ongoing obligation to shareholders to provide an attractive level of income by
investing in high-quality securities. Our long-term goal is to achieve increases
in Wellesley's dividend by purchasing stocks of strong companies expected to
provide higher dividends generated from rising earnings. We avoid stocks with
ultra-high dividends, which may not be sustainable over the longer term.
SUMMARY
We are disappointed by the absolute and relative performance of Wellesley Income
Fund during 1999, especially given that the stock market averages were setting
new highs. We will continue to focus on fulfilling the fund's objective--to
produce relatively high and sustainable current income and long-term growth in
income and capital. We'll maintain a tight range for allocations to bonds and
stocks, and we'll continue to buy high-quality securities.
Earl E. McEvoy, Senior Vice President
John R. Ryan, Senior Vice President
Wellington Management Company, LLP
January 14, 2000
10
<PAGE>
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. An investor's shares, when
redeemed, could be worth more or less than their original cost.
TOTAL INVESTMENT RETURNS: DECEMBER 31, 1979-DECEMBER 31, 1999
- --------------------------------------------------------------------------------
WELLESLEY INCOME FUND COMPOSITE*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- --------------------------------------------------------------------------------
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
1998 6.4 5.4 11.8 13.9
1999 -9.2 5.1 -4.1 -1.4
- --------------------------------------------------------------------------------
*65% Lehman Long-Term Corporate Bond Index and 35% S&P 500 Index through
December 31, 1985; 65% Lehman Long Corporate AA or Better Index, 26% S&P
500/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 23 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE: DECEMBER 31, 1989-DECEMBER 31, 1999
- --------------------------------------------------------------------------------
198912 10000 10000 10000 10000
199003 9797 9761 9724 9787
199006 10065 10047 10055 10196
199009 9689 9429 9604 10100
199012 10376 9853 10248 10692
199103 10927 10765 10884 11143
199106 11039 10836 10949 11285
199109 11797 11568 11669 12107
199112 12613 12114 12351 12853
199203 12181 12279 12120 12625
199206 12828 12562 12685 13171
199209 13543 13004 13239 13825
199212 13708 13177 13487 13968
199303 14644 14075 14396 14693
199306 15091 14398 14864 15213
199309 15854 14684 15587 15890
199312 15716 14780 15454 15778
199403 15014 14553 14750 15054
199406 14961 14521 14556 14692
199409 15079 14645 14655 14682
199412 15018 14349 14749 14870
199503 16095 15443 15862 15876
199506 17463 16336 17246 17289
199509 18201 16898 18063 17733
199512 19360 17457 19273 18841
199603 19121 18294 18922 17969
199606 19316 18649 19138 18012
199609 19875 18740 19409 18342
199612 21184 19464 20584 19113
199703 21056 19887 20367 18681
199706 22564 21528 21994 19668
199709 24232 22415 23342 20685
199712 25461 22652 24580 21698
199803 26639 24306 25812 22009
199806 27152 24532 26401 22819
199809 27599 23070 26335 23721
199812 28476 24458 27988 23980
199903 27733 24909 27417 23254
199906 28410 25896 28018 22539
199909 27530 24839 27176 22469
199912 27299 25673 27596 22295
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1999
------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- --------------------------------------------------------------------------------
Wellesley Income Fund -4.14% 12.69% 10.56% $27,299
Average Income Fund* 4.97 12.34 9.89 25,673
Wellesley Composite Index** -1.40 13.35 10.68 27,596
Lehman Long Corporate AA or
Better Index -7.00 8.44 8.35 22,295
- --------------------------------------------------------------------------------
*Derived from data provided by Lipper Inc.
**65% Lehman Long Corporate AA or Better Index, 26% S&P 500/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, 1999
- ------------------------------------------------------------------------------------------
10 YEARS
INCEPTION ----------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Wellesley Income Fund 7/1/1970 -4.14% 12.69% 3.95% 6.61% 10.56%
- ------------------------------------------------------------------------------------------
</TABLE>
11
<PAGE>
FUND PROFILE
WELLESLEY INCOME FUND
This Profile provides a snapshot of the fund's characteristics as of December
31, 1999, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on pages 14-15.
