<PAGE> 1
VANGUARD/
WINDSOR FUND
Semiannual Report
April 30, 1997
[THE VANGUARD GROUP LOGO]
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THE VANGUARD GROUP:
LINKING TRADITION
AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our
course toward the twenty-first century. Our Report cover reflects that blending
of tradition and innovation, of past, present, and future. The montage includes
a bronze medallion with a likeness of our namesake, HMS Vanguard (Lord Nelson's
flagship at The Battle of the Nile); a clock built circa 1816 in Scotland,
featuring a portrait of Nelson; and several views of our recently completed
campus, which is steeped in nautical imagery--from our buildings named after
Nelson's warships (Victory, Majestic, and Goliath are three shown), to our
artwork and ornamental compass rose.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
3
Report From
The Adviser
5
Performance
Summary
7
Financial
Statements
8
Directors And
Officers
INSIDE BACK COVER
All comparative mutual fund data
are from Lipper Analytical Services, Inc.
or Morningstar unless otherwise noted.
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[PHOTO]
FELLOW SHAREHOLDER,
The rollicking bull market for large-capitalization stocks continued
during the six months ended April 30, 1997, the first half of Windsor Fund's
1997 fiscal year. Your Fund achieved a return of +13.6% in the period, a result
that was satisfying not only on an absolute basis, but also relative to mutual
funds with comparable objectives.
The following table compares Windsor's total return (capital change plus
reinvested dividends) for the period with those of the average value (growth
and income) mutual fund and the unmanaged Standard & Poor's 500 Composite Stock
Price Index, which is dominated by large-cap stocks.
The Fund's return is based on an increase in net asset value from $16.99
per share on October 31, 1996, to $17.66 per share on April 30, 1997, with the
latter figure adjusted for our semiannual dividend of $0.21 per share paid from
net investment income and distributions totaling $1.33 per share from net
realized capital gains. Both payments were made on December 16, 1996.
<TABLE>
<CAPTION>
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TOTAL RETURN
SIX MONTHS ENDED
APRIL 30, 1997
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<S> <C>
Vanguard/Windsor Fund +13.6%
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Average Value Fund +10.8%
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S&P 500 Index +14.7%
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</TABLE>
THE PERIOD IN REVIEW
A nearly ideal climate for common stocks--strong economic growth, rising
corporate profits, and relatively low inflation--prevailed during the six
months. Yet the stock market's robust advance was bumpy and not all sectors
went along for the ride. Volatility was particularly manifest in the market's
decline of nearly 10% during the seven weeks following February 18, when the
S&P 500 Index reached a record high. To the surprise of some observers,
however, the drop was quickly aborted, and nearly all of the lost ground was
retraced during the final three weeks of the period.
Jitters about interest rates and inflation were the apparent causes of the
brief slide. Although the Federal Reserve Board raised its target for
short-term interest rates by a quarter-point to 5.50% on March 25, interest
rates on balance were up only slightly during the six months (by amounts
ranging from 0.08% on 90-day U.S. Treasury bills to roughly 0.30% for 10-year
and 30-year Treasuries). The stock market's rebound late in the period stemmed
from a combination of factors, including strong earnings reports by many key
companies, a lessening of inflation fears, and an easing in market interest
rates. Whatever their causes, the price fluctuations served as a clear reminder
of the volatility that is very much a part of investing in stocks.
Windsor Fund gave a good account of itself during the period. While the
Fund's return trailed the +14.7% gain in the S&P 500 Index by 1.1 percentage
points, we regard that as a satisfactory result, given the market's tilt toward
the largest-capitalization growth stocks. One indication of the bias toward
large-cap stocks during the period is that the return on the S&P 500 Index was
nearly 14 percentage points higher than the scant +1.0% return on the rest of
the stock market (as represented by the Wilshire 4500 Equity Index). The fact
that the average market capitalization of Windsor's holdings ($7.1 billion) was
well below that of the S&P 500 Index ($28.7 billion) accounted for part of our
tiny shortfall.
1
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Windsor Fund's emphasis on value stocks--those with relatively low prices
in relation to earnings, dividends, and book value--accounted for the
remainder. The Index is made up of both value and growth stocks, and during the
six months, its growth component provided a +17.5% return, well ahead of the
+11.8% return for its value component. Returns on these two components have
been similar over long periods, but have often diverged over shorter periods.
While Windsor held no consumer-staples stocks, one of the period's
best-performing sectors and a significant segment in the growth component of
the Index, it compensated with an excellent selection of stocks in the
technology, producer-durables, and financial-services sectors.
Our significant edge of 2.8 percentage points over the average competing
fund during the six months stemmed from good stock selection, aided by Windsor
Fund's expense advantage (our expenses amounted to 0.31% of average net assets
in fiscal 1996 versus 1.23% for the average value fund).
IN SUMMARY
The sizable, sudden fluctuations in the stock market during the first half of
our fiscal year reinforced the two key messages that we have repeatedly
stressed in these Reports to you.
The first message, of course, concerns the importance of holding a
balanced portfolio of stock funds, bond funds, and money market funds in
proportions appropriate to your financial situation, tolerance for risk, and
investment objectives. By making it easier to ride out episodes of market
volatility, a balanced portfolio helps investors to adhere to our second
message: Always "stay the course" toward your long-term investment goals.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Chairman of the Board President
May 14, 1997
2
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[PHOTO]
THE MARKETS IN PERSPECTIVE
SIX MONTHS ENDED APRIL 30, 1997
U.S. EQUITY MARKETS
The U.S. stock market continued to perform solidly over the six months,
reflecting a confidence based on moderate economic growth, quiescent inflation,
and solid increases in corporate profits. While concern grew among some
investors that continued economic expansion could lead to higher inflation, as
of the period's end there was no confirmed sign that inflation had increased.
The inflation fears nonetheless led to an erratic upward drift in interest
rates amid the ongoing strong returns from domestic equities.
Those strong returns have, however, been concentrated in the shares of
large companies. The Standard & Poor's 500 Composite Stock Price Index, for
example, gained 14.7% over the six-month period, compared to a meager 1.6% gain
for the Russell 2000 Index. In April alone, the S&P 500 Index beat the Russell
2000 Index by 5.7% (6.0% versus 0.3%). Larger companies have outperformed their
smaller-capitalization counterparts fairly consistently since the end of 1993.
There are a variety of theories as to why, including better earnings growth,
greater productivity, and fewer negative earnings surprises.
<TABLE>
<CAPTION>
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TOTAL RETURNS
PERIODS ENDED APRIL 30, 1997
----------------------------------------
6 MONTHS 1 YEAR 5 YEARS*
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<S> <C> <C> <C>
EQUITY
S&P 500 Index 14.7% 25.1% 17.1%
Russell 2000 Index 1.6 0.1 13.7
MSCI-EAFE Index 1.7 -0.6 10.9
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FIXED-INCOME
Lehman Aggregate Bond Index 1.7% 7.1% 7.4%
Lehman 10-Year Municipal
Bond Index 2.3 6.4 7.5
Salomon 90-Day U.S. Treasury Bills 2.6 5.2 4.5
- ----------------------------------------------------------------------------------
OTHER
Consumer Price Index 1.2% 2.5% 2.8%
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</TABLE>
*Average annual.
The recent gap in performance between large and small is particularly
noticeable in two sectors: technology and health care. Over the past six
months, technology issues in the S&P 500 Index have gained 26.3% while those in
the Russell 2000 Index have dropped -11.9%. In health care, the S&P's holdings
gained 17.6%, compared to a decline of -6.8% in the Russell 2000 Index. Within
these sectors, the larger companies' dominant products and the predictable
earnings they generate appear to be the primary difference.
Financial-services firms, by contrast, have generally fared well regardless
of size, with gains of 16.9% in the S&P 500 Index and 12.2% in the Russell 2000
Index since October. The strength of the economy, which helps to keep bad-debt
levels at a minimum, and the overall growth of consumer credit have helped
these stocks greatly.
U.S. FIXED-INCOME MARKETS
The erratic rise in interest rates during the past six months reflected rising
and falling expectations regarding economic growth and inflation. During
November, investors seemed to expect a slowing of growth, and the 10-year U.S.
Treasury's yield declined from 6.38%
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to 6.04%. The same note's yield then rose to 6.67% in late January, riding a
perception that growth was markedly stronger than analysts had expected. Then
the pattern repeated itself, with the 10-year's rate falling to 6.26% in
mid-February and rising to 6.90% at the end of March. In April, the consensus
seemed to be shifting again, with the 10-year Treasury yield falling to 6.72%.
There is a simple explanation for this interest rate seesaw. Many
investors consider it a paradox that the economy has continued to expand at a
robust pace accompanied by strong job growth and low unemployment--but no
increase in inflation. Bond investors have therefore been particularly
sensitive to economic reports that might reveal inflation to be creeping up at
last. The data have been variable, tilting the consensus back and forth between
expectations of higher or continued stable inflation rates. The most recent
releases depict an exceptionally strong economy. For example, the U.S. economy
expanded at a 5.6% rate in the first quarter with no inflationary pressures
(e.g., declining producer prices and an increase of only 2.5% in employment
costs).
The net result for bond investors has been mediocre returns. The 1.7%
generated by the Lehman Brothers Aggregate Bond Index over the past six months,
for example, consists of an income return of 3.4% and a capital decline of
- -1.7%, reflecting the modest increase in interest rates. During this period,
investors who favored shorter-maturity and higher-quality issues achieved
somewhat better returns. Mortgage-backed securities performed well on a
relative basis, as higher rates led to fewer mortgage refinancings. Municipal
issues also tended to perform better than their taxable counterparts.
