VANGUARD
WINDSOR
FUND
Annual Report
October 31, 1999
[SHIP GRAPHIC]
[A MEMBER OF THE VANGUARD GROUP(R) LOGO]
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[PHOTO OF JOHN C. BOGLE]
JOHN C. BOGLE
FELLOW SHAREHOLDERS:
TWO ROADS DIVERGED IN A WOOD, AND I--I TOOK THE ONE LESS TRAVELED BY, AND
THAT HAS MADE ALL THE DIFFERENCE.
I can think of no better words than those of Robert Frost to begin this special
letter to our shareholders, who have placed such extraordinary trust in me and
in Vanguard over the past quarter century. When the firm was founded 25 years
ago, we deliberately took a new road to managing a mutual fund enterprise.
Instead of having the funds controlled by an outside management company with its
own financial interests, the Vanguard funds--there were only 11 of them
then--would be controlled by their own shareholders and operate solely in their
financial interests. The outcome of our unprecedented decision was by no means
certain. We described it then as "The Vanguard Experiment."
Well, I guess it's fair to say it's an experiment no more. During the past
25 years, the assets we hold in stewardship for investors have grown from $1
billion to more than $500 billion, and I believe that our reputation for
integrity, fair-dealing, and sound investment principles is second to none in
this industry. Our staggering growth--which I never sought--has come in
important part as a result of the simple investment ideas and basic human values
that are the foundation of my personal philosophy. I have every confidence that
they will long endure at Vanguard, for they are the right ideas and right
values, unshakable and eternal.
While Emerson believed that "an institution is the lengthened shadow of one
man," Vanguard today is far greater than any individual. The Vanguard crew has
splendidly implemented and enthusiastically supported our founding ideas and
values, and deserves the credit for a vital role in forging our success over the
years. It is a dedicated crew of fine human beings, working together in an
organization that is well prepared to press on regardless long after I am gone.
Creating and leading this enterprise has been an exhilarating run. Through it
all, I've taken the kudos and the blows alike, enjoying every moment to the
fullest, and even getting a second chance at life with a heart transplant three
years ago. What more could a man ask?
While I shall no longer be serving on the Vanguard Board, I want to assure
you that I will remain vigorous and active in a newly created Vanguard unit,
researching the financial markets, writing, and speaking. I'll continue to focus
whatever intellectual power and ethical strength I possess on my mission to
assure that mutual fund investors everywhere receive a fair shake. In the spirit
of Robert Frost:
BUT I HAVE PROMISES TO KEEP, AND MILES TO GO BEFORE I SLEEP, AND MILES TO
GO BEFORE I SLEEP.
You have given me your loyalty and friendship over these long years, and I
deeply appreciate your thousands of letters of support. For my part, I will
continue to keep an eagle eye on your interests, for you deserve no less. May
God bless you all, always.
/S/
JCB
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CONTENTS
REPORT FROM THE CHAIRMAN ............1 PERFORMANCE SUMMARY ................11
AFTER-TAX RETURNS REPORT ............5 FUND PROFILE .......................12
THE MARKETS IN PERSPECTIVE ..........6 FINANCIAL STATEMENTS ...............14
REPORTS FROM THE ADVISERS ...........8 REPORT OF INDEPENDENT ACCOUNTANTS ..23
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REPORT FROM THE CHAIRMAN
[PHOTO OF JOHN J. BRENNAN]
John J. Brennan
Vanguard Windsor Fund posted a return of 13.7% during the fiscal year ended
October 31, 1999. While this was a solid result that surpassed the 11.7% return
of the average comparable fund, it was well behind the outstanding 25.7% advance
of the Standard & Poor's 500 Index, which was propelled by a roaring market for
large technology stocks.
The table at right presents Windsor's fiscal year total return (capital
change plus reinvested dividends). It also lists returns for the average
multi-cap value fund (the category in which fund analyst Lipper Inc. has placed
Windsor, which holds both large- and mid-capitalization stocks), as well as for
the S&P 500 Index and its value-stock component. The fund's return is based on
an increase in net asset value from $16.34 per share on October 31, 1998, to
$16.91 per share on October 31, 1999. The return is adjusted for dividends
totaling $0.24 per share paid from net investment income and a distribution of
$1.23 per share paid in December 1998 from net realized capital gains. We
estimate that the fund will make a distribution of approximately $1.88 from net
realized capital gains in December 1999.
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TOTAL RETURNS
FISCAL YEAR ENDED
OCTOBER 31, 1999
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Vanguard Windsor Fund 13.7%
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Average Multi-Cap Value Fund* 11.7%
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S&P 500 Index 25.7%
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S&P 500/BARRA Value Index 19.0%
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*Derived from data provided by Lipper Inc.