TOTAL FUND CHARACTERISTICS
- --------------------------
Yield 5.7%
Turnover Rate 20%
Expense Ratio 0.30%
Cash Reserves 1.2%
FUND ASSET ALLOCATION
- --------------------------
STOCKS 40
BONDS 59
CASH RESERVES 1
TOTAL FUND VOLATILITY MEASURES
- ---------------------------------------
WELLESLEY S&P 500
- ---------------------------------------
R-Squared 0.46 1.00
Beta 0.29 1.00
TEN LARGEST STOCKS
(% OF EQUITIES)
- ---------------------------------------
Exxon Mobil Corp. 5.1%
Ford Motor Co. 4.5
National City Corp. 3.3
Bell Atlantic Corp. 3.3
Atlantic Richfield Co. 3.2
Shell Transport & Trading Co. ADR 3.1
Wachovia Corp. 2.9
Pharmacia & Upjohn, Inc. 2.9
USX-Marathon Group 2.9
Equitable Resources, Inc. 2.8
- ---------------------------------------
Top Ten 34.0%
- ---------------------------------------
Top Ten as % of Total Net Assets 13.7%
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- -----------------------------------------------------------------------
DECEMBER 31, 1998 DECEMBER 31, 1999
------------------------------------------------
WELLESLEY WELLESLEY S&P 500
------------------------------------------------
Auto & Transportation 4.0% 6.6% 1.9%
Consumer Discretionary 6.1 5.3 13.9
Consumer Staples 5.0 4.7 6.3
Financial Services 20.5 17.3 13.8
Health Care 5.7 5.6 9.3
Integrated Oils 17.0 18.0 4.8
Other Energy 0.0 4.0 1.3
Materials & Processing 7.4 10.3 3.2
Producer Durables 0.0 0.0 3.6
Technology 0.0 0.0 25.4
Utilities 31.5 21.7 10.2
Other 2.8 6.5 6.3
- -----------------------------------------------------------------------
12
<PAGE>
EQUITY CHARACTERISTICS
- ----------------------------------------------
WELLESLEY S&P 500
- ----------------------------------------------
Number of Stocks 69 500
Median Market Cap $15.8B $86.7B
Price/Earnings Ratio 17.0x 29.8x
Price/Book Ratio 2.4x 5.5x
Dividend Yield 3.7% 1.1%
Return on Equity 17.2% 23.4%
Earnings Growth Rate 5.4% 16.6%
Foreign Holdings 7.7% 1.3%
EQUITY INVESTMENT FOCUS
- --------------------------------
[grid]
STYLE VALUE
MARKET CAP LARGE
FIXED-INCOME CHARACTERISTICS
- ----------------------------------------------
WELLESLEY LEHMAN*
- ----------------------------------------------
Number of Bonds 164 5,545
Yield to Maturity 7.6% 7.2%
Average Coupon 6.9% 6.8%
Average Maturity 15.8 years 8.9 years
Average Quality Aa3 Aaa
Average Duration 7.6 years 4.9 years
*Lehman Aggregate Bond Index.
FIXED-INCOME INVESTMENT FOCUS
- ---------------------------------------------------
[grid]
AVERAGE MATURITY LONG
CREDIT QUALITY INVESTMENT-GRADE CORPORATE
DISTRIBUTION BY ISSUER
(% OF BONDS)
- ---------------------------------
Asset-Backed 0.0%
Finance 25.0
Foreign 0.7
Industrial 35.5
Mortgage 15.1
Treasury/Agency 8.3
Utilities 15.4
- ---------------------------------
Total 100.0%
DISTRIBUTION BY CREDIT QUALITY
(% OF BONDS)
- ---------------------------------
Treasury/Agency 8.3%
Aaa 17.9
Aa 19.7
A 40.6
Baa 13.0
Ba 0.5
B 0.0
Not Rated 0.0
- ---------------------------------
Total 100.0%
13
<PAGE>
AVERAGE COUPON. The average interest rate paid on the securities held by a fund.
It is expressed as a percentage of face value.
AVERAGE DURATION. An estimate ofhow much a bond fund's share price will
fluctuate in response to a change in interest rates. To see how the price could
shift, multiply the fund's duration by the change in rates. If interest rates
rise by one percentage point, the share price of a fund with an average duration
of five years would decline by about 5%. If rates decrease by a percentage
point, the fund's share price would rise by 5%.
AVERAGE MATURITY. The average length of time until bonds held by a fund reach
maturity (or are called) and are repaid. In general, the longer the average
maturity, the more a fund'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 fund'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. U.S. Treasury securities are considered to
have the highest credit quality.
BETA. A measure of the magnitude of a fund'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 fund 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 fund'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 investment.
DISTRIBUTION BY CREDIT QUALITY. This breakdown of a fund'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 fund'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 fund, 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 fund.
EQUITY INVESTMENT FOCUS. This grid indicates the focus of a fund's equity
holdings 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 fund'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 fund's
fixed-income holdings in terms of two attributes: average maturity (short,
medium, or long) and average credit quality (Treasury/agency, investment-grade
corporate, or below investment-grade).
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or American Depositary Receipts of companies based outside the United States.
FUND ASSET ALLOCATION. This chart shows the proportions of a fund's holdings
allocated to different types of assets.
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the
14
<PAGE>
proportion of the fund's assets invested in each stock. Stocks representing half
of the fund's assets have market capitalizations above the median, and the rest
are below it.
NUMBER OF BONDS. An indicator of diversification. The more separate issues a
fund holds, the less susceptible it is to a price decline stemming from the
problems of a particular bond issuer.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds,
the more diversified it is and the more likely to perform in line with the
overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, 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 fund, 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 fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund'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 fund, the weighted average return on
equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a fund'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 fund has invested in
its ten largest stocks. As this percentage rises, a fund's 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. Funds
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 fund's income from interest and dividends. The yield,
expressed as a percentage of the fund'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 fund were held to their maturity dates.
15
<PAGE>
FINANCIAL STATEMENTS
DECEMBER 31, 1999
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, 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 but may differ because certain
investments or transactions may be treated differently for financial statements
and tax purposes. 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.
- -------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
WELLESLEY INCOME FUND (000) (000)
- -------------------------------------------------------------
CORPORATE BONDS (44.5%)
- -------------------------------------------------------------
FINANCE (14.7%)
Allstate Corp.
6.75%, 5/15/2018 $ 30,000 $ 26,697
7.50%, 6/15/2013 20,000 19,677
American Re Corp.
7.45%, 12/15/2026 25,000 23,372
Associates Corp. of North America
6.25%, 11/1/2008 25,000 22,984
Bank One Corp.
7.75%, 7/15/2025 40,000 38,773
BankBoston Corp.
6.625%, 12/1/2005 15,000 14,279
6.875%, 7/15/2003 10,000 9,847
Boatmen's Bancshares Inc.
7.625%, 10/1/2004 10,000 10,163
CIGNA Corp.
7.875%, 5/15/2027 25,000 23,286
Cincinnati Financial Corp.