INTERNATIONAL EQUITY MARKETS
With the dollar strengthening by 10% to 16% against most major currencies, U.S.
investors who held foreign equities faced a headwind during the past six
months. (The major exception was the pound sterling, which was effectively
unchanged against the dollar.) The Morgan Stanley Capital International-Europe,
Australasia, Far East Index gained 1.7% in dollar terms, while in local terms
the return was 11.2%. Those who favored Europe over the Pacific region did not
feel the pain as much, due to the strong (23.1%) return generated by the local
markets. For U.S. investors, European markets provided 11.9%. The strength of
the European markets can be attributed to several factors, including (1)
ongoing efforts to lower government deficits consistent with the Maastricht
Treaty guidelines, (2) improving economic growth, and (3) a greater commitment
by corporate executives to increasing "shareholder value."
Investors with a focus in the Pacific markets were less fortunate, as
illustrated by the weak Japanese market, which fell -3.2% (a -13.2% drop for
dollar-based investors). Despite positive news, including reports of growth in
exports, lower inventories, and higher industrial production, the focus in the
Japanese market has been the poor quality of many banks' balance sheets and the
likely effects of an increase in the consumption tax. However, according to
some observers, the level of economic activity seems to be improving now in
Japan.
4
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[PHOTO]
REPORT FROM THE ADVISER
The market has gone on a dizzying round trip in the first four months of
1997. After breaking out of the gate with a 10% jump in the first month and a
half, the S&P 500 had given up all of this by mid-April, only to then go on a
13% tear in the subsequent three to four weeks. We were net sellers in the
first advance, letting our invested ratio decline from 92% at the beginning of
the year to 89%, then put virtually all of our cash to work during the
downdraft. We were again net sellers into the second period of market
enthusiasm, and our invested ratio is presently 94%. This is relative to our
continuing commitment to be at least 95% invested by mid-1997, and then stay at
least 95-100%, i.e., essentially fully invested, beyond that point, as
discussed in last year's annual report.
We were sellers of banks and technology stocks in the early part of 1997,
then bought them back when both groups led the market downturn. Other
significant purchases this year include Caterpillar, Rhone-Poulenc Rorer,
General Instrument, Goodyear, cable TV stocks, and electric utilities, all new,
as well as additions to our airline and Case positions. Other significant sales
included Nokia and Ahmanson, which had achieved our objectives, Morgan Stanley,
after its announced merger with Dean Witter Discover, plus reductions in our
oil and auto holdings. We are concerned that there may be a further decline in
oil prices to maybe $16 per barrel, and re: the autos, light truck
profitability has declined much faster than we had earlier expected. The major
concentrations in the portfolio at April 30 were in banks and other financial
services (19% versus 15% for the S&P 500), technology (12%, 14%), basic
materials (18%, 5%), and energy (9% each). Other notable concentrations include
5-6% positions each in airlines, "ag" (farm equipment and fertilizer),
communication services (cable and long distance telephones), health care (HMO's
and life science companies), and in autos, still.
After beating the S&P 500 in calendar 1996, +26.4% versus +23%, we are
trailing by over two points for the first four months of calendar 1997, +6.4%
versus +8.8%. As recently as April 11, we were nearly a point ahead, but in the
interim, the market rocketed ahead nearly 9% in just 13 sessions, and left us
in its dust. This is consistent with the pattern we have seen for some months
now, that is, when the S&P 500 goes on these tears, it is led by its largest
caps, presumably as folks who are looking to put money to work quickly, look to
these most liquid names. As we only own 12 of the 100 largest caps in the S&P
500--because the other 88 are rather fully valued--we get left behind in such
periods of burst in the market, but then when the market later digests these
gains, our stocks tend to catch up, and we have seen this to some extent so far
in May. Compared to the average Lipper growth and income fund, after beating it
by 5.7 percentage points in calendar 1996, we are 1.7 percentage points ahead
through April 30 this year.
The S&P 500's 13% advance since mid-April is on the back of some very good
recent economic news. On an annual rate basis, first-quarter employment costs
actually decelerated to +2.5%, productivity accelerated to
INVESTMENT PHILOSOPHY
The adviser believes that superior long-term investment results can be achieved
by emphasizing common stocks that are generally misunderstood, out of favor, or
undervalued by fundamental measures such as price/earnings ratio or dividend
yield. The adviser will concentrate a large portion of the Fund's assets in
those securities it believes offer the best return potential.
5
<PAGE> 8
+2%, and unit labor costs, using the employment cost data, were up only 0.5% in
the first quarter, and +1.7% year to year. So this all-important inflation
indicator, unit-labor costs, is behaving very well this far into an economic
expansion, and especially given very strong fourth quarter 1996/first quarter
1997 real GDP growth of 3.8%/5.6%. The market has been, not surprisingly,
impressed. The rub, though, is that the current unemployment rate of about 5%
is about as low as it gets, and if consumer spending grows in line with present
real disposable personal income growth of over 4%, let alone the 6% we saw in
the first quarter, it would seem almost axiomatic that wage inflation
accelerates from here. It will be difficult, though not impossible, for
productivity to accelerate further to contain this pressure. If it does not,
unit labor costs will also accelerate, with negative implications for interest
rates and/or corporate profits, and, in either case, the stock
market--especially with the market P/E as stretched as it is at this time. Our
guess is that the S&P 500 will have a hard time holding onto its gains so far
this year, and might even finish only even for the year as a whole, our
original guess.
Our goal, as it has always been, is to provide you with an out of the
ordinary return, i.e., to beat the S&P 500 by a significant margin. Given this
goal, it is not surprising that our portfolio is very different from the
S&P--you can't be the S&P and still try to beat it. As mentioned, we own only
12 of its largest stocks, which represent over 65% of its total value. Consumer
staples--soft drinks, food, household products, etc.--total about 16% of the
S&P, but are zero in our portfolio, because they are not undervalued, in our
view. Our weighted average and median cap are substantially less than the S&P,
and other very large equity funds, for that matter. Most importantly, our
price/earnings ratio is only about two-thirds of the market multiple, with a
competitive, in our view, total return--projected earnings growth and yield. It
is this edge that gives us confidence that the portfolio is undervalued, even
at a point in time when the 500 particular stocks in the Index look on the high
side.
Charles T. Freeman, Portfolio Manager
Wellington Management Company, LLP
May 20, 1997
6
<PAGE> 9
PERFORMANCE SUMMARY
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Fund. Note, too, that
both share price and return can fluctuate widely so that an investment in the
Fund could lose money.
<TABLE>
<CAPTION>
WINDSOR FUND
TOTAL INVESTMENT RETURNS: OCTOBER 31, 1976-APRIL 30, 1997
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WINDSOR FUND S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ------------------------------------------------------------
<S> <C> <C> <C> <C>
1977 3.8% 4.3% 8.1% -6.1%
1978 6.2 5.0 11.2 6.3
1979 13.5 6.0 19.5 15.3
1980 17.2 7.0 24.2 32.1
1981 11.1 6.9 18.0 0.6
1982 14.2 7.0 21.2 16.3
1983 25.3 7.3 32.6 27.8
1984 9.6 6.9 16.5 6.3
1985 16.6 6.7 23.3 19.4
1986 22.8 6.5 29.3 33.2
1987 2.7 1.9 4.6 6.4
1988 18.9% 8.1% 27.0% 14.8%
1989 11.9 5.2 17.1 26.4
1990 -31.8 3.9 -27.9 -7.5
1991 35.7 9.0 44.7 33.5
1992 4.3 5.0 9.3 10.0
1993 24.6 3.7 28.3 14.9
1994 3.7 2.6 6.3 3.9
1995 14.2 3.6 17.8 26.4
1996 19.6 3.6 23.2 24.1
1997* 12.3 1.3 13.6 14.7
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</TABLE>
*Six months ended April 30, 1997.
See Financial Highlights table on page 13 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 1997*
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10 YEARS
INCEPTION ----------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Windsor Fund 10/23/58 23.15% 17.78% 8.03% 4.68% 12.71%
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</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
7
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[PHOTO]
FINANCIAL STATEMENTS
APRIL 30, 1997 (unaudited)
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, preferred stocks, bonds,
etc.) and by industry sector. Other assets are added to, and liabilities are
subtracted from, the value of Total Investments to calculate the Fund's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the Fund
to arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying
the composition of the Fund's net assets on both a dollar and per-share basis.
Because all income and any realized gains must be distributed to shareholders
each year, the bulk of net assets consists of Paid in Capital (money invested
by shareholders). The amounts shown for Undistributed Net Investment Income and
Accumulated Net Realized Gains usually approximate the sums the Fund had
available to distribute to shareholders as income dividends or capital gains as
of the statement date. Any Accumulated Net Realized Losses, and any cumulative
excess of distributions over net income or net realized gains, will appear as
negative balances. Unrealized Appreciation (Depreciation) is the difference
between the market value of the Fund's investments and their cost, and reflects
the gains (losses) that would be realized if the Fund were to sell all of its
investments at their statement-date values.
<TABLE>
<CAPTION>
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MARKET
VALUE*
WINDSOR FUND SHARES (000)
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<S> <C> <C>
COMMON STOCKS (96.2%)
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AUTO & TRANSPORTATION (11.9%)
# AMR Corp. 2,483,000 $ 231,229
# America West Holdings Corp. 2,102,300 32,323
Chrysler Corp. 22,675,800 680,274
#(1) Continental Airlines, Inc.