FINANCIAL MARKETS IN REVIEW
The fiscal year ended October 31 comprised two distinctly different halves. For
most of the first half, stock prices worldwide were rebounding strongly from a
slump in the summer of 1998 that had been prompted by economic crises in Asia,
Russia, and parts of Latin America. The stock market's comeback was aided by a
pickup in global economic activity and by interest rate reductions by the
Federal Reserve Board that autumn. These developments--and the continued
ebullience of the U.S. economy--erased investors' fears that the troubles abroad
would depress business activity and profits at home. Even though interest rates
rose during the six months from October 31 through April 30, the stock market,
as measured by the Wilshire 5000 Total Market Index, gained 22.8% and the S&P
500 Index was up 22.3%.
However, during the second half of our fiscal year, most stock prices
stagnated or fell (with the notable exception of technology stocks). The
Wilshire 5000 advanced 2.3%, bringing its full-year return to 25.7%. The S&P
500's second-half return of 2.7% brought it to an identical 25.7% return for our
fiscal year. Large-cap growth stocks were the strongest market sector, led by
simply stupendous gains for a number of dominant technology stocks, such as
QUALCOMM (700%), Sun Microsystems (263%), Cisco Systems (135%), Microsoft (75%),
and Intel (74%). The growth stocks within the S&P 500 gained 31.6%, while the
index's value stocks, as measured by the S&P 500/BARRA Value Index, returned
19.0% as a group. Small-cap stocks were left in the wake of the big stocks: the
Russell 2000 Index
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of small stocks gained 14.9%. The growth/value split was even wider among the
small-caps, as the Russell 2000 growth stocks gained 29.3% versus a paltry 0.7%
return for the index's value stocks.
One drag on the stock market in general was a strong uptrend in interest
rates that began in February. The Federal Reserve encouraged this move, acting
in late June and again in August to boost short-term interest rates by a total
of 0.5 percentage point. Fears of a global economic slump were supplanted by
worries that economic growth-- especially in the United States--was so strong
that it would cause wages and commodity prices to surge, pushing up inflation.
For the full year, yields on long-term U.S. Treasury bonds rose
significantly. The yield on the 30-year Treasury increased exactly 1 percentage
point (100 basis points) to 6.16% on October 31, 1999. Bond prices, which move
in the opposite direction from interest rates, fell during the year. The Lehman
Brothers Aggregate Bond Index, a benchmark for taxable bonds, eked out a return
of 0.5% for the year, as its interest income of 6.2% only barely offset price
declines of -5.7%.
FISCAL 1999 PERFORMANCE OVERVIEW
Windsor Fund's 13.7% return during the fiscal year was 2 percentage points ahead
of that of the average multi-cap value fund--the category that Lipper--and
Vanguard, for that matter--regards as the correct peer group. However, we
trailed the S&P 500 Index's 25.7% return by 12 percentage points.
Half of our performance gap versus the index can be explained by the simple
fact that during fiscal 1999, growth stocks--whose relatively high
price/earnings, price/book value, and price/dividend ratios reflect rosy
expectations for future growth--ruled on Wall Street. As noted earlier, the
return for growth stocks within the S&P 500 outdistanced that for value stocks
by nearly 13 percentage points--31.6% versus 19.0%. Several large tech stocks
are selling at prices of $50 or more per $1 of earnings, while large industrial
companies are selling for $10 to $20 per $1 of earnings. Time will tell whether
the great expectations for growth built into tech stock prices will be justified
by actual earnings.
Value stocks--particularly in such sectors as materials & processing,
producer durables, big oil companies, and utilities--enjoyed a powerful rally in
April and May, outperforming their growth stock competitors by 9.8 percentage
points in those two months. But the resurgence was brief, and the market soon
resumed its love affair with tech stocks. Within the S&P 500, technology stocks
posted a 67% gain during our fiscal year. Windsor Fund's tech holdings earned a
similar 66% return, but our stake in this group averaged about 4% of assets, a
fraction of the 18% weighting for tech stocks in the S&P 500. Given the fund's
value investing style and mandate to seek growth and income, it would be odd for
it to emphasize technology stocks, with their high valuations and low dividend
yields. (Only 19 of 52 tech stocks in the S&P 500 pay any dividend at all.)
Another reason for our shortfall versus the broad index was poor
performance of our holdings in several sectors, including "other energy,"
financial services, and health care. We were hurt, for example, by HMO and
hospital stocks that suffered due to pricing pressures and concerns about legal
and regulatory difficulties. One plus for your fund was our light stake in
consumer-staples companies such as beverage and food makers. We held an average
of just 0.5% of assets in this sector, which was the market's weakest.
Interestingly, our light weighting in this sector stemmed from the same value
disciplines that have kept us from investing heavily in technology.
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As you know, during the year Sanford C. Bernstein & Co. began managing a
portion of the fund's assets, joining our lead adviser, Wellington Management
Company. The transition went smoothly. Careful planning and excellent
cooperation between our advisers minimized the costs associated with the
movement of some $4 billion in assets to Bernstein & Co. We estimate that these
one-time transaction costs trimmed the fund's return by 0.10 to 0.20 percentage
point.