6.90%, 5/15/2028 25,000 21,697
Citicorp
6.65%, 12/15/2010 25,000 23,125
7.125%, 9/1/2005 15,000 14,821
Citigroup, Inc.
6.625%, 1/15/2028 25,000 21,218
CoreStates Capital Corp.
6.625%, 3/15/2005 20,000 19,235
Equitable Companies Inc.
7.00%, 4/1/2028 25,000 22,354
Farmers Exchange Capital
7.05%, 7/15/2028 25,000 20,911
Fifth Third Bancorp
6.75%, 7/15/2005 25,000 24,266
First Bank N.A.
7.55%, 6/15/2004 8,000 8,072
First Bank System
6.625%, 5/15/2003 10,000 9,793
7.625%, 5/1/2005 7,500 7,515
First Chicago Corp.
7.625%, 1/15/2003 15,000 15,119
First Union Corp.
6.00%, 10/30/2008 15,000 13,348
Fleet Financial Group, Inc.
6.875%, 3/1/2003 30,000 29,598
General Electric Capital Corp.
8.125%, 5/15/201 10,000 10,501
General Electric Capital Services
7.50%, 8/21/2035 14,000 13,423
General Electric Global Insurance
Holdings Corp.
7.00%, 2/15/2026 60,000 54,710
GMAC
7.00%, 9/15/2002 30,000 29,872
John Hancock Mutual Life
Insurance Co.
7.375%, 2/15/2024 50,000 46,207
Liberty Mutual Insurance Co.
8.50%, 5/15/2025 35,000 34,128
Lumbermens Mutual Casualty Co.
9.15%, 7/1/2026 27,250 26,219
MBIA Inc.
7.00%, 12/15/2025 19,500 17,391
16
<PAGE>
- -------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- -------------------------------------------------------------
Massachusetts Mutual Life
7.50%, 3/1/2024 $ 8,690$ 8,101
7.625%, 11/15/2023 14,500 13,857
Metropolitan Life Insurance Co.
7.80%, 11/1/2025 30,000 29,362
J.P. Morgan & Co., Inc.
5.75%, 10/15/2008 20,000 17,572
6.25%, 1/15/2009 20,000 18,144
NBD Bank N.A.
6.25%, 8/15/2003 20,000 19,296
National City Bank Cleveland
6.50%, 5/1/2003 10,000 9,731
National City Bank Pennsylvania
7.25%, 10/21/2011 22,000 21,182
National City Corp.
7.20%, 5/15/2005 20,000 19,784
NationsBank Corp.
7.75%, 8/15/2004 20,000 20,417
Republic New York Corp.
5.875%, 10/15/2008 15,000 12,977
SunTrust Banks, Inc.
6.00%, 2/15/2026 25,000 23,129
6.125%, 2/15/2004 20,000 19,218
Transamerica Financial Corp.
6.125%, 11/1/2001 25,000 24,574
Travelers Property Casualty Corp.
7.75%, 4/15/2026 25,000 24,249
UNUM Corp.
6.75%, 12/15/2028 25,000 20,440
Wachovia Corp.
6.375%, 4/15/2003 20,000 19,574
6.605%, 10/1/2025 30,000 28,891
---------
1,023,099
---------
INDUSTRIAL (20.8%)
AirTouch Communications, Inc.
6.35%, 6/1/2005 25,000 23,732
Aluminum Co. of America
6.75%, 1/15/2028 25,000 21,664
Baxter International, Inc.
7.65%, 2/1/2027 25,000 24,050
Bestfoods
6.625%, 4/15/2028 25,000 21,933
Bristol-Myers Squibb Co.
6.80%, 11/15/2026 25,000 23,137
Burlington Northern Santa Fe Corp.
6.375%, 12/15/2005 12,500 11,807
6.875%, 12/1/2027 25,000 22,116
CPC International, Inc.
7.25%, 12/15/2026 25,000 23,744
CSX Corp.
7.95%, 5/1/2027 25,000 24,682
Caterpillar Inc.
6.625%, 7/15/2028 25,000 21,546
Champion International Corp.
7.35%, 11/1/2025 30,000 27,057
Chrysler Corp.
7.45%, 3/1/2027 25,000 24,277
Coca Cola Enterprises
5.75%, 11/1/2008 25,000 22,323
Comcast Cable Communications
6.20%, 11/15/2008 25,000 22,629
Conoco Inc.
6.35%, 4/15/2009 25,000 23,124
The Walt Disney Co.
6.75%, 3/30/2006 15,000 14,631
E.I. du Pont de Nemours & Co.
6.50%, 1/15/2028 25,000 21,766
6.75%, 9/1/2007 25,000 24,181
Eaton Corp.
6.50%, 6/1/2025 10,000 9,495
Ferro Corp.
7.125%, 4/1/2028 10,000 8,276
Ford Motor Co.
7.50%, 8/1/2026 20,000 19,256
8.90%, 1/15/2032 20,000 22,283
General Motors Corp.
7.40%, 9/1/2025 30,000 28,596
9.40%, 7/15/2021 20,000 23,163
Georgia-Pacific Group
7.25%, 6/1/2028 25,000 22,411
Gillette Co.
5.75%, 10/15/2005 35,000 32,624
6.25%, 8/15/2003 10,000 9,762
Hershey Foods Corp.
6.95%, 3/1/2007 13,000 12,717
Hubbell Inc.
6.625%, 10/1/2005 10,000 9,680
Illinois Tool Works, Inc.
5.75%, 3/1/2009 25,000 22,405
International Business
Machines Corp.
7.00%, 10/30/2025 35,000 32,843
International Paper Co.