Class B 2,965,500 94,155
(1) Delta Air Lines, Inc. 5,272,800 485,757
Ford Motor Co. 12,337,700 428,735
The Goodyear Tire &
Rubber Co. 3,400,000 178,925
# Northwest Airlines Corp.
Class A 470,200 18,279
USFreightways Corp. 491,500 13,209
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2,162,886
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CONSUMER DISCRETIONARY (0.1%)
# Ryerson Tull, Inc. Class A 1,450,500 20,670
---------------
FINANCIAL SERVICES (20.0%)
Aetna Inc. 2,831,400 258,011
H.F. Ahmanson & Co. 2,225,545 84,849
Allstate Corp. 4,378,100 286,766
Bear Stearns Co., Inc. 2,222,023 67,772
Canadian Imperial Bank of
Commerce 6,060,000 139,181
CIGNA Corp. 1,418,100 213,247
Chase Manhattan Corp. 3,940,700 365,007
Citicorp 8,796,400 990,695
Dean Witter Discover & Co. 1,620,200 61,973
Equity Residential Properties
Trust REIT 1,517,600 66,395
First Union Corp. 1,516,800 127,411
(1) Golden West Financial Corp. 5,652,100 367,387
(1) Great Western Financial Corp. 7,736,786 324,945
Horace Mann Educators Corp. 423,500 19,852
Mid Ocean Ltd. 287,300 13,180
Pacific Century Financial Corp. 940,000 40,185
PartnerRe Ltd. 2,116,200 71,157
St. Paul Cos., Inc. 297,000 19,899
U.S. Bancorp 1,494,800 85,017
Washington Mutual Inc. 382,000 18,766
---------------
3,621,695
---------------
HEALTH CARE (1.8%)
# Foundation Health Systems
Class A 4,787,160 129,253
Rhone-Poulenc Rorer, Inc. 2,700,000 194,738
---------------
323,991
---------------
INTEGRATED OILS (6.9%)
(1) Cabot Oil & Gas Corp. Class A 2,255,200 37,775
(1) Freeport-McMoRan Resource
Partners, LP 8,973,200 134,598
(1) Lyondell Petrochemical Co. 7,410,600 150,065
Murphy Oil Corp. 2,081,700 90,554
Norsk Hydro AS ADR 3,082,500 151,043
(1) USX-Marathon Group 18,575,200 513,140
(1) Valero Energy Corp. 3,054,500 107,289
YPF SA ADR 2,200,400 60,786
---------------
1,245,250
---------------
OTHER ENERGY (3.2%)
(1) Burlington Resources, Inc. 11,181,000 473,795
# Enserch Exploration, Inc. 2,490,800 22,106
Ultramar Diamond
Shamrock Corp. 2,516,200 80,833
---------------
576,734
---------------
</TABLE>
8
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<TABLE>
<CAPTION>
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MARKET
VALUE*
SHARES (000)
- ----------------------------------------------------------------------------------
<S> <C> <C>
MATERIALS & PROCESSING (23.8%)
(1) AK Steel Holding Corp. 2,604,400 $ 94,410
Akzo Nobel NV ADR 412,500 26,709
Alcan Aluminium Ltd. 3,891,900 131,838
# Alumax, Inc. 2,384,600 87,038
Aluminum Co. of America 5,632,400 393,564
(1) Bowater Inc. 3,500,000 151,375
British Steel PLC ADR 3,103,200 69,046
#(1) Burlington Industries, Inc. 5,989,300 61,390
(1) Centex Construction Products 2,211,200 40,907
(1) Century Aluminum Co. 2,000,000 33,000
(1) Champion International Corp. 6,300,000 292,950
Deltic Timber Corp. 538,171 13,656
Eastman Chemical Co. 504,200 25,714
(1) Freeport-McMoRan, Inc. 1,690,600 49,450
(1) Geon Co. 2,480,000 54,250
(1) Georgia Gulf Corp. 3,705,300 89,854
(1) Georgia-Pacific Corp. 8,338,200 650,380
(1) IMC Global Inc. 5,861,300 216,135
(1) Lafarge Corp. 5,471,500 132,684
Millenium Chemicals, Inc. 530,500 9,416
(1) Mississippi Chemical Corp. 1,956,600 43,045
(1) Owens-Corning 5,096,800 206,420
(1) Reynolds Metals Co. 6,373,400 432,595
Rhone-Poulenc SA ADR 13,290,472 450,215
Rouge Steel Co. Class A 1,368,600 21,555
Southdown, Inc. 165,300 5,971
(1) Stone Container Corp. 9,470,000 95,884
#(1) Stormedia, Inc. 1,305,600 16,483
(1) Terra Industries, Inc. 4,788,000 55,660
# USG Corp. 585,000 20,036
(1) Union Camp Corp. 4,049,800 196,922
Union Carbide Corp. 3,098,300 154,528
---------------
4,323,080
---------------
PRODUCER DURABLES (6.3%)
# Beazer Homes USA, Inc. 171,900 2,385
(1) Case Corp. 7,242,500 401,053
Caterpillar, Inc. 4,271,200 380,137
(1) Continental Homes
Holding Corp. 687,900 10,920
# Gulfstream Aerospace Corp. 3,052,600 77,841
Lincoln Electric Co. 139,200 5,255
Lincoln Electric Co. Class A 529,600 16,947
(1) MDC Holdings, Inc. 1,298,600 10,713
Nokia Corp. Pfd. ADR 1,220,800 78,894
(1) Standard Pacific Corp. 1,750,000 14,000
(1) Tecumseh Products Co.
Class B 495,000 25,369
Tektronix, Inc. 852,800 46,158
#(1) Toll Brothers, Inc. 2,408,700 43,959
#(1) U.S. Home Corp. 1,100,000 27,087
---------------
1,140,718
---------------
TECHNOLOGY (11.1%)
(1) Advanced Micro Devices, Inc. 9,307,300 395,560
# Compaq Computer Corp. 6,627,900 565,857
#(1) General Instrument Corp. 11,636,000 271,991
#(1) S3, Inc. 4,535,200 43,084
#(1) Seagate Technology 16,062,516 736,868
---------------
2,013,360
---------------
UTILITIES (6.7%)
AT&T Corp. 17,935,000 600,822
CINergy Corp. 3,972,100 132,072
DQE Inc. 354,300 9,788
(1) ENSERCH Corp. 6,077,500 119,271
Sprint Corp. 2,583,000 113,329
Texas Utilities Co. 5,696,000 192,240
Unicom Corp. 2,553,999 55,549
---------------
1,223,071
---------------
OTHER (4.4%)
(1) IPC Holdings Ltd. 1,489,700 33,704
# Kemira Oy ADR 4,957,300 91,710
LaSalle Re Holdings Ltd. 272,900 7,573
Miscellaneous (3.7%) 677,809
---------------
810,796
---------------
FOREIGN
# Rhone-Poulenc SA-A 100,000 3,375
---------------
- ----------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $13,985,499) 17,465,626
- ----------------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCKS (0.1%)
- ----------------------------------------------------------------------------------
Atlantic Richfield Cvt. 9.00%
(Convertible into Lyondell
Petrochemical Co.) 610,000 12,352
Bethlehem Steel Corp. $5.00 33,900 1,716
- ----------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(COST $17,327) 14,068
- ----------------------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT
(000)
- ----------------------------------------------------------------------------------
<S> <C> <C>
TEMPORARY CASH INVESTMENTS (2.0%)
- ----------------------------------------------------------------------------------
COMMERCIAL PAPER (0.2%)
MetLife Funding Inc.
5.383%, 5/7/97 $ 21,591 21,568
Southwestern Bell Telephone Co.
5.447%, 5/6/97 20,000 19,982
---------------
41,550
---------------
FEDERAL NATIONAL
MORTGAGE ASSN. (0.2%)
5.373%, 5/6/97 25,000 24,978
---------------
REPURCHASE AGREEMENT (1.6%)
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.31%, 5/1/97 294,403 294,403
- ----------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $360,942) 360,931
- ----------------------------------------------------------------------------------
TOTAL INVESTMENTS (98.3%)
(COST $14,363,768) 17,840,625
- ----------------------------------------------------------------------------------
</TABLE>
9
<PAGE> 12
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
MARKET
VALUE*
WINDSOR FUND (000)
- ----------------------------------------------------------------------------------
<S> <C>
OTHER ASSETS AND LIABILITIES (1.7%)
- ----------------------------------------------------------------------------------
Other Assets--Notes C and F $ 665,620
Liabilities--Note F (356,461)
--------------
309,159
- ----------------------------------------------------------------------------------
NET ASSETS (100%)
- ----------------------------------------------------------------------------------
Applicable to 1,027,951,769 outstanding
$.01 par value shares
(authorized 1,300,000,000 shares) $18,149,784
==================================================================================
NET ASSET VALUE PER SHARE $17.66
==================================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
# Non-Income Producing Security.
(1) Considered an affiliated company as the Fund owns more than 5% of the
outstanding voting securities of such company. The total market value of
investments in affiliated companies was $7,736,279,000.
ADR--American Depository Receipt.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ----------------------------------------------------------------------------------
<S> <C> <C>
AT APRIL 30, 1997, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------------------------
Paid in Capital $13,314,944 $12.96
Undistributed Net
Investment Income 103,080 .10
Accumulated Net
Realized Gains 1,254,903 1.22
Unrealized Appreciation--
Note E 3,476,857 3.38
- ----------------------------------------------------------------------------------
NET ASSETS $18,149,784 $17.66
==================================================================================
</TABLE>
10
<PAGE> 13
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Fund during the
reporting period, and details the operating expenses charged to the Fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
WINDSOR FUND
SIX MONTHS ENDED APRIL 30, 1997
(000)
- --------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends* $ 170,130
Interest 39,434
------------
Total Income 209,564
------------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 10,920
Performance Adjustment (3,214)
The Vanguard Group--Note C
Management and Administrative 17,831
Marketing and Distribution 1,667
Taxes (other than income taxes) 641
Auditing Fees 10
Shareholders' Reports 190
Annual Meeting and Proxy Costs 28
Directors' Fees and Expenses 21
------------
Total Expenses 28,094
Expenses Paid Indirectly--Note C (2,408)
------------
Net Expenses 25,686
- --------------------------------------------------------------------------------------
NET INVESTMENT INCOME 183,878
- --------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD* 1,256,083
- --------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 694,564
- --------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $2,134,525
======================================================================================
</TABLE>
*Dividend income and realized net gain from affiliated companies were
$60,140,000 and $227,685,000, respectively.