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TOTAL ASSETS MANAGED
AS OF OCTOBER 31, 1999
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$ MILLION PERCENT
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Wellington Management Company, LLP $12,595 75%
Sanford C. Bernstein & Co., Inc. 4,080 24
Cash Reserve* 149 1
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Total $16,824 100%
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* This cash reserve is invested in equity index futures to simulate
investment in stocks; each adviser may also maintain a modest cash reserve.
The table above shows the share of assets supervised by each adviser at the
end of the fiscal year.
LONG-TERM PERFORMANCE OVERVIEW
An annual review of a mutual fund's record should also include a look at its
longer-term performance. The table below presents the average annual returns of
Windsor Fund and its comparative benchmarks for the past ten years. It also
presents the results of hypothetical $10,000 investments made a decade ago in
the fund, the average fund in its peer group, the S&P 500 Index and the S&P
500/BARRA Value Index.
Although Windsor Fund's 12.5% average annual return for the past decade was
generous in comparison with long-term stock market returns, it was modestly
short of the 13.4% return for its average peer, and well shy of the truly
amazing 17.8% return chalked up by the unmanaged S&P 500 Index. In part, we
trailed the index because the past ten years were a growth-stock decade: the
growth stocks within the S&P 500 posted average returns of 19.9% a year, far
ahead of the 15.4% return of the index's value stocks.
However, even allowing for the disparity in growth and value stock returns,
our performance has been subpar. All of us on the Windsor Fund team are focused
on improving our performance relative to our primary benchmark, the S&P 500
Index. Our goal is to provide superior returns over the long term, and while we
have fallen short of this goal of late, we continue to believe that our
disciplined value-investing approach and low operating costs give us a good
chance to accomplish it in the years ahead. Our annual expenses in fiscal 1999
amounted to a slender 0.28% of average assets, more than a full percentage point
below the 1.38% expense ratio for the average multi-cap value fund, according to
Lipper. We expect this advantage to aid us, year after year, in our effort to
provide superior returns.
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TOTAL RETURNS
10 YEARS ENDED OCTOBER 31, 1999
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AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
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Vanguard Windsor Fund 12.5% $32,344
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Average Multi-Cap Value Fund 13.4% $35,087
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S&P 500 Index 17.8% $51,526
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S&P 500/BARRA Value Index 15.4% $41,790
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Keep in mind that the returns earned by stocks--particularly large growth
stocks--over the past decade were high by historical standards and will probably
be lower in the future. This is not a prediction, but rather a prudent
assumption that investors should
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incorporate into their plans, given that the long-term average return from
stocks is about 11% annually. It's worth noting that this long-term average
includes lean years as well as the fabulous gains of the 1990s.
IN SUMMARY
The U.S. stock market provided another big gain for investors during the past 12
months, which marked the fifth fiscal year in a row during which the S&P 500
Index returned more than 20%. There has never been a streak like it in market
history. Such outsized rewards have pushed stock valuations to very high levels,
reflecting the superb economic and business conditions that have prevailed in
recent years, as well as widespread expectations for more of the same. It's
important to recognize, however, that such high valuations carry high risk,
should future results fail to match expectations.
Given the risk of wide short-term fluctuations in returns from the
financial markets, I repeat our longstanding advice that investors should hold
balanced portfolios of both value and growth stock funds, bond funds, and
short-term reserves in proportions suitable to their own investment time
horizon, goals, and financial situation. Such diversification can lessen some of
the jolts you're sure to encounter on the road toward your financial goals. In
short, I advise preparing an investment plan and sticking with it.
/S/
John J. Brennan
Chairman and Chief Executive Officer
November 11, 1999
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A NOTE OF THANKS TO OUR FOUNDER
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As you may have read on the inside cover of our report, our founder, John C.
Bogle, is retiring December 31, 1999, as Senior Chairman of our Board after
nearly 25 years of devoted service to Vanguard and our shareholders. Vanguard
investors have Jack to thank for creating a truly mutual mutual fund company
that operates solely in the interest of its fund shareholders. And mutual fund
investors everywhere have benefited from his energetic efforts to improve this
industry. Finally, on a personal note, I am forever grateful to Jack for giving
me the opportunity to join this great company in 1982.
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A REPORT ON YOUR FUND'S AFTER-TAX RETURNS
Beginning with this annual report, Vanguard is pleased to provide a review of
Windsor Fund's after-tax performance. The figures on this page demonstrate the
considerable impact that federal income taxes can have on a fund's return--an
important consideration for investors who own mutual funds in taxable accounts.
While the pretax return is most often used to tally a fund's performance, the
fund's after-tax return, which accounts for taxes on distributions of capital
gains and income dividends, is a better representation of the return that many
investors actually received. IF YOU OWN WINDSOR FUND IN A TAX-DEFERRED ACCOUNT
SUCH AS AN INDIVIDUAL RETIREMENT ACCOUNT OR A 401(K), THIS INFORMATION DOES NOT
APPLY TO YOU. SUCH ACCOUNTS ARE NOT SUBJECT TO CURRENT TAXES.