7.625%, 1/15/2007 15,000 14,904
Johnson & Johnson
6.73%, 11/15/2023 15,000 13,826
Kimberly-Clark Corp.
6.25%, 7/15/2018 25,000 22,024
Eli Lilly & Co.
7.125%, 6/1/2025 25,000 23,847
Lockheed Corp.
6.75%, 3/15/2003 7,000 6,765
Masco Corp.
6.625%, 4/15/2018 20,000 17,721
Mead Corp.
7.35%, 3/1/2017 10,350 9,632
Merck & Co.
6.30%, 1/1/2026 25,000 21,758
Minnesota Mining &
Manufacturing Corp.
6.375%, 2/15/2028 35,000 30,430
Mobil Corp.
8.625%, 8/15/2021 20,000 22,284
Monsanto Co.
6.75%, 12/15/2027 20,000 17,274
Motorola, Inc.
7.50%, 5/15/2025 25,000 24,323
New York Times Co.
8.25%, 3/15/2025 26,000 25,723
News America Holdings Inc.
8.00%, 10/17/2016 40,000 39,113
17
<PAGE>
- -------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
WELLESLEY INCOME FUND (000) (000)
- -------------------------------------------------------------
Norfolk Southern Corp.
7.80%, 5/15/2027 $ 25,000$ 24,433
PPG Industries, Inc.
6.875%, 2/15/2012 10,200 9,548
9.00%, 5/1/2021 15,000 16,779
Phelps Dodge Corp.
7.125%, 11/1/2027 12,500 10,624
Praxair, Inc.
6.75%, 3/1/2003 25,000 24,446
Procter & Gamble Co.
5.25%, 9/15/2003 15,000 14,173
6.45%, 1/15/2026 25,000 22,029
Procter & Gamble Co. ESOP
9.36%, 1/1/2021 30,000 34,474
Raytheon Co.
7.20%, 8/15/2027 25,000 22,294
Rohm & Haas Co.
7.85%, 7/15/2029 25,000 25,044
E.W. Scripps Co.
6.625%, 10/15/2007 20,000 18,874
Joseph Seagram & Sons, Inc.
7.50%, 12/15/2018 20,000 18,894
Tenneco Packaging Inc.
8.125%, 6/15/2017 30,000 27,982
8.375%, 4/15/2027 20,000 18,754
Texaco Capital
8.625%, 4/1/2032 25,000 27,275
Time Warner Inc.
6.625%, 5/15/2029 25,000 21,267
Tribune Co.
6.875%, 11/1/2006 20,000 19,293
USX Corp.
6.85%, 3/1/2008 25,000 23,520
USA Waste Services Inc.
7.00%, 7/15/2028 25,000 18,425
Ultramar Diamond Shamrock
7.20%, 10/15/2017 25,000 22,159
Vulcan Materials Co.
6.00%, 4/1/2009 25,000 22,384
Washington Post Co.
5.50%, 2/15/2009 50,000 44,039
Weyerhaeuser Co.
8.50%, 1/15/2025 10,000 10,600
Whirlpool Corp.
9.00%, 3/1/2003 10,000 10,357
---------
1,449,201
---------
UTILITIES (9.0%)
AT&T Corp.
6.50%, 3/15/2029 50,000 42,884
Alabama Power Co.
5.49%, 11/1/2005 8,250 7,520
Arizona Public Service Co.
6.625%, 3/1/2004 10,000 9,729
Baltimore Gas & Electric Co.
7.25%, 7/1/2002 15,000 15,075
BellSouth Telecommunications
6.25%, 5/15/2003 12,000 11,724
Chesapeake & Potomac Telephone
Co. (VA)
7.875%, 1/15/2022 16,000 16,051
Consolidated Edison Co. of
New York, Inc.
6.375%, 4/1/2003 20,000 19,579
Duke Energy Corp.
6.00%, 12/1/2028 25,000 19,922
El Paso Natural Gas Co.
7.50%, 11/15/2026 25,000 22,872
Enron Corp.
6.875%, 10/15/2007 20,000 18,939
Florida Power Corp.
6.75%, 2/1/2028 22,380 19,730
GTE California Inc.
6.70%, 9/1/2009 25,000 23,715
GTE Southwest, Inc.
6.00%, 1/15/2006 10,000 9,258
Illinois Power Co.
6.50%, 8/1/2003 10,000 9,679
Indiana Bell Telephone Co., Inc.
7.30%, 8/15/2026 30,000 28,279
Kentucky Utilities Co.
7.92%, 5/15/2007 5,000 5,076
MCI Communications Corp.
7.50%, 8/20/2004 15,000 15,186
Michigan Bell Telephone Co.
7.85%, 1/15/2022 25,000 24,885
New Jersey Bell Telephone Co.
8.00%, 6/1/2022 40,000 41,076
New York Telephone Co.
6.50%, 3/1/2005 30,000 28,924
Northern States Power Co.
6.375%, 4/1/2003 8,000 7,800
7.125%, 7/1/2025 30,000 27,884
Ohio Bell Telephone Co.
6.125%, 5/15/2003 15,000 14,532
Oklahoma Gas & Electric Co.
6.50%, 4/15/2028 12,770 10,520
Pacific Bell
7.125%, 3/15/2026 25,000 23,270
PacifiCorp
6.625%, 6/1/2007 10,000 9,539
Pennsylvania Power & Light Co.
6.50%, 4/1/2005 15,000 14,298
PECO Energy
6.50%, 5/1/2003 30,000 29,252
Southwestern Public Service Co.
7.25%, 7/15/2004 10,000 9,883
Sprint Capital Corp.
6.875%, 11/15/2028 20,000 17,795
Tennessee Gas Pipeline Co.