11
<PAGE> 14
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
that is 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 vincome was earned or the gains were realized on the financial
statements. The Capital Share Transactions section shows the amount
shareholders invested in the Fund, either by purchasing shares or by
reinvesting distributions, as well as the amounts redeemed. The corresponding
numbers of Shares Issued and Redeemed are shown at the end of the Statement.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
WINDSOR FUND
-------------------------------------
SIX MONTHS YEAR
ENDED ENDED
APR. 30, 1997 OCT. 31, 1996
(000) (000)
- --------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 183,878 $ 396,076
Realized Net Gain 1,256,083 1,243,836
Change in Unrealized Appreciation (Depreciation) 694,564 1,366,247
-------------------------------------
Net Increase in Net Assets Resulting from Operations 2,134,525 3,006,159
-------------------------------------
DISTRIBUTIONS
Net Investment Income (195,447) (406,918)
Realized Capital Gain (1,237,834) (1,165,890)
-------------------------------------
Total Distributions (1,433,281) (1,572,808)
-------------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 1,221,023 1,866,840
Issued in Lieu of Cash Distributions 1,367,495 1,499,031
Redeemed (981,028) (1,965,937)
-------------------------------------
Net Increase from Capital Share Transactions 1,607,490 1,399,934
- --------------------------------------------------------------------------------------------------------
Total Increase 2,308,734 2,833,285
- --------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 15,841,050 13,007,765
-------------------------------------
End of Period $18,149,784 $15,841,050
========================================================================================================
(1)Shares Issued (Redeemed)
Issued 69,863 121,079
Issued in Lieu of Cash Distributions 82,231 102,408
Redeemed (56,616) (127,266)
-------------------------------------
Net Increase in Shares Outstanding 95,478 96,221
========================================================================================================
</TABLE>
12
<PAGE> 15
FINANCIAL HIGHLIGHTS
This table summarizes the Fund's investment results and distributions to
shareholders on a per-share basis. It also presents the Fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the Fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the Fund's total return; how much it costs to operate the
Fund; and the extent to which the Fund tends to distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in
the Fund for one year. Finally, the table lists the Fund's Average Commission
Rate Paid, a disclosure required by the SEC beginning in 1996. This rate is
calculated by dividing total commissions paid on portfolio securities by the
total number of shares purchased and sold on which commissions were charged.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
WINDSOR FUND
YEAR ENDED OCTOBER 31,
FOR A SHARE OUTSTANDING SIX MONTHS ENDED ------------------------------------------------------------
THROUGHOUT EACH PERIOD APRIL 30, 1997 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF PERIOD $16.99 $15.55 $14.55 $14.95 $12.37 $12.79
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
INVESTMENT OPERATIONS
Net Investment Income .19 .43 .44 .44 .37 .49
Net Realized and Unrealized Gain
on Investments 2.02 2.85 1.86 .42 2.98 .50
------------------------------------------------------------------------
Total from Investment Operations 2.21 3.28 2.30 .86 3.35 .99
------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.21) (.46) (.44) (.37) (.39) (.57)
Distributions from Realized Capital Gains (1.33) (1.38) (.86) (.89) (.38) (.84)
------------------------------------------------------------------------
Total Distributions (1.54) (1.84) (1.30) (1.26) (.77) (1.41)
- ---------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $17.66 $16.99 $15.55 $14.55 $14.95 $12.37
===========================================================================================================================
TOTAL RETURN 13.57% 23.16% 17.80% 6.35% 28.29% 9.30%
===========================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $18,150 $15,841 $13,008 $11,406 $10,537 $8,250
Ratio of Total Expenses to
Average Net Assets--Note C 0.32%* 0.31% 0.45% 0.45% 0.40% 0.26%
Ratio of Net Investment Income to
Average Net Assets 2.12%* 2.75% 3.01% 3.11% 2.68% 3.89%
Portfolio Turnover Rate 61%* 34% 32% 34% 25% 32%
Average Commission Rate Paid $.0559 $.0579 N/A N/A N/A N/A
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized.
13
<PAGE> 16
NOTES TO FINANCIAL STATEMENTS
Vanguard/Windsor Fund is registered under the Investment Company Act of 1940 as
a diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The Fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Securities listed on an exchange are valued at the
latest quoted sales prices as of the close of trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such
securities not traded on the valuation date are valued at the mean of the
latest quoted bid and asked prices. Securities not listed on an exchange are
valued at the latest quoted bid prices. Bonds, and temporary cash investments
acquired over 60 days to maturity, 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. Other temporary cash investments are valued at
amortized cost, which approximates market value.
2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. 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.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. 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 the S&P 500 Index. For the six months ended April 30, 1997, the
advisory fee represented an effective annual basic rate of 0.13% of the Fund's
average net assets before a decrease of $3,214,000 (an annual rate of 0.04%)
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 directors. At April 30,
1997, the Fund had contributed capital of $1,465,000 to Vanguard (included in
Other Assets), representing 7.3% of Vanguard's capitalization. The Fund's
directors and officers are also directors and officers of Vanguard.
Vanguard has asked the Fund's investment adviser to direct certain
portfolio trades, subject to obtaining the best price and execution, to brokers
who have agreed to rebate to the Fund part of the commissions generated. Such
rebates are used solely to reduce the Fund's administrative expenses. For the
six months ended April 30, 1997, these arrangements reduced the Fund's expenses
by $2,408,000 (an annual rate of 0.03% of average net assets).
D. During the six months ended April 30, 1997, the Fund purchased
$6,056,165,000 of investment securities and sold $4,632,060,000 of investment
securities, other than U.S. government securities and temporary cash
investments. Sales of U.S. government securities were $204,500,000.
14
<PAGE> 17
E. At April 30, 1997, net unrealized appreciation of investment securities for
financial reporting and federal income tax purposes was $3,476,857,000,
consisting of unrealized gains of $3,944,849,000 on securities that had risen
in value since their purchase and $467,992,000 in unrealized losses on
securities that had fallen in value since their purchase.
F. The market value of securities on loan to broker/dealers at April 30, 1997,
was $195,188,000, for which the Fund held cash collateral of $203,474,000.
15
<PAGE> 18
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director of The Vanguard Group, Inc.
and of each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN, President, Chief Executive Officer, and Director of The
Vanguard Group, Inc. and of each of the investment companies in The
Vanguard Group.
ROBERT E. CAWTHORN, Chairman Emeritus and Director of Rhone-Poulenc Rorer Inc.;
Director of Sun Company, Inc., Westinghouse Electric Corp., and
Global Health Care Partners/DLJ Merchant Banking Partners.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea Co.,
Ikon Business Solutions, Inc., Raytheon Co., Knight-Ridder, Inc., and
Massachusetts Mutual Life Insurance Co.; Trustee Emerita of Wellesley
College.
BRUCE K. MACLAURY, President Emeritus of The Brookings Institution; Director of
American Express Bank Ltd., The St. Paul Companies, Inc., and National
Steel Corp.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl
Corp., Baker Fentress & Co., The Jeffrey Co., and Southern New
England Communications Co.
ALFRED M. RANKIN, JR., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich
Co., and The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co.
and President of New York University; Director of Pacific Gas and
Electric Co., Procter & Gamble Co., and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc.
and Kmart Corp.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas Co.;
Director of Cummins Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
Raymond J. Klapinsky, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies
in The Vanguard Group.
RICHARD F. HYLAND, Treasurer; Principal of The Vanguard Group, Inc.; Treasurer
of each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller; Principal of The Vanguard Group, Inc.; Controller of
each of the investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President, Information Technology.
JAMES H. GATELY, Senior Vice President, Individual Investor Group.
IAN A. MACKINNON, Senior Vice President, Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President, Institutional.
RALPH K. PACKARD, Senior Vice President and Chief Financial Officer.
[THE VANGUARD GROUP LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
http://www.vanguard.com [email protected]
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before investing or sending money. Prospectuses
may be obtained directly from The Vanguard Group.
(C) 1997 Vanguard Marketing Corporation, Distributor
<PAGE> 19
THE VANUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Growth and Income Portfolio
Vanguard Selected Value Portfolio
Vanguard/Trustees' Equity-U.S. Portfolio
Vanguard Convertible Securities Fund
BALANCED FUNDS
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LifeStrategy Portfolios
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard International Value Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Treasury Money Market Portfolio
Vanguard Admiral Funds
INCOME FUNDS
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
Q222-4/97
<PAGE> 20
[PHOTO]
VANGUARD/
WINDSOR II
Semiannual Report
April 30, 1997
[THE VANGUARD GROUP LOGO]
<PAGE> 21
[PHOTO]
THE VANGUARD GROUP:
LINKING TRADITION
AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our course
toward the twenty-first century. Our Report cover reflects that blending of
tradition and innovation, of past, present, and future. The montage includes a
bronze medallion with a likeness of our namesake, HMS Vanguard (Lord Nelson's
flagship at The Battle of the Nile); a clock built circa 1816 in Scotland,
featuring a portrait of Nelson; and several views of our recently completed
campus, which is steeped in nautical imagery--from our buildings named after
Nelson's warships (Victory, Majestic, and Goliath are three shown), to our
artwork and ornamental compass rose.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
3
Report From
The Adviser
5
Performance
Summary
7
Financial
Statements
8
Directors And
Officers
INSIDE BACK COVER
All comparative mutual fund data
are from Lipper Analytical Services, Inc.
or Morningstar unless otherwise noted.
<PAGE> 22
[PHOTO]
FELLOW SHAREHOLDER,
Vanguard/Windsor II provided a solid total return during the first six months
of its 1997 fiscal year as the stock market extended its impressive-- albeit
uneven--rise. During the period ended April 30, Windsor II's return of +11.9%
outpaced that of the average competing fund but fell short of the return on the
unmanaged Standard & Poor's 500 Composite Stock Price Index.
The adjacent table compares the Fund's six-month total return (capital
change plus reinvested dividends) with those of the S&P 500 Index--dominated by
large, blue chip stocks--and the average value (growth and income) mutual fund,
the group that best reflects the value-investing philosophy of Windsor II.