The table below presents the pretax and after-tax returns for your fund and
an appropriate peer group of mutual funds. Two things to keep in mind:
o The after-tax return calculations use the top federal income tax rates in
effect at the time of each distribution. The tax burden, therefore, would be
somewhat less, and the after-tax return somewhat more, for those in lower tax
brackets.
o The peer funds' returns are based on data from Morningstar, Inc.
(Elsewhere in this report, returns for comparable funds are based on data from
Lipper Inc., which differ somewhat.)
As you can see, Windsor Fund's pretax total return of 13.7% for the 12
months ended October 31, 1999, was reduced by taxes to 11.4%. In other words,
for investors in the highest tax bracket, taxes cut the fund's pretax return by
2.3 percentage points. In comparison, the average mid-cap value fund earned a
pretax return of 8.7% and an after-tax return of 6.6%, a difference of 2.1
percentage points.
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AVERAGE ANNUAL RETURNS: PRETAX AND AFTER-TAX
PERIODS ENDED OCTOBER 31, 1999
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1 YEAR 5 YEARS 10 YEARS
------------------ ----------------- -----------------
PRETAX AFTER-TAX PRETAX AFTER-TAX PRETAX AFTER-TAX
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Windsor Fund 13.7% 11.4% 15.8% 11.9% 12.5% 9.0%
Average Mid-Cap Value Fund* 8.7 6.6 14.6 11.4 12.1 9.6
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*Based on data from Morningstar, Inc.
Over the past decade, Windsor Fund's pretax returns exceeded those of the
average fund in Morningstar's mid-cap value category before taxes, but not after
taxes. For the ten years ended October 31, 1999, Windsor slightly outpaced its
average peer, but lost more to taxes (3.5 percentage points) than its peer-group
average (2.5 points).
We stress that because many interrelated factors affect how tax-friendly a
fund may be, it's very difficult to predict tax efficiency. A fund's tax
efficiency can be influenced by its turnover rate, the types of securities it
holds, the accounting practices it uses when selling shares, and the net cash
flow it receives.
Finally, it's important to understand that our calculation does not reflect
the tax effect of your own investment activities. Specifically, you may incur
additional capital gains taxes--thereby lowering your after-tax return--if you
decide to sell all or some of your shares.
A NOTE ABOUT OUR CALCULATIONS: Pretax total returns assume that all
distributions received (income dividends, short-term capital gains, and
long-term capital gains) are reinvested in new shares, while our after-tax
returns assume that distributions are reduced by any taxes owed on them before
reinvestment. When calculating the taxes due, we used the highest individual
federal income tax rates at the time of the distributions. Those rates are
currently 39.6% for dividends and short-term capital gains and 20% for long-term
capital gains. State and local income taxes were not considered. The competitive
group returns provided by Morningstar are calculated in a manner consistent with
that used for Vanguard funds.
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THE MARKETS IN PERSPECTIVE
YEAR ENDED OCTOBER 31, 1999
Caution followed exuberance in the U.S. stock market during the fiscal year
ended October 31, 1999. Improving economic conditions during the first half of
the year set off a raucous rally from the lows of summer 1998, when fears of a
global economic slump swept world markets. However, during the second half of
the fiscal year, interest rates kept rising, pulling down bond prices and
tempering the stock market's optimism. The notion of a global slump was replaced
by worries that economic growth might be so strong as to threaten a surge in
inflation.
U.S. STOCK MARKETS
A booming U.S. economy and solid increases in corporate earnings lifted the U.S.
stock market, especially during the first half of the fiscal year. The nation's
economic output increased by about 4% during the year. Consumer spending, which
accounts for roughly two-thirds of economic activity, powered the expansion.
Americans spent virtually every dollar they earned, encouraged by rising wealth
from a long bull market, plentiful employment, and rising incomes. (After-tax
personal income rose about 5% during the year; unemployment fell to a 30-year
low of 4.1% of the workforce in October.)
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AVERAGE ANNUAL RETURNS
PERIODS ENDED OCTOBER 31, 1999
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1 YEAR 3 YEARS 5 YEARS
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STOCKS
S&P 500 Index 25.7% 26.5% 26.0%
Russell 2000 Index 14.9 9.4 12.6
Wilshire 5000 Index 25.7 23.8 23.8
MSCI EAFE Index 23.4 12.5 9.5
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BONDS
Lehman Aggregate Bond Index 0.5% 6.2% 7.9%
Lehman 10 Year Municipal Bond Index -1.2 5.2 7.0
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 4.6 5.0 5.2
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OTHER
Consumer Price Index 2.6% 2.0% 2.4%
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From October 31, 1998, through April 30, 1999, the stock market rose 22.8%,
as measured by the Wilshire 5000 Total Market Index. Investor confidence,
already high due to the booming economy, was bolstered by easier monetary
policy--the Federal Reserve cut short-term interest rates in November 1998 for
the third time in less than two months. But by summer, the Fed reversed course,
twice boosting its target for short-term interest rates to slow the economy and
reduce inflationary pressures.