7.50%, 4/1/2017 25,000 23,850
Texas Utilities Electric Co.
6.75%, 7/1/2005 10,000 9,645
Union Electric Co.
6.875%, 8/1/2004 10,000 9,852
Wisconsin Electric Power Co.
6.50%, 6/1/2028 25,000 21,320
Wisconsin Power & Light
5.70%, 10/15/2008 12,650 11,170
---------
630,713
---------
- -------------------------------------------------------------
TOTAL CORPORATE BONDS
(Cost $3,307,895) 3,103,013
- -------------------------------------------------------------
18
<PAGE>
- -------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- -------------------------------------------------------------
FOREIGN BONDS (U.S. DOLLAR-DENOMINATED)(0.4%)
- -------------------------------------------------------------
Province of Manitoba
6.125%, 1/19/2004 $ 7,000$ 6,794
Province of Ontario
6.00%, 2/21/2006 25,000 23,562
- -------------------------------------------------------------
TOTAL FOREIGN BONDS
(Cost $31,815) 30,356
- -------------------------------------------------------------
U.S. GOVERNMENT AND AGENCY OBLIGATIONS (13.7%)
- -------------------------------------------------------------
U.S. GOVERNMENT SECURITIES (2.8%)
U.S. Treasury Bond
5.50%, 8/15/2028 25,000 21,332
U.S. Treasury Note
6.25%, 8/31/2002 50,000 49,942
6.875%, 5/15/2006 125,000 127,093
---------
198,367
---------
AGENCY BONDS & NOTES (2.1%)
Federal Home Loan Bank
5.125%, 9/15/2003 50,000 47,240
Federal Home Loan Mortgage Corp.
5.75%, 7/15/2003 50,000 48,348
Federal National Mortgage Assn.
5.75%, 6/15/2005 50,000 47,439
---------
143,027
---------
Mortgage Obligations (8.8%)
Federal National Mortgage Assn.
(1)5.735%, 1/01/2009 14,843 13,338
Government National
Mortgage Assn.
(1)6.00%, 6/15/2028-3/15/2029 437,803 399,302
(1)6.50%, 2/15/2026-8/15/2029 217,496 204,612
---------
617,252
---------
- -------------------------------------------------------------
TOTAL U.S. GOVERNMENT AND AGENCY OBLIGATIONS
(COST $1,025,913) 958,646
- -------------------------------------------------------------
SHARES
- -------------------------------------------------------------
COMMON STOCKS (40.2%)
- -------------------------------------------------------------
AUTO & TRANSPORTATION (2.6%)
CSX Corp. 285,600 8,961
Ford Motor Co. 2,350,500 125,605
General Motors Corp. 500,000 36,344
Norfolk Southern Corp. 655,000 13,428
---------
184,338
---------
CONSUMER DISCRETIONARY (2.1%)
Eastman Kodak Co. 916,000 60,685
May Department Stores Co. 1,695,000 54,664
J.C. Penney Co., Inc. 820,300 16,355
The Stanley Works 600,000 18,075
---------
149,779
---------
CONSUMER STAPLES (1.9%)
Flowers Industries, Inc. 2,718,300 43,323
H.J. Heinz Co. 1,000,800 39,844
Philip Morris Cos., Inc. 1,645,000 38,143
Universal Corp. 400,000 9,125
---------
130,435
---------
FINANCIAL SERVICES (7.0%)
American General Corp. 400,000 30,350
Bank of America Corp. 201,064 10,091
Brandywine Realty Trust REIT 484,500 7,934
CBL & Associates Properties,
Inc. REIT 555,100 11,449
Colonial Properties Trust REIT 204,900 4,751
FelCor Lodging Trust, Inc. REIT 630,000 11,025
First Union Corp. 400,000 13,125
General Growth Properties
Inc. REIT 882,300 24,704
HSB Group Inc. 233,300 7,888
IPC Holdings Ltd. 655,300 9,748
Kimco Realty Corp. REIT 258,700 8,763
The Macerich Co. REIT 619,100 12,885
Marsh & McLennan Cos., Inc. 785,000 75,115
National City Corp. 3,940,200 93,333
Nationwide Health Properties,
Inc. REIT 680,000 9,350
St. Paul Cos., Inc. 300,000 10,106
Sun Communities, Inc. REIT 685,600 22,068
U.S. Bancorp 900,000 21,431
Urban Shopping Centers,
Inc. REIT 682,000 18,499
Wachovia Corp. 1,206,900 82,069
---------
484,684
---------
HEALTH CARE (2.3%)
Baxter International, Inc. 1,197,700 75,231
Pharmacia & Upjohn, Inc. 1,808,500 81,383
---------
156,614
---------
INTEGRATED OILS (7.2%)
Atlantic Richfield Co. 1,036,000 89,614
BP Amoco PLC ADR 926,204 54,935
Exxon Mobil Corp. 1,779,463 143,358
Royal Dutch Petroleum Co. ADR 1,263,000 76,333
Texaco Inc. 1,070,000 58,114
USX-Marathon Group 3,266,100 80,632
---------
502,986
---------
OTHER ENERGY (1.6%)
Ashland, Inc. 1,030,000 33,926
(2)Equitable Resources, Inc. 2,352,100 78,501
---------
112,427
---------
MATERIALS & PROCESSING (4.1%)
Air Products & Chemicals, Inc. 800,000 26,850
CK Witco Corp. 212,858 2,847
Consolidated Papers 403,200 12,827
Eastman Chemical Co. 1,383,400 65,971
The Timber Co. 2,277,000 56,071
Westvaco Corp. 1,414,400 46,145
Weyerhaeuser Co. 1,064,000 76,409
---------
287,120
---------
UTILITIES (8.7%)
AT&T Corp. 1,347,500 68,386
Bell Atlantic Corp. 1,500,000 92,344
Central & South West Corp. 2,232,300 44,646
Consolidated Edison Inc. 947,400 32,685
Constellation Energy Group 850,000 24,650
DQE Inc. 2,051,650 71,038
DTE Energy Co. 1,238,200 38,849
Duke Energy Corp. 300,000 15,037
GPU, Inc. 1,208,600 36,182
MCN Energy Group Inc. 501,100 11,901
19
<PAGE>
- -------------------------------------------------------------
MARKET
VALUE*
WELLESLEY INCOME FUND SHARES (000)
- -------------------------------------------------------------
National Fuel Gas Co. 182,100 $ 8,468
NICOR, Inc. 722,300 23,475
PECO Energy Corp. 810,000 28,148
Pinnacle West Capital Corp. 760,000 23,228
Questar Corp. 2,000,000 30,000
SCANA Corp. 1,021,600 27,456
Southern Co. 1,340,000 31,490
---------
607,983
---------
OTHER (2.7%)
Cooper Industries, Inc. 995,900 40,272
Minnesota Mining &
Manufacturing Co. 600,000 58,725
Shell Transport & Trading
Co. ADR 1,738,900 85,641
---------
184,638
---------
- -------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $2,368,613) 2,801,004
- -------------------------------------------------------------
FACE
AMOUNT
(000)
- -------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (0.9%)
- -------------------------------------------------------------
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
3.25%, 1/3/2000 $60,467 60,467
3.40%-3.47%, 1/3/2000--Note G 104 104
- -------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(Cost $60,571) 60,571
- -------------------------------------------------------------
TOTAL INVESTMENTS (99.7%)
(Cost $6,794,807) 6,953,590
- -------------------------------------------------------------
MARKET
VALUE*
(000)
- -------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.3%)