Our Fund's return is based on an increase in net asset value from $24.04
per share on October 31, 1996, to $25.21 per share on April 30, 1997, with the
latter figure adjusted for the reinvestment of a semiannual dividend of $0.43
per share from net investment income and distributions totaling $1.16 per share
from net capital gains realized during 1996.
<TABLE>
<CAPTION>
- -----------------------------------------------
TOTAL RETURN
SIX MONTHS ENDED
APRIL 30, 1997
- -----------------------------------------------
<S> <C>
Vanguard/Windsor II +11.9%
- -----------------------------------------------
Average Value Fund +10.8%
- -----------------------------------------------
S&P 500 Index +14.7%
- -----------------------------------------------
</TABLE>
THE PERIOD IN REVIEW
A nearly ideal climate for common stocks--strong economic growth, rising
corporate profits, and relatively low inflation--prevailed during the six
months. Yet the stock market's robust overall advance was bumpy and not all
sectors went along for the ride. Volatility was particularly manifest in the
S&P 500 Index's decline of nearly -10% during the seven weeks that followed its
record high on February 18. To the surprise of many observers, however, nearly
all of the lost ground was retraced during the final three weeks of the period.
Jitters about interest rates and inflation were the apparent causes of the
brief slide. Although the Federal Reserve Board raised its target for
short-term interest rates by a quarter-point to 5.50% on March 25, interest
rates on balance were up only slightly during the six months (by amounts
ranging from 0.08% on 90-day U.S. Treasury bills to roughly 0.30% for 10-year
and 30-year Treasuries). The stock market's rebound late in the period stemmed
from a combination of factors, including strong earnings reports by many key
companies, a lessening of inflation fears, and an easing in interest rates.
Whatever their causes, the price fluctuations served as a clear reminder of the
volatility that is very much a part of investing in stocks. While stocks of the
biggest companies continued to lead the market higher (the S&P 500 Index's
return was nearly 14 percentage points higher than the scant +1.0% return on
the rest of the U.S. stock market), a significant gap developed between
large-capitalization value and growth stocks during the period. Over the six
months, the S&P 500 Index's growth component provided a +17.5% return, well
ahead of the +11.8% return for its value component. Returns on these two
components have been similar over long periods, but have often diverged over
shorter periods.
1
<PAGE> 23
The market's pronounced tilt toward growth stocks during the half-year was
a major factor in Windsor II's shortfall versus the S&P 500 Index. Windsor II
emphasizes value stocks--characterized by relatively low prices in relation to
earnings, dividends, and book value--while the Index includes both value and
growth stocks.
More specifically, our performance relative to the Index was impeded by
our characteristically low weighting in the market-leading technology sector
(about 4% for our Fund, compared with about 12% for the Index). We should point
out that most technology stocks, which typically have low dividend yields, are
not candidates for inclusion in Windsor II. Our heavier weight and subpar stock
selection in the utilities sector, a market laggard, also hampered our relative
return. Finally, the drag of a nearly 10% cash position during a rising market
also took its toll.
On the positive side, our heavier-than-market weighting among financial-
services companies (26% of the Fund's assets; 16% for the Index)-- coupled with
fine stock selection in the sector--proved beneficial, as did our excellent
selection of stocks in the health-care and the consumer discretionary and
services sectors.
As for our fairly good performance versus the average value mutual fund,
our much-lower expenses (0.39% of average net assets in fiscal 1996 versus
1.23% for our average competitor) provide a significant--and consistent--edge.
Also, by virtue of our emphasis on very large stocks, we believe we benefited
from investors' recent preference for bigger stocks. The median market
capitalization of Windsor II's stocks is about $24 billion, nearly two-thirds
larger than that of the average value fund.
Our philosophy of maintaining a diversified portfolio of out-of-favor
stocks with below-average price/earnings ratios and above-average dividend
yields is carried out by a team of four managers, each having full discretion
in managing a portion of the Fund's assets. The table above shows the
allocation to each adviser as of April 30, 1997.
<TABLE>
<CAPTION>
- -------------------------------------------------------
TOTAL ASSETS MANAGED
---------------------
$ MILLION PERCENT
- -------------------------------------------------------
<S> <C> <C>
Barrow, Hanley, Mewhinney
& Strauss, Inc. $12,179 68%
Equinox Capital Management, Inc. 1,763 10
Tukman Capital Management, Inc. 1,772 10
Vanguard Core Management Group 1,207 7
Cash Reserves* 907 5
- -------------------------------------------------------
Total $17,828 100%
- -------------------------------------------------------
</TABLE>
*Each adviser also may maintain a modest cash reserve.
IN SUMMARY
The sizable, sudden fluctuations in the stock market during the first half of
our fiscal year reinforced the two key messages that we have repeatedly
provided in our Reports to you.
The first message, of course, is our emphasis on the importance of holding
a balanced portfolio of stock funds, bond funds, and money market funds in
proportions appropriate to your financial situation, tolerance for risk, and
investment objectives. By making it easier to ride out episodes of market
volatility, a balanced portfolio, in turn, helps investors to adhere to our
second message: Always "stay the course" toward your long-term investment
goals.
We look forward to reporting to you on the full 1997 fiscal year six
months hence.
/s/ JOHN C. BOYLE /S/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Chairman of the Board President
May 19, 1997
2
<PAGE> 24
THE MARKETS IN PERSPECTIVE
SIX MONTHS ENDED APRIL 30, 1997
U.S. EQUITY MARKETS
The U.S. stock market continued to perform solidly over the six months,
reflecting a confidence based on moderate economic growth, quiescent inflation,
and solid increases in corporate profits. While concern grew among some
investors that continued economic expansion could lead to higher inflation, as
of the period's end there was no confirmed sign that inflation had increased.
The inflation fears nonetheless led to an erratic upward drift in interest
rates amid the ongoing strong returns from domestic equities.
Those strong returns have, however, been concentrated in the shares of
large companies. The Standard & Poor's 500 Composite Stock Price Index, for
example, gained 14.7% over the six-month period, compared to a meager 1.6% gain
for the Russell 2000 Index. In April alone, the S&P 500 Index beat the Russell
2000 Index by 5.7% (6.0% versus 0.3%). Larger companies have outperformed their
smaller-capitalization counterparts fairly consistently since the end of 1993.
There are a variety of theories as to why, including better earnings growth,
greater productivity, and fewer negative earnings surprises.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
TOTAL RETURNS
PERIODS ENDED APRIL 30, 1997
----------------------------------
6 MONTHS 1 YEAR 5 YEARS*
- ------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 14.7% 25.1% 17.1%
Russell 2000 Index 1.6 0.1 13.7
MSCI-EAFE Index 1.7 -0.6 10.9
- ------------------------------------------------------------------------
FIXED-INCOME
Lehman Aggregate Bond Index 1.7% 7.1% 7.4%
Lehman 10-Year Municipal
Bond Index 2.3 6.4 7.5
Salomon 90-Day U.S. Treasury Bills 2.6 5.2 4.5
- ------------------------------------------------------------------------
OTHER
Consumer Price Index 1.2% 2.5% 2.8%
- ------------------------------------------------------------------------
</TABLE>
*Average annual.
The recent gap in performance between large and small is particularly
noticeable in two sectors: technology and health care. Over the past six
months, technology issues in the S&P 500 Index have gained 26.3% while those in
the Russell 2000 Index have dropped -11.9%. In health care, the S&P's holdings
gained 17.6%, compared to a decline of -6.8% in the Russell 2000 Index. Within
these sectors, the larger companies' dominant products and the predictable
earnings they generate appear to be the primary difference.
Financial-services firms, by contrast, have generally fared well
regardless of size, with gains of 16.9% in the S&P 500 Index and 12.2% in the
Russell 2000 Index since October. The strength of the economy, which helps to
keep bad-debt levels at a minimum, and the overall growth of consumer credit
have helped these stocks greatly.
U.S. FIXED-INCOME MARKETS
The erratic rise in interest rates during the past six months reflected rising
and falling expectations regarding economic growth and inflation. During
November, investors seemed to expect a slowing of growth, and the 10-year U.S.
Treasury's yield declined from 6.38%
3
<PAGE> 25
to 6.04%. The same note's yield then rose to 6.67% in late January, riding a
perception that growth was markedly stronger than analysts had expected. Then
the pattern repeated itself, with the 10-year's rate falling to 6.26% in
mid-February and rising to 6.90% at the end of March. In April, the consensus
seemed to be shifting again, with the 10-year Treasury yield falling to 6.72%.
There is a simple explanation for this interest rate seesaw. Many
investors consider it a paradox that the economy has continued to expand at a
robust pace accompanied by strong job growth and low unemployment--but no
increase in inflation. Bond investors have therefore been particularly
sensitive to economic reports that might reveal inflation to be creeping up at
last. The data have been variable, tilting the consensus back and forth between
expectations of higher or continued stable inflation rates. The most recent
releases depict an exceptionally strong economy. For example, the U.S. economy
expanded at a 5.6% rate in the first quarter with no inflationary pressures
(e.g., declining producer prices and an increase of only 2.5% in employment
costs).
The net result for bond investors has been mediocre returns. The 1.7%
generated by the Lehman Brothers Aggregate Bond Index over the past six months,
for example, consists of an income return of 3.4% and a capital decline of
- -1.7%, reflecting the modest increase in interest rates. During this period,
investors who favored shorter-maturity and higher-quality issues achieved
somewhat better returns. Mortgage-backed securities performed well on a
relative basis, as higher rates led to fewer mortgage refinancings. Municipal
issues also tended to perform better than their taxable counterparts.
INTERNATIONAL EQUITY MARKETS
With the dollar strengthening by 10% to 16% against most major currencies, U.S.
investors who held foreign equities faced a headwind during the past six
months. (The major exception was the pound sterling, which was effectively
unchanged against the dollar.) The Morgan Stanley Capital International-Europe,
Australasia, Far East Index gained 1.7% in dollar terms, while in local terms
the return was 11.2%. Those who favored Europe over the Pacific region did not
feel the pain as much, due to the strong (23.1%) return generated by the local
markets. For U.S. investors, European markets provided 11.9%. The strength of
the European markets can be attributed to several factors, including (1)
ongoing efforts to lower government deficits consistent with the Maastricht
Treaty guidelines, (2) improving economic growth, and (3) a greater commitment
by corporate executives to increasing "shareholder value."