Higher interest rates helped take the steam out of the stock market's rally
during the second half of the fiscal year, even though estimates of corporate
earnings kept rising. Higher rates tend to hurt stocks because many investors
use current interest rates to discount the value of a stock's projected earnings
and dividends. The higher the rate, the more future earnings are discounted, and
the less investors will pay for the stock now. After a second-half gain of 2.3%,
the Wilshire 5000 Index recorded a 25.7% return for the full fiscal year.
Big stocks outperformed small stocks in fiscal 1999, and growth stocks
outpaced value stocks. The S&P 500 Index, which is dominated by
large-capitalization stocks, gained 25.7%,
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while the small-cap Russell 2000 Index was up 14.9%. Growth stocks--whose high
prices in relation to earnings, book value, and dividends indicate high
expectations for future growth--lost none of their appeal, despite soaring
valuations for many. Both large- and small-cap growth issues gained roughly 30%,
while value stocks within the S&P 500 Index were up 19.0%, and the Russell
2000's value stocks had a scant 0.7% return.
The growth/value gap was due partly to the incredible performance of
technology stocks, most of which are classified as growth issues. Within the S&P
500 Index, tech stocks gained 67% during the fiscal year. Advances of about 30%
were recorded by retailers and other consumer-discretionary stocks and by the
utilities sector, where gains were concentrated in telecommunications stocks.
The only sector with a loss was consumer staples (-8%), where food and beverage
company stocks suffered from falling profits.
Other laggards were the auto & transportation sector (+6%) and health-care
stocks (+9%).
U.S. BOND MARKETS
Rapid economic growth was a help to the stock market but a hindrance to bonds.
Investors worried that, with unemployment so low, growth above the 2.5% to 3%
range would cause wages and prices to accelerate. Indeed, inflation did rise a
bit, although the Consumer Price Index was up a relatively modest 2.6% during
the 12-month period.
As mentioned, the Fed sought to combat inflationary pressures by increasing
short-term interest rates by a quarter-point on June 30 and again on August 24.
The bond market was already pushing up rates well before the Fed acted. Yields
of long-term U.S. Treasury bonds began rising significantly in February. By
fiscal year-end, the 30-year Treasury bond's yield was 6.16%, up precisely 1
percentage point for the year. The 10-year Treasury's yield rose 1.41 percentage
points, from 4.61% to 6.02%. Short-term interest rates didn't rise as far, and
3-month Treasury bill yields were up 0.77 point to 5.09% at fiscal year-end.
Rising interest rates mean lower prices for existing bonds, of course.
Price declines were higher for longer-term bonds, which are most sensitive to
changing rates. For the taxable bond market as a whole, as measured by the
Lehman Aggregate Bond Index, prices fell -5.7%, resulting in a total return of
just 0.5% for the fiscal year. High-yield (junk) bonds and mortgage-backed
securities posted higher returns than Treasuries.
INTERNATIONAL STOCK MARKETS
International markets soared in local currencies during the 12 months ended
October 31, with European stocks gaining 22.7% and Pacific-region stocks
advancing 37.8%. The U.S. dollar rose in value against most European currencies
but fell against the Japanese yen. For U.S. investors, the upshot of these
currency fluctuations was to trim returns from Europe to 12.7% in dollar terms
and to boost returns from the Pacific to 50.5%.
In the major developed international markets, U.S. investors earned 23.4%,
as measured by the Morgan Stanley Capital International Europe, Australasia, Far
East (EAFE) Index. The bull markets in most nations stemmed from a renewed
appetite for risk on the part of investors encouraged by clear signs of
expanding business activity and generally easier monetary policy. Japan and the
rest of Asia, which were hit hardest by currency and economic crises in 1997 and
1998, saw the biggest gains. In Japan, massive government spending programs
appeared to be working--at least in the short run--to lift that nation out of a
recession.
Emerging markets, as measured by the Select Emerging Markets Free Index,
gained 34.1% for U.S. investors, as local returns of better than 70% were cut
nearly in half by weaker currencies in Latin America and eastern Europe.
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REPORT FROM WELLINGTON MANAGEMENT
COMPANY, LLP
Vanguard Windsor Fund's 13.7% return during the fiscal year ended October 31,
1999, was ahead of the 11.7% return of the average multi-cap value fund but
behind returns of both the S&P 500 Index (25.7%) and its value component, the
S&P 500/BARRA Value Index (19.0%).
We continue to invest as we have in the past. Our approach is to look for
good companies that the market has misappraised for some reason, that have
price/earnings (P/E) ratios below the market's, and that have an upside
appreciation potential of at least 30%. We make commitments only after thorough
research and careful deliberation, and we then follow closely everything we own.