- -------------------------------------------------------------
Other Assets--Note C $ 112,156
Liabilities--Note G (89,361)
---------
22,795
- -------------------------------------------------------------
NET ASSETS (100%)
- -------------------------------------------------------------
Applicable to 370,015,613 outstanding $.001 par value
shares of beneficial interest
(unlimited authorization) $6,976,385
=============================================================
NET ASSET VALUE PER SHARE $18.85
=============================================================
*See Note A in Notes to Financial Statements.
(1)The average maturity is shorter than the final
maturity shown due to scheduled interim principal
payments.
(2)Considered an affiliated company as the fund owns more
than 5% of the outstanding voting securities of such
company.
ADR--American Depositary Receipt.
REIT--Real Estate Investment Trust.
- -------------------------------------------------------------
AT DECEMBER 31, 1999, NET ASSETS CONSISTED OF:
- -------------------------------------------------------------
AMOUNT PER
(000) SHARE
- -------------------------------------------------------------
Paid in Capital $6,828,853 $18.45
Overdistributed Net
Investment Income (3,989) (.01)
Overdistributed Net Realized Gains (7,262) (.02)
Unrealized Appreciation--Note F 158,783 .43
- -------------------------------------------------------------
NET ASSETS $6,976,385 $18.85
=============================================================
20
<PAGE>
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.
- --------------------------------------------------------------------------------
WELLESLEY INCOME FUND
YEAR ENDED DECEMBER 31, 1999
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends* $ 107,386
Interest 328,795
Security Lending 264
-------------
Total Income 436,445
-------------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 3,763
Performance Adjustment (196)
The Vanguard Group--Note C
Management and Administrative 18,640
Marketing and Distribution 1,109
Custodian Fees 98
Auditing Fees 11
Shareholders' Reports 213
Trustees' Fees and Expenses 12
-------------
Total Expenses 23,650
Expenses Paid Indirectly--Note D (429)
-------------
Net Expenses 23,221
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 413,224
- --------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD* 370,860
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF
INVESTMENT SECURITIES (1,110,605)
- --------------------------------------------------------------------------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (326,521)
================================================================================
*Dividend income and realized net gain from affiliated companies
were $2,549,000 and $28,000, respectively.
21
<PAGE>
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.
- --------------------------------------------------------------------------------
WELLESLEY INCOME FUND
YEAR ENDED DECMEBER 31,
-------------------------
1999 1998
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 413,224 $ 403,978
Realized Net Gain 370,860 397,100
Change in Unrealized Appreciation (Depreciation) (1,110,605) 96,210
-------------------------
Net Increase (Decrease) in Net Assets Resulting
from Operations (326,521) 897,288
-------------------------
DISTRIBUTIONS
Net Investment Income (414,744) (402,480)
Realized Capital Gain (444,853) (413,626)
-------------------------
Total Distributions (859,597) (816,106)
-------------------------
CAPITAL SHARE TRANSACTIONS1
Issued 778,086 1,254,529
Issued in Lieu of Cash Distributions 739,241 705,454
Redeemed (1,852,604) (1,189,285)
-------------------------
Net Increase (Decrease) from Capital
Share Transactions (335,277) 770,698
- --------------------------------------------------------------------------------
Total Increase (Decrease) (1,521,395) 851,880
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 8,497,780 7,645,900
-------------------------
End of Year $6,976,385 $8,497,780
================================================================================
1Shares Issued (Redeemed)
Issued 36,384 55,868
Issued in Lieu of Cash Distributions 37,674 31,680
Redeemed (88,183) (53,098)
-------------------------
Net Increase (Decrease) in Shares Outstanding (14,125) 34,450
================================================================================
23
<PAGE>
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.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
WELLESLEY INCOME FUND
YEAR ENDED DECEMBER 31,
------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1999 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $22.12 $21.86 $20.51 $20.44 $17.05
- ------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income 1.120 1.13 1.190 1.17 1.13
Net Realized and Unrealized Gain (Loss) on Investments (2.025) 1.40 2.805 .66 3.68
------------------------------------------
Total from Investment Operations (.905) 2.53 3.995 1.83 4.81
------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (1.120) (1.13) (1.200) (1.16) (1.14)
Distributions from Realized Capital Gains (1.245) (1.14) (1.445) (.60) (.28)
------------------------------------------
Total Distributions (2.365) (2.27) (2.645) (1.76) (1.42)
- ------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $18.85 $22.12 $21.86 $20.51 $20.44
======================================================================================================
TOTAL RETURN -4.14% 11.84% 20.19% 9.42% 28.91%
======================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $6,976 $8,498 $7,646 $7,013 $7,181
Ratio of Total Expenses to Average Net Assets 0.30% 0.31% 0.31% 0.31% 0.35%
Ratio of Net Investment Income to Average Net Assets 5.22% 5.05% 5.47% 5.74% 5.96%
Portfolio Turnover Rate 20% 32% 36% 26% 32%
======================================================================================================
</TABLE>
23
<PAGE>
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: Equity securities 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. Prices are taken from the primary market in which each security
trades. 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.