Investors with a focus in the Pacific markets were less fortunate, as
illustrated by the weak Japanese market, which fell -3.2% (a -13.2% drop for
dollar-based investors). Despite positive news, including reports of growth in
exports, lower inventories, and higher industrial production, the focus in the
Japanese market has been the poor quality of many banks' balance sheets and the
likely effects of an increase in the consumption tax. However, according to
some observers, the level of economic activity seems to be improving now in
Japan.
4
<PAGE> 26
[PHOTO]
REPORT FROM THE ADVISER
The results from Vanguard/Windsor II for the first half of fiscal 1997 were
disappointing. Even with a return of 11.9% for the six months ended April 30
(beating both the Standard & Poor's/BARRA Value Index return of 11.8% and the
10.8% return on the average growth and income fund), we lagged the 14.7% return
achieved by the S&P 500 Index. For more details on performance results for this
six-month period, see the Message To Shareholders, which begins on page 1.
Throughout the current economic expansion--now in its seventh
year--activity has vacillated between moderate growth and very surprising
strength. Thus far in 1997, the pace of economic growth has been much better
than one would expect from a cycle that is, by historical standards, somewhat
long in the tooth. This is particularly true in light of the recent movement by
monetary authorities toward greater restraint.
The Federal Reserve Board, consistent with the pronouncements of Chairman
Alan Greenspan on an overly exuberant equity market, has started to raise
interest rates. Thus far, this action has only made stocks more volatile and
markets more focused. The vast majority of stocks are lagging the very largest
companies, something of a replay of the "nifty 50" stocks that dominated the
equity market in the early 1970s. For the past several quarters, the number of
companies reporting disappointing results has been greater than those with
positive surprises. If one is unfortunate enough to own the stock of one of the
underachievers, the "reward" is usually an immediate price drop of -15% to -25%
or more. This sort of reaction is unusual in rising markets.
Mr. Greenspan is worried about the huge stock market advance enabling
investors to cash out significant assets with a view to spending at least a
portion of the proceeds on goods and services. Such activity, if it were
widespread, would move the economy into a demand-pull phase of higher prices
(i.e., inflation). If this concern is well-founded, we doubt that a modest
increase in rates is the last we would hear about the matter. Stay tuned for
the likelihood of more volatility and the potential of lower stock prices.
In the end, however, price levels for common stocks will be driven by
economic results and earnings. Restructuring moves over the past few years have
set the stage for a significant expansion in business profitability. With the
price/earnings multiples of stocks at relatively high levels for this stage of
an economic recovery, it is corporate profitability that will determine the
ultimate level of equity prices.
The agreement between the President and congressional leaders to balance
the budget is being viewed positively by investors. However, it is difficult to
envision Washington giving its final blessing to two other much-discussed
political topics of importance to investors: the possibility of any significant
cut in capital gains tax rates without some limitations based on income levels
and the revamping of the Social Security system to allow a meaningful exposure
to the stock market.
Since our last letter, the Fund has slightly decreased its holdings in
banks and pharmaceuticals and increased its investments in energy, electric
utilities, and telephone companies.
INVESTMENT PHILOSOPHY
The Fund reflects a belief that superior long-term investment results can
be achieved by holding a diversified portfolio of out-of-favor stocks with
below-average price/earnings ratios, above-average dividend yields, and the
prospect of above-average total return.
5
<PAGE> 27
We believe our portfolio is well positioned to generate adequate returns,
but we believe that it also possesses defensive characteristics.
Barrow, Hanley, Mewhinney & Strauss, Inc.
May 12, 1997
6
<PAGE> 28
PERFORMANCE SUMMARY
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Fund. Note, too, that
both share price and return can fluctuate widely so that an investment in the
Fund could lose money.
<TABLE>
<CAPTION>
WINDSOR II
TOTAL INVESTMENT RETURNS: JUNE 24, 1985-APRIL 30, 1997
- ------------------------------------------------------
WINDSOR II S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ------------------------------------------------------
<S> <C> <C> <C> <C>
1985 -0.9% 1.1% 0.2% 1.8%
1986 31.2 4.4 35.6 33.2
1987 -0.6 1.5 0.9 6.4
1988 14.5 6.0 20.5 14.8
1989 19.5 5.2 24.7 26.4
1990 -21.5 4.0 -17.5 -7.5
1991 29.4 7.2 36.6 33.5
1992 7.9% 4.6% 12.5% 10.0%
1993 15.8 3.7 19.5 14.9
1994 -0.8 3.0 2.2 3.9
1995 19.2 3.9 23.1 26.4
1996 23.8 3.4 27.2 24.1
1997* 10.0 1.9 11.9 14.7
- ------------------------------------------------------
</TABLE>
*Six months ended April 30, 1997.
See Financial Highlights table on page 13 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED MARCH 31, 1997*
- -----------------------------------------------------------------------------------------
10 YEARS
INCEPTION ------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Windsor II 6/24/85 18.10% 17.08% 8.74% 4.35% 13.09%
- -----------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
7
<PAGE> 29
FINANCIAL STATEMENTS
APRIL 30, 1997 (unaudited)
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, preferred stocks, bonds,
etc.) and by industry sector. Other assets are added to, and liabilities are
subtracted from, the value of Total Investments to calculate the Fund's Net
Assets. Finally, Net Assets are divided by the outstanding shares of the Fund
to arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the Fund's net assets on both a dollar and
per-share basis. Because all income and any realized gains must be distributed
to shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the Fund had available to distribute to shareholders as income dividends
or capital gains as of the statement date. Any Accumulated Net Realized Losses,
and any cumulative excess of distributions over net income or net realized
gains, will appear as negative balances. Unrealized Appreciation (Depreciation)
is the difference between the market value of the Fund's investments and their
cost, and reflects the gains (losses) that would be realized if the Fund were
to sell all of its investments at their statement-date values.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
MARKET
VALUE*
WINDSOR II SHARES (000)
- --------------------------------------------------------------------------------
COMMON STOCKS (90.3%)
- --------------------------------------------------------------------------------
<S> <C> <C>
AUTO & TRANSPORTATION(3.2%)
# AMR Corp. 48,600 $ 4,526
Burlington Northern
Santa Fe Corp. 73,100 5,757
CSX Corp. 1,340,200 62,487
Chrysler Corp. 228,700 6,861
Delta Air Lines, Inc. 38,800 3,574
Fleetwood Enterprises, Inc. 439,200 11,584
Ford Motor Co. 12,010,500 417,365
General Motors Corp. 439,200 25,419
The Goodyear Tire & Rubber Co. 97,900 5,152
# Halter Marine Group, Inc 67,477 1,324
Illinois Central Corp. 20,400 678
Newport News Shipbuilding Inc. 661,340 9,920
Norfolk Southern Corp. 133,000 11,953
# UAL Corp. 46,600 3,466
---------
570,066
---------
CONSUMER DISCRETIONARY (7.1%)
# Boston Chicken, Inc. 111,000 2,636
Dayton-Hudson Corp. 159,900 7,196
Deluxe Corp. 207,300 6,349
Dillard Department Stores
Class A 148,100 4,573
The Walt Disney Co. 1,292,944 106,021
R.R. Donnelley & Sons Co. 109,400 3,747
Eastman Kodak Co. 4,354,300 363,584
Gannett Co., Inc. 1,548,800 135,133
#(1) Kmart Corp. 27,928,700 380,529
Maytag Corp. 254,400 5,819
Russell Corp. 175,900 4,881
Sears, Roebuck & Co. 1,604,200 77,002
Wal-Mart Stores, Inc. 3,667,500 103,607
Washington Post Co. Class B 10,200 3,664
Whirlpool Corp. 1,280,600 59,868
# Woolworth Corp. 139,200 2,993
---------
1,267,602
---------
CONSUMER STAPLES (7.1%)
American Stores Co. 72,600 3,303
Anheuser-Busch Cos., Inc. 6,406,400 274,674
Great Atlantic & Pacific
Tea Co., Inc. 127,700 3,177
H.J. Heinz Co. 3,041,300 126,214
# Imperial Tobacco Group ADR 4,377,600 61,560
Interstate Bakeries 50,700 2,630
PepsiCo, Inc. 3,994,900 139,322