The P/E ratio of our portfolio (and of the fund as a whole) is distinctly below
the market's, usually by about one-third. Yet our prospective total
return--which we define as 5-year earnings growth and dividend yield--is within
10%-15% of the market's. That is our value proposition.
We buy stocks when we think they are undervalued, sell them when they get
to fair value, and replace them with new undervalued names. We are not afraid to
concentrate when it makes sense and when, having done our homework, our
conviction is strong. Our goal is to provide returns on your investment that are
out of the ordinary, without taking undue risks. "Closet indexing"--aligning the
portfolio with a market index--is not consistent with this objective.
All this makes for a portfolio that is very different from the S&P 500
Index. The current portfolio is overweight in selected commodity and materials
producers--energy,aluminum, paper, and specialty chemicals--with holdings equal
to about 25% of the portfolio versus about 9% of the S&P 500. These stocks hurt
us in fiscal 1998, but helped in 1999. Alcoa, which gained about 55%, is our
largest holding in this phalanx and the third-largest holding in our portion of
the fund, at 51/2% of the portfolio. These stocks shot up in April and May, and
the market has been digesting those gains since. But we see another upward leg
or two ahead, if our forecast for global economic growth of 3.5% for next year
is right. Our energy fortunes are, importantly, also tied to the domestic
natural gas market, where we see strong fundamentals--demand growing 2% a year,
a supply base that has peaked out, and a market that will need higher prices to
bring supply into balance with demand.
We also have an outsize position in financial services--banks, savings &
loans, specialty finance, and some insurance--where our portfolio's weighting is
24% versus 16% for the S&P 500 Index. Again, these stocks lagged in 1998, which
we used as an opportunity to buy more. This paid off in 1999; Citigroup, the
fund's biggest holding at 6.5% of assets, was up about 75%. We still see a lot
of value in selected financials, such as Associates First, a new 2.2% stake for
the fund in a well-managed, 15%-a-year grower selling at only 15 times next
year's earnings.
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INVESTMENT PHILOSOPHY
The fund reflects a belief 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 fund may concentrate a large portion of assets in those
securities or industries the advisers believe offer the best return potential.
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We own no consumer nondurables--food, household products, beverages, and
tobacco--which make up
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nearly 10% of the S&P 500. This void served us well in fiscal 1999, as these
stocks lagged the market by about 30 percentage points. Such companies as
Coca-Cola, Procter & Gamble, and Gillette are still trading at 25 to 40 times
earnings while offering long-term growth prospects on the order of 10% to 12%.
This seems pricey to us, and so we still have nothing in this sector.
The other big sector difference between us and the market is
technology--which makes up 6% of our portfolio versus 21% of the market. This
disparity was a significant negative in 1999, because the tech piece of the S&P
500 Index was up 67%, accounting for more than half of the index's 25.7% gain.
Our tech weighting is low for good valuation reasons. Our view is that the P/E
multiples--from 40 to 70 times earnings--sported by a number of large tech
stocks are built on investor expectations that will be difficult to live up to.
An old rule of thumb is that growth stocks' P/E ratios should be roughly twice
the stocks' growth rates. This suggests that these large tech stocks need to
grow at 20% to 35% on a long-term basis to justify their multiples. Given that
U.S. information technology spending is growing at 11% a year, we expect to see
a lot of potholes in the technology landscape in the next 12 months as some
companies "fall short" of expectations and their stocks correct. When tech
stocks correct, they tend to come down hard, and we may get some buying
opportunities. If we're going to close our large gap versus the S&P 500's tech
weighting, we want to do so on our terms. A recent instance was IBM, where we
grabbed a new position of nearly 2% of assets when the company suggested that
Y2K distortions would hurt earnings for the next two quarters. We paid about
211/2 times earnings for this 15% grower, which also pays a 0.5% dividend yield;
its P/E-to-total-return ratio of 1.4 is well below the market's 1.9 ratio.
Our portion of the fund continues to be highly concentrated, with the ten
largest holdings totaling 41% of assets. Our overall portfolio P/E of 15.1,
based on estimated year 2000 earnings, is 63% of the market's 23.9 P/E multiple.
By way of comparison, our projected total return is 12.4%, about 90% of the
market's projected return. We have been looking for, and finding, solid
double-digit growers, with P/E-to-total-return ratios well below average for the
market. Besides Associates First and IBM, these are TJX Companies, Ross Stores,
Air Products, MCI WorldCom, and Pharmacia & Upjohn--names that account for about
12% of the portfolio. The dedicated Windsor team that I am proud to lead will
continue to forage, in our usual entrepreneurial style, for undervalued
situations that can add to the portfolio's already considerable appreciation
potential.
Charles T. Freeman, Portfolio Manager
November 16, 1999
9
<PAGE>
REPORT FROM SANFORD C. BERNSTEIN & CO., INC.