Securities for which market quotations are not readily available are valued by
methods deemed by the Board of Trustees to represent fair 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. 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.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold. 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 500/BARRA Value Index, the S&P Utilities Index, and
the S&P Telephone Index. For the year ended December 31, 1999, the advisory fee
represented an effective annual basic rate of 0.05% of the fund's average net
assets before a decrease of $196,000 based on performance.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the Board of Trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At December 31, 1999, the fund had contributed capital of $1,500,000
to Vanguard (included in Other Assets), representing 0.02% of the fund's net
assets and 1.5% of Vanguard's capitalization. The fund's Trustees and officers
are also Directors and officers of Vanguard.
24
<PAGE>
D. Vanguard has asked the fund's investment adviser to direct certain security
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 management and administrative expenses. The
fund's custodian bank has also agreed to reduce its fees when the fund maintains
cash on deposit in the non-interest-bearing custody account. For the year ended
December 31, 1999, directed brokerage and custodian fee offset arrangements
reduced expenses by $410,000 and $19,000, respectively. The total expense
reduction represented an effective annual rate of 0.01% of the fund's average
net assets.
E. During the year ended December 31, 1999, the fund purchased $1,228,453,000 of
investment securities and sold $1,721,450,000 of investment securities, other
than U.S. government securities and temporary cash investments. Purchases and
sales of U.S. government securities were $349,480,000 and $494,119,000,
respectively.
F. At December 31, 1999, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $158,783,000,
consisting of unrealized gains of $584,652,000 on securities that had risen in
value since their purchase and $425,869,000 in unrealized losses on securities
that had fallen in value since their purchase.
G. The market value of securities on loan to broker/dealers at Decmber 31, 1999,
was $274,183,000, for which the fund held cash collateral of $104,000 and U.S.
Treasury securities with a market value of $276,976,000. 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.
25
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Trustees 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 31,1999, 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 accounting
principles generally accepted in the United States. 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 auditing standards
generally accepted in the United States, 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, 1999 by correspondence with the custodian, provide a reasonable basis for
the opinion expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
February 2, 2000
- --------------------------------------------------------------------------------
SPECIAL 1999 TAX INFORMATION (UNAUDITED) FOR
VANGUARD WELLESLEY INCOME FUND
This information for the fiscal year ended December 31, 1999, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $417,769,000 as capital gain dividends (from net
long-term capital gains) to shareholders during the fiscal year ended December
1999, all of which is designated as a 20% rate gain distribution.
For corporate shareholders, 19.9% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
- --------------------------------------------------------------------------------
26
<PAGE>
THE VANGUARD FAMILY OF FUNDS
STOCK FUNDS
- ------------------------------------------------
500 Index Fund
Aggressive Growth Fund
Capital Opportunity Fund
Convertible Securities Fund
Emerging Markets Stock Index Fund
Energy Fund Equity Income Fund
European Stock Index Fund
Explorer Fund
Extended Market Index Fund*
Global Equity Fund
Gold and Precious Metals Fund
Growth and Income Fund
Growth Index Fund*
Health Care Fund
Institutional Index Fund*
International Growth Fund
International Value Fund
Mid-Cap Index Fund*
Morgan Growth Fund
Pacific Stock Index Fund
PRIMECAP Fund
REIT Index Fund
Selected Value Fund
Small-Cap Growth Index Fund*
Small-Cap Index Fund*
Small-Cap Value Index Fund*
Tax-Managed Capital Appreciation Fund*
Tax-Managed Growth and Income Fund*
Tax-Managed International Fund*
Tax-Managed Small-Cap Fund*
Total International Stock Index Fund
Total Stock Market Index Fund*
U.S. Growth Fund
Utilities Income Fund
Value Index Fund*
Windsor Fund
Windsor II Fund
BALANCED FUNDS
- ------------------------------------------------
Asset Allocation Fund
Balanced Index Fund
Global Asset Allocation Fund
LifeStrategy Conservative Growth Fund
LifeStrategy Growth Fund
LifeStrategy Income Fund
LifeStrategy Moderate Growth Fund
STAR Fund
Tax-Managed Balanced Fund
Wellesley Income Fund
Wellington Fund
BOND FUNDS
- ------------------------------------------------
Admiral Intermediate-Term Treasury Fund
Admiral Long-Term Treasury Fund
Admiral Short-Term Treasury Fund
GNMA Fund
High-Yield Corporate Fund
High-Yield Tax-Exempt Fund
Insured Long-Term Tax-Exempt Fund
Intermediate-Term Bond Index Fund
Intermediate-Term Corporate Fund
Intermediate-Term Tax-Exempt Fund