Philip Morris Cos., Inc. 14,114,800 555,770
Sara Lee Corp. 2,536,700 106,541
---------
1,273,191
---------
FINANCIAL SERVICES (23.5%)
Aetna Inc. 839,900 76,536
H.F. Ahmanson & Co. 2,197,600 83,784
Allstate Corp. 6,554,022 429,288
American Express Co. 4,299,508 283,230
American International
Group, Inc. 1,591,125 204,460
AmSouth Bancorp 255,800 13,493
Aon Corp. 2,216,450 147,394
Banc One Corp. 1,414,000 59,918
BankAmerica Corp. 2,945,823 344,293
BankBoston Corp. 231,600 16,849
CIGNA Corp. 89,000 13,383
# CNA Financial Corp. 94,400 9,381
Chase Manhattan Corp. 6,911,028 640,134
</TABLE>
8
<PAGE> 30
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
The Chubb Corp. 1,167,000 67,394
Citicorp 285,600 32,166
Dean Witter Discover & Co. 1,916,000 73,287
Fannie Mae 4,596,100 189,015
First Chicago NBD Corp. 6,413,871 360,780
First Union Corp. 257,200 21,605
Firstar Corp. 483,800 14,212
Fleet Financial Group, Inc. 329,500 20,100
Loews Corp. 100,100 9,197
Merrill Lynch & Co., Inc. 814,600 77,591
J.P. Morgan & Co., Inc. 202,2 20,599
Northern Trust Corp. 17,472 778
Norwest Corp. 385,100 19,207
Old Republic International Corp. 27,200 768
PNC Bank Corp. 9,446,900 388,504
Providian Corp. 161,200 9,309
Regions Financial Corp. 51,800 2,940
Salomon, Inc. 236,300 11,815
Star Banc Corp. 24,300 1,033
Student Loan Marketing Assn. 95,800 11,328
Travelers Group Inc. 7,102,873 393,322
UnionBanCal Corp. 61,426 3,486
Wells Fargo & Co. 489,200 130,494
---------
4,181,073
---------
HEALTH CARE (3.9%)
American Home Products Corp. 1,664,800 110,293
Beckman Instruments, Inc. 162,700 6,833
Becton, Dickinson & Co. 140,600 6,468
Bristol-Myers Squibb Co. 1,274,800 83,499
Johnson & Johnson 376,100 23,036
Pharmacia & Upjohn, Inc. 3,849,100 114,030
Rhone-Poulenc Rorer, Inc. 128,800 9,290
# Tenet Healthcare Corp. 242,300 6,300
Warner-Lambert Co. 3,509,900 343,970
---------
703,719
---------
INTEGRATED OILS (10.0%)
Amoco Corp. 4,655,500 389,316
Atlantic Richfield Co. 691,300 94,103
Chevron Corp. 203,900 13,967
Exxon Corp. 9,413,600 533,045
Mobil Corp. 481,500 62,595
Phillips Petroleum Co. 8,346,200 328,632
Royal Dutch Petroleum Co. ADR1, 918,300 345,774
Texaco Inc. 196,800 20,762
USX-Marathon Group 21,400 591
---------
1,788,785
---------
OTHER ENERGY (4.0%)
Burlington Resources, Inc. 186,300 7,894
Occidental Petroleum Corp. 15,529,000 343,579
# Reading & Bates Corp. 63,500 1,421
Schlumberger Ltd. 3,166,900 350,734
# Western Atlas, Inc. 42,100 2,610
---------
706,238
MATERIALS & PROCESSING (3.4%)
Archer-Daniels-Midland Co. 877,430 16,123
E.I. du Pont de Nemours & Co. 272,800 28,951
Eastman Chemical Co. 2,723,950 138,921
Ethyl Corp. 78,000 712
The BFGoodrich Co. 521,600 20,799
M.A. Hanna Co. 360,800 7,532
James River Corp. 2,343,700 70,018
Kimberly-Clark Corp. 315,600 16,175
The Mead Corp. 183,300 10,288
(1) Millenium Chemicals, Inc. 3,962,442 70,333
Morton International, Inc. 148,300 6,210
# Owens-Illinois, Inc. 96,700 2,611
Phelps Dodge Corp. 152,900 11,735
Schuller Corp. 413,600 4,033
The Timken Co. 75,700 4,400
USX-U.S. Steel Group 100,500 2,940
Union Carbide Corp. 130,300 6,499
(1) Witco Chemical Corp. 5,032,000 188,071
---------
606,351
---------
PRODUCER DURABLES (3.6%)
The Boeing Co. 644,700 63,584
Deere & Co. 31,600 1,454
General Signal Corp. 26,500 1,040
Harnischfeger Industries Inc. 191,600 7,975
Honeywell, Inc. 3,706,000 261,736
Pitney Bowes, Inc. 137,600 8,806
Tecumseh Products Co. Class A 139,800 7,549
Tektronix, Inc. 44,200 2,392
Thomas & Betts Corp. 302,200 13,712
United Technologies Corp. 181,600 13,733
Xerox Corp. 4,226,421 259,925
---------
641,906
---------
TECHNOLOGY (3.9%)
# Compaq Computer Corp. 164,500 14,044
Electronic Data Systems Corp. 2,677,400 89,358
Intel Corp. 471,000 72,063
International Business
Machines Corp. 3,131,700 503,421
# NCR Corp. 26,456 767
# Storage Technology Corp. 214,300 7,527
# Western Digital Corp. 5,400 333
---------
687,513
---------
UTILITIES (11.2%)
AT&T Corp. 1,799,700 60,290
Ameritech Corp. 348,800 21,320
Boston Edison Co. 288,800 7,364
CMS Energy Corp. 248,900 7,903
(1) Centerior Energy Corp. 8,912,900 89,129
Central & South West Corp. 3,503,200 70,502
Century Telephone
Enterprises, Inc. 296,800 8,867
Consolidated Edison Co. of
New York, Inc. 425,800 11,816
DTE Energy Co. 344,800 9,223
Edison International 492,700 10,347
# Energy Group PLC ADR 3,371,250 105,773
Entergy Corp. 10,352,200 241,983
GPU Inc. 236,300 7,621
GTE Corp. 432,500 19,841
Houston Industries, Inc. 4,596,100 91,922
MCI Communications Corp. 1,715,000 65,170
NGC Corp. 108,500 1,912
New York State Electric
& Gas Corp. 454,000 9,534
Niagara Mohawk Power Corp. 361,500 3,073
</TABLE>
9
<PAGE> 31
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
MARKET
VALUE*
WINDSOR II SHARES (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
NYNEX Corp. 341,300 17,662
Ohio Edison Co. 2,705,000 54,100
Public Service Enterprise
Group Inc. 4,287,800 103,443
SBC Communications Inc. 5,548,999 307,969
Southern Co. 340,000 6,927
Southern New England
Telecommunications Corp. 188,900 6,895
Texas Utilities Co. 300,400 10,138
# 360 Communications Co. 433,500 7,532
(1) Unicom Corp. 12,598,300 274,013
# U.S. Cellular Corp. 220,800 5,520
U S WEST Communications
Group 10,463,000 367,513
---------
2,005,302
---------
OTHER (9.4%)
Brunswick Corp. 91,800 2,593
Cooper Industries, Inc. 19,000 874
Crane Co. 61,300 2,291
(1) Dresser Industries, Inc. 10,062,800 300,626
General Electric Co. 1,356,300 150,380
Hanson PLC ADR 3,371,250 81,753
Harris Corp. 63,200 5,404
(1) ITT Industries, Inc. 7,263,200 183,396
# Litton Industries, Inc. 261,800 11,094
Minnesota Mining &
Manufacturing Co. 70,500 6,133
Raytheon Co. 6,360,500 277,477
Tenneco, Inc. 7,342,900 292,798
Trinity Industries, Inc. 193,900 5,090
Westinghouse Electric Corp. 20,903,000 355,351
---------
1,675,260
---------
- -------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $11,451,060) 16,107,006
- -------------------------------------------------------------------------------
<CAPTION>
FACE
AMOUNT
(000)
- -------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (9.0%)
- -------------------------------------------------------------------------------
<S> <C> <C>
U.S. TREASURY BILL
(2) 5.21%, 7/24/97 $ 1,600 1,581
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.31%, 5/1/97 1,596,402 1,596,402
- -------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $1,597,982) 1,597,983
- -------------------------------------------------------------------------------
TOTAL INVESTMENTS (99.3%)
(COST $13,049,042) 17,704,989
- -------------------------------------------------------------------------------
<CAPTION>
- -------------------------------------------------------------------------------
Market
Value*
(000)
- -------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.7%)
- -------------------------------------------------------------------------------
<S> <C>
Other Assets--Notes C and F $ 250,322
Liabilities--Note F (127,245)
----------
123,077
- -------------------------------------------------------------------------------
NET ASSETS (100%)
- -------------------------------------------------------------------------------
Applicable to 707,042,577 outstanding
$.01 par value shares
(authorized 900,000,000 shares) $17,828,066
===============================================================================
NET ASSET VALUE PER SHARE $25.21
===============================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
# Non-Income Producing Security.
(1)Considered an affiliated company as the Fund owns more than 5% of the
outstanding voting securities of such company.
(2)Security segregated as initial margin for open futures contracts.
ADR--American Depository Receipt.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
AT APRIL 30, 1997, NET ASSETS CONSISTED OF:
- -----------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- -----------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $12,208,423 $17.27
Undistributed Net
Investment Income 136,903 .19
Accumulated Net
Realized Gains 826,621 1.17
Unrealized Appreciation--Note E
Investment Securities 4,655,947 6.58
Futures Contracts 172 --
- -----------------------------------------------------------------------------
NET ASSETS $17,828,066 $25.21
=============================================================================
</TABLE>
10
<PAGE> 32
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. If the
Fund invested in futures contracts during the period, the results of these
investments are shown separately.