When Sanford C. Bernstein & Co. began managing a portion of Vanguard Windsor
Fund on June 1, we saw enormous opportunities in an unusually bifurcated market.
Prices for traditional cyclical companies, particularly commodity producers, had
fallen sharply over the previous two years because investors feared that
earnings shortfalls due to the spread of the Asian crisis would last
indefinitely. At the same time, euphoria surrounding the Internet was lifting
technology and telecommunications stock prices to extraordinarily high levels,
and a handful of very large, very expensive stocks were driving most of the
market's rally.
We positioned the portfolio to capture the deep values we saw in cyclicals,
particularly the commodity producers and railroads. We also saw opportunity in
health maintenance organizations (HMOs) and in retail, food, and tobacco
companies. Although growth stocks have continued to outperform, the outlook for
value stocks has become very strong--indeed, even better than we anticipated
when we initiated these positions.
Economic growth has been surprisingly strong around the globe, and
inventories have shrunk for many commodities. As a result, commodity prices are
rising, as are consensus earnings expectations for many of our holdings. In
several cases, third-quarter earnings reports significantly beat expectations.
At the same time, an extraordinary burst of restructuring activity and mergers
has increased the long-term earnings power of many commodity producers we hold.
For example, Dow Chemical's acquisition of Union Carbide this summer is creating
a global behemoth with enormous opportunities to cut costs and to increase
revenues through cross-selling a more complete product line to both companies'
customers. We also see large opportunities in railroad companies that are
smoothing out operational difficulties that arose from strategically sound
mergers. Railroads should benefit as freight volumes recover from declining
sales to Asia.
Other opportunities are more insulated from global considerations. HMO
stocks recently fell because of concern about adverse political developments and
possible class-action lawsuits. In our view, it is highly unlikely that such
suits will withstand court scrutiny, and the industry appears able to pass
through to consumers the costs of regulatory changes; indeed, pricing power is
finally returning to the industry. These stocks offer exceptional value.
Our portion of Windsor Fund has no holdings in the high-priced
semiconductor and Internet industries, and few in computer software or services.
One very attractive company in the hardware and peripherals segment is Seagate
Technology, a maker of disk drives that has recovered its market leadership and
gained a compelling cost advantage; as a result, it is the only disk-drive
manufacturer with current profits.
Overall, the value opportunities we see today are the largest in our
experience. We expect improvement in both forecast and reported earnings to be
the catalyst for stock price gains. Such improvement is now appearing for some
of our holdings, increasing our confidence in our current strategy.
Marilyn G. Fedak, Portfolio Manager
Steven Pisarkiewicz, Portfolio Manager
November 10, 1999
10
<PAGE>
PERFORMANCE SUMMARY
WINDSOR FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the fund. Note, too, that both
share price and return can fluctuate widely. An investor's shares, when
redeemed, could be worth more or less than their original cost.
- --------------------------------------------------------------------------------
TOTAL INVESTMENT RETURNS: OCTOBER 31, 1979-OCTOBER 31, 1999
WINDSOR FUND S&P 500
- --------------------------------------------------------------------------------
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- --------------------------------------------------------------------------------
1980 17.2% 7.0% 24.2% 32.1%
1981 11.1 6.9 18.0 0.6
1982 14.2 7.0 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
- --------------------------------------------------------------------------------
WINDSOR FUND S&P 500
- --------------------------------------------------------------------------------
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- --------------------------------------------------------------------------------
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 24.3 2.7 27.0 32.1
1998 -2.0 1.2 -0.8 22.0
1999 12.1 1.6 13.7 25.7
- --------------------------------------------------------------------------------
See Financial Highlights table on page 20 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE: OCTOBER 31, 1989-OCTOBER 31, 1999
[MOUNTAIN CHART]
- --------------------------------------------------------------------------------
AVERAGE
WINDSOR MULTI-CAP S&P 500
FUND VALUE FUND* INDEX
- --------------------------------------------------------------------------------
1989/10 10000 10000 10000
1990/01 9038 9630 9747
1990/04 9002 9662 9882
1990/07 9261 10204 10738
1990/10 7207 8702 9252
1991/01 8813 10013 10566
1991/04 9776 10947 11623
1991/07 10045 11342 12108
1991/10 10428 11764 12351
1992/01 10784 12363 12963
1992/04 11416 12586 13253
1992/07 11813 12825 13656
1992/10 11398 12921 13581
1993/01 12974 13873 14334
1993/04 13311 14101 14478
1993/07 13977 14527 14849
1993/10 14622 15444 15610
1994/01 15554 16034 16180
1994/04 14511 15235 15248
1994/07 15347 15445 15615
1994/10 15550 16009 16214
1995/01 14927 15694 16266
1995/04 16473 17072 17911
1995/07 18365 18668 19692
1995/10 18318 19288 20501
1996/01 19599 20874 22555
1996/04 20845 21764 23323
1996/07 20304 20995 22954
1996/10 22561 23267 25441
1997/01 25564 25522 28497
1997/04 25622 25359 29184
1997/07 29980 30056 34922
1997/10 28661 29968 33610
1998/01 29342 30787 36165
1998/04 33717 34171 41169
1998/07 30716 32346 41657
1998/10 28436 31407 41001
1999/01 29522 33792 47915
1999/04 34692 35760 50154
1999/07 33760 35898 50073
1999/10 32344 35087 51526
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED OCTOBER 31, 1999
------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- --------------------------------------------------------------------------------
Windsor Fund 13.74% 15.77% 12.46% $32,344
Average Multi-Cap
Value Fund* 11.72 16.99 13.37 35,087
S&P 500 Index 25.67 26.02 17.82 51,526
- --------------------------------------------------------------------------------
*Derived from data provided by Lipper Inc.