Intermediate-Term Treasury Fund
Limited-Term Tax-Exempt Fund
Long-Term Bond Index Fund
Long-Term Corporate Fund
Long-Term Tax-Exempt Fund
Long-Term Treasury Fund
Preferred Stock Fund
Short-Term Bond Index Fund
Short-Term Corporate Fund*
Short-Term Federal Fund
Short-Term Tax-Exempt Fund
Short-Term Treasury Fund
State Tax-Exempt Bond Funds (California,
Florida, Massachusetts, New Jersey,
New York, Ohio, Pennsylvania)
Total Bond Market Index Fund*
MONEY MARKET FUNDS
- ------------------------------------------------
Admiral Treasury Money Market Fund
Federal Money Market Fund
Prime Money Market Fund*
State Tax-Exempt Money Market Funds
(California, New Jersey, New York,
Ohio, Pennsylvania)
Tax-Exempt Money Market Fund
Treasury Money Market Fund
VARIABLE ANNUITY PLAN
- ------------------------------------------------
Balanced Portfolio
Diversified Value Portfolio
Equity Income Portfolio
Equity Index Portfolio
Growth Portfolio
High-Grade Bond Portfolio
High Yield Bond Portfolio
International Portfolio
Mid-Cap Index Portfolio
Money Market Portfolio
REIT Index Portfolio
Short-Term Corporate Portfolio
Small Company Growth Portfolio
*Offers Institutional Shares.
For information about Vanguard funds and our variable annuity plan, including
charges and expenses, obtain a prospectus from The Vanguard Group, P.O. Box
2600, Valley Forge, PA 19482-2600. Read it carefully before you invest or send
money.
27
<PAGE>
- --------------------------------------------------------------------------------
THE PEOPLE WHO GOVERN YOUR FUND
The Trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are part owner of
the fund. Your fund Trustees also serve on the Board of Directors of The
Vanguard Group, which is owned by the funds and exists solely to provide
services to them on an at-cost basis.
Seven of Vanguard's nine board members are independent, meaning that
they have no affiliation with Vanguard or the funds they oversee, apart from the
sizable personal investments they have made as private individuals. They bring
distinguished backgrounds in business, academia, and public service to their
task of working with Vanguard officers to establish the policies and oversee the
activities of the funds.
Among board members' responsibilities are selecting investment advisers
for the funds; monitoring fund operations, performance, and costs; reviewing
contracts; nominating and selecting new Trustees/Directors; and electing
Vanguard officers.
The list below provides a brief description of each Trustee's
professional affiliations. Noted in parentheses is the year in which the Trustee
joined the Vanguard Board.
TRUSTEES
JOHN C. BOGLE (1967) Founder, Senior Chairman of the Board, and Director/Trustee
of The Vanguard Group, Inc., and each of the investment companies in The
Vanguard Group.
JOHN J. BRENNAN (1987) Chairman of the Board, Chief Executive Officer, and
Director/Trustee of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
JOANN HEFFERNAN HEISEN (1998) Vice President, Chief Information Officer, and a
member of the Executive Committee of Johnson & Johnson; Director of Johnson &
Johnson Merck Consumer Pharmaceuticals Co., The Medical Center at Princeton, and
Women's Research and Education Institute.
BRUCE K. MACLAURY (1990) President Emeritus of The Brookings Institution;
Director of American Express Bank Ltd., The St. Paul Companies, Inc., and
National Steel Corp.
BURTON G. MALKIEL (1977) Chemical Bank Chairman's Professor of Economics,
Princeton University; Director of Prudential Insurance Co. of America, Banco
Bilbao Gestinova, Baker Fentress & Co., The Jeffrey Co., and Select Sector SPDR
Trust.
ALFRED M. RANKIN, JR. (1993) Chairman, President, Chief Executive Officer, and
Director of NACCO Industries, Inc.; Director of The BFGoodrich Co.
JOHN C. SAWHILL (1991) 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., NACCO Industries, and Newfield Exploration Co.
JAMES O. WELCH, JR. (1971) 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 (1985) Retired Chairman 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.
THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of
each of the investment companies in The Vanguard Group.
VANGUARD MANAGING DIRECTORS
R. GREGORY BARTON Legal Department.
ROBERT A. DISTEFANO Information Technology.
JAMES H. GATELY Individual Investor Group.
KATHLEEN C. GUBANICH Human Resources.
IAN A. MACKINNON Fixed Income Group.
F. WILLIAM MCNABB, III Institutional Investor Group.
MICHAEL S. MILLER Planning and Development.
RALPH K. PACKARD Chief Financial Officer.
GEORGE U. SAUTER Core Management Group.
<PAGE>
ABOUT OUR COVER
Our cover art, depicting HMS Vanguard at sea, is a reproduction of Leading the
Way, a 1984 work created and copyrighted by noted naval artist Tom Freeman, of
Forest Hill, Maryland.
[SHIP]
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482-2600
All comparative mutual fund data are from Lipper Inc. or Morningstar, Inc.,
unless otherwise noted.
"Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500," 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.
WORLD WIDE WEB
www.vanguard.com
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
This report is intended for the fund's shareholders. It may not be distributed
to prospective investors unless it is preceded or accompanied by the current
fund prospectus.
Q270-02/18/2000
(C) 2000 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