<TABLE>
<CAPTION>
===============================================================================
WINDSOR II
SIX MONTHS ENDED APRIL 30, 1997
(000)
===============================================================================
<S> <C>
INVESTMENT INCOME
INCOME
Dividends 205,326
Interest 36,159
----------
Total Income 241,485
----------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 10,463
Performance Adjustment 1,374
The Vanguard Group--Note C
Management and Administrative 17,597
Marketing and Distribution 1,744
Taxes (other than income taxes) 612
Custodian Fees 26
Auditing Fees 10
Shareholders' Reports 221
Annual Meeting and Proxy Costs 39
Directors' Fees and Expenses 21
----------
Total Expenses 32,107
Expenses Paid Indirectly--Note C (957)
----------
Net Expenses 31,150
- -----------------------------------------------------------------------------
NET INVESTMENT INCOME 210,335
- -----------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 827,057
Futures Contracts 2,479
- -----------------------------------------------------------------------------
REALIZED NET GAIN 829,536
- -----------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 746,224
Futures Contracts (218)
- -----------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 746,006
- -----------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $1,785,877
=============================================================================
</TABLE>
11
<PAGE> 33
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
that is detailed in the Statement of Operations. The amounts shown as
Distributions to shareholders from the Fund's net income and capital gains may
not match the amounts shown in the Operations section, because distributions
are determined on a tax basis and may be made in a period different from the
one in which the income was earned or the gains were realized on the financial
statements. The Capital Share Transactions section shows the amount
shareholders invested in the Fund, either by purchasing shares or by
reinvesting distributions, as well as the amounts redeemed. The corresponding
numbers of Shares Issued and Redeemed are shown at the end of the Statement.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------
WINDSOR II
------------------------------
SIX MONTHS YEAR
ENDED ENDED
APR. 30, 1997 OCT. 31, 1996
(000) (000)
- ------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
Operations
Net Investment Income $ 210,335 $ 362,868
Realized Net Gain 829,536 714,637
Change in Unrealized Appreciation (Depreciation) 746,006 1,828,051
----------------------------
Net Increase in Net Assets Resulting from Operations 1,785,877 2,905,556
----------------------------
DISTRIBUTIONS
Net Investment Income (265,780) (309,925)
Realized Capital Gain (716,991) (352,517)
----------------------------
Total Distributions (982,771) (662,442)
----------------------------
CAPITAL SHARE TRANSACTIONS (1)
Issued 2,578,252 3,658,017
Issued in Lieu of Cash Distributions 949,212 550,557
Redeemed (1,260,390) (1,965,967)
----------------------------
Net Increase from Capital Share Transactions 2,267,074 2,242,607
- -----------------------------------------------------------------------------------------
Total Increase 3,070,180 4,485,721
- -----------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 14,757,886 10,272,165
----------------------------
End of Period $17,828,066 $14,757,886
=========================================================================================
(1)Shares Issued (Redeemed)
Issued 104,257 166,158
Issued in Lieu of Cash Distributions 40,085 26,223
Redeemed (51,064) (90,590)
----------------------------
Net Increase in Shares Outstanding 93,278 101,791
=========================================================================================
</TABLE>
12
<PAGE> 34
FINANCIAL HIGHLIGHTS
This table summarizes the Fund's investment results and distributions to
shareholders on a per-share basis. It also presents the Fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the Fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the Fund's total return; how much it costs to operate the
Fund; and the extent to which the Fund tends to distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in
the Fund for one year. Finally, the table lists the Fund's Average Commission
Rate Paid, a disclosure required by the SEC beginning in 1996. This rate is
calculated by dividing total commissions paid on portfolio securities by the
total number of shares purchased and sold on which commissions were charged.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
WINDSOR II
YEAR ENDED OCTOBER 31,
FOR A SHARE OUTSTANDING SIX MONTHS ENDED -----------------------------------------------
THROUGHOUT EACH PERIOD APRIL 30, 1997 1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $24.04 $20.06 $17.33 $17.98 $15.75 $15.07
- ------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .31 .62 .58 .55 .50 .56
Net Realized and Unrealized Gain (Loss)
on Investments 2.45 4.63 3.17 (.19) 2.47 1.17
---------------------------------------------------------
Total from Investment Operations 2.76 5.25 3.75 .36 2.97 1.73
---------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.43) (.58) (.55) (.51) (.52) (.61)
Distributions from Realized Capital Gains (1.16) (.69) (.47) (.50) (.22) (.44)
---------------------------------------------------------
Total Distributions (1.59) (1.27) (1.02) (1.01) (.74) (1.05)
- ------------------------------------------------------------------------------------------------------
NET ASSET vALUE, End of Period $25.21 $24.04 $20.06 $17.33 $17.98 $15.75
======================================================================================================
TOTAL RETURN 11.91% 27.17% 23.08% 2.22% 19.51% 12.50%
======================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $17,828 $14,758 $10,272 $8,246 $7,486 $4,878
Ratio of Total Expenses to
Average Net Assets 0.39%* 0.39% 0.40% 0.39% 0.39% 0.41%
Ratio of Net Investment Income to
Average Net Assets 2.56%* 2.92% 3.27% 3.26% 3.11% 3.72%
Portfolio Turnover Rate 32%* 32% 30% 24% 26% 23%
Average Commission Rate Paid $.0533 $.0483 N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized.
13
<PAGE> 35
NOTES TO FINANCIAL STATEMENTS
Vanguard/Windsor II is registered under the Investment Company Act of 1940 as a
diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The Fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Securities listed on an exchange are valued at the
latest quoted sales prices as of the close of trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such
securities not traded on the valuation date are valued at the mean of the
latest quoted bid and asked prices. Securities not listed on an exchange are
valued at the latest quoted bid prices. Temporary cash investments acquired
over 60 days to maturity 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. Other temporary cash investments are valued at amortized
cost, which approximates market value.
2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. 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. FUTURES: The Fund uses S&P 500 Index futures contracts to a limited
extent, with the objectives of maintaining full exposure to the stock market
while maintaining liquidity. The Fund may purchase or sell futures contracts to
achieve a desired level of investment, whether to accommodate portfolio
turnover or cash flows from capital shares transactions. The primary risks
associated with the use of futures contracts are imperfect correlation between
changes in market values of stocks held by the Fund and the prices of futures
contracts, and the possibility of an illiquid market. Futures contracts are
valued at their quoted daily settlement prices. The aggregate principal amounts
of the contracts are not recorded in the financial statements. Fluctuations in
the value of the contracts are recorded in the Statement of Net Assets as an
asset (liability) and in the Statement of Operations as unrealized appreciation
(depreciation) until the contracts are closed, when they are recorded as
realized futures gains (losses).
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Barrow, Hanley, Mewhinney & Strauss, Inc.; Equinox Capital Management, Inc.;
and Tukman Capital Management, Inc. provide investment advisory services to the
Fund for fees calculated at an annual percentage rate of average net assets.
The basic fees thus computed for Barrow, Hanley, Mewhinney & Strauss, Inc. are
subject to quarterly adjustments based on performance relative to the S&P/BARRA
Value Index; such fees for Equinox Capital Management, Inc. are subject to
quarterly adjustments based on performance relative to the Russell 1000 Value
Index; such fees for Tukman Capital Management, Inc. are subject to quarterly
adjustments based on performance relative to the S&P 500 Index. For the six
months ended April 30, 1997, the aggregate investment advisory fee represented
an effective annual rate of 0.13% of average net assets before an increase of
$1,374,000 (an annual rate of 0.02%) based on performance.
The Vanguard Group provides investment advisory services to a portion of
the Fund on an at-cost basis.
14
<PAGE> 36
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the Fund under methods approved by the board of directors. At April 30,
1997, the Fund had contributed capital of $1,407,000 to Vanguard (included in
Other Assets), representing 7.0% of Vanguard's capitalization. The Fund's
directors and officers are also directors and officers of Vanguard.
Vanguard has asked the Fund's investment adviser to direct certain
portfolio trades, subject to obtaining the best price and execution, to brokers
who have agreed to rebate to the Fund part of the commissions generated. Such
rebates are used solely to reduce the Fund's administrative expenses. For the
six months ended April 30, 1997, these arrangements reduced the Fund's expenses
by $957,000 (an annual rate of 0.01% of average net assets).
D. During the six months ended April 30, 1997, the Fund purchased
$3,269,925,000 of investment securities and sold $2,385,444,000 of investment
securities, other than temporary cash investments.
E. At April 30, 1997, net unrealized appreciation of investment securities for
financial reporting and federal income tax purposes was $4,655,947,000,
consisting of unrealized gains of $4,954,419,000 on securities that had risen
in value since their purchase and $298,472,000 in unrealized losses on
securities that had fallen in value since their purchase.
At April 30, 1997, the aggregate settlement value of open S&P 500 Index
futures contracts expiring in June 1997, and the unrealized appreciation on
those contracts were $30,908,000 and $172,000, respectively.
F. The market value of securities on loan to broker/dealers at April 30,
1997, was $4,367,000, for which the Fund held cash collateral of $4,469,000.
15
<PAGE> 37
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director of The Vanguard Group,
Inc. and of each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN, President, Chief Executive Officer, and Director of The
Vanguard Group, Inc. and of each of the investment companies in The
Vanguard Group.
ROBERT E. CAWTHORN, Chairman Emeritus and Director of Rhone-Poulenc Rorer
Inc.; Director of Sun Company, Inc., Westinghouse Electric Corp., and
Global Health Care Partners/DLJ Merchant Banking Partners.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea
Co., Ikon Business Solutions, Inc., Raytheon Co., Knight-Ridder,
Inc., and Massa-chusetts Mutual Life Insurance Co.; Trustee Emerita
of Wellesley College.
BRUCE K. MACLAURY, President Emeritus of The Brookings Institution; Director of
American Express Bank Ltd., The St. Paul Companies, Inc., and
National Steel Corp.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl
Corp., Baker Fentress & Co., The Jeffrey Co., and Southern New England
Communications Co.
ALFRED M. RANKIN, JR., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich
Co., and The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co.
and President of New York University; Director of Pacific Gas and
Electric Co., Procter & Gamble Co., and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc.
and Kmart Corp.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas Co.;
Director of Cummins Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies
in The Vanguard Group.
RICHARD F. HYLAND, Treasurer; Principal of The Vanguard Group, Inc.;
Treasurer of each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller; Principal of The Vanguard Group, Inc.; Controller of
each of the investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President, Information Technology.
JAMES H. GATELY, Senior Vice President, Individual Investor Group.
IAN A. MACKINNON, Senior Vice President, Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President, Institutional.
RALPH K. PACKARD, Senior Vice President and Chief Financial Officer
[THE VANGUARD GROUP LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
http://www.vanguard.com [email protected]
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before investing or sending money. Prospectuses
may be obtained directly from The Vanguard Group.
(C) 1997 Vanguard Marketing Corporation, Distributor
<PAGE> 38
[PHOTO]
THE VANGUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Growth and Income Portfolio
Vanguard Selected Value Portfolio
Vanguard/Trustees' Equity-U.S. Portfolio
Vanguard Convertible Securities Fund
BALANCED FUNDS
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LifeStrategy Portfolios
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard International Value Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Treasury Money Market Portfolio
Vanguard Admiral Funds
INCOME FUNDS
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
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TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
Q732-4/97