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1999*
- --------------------------------------------------------------------------------
10 YEARS
INCEPTION ---------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------
Windsor Fund 10/23/1958 19.36% 15.57% 7.88% 3.64% 11.52%
- --------------------------------------------------------------------------------
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
11
<PAGE>
FUND PROFILE
WINDSOR FUND
This Profile provides a snapshot of the fund's characteristics as of October 31,
1999, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 13.
PORTFOLIO CHARACTERISTICS
- ---------------------------------------------------------
WINDSOR S&P 500
- ---------------------------------------------------------
Number of Stocks 195 500
Median Market Cap $13.1B $72.6B
Price/Earnings Ratio 17.4x 27.7x
Price/Book Ratio 2.2x 5.1x
Yield 1.6% 1.2%
Return on Equity 15.0% 23.0%
Earnings Growth Rate 9.6% 15.0%
Foreign Holdings 11.4% 1.5%
Turnover Rate 56% --
Expense Ratio 0.28% --
Cash Reserves 1.3% --
INVESTMENT FOCUS
- ---------------------------------------------------------
[GRID]
Style............Value
Market Cap.......Medium
VOLATILITY MEASURES
- ---------------------------------------------------------
WINDSOR S&P 500
- ---------------------------------------------------------
R-Squared 0.78 1.00
Beta 1.05 1.00
TEN LARGEST HOLDINGS
(% OF TOTAL NET ASSETS)
- ---------------------------------------------------------
Citigroup, Inc. 6.5%
AT&T Corp. 4.6
Rhone-Poulenc SA 4.6
Alcoa Inc. 4.3
Bank of America Corp. 3.1
Columbia/HCA Healthcare Corp. 2.3
Washington Mutual, Inc. 2.2
Associates First Capital Corp. 2.2
Golden West Financial Corp. 2.1
MCI WorldCom, Inc. 2.0
- ---------------------------------------------------------
Top Ten 33.9%
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- ---------------------------------------------------------
OCTOBER 31, 1998 OCTOBER 31, 1999
------------------------------------
WINDSOR WINDSOR S&P 500
------------------------------------
Auto & Transportation ... 6.4% 7.4% 2.2%
Consumer Discretionary .. 0.8 4.7 12.5
Consumer Staples ........ 0.0 1.1 7.2
Financial Services ...... 29.0 29.4 16.1
Health Care ............. 7.8 6.9 11.0
Integrated Oils ......... 3.5 2.8 5.2
Other Energy ............ 10.3 6.2 1.4
Materials & Processing .. 21.0 21.2 3.2
Producer Durables ....... 5.8 3.3 3.3
Technology .............. 5.4 4.8 20.5
Utilities ............... 7.3 9.7 11.2
Other ................... 2.7 2.5 6.2
- ---------------------------------------------------------
12
<PAGE>
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a fund with a beta
of 1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities. This
figure does not include cash invested in futures contracts to simulate stock
investment.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or American Depositary Receipts of companies based outside the United States.
INVESTMENT FOCUS. This grid indicates the focus of a fund in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds,
the more diversified it is and the more likely to perform in line with the
overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund's returns bore no relationship to the
market's returns, its R-squared would be 0.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a fund's common stocks that come from
each of the major industry groups that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of net assets that a fund has invested in
its ten largest holdings. (The average for stock mutual funds is about 35%.) As
this percentage rises, a fund's returns are likely to be more volatile because
they are more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year. Funds
with high turnover rates incur higher transaction costs and are more likely to
distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a fund's income from interest and dividends. The yield,
expressed as a percentage of the fund's net asset value, is based on income
earned over the past 30 days and is annualized, or projected forward for the
coming year. The index yield is based on the current annualized rate of
dividends paid on stocks in the index.
13
<PAGE>
FINANCIAL STATEMENTS
OCTOBER 31, 1999
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.) and by
industry sector. Other assets are added to, and liabilities are subtracted from,
the value of Total Investments to calculate the fund's Net Assets. Finally, Net
Assets are divided by the outstanding shares of the fund to arrive at its share
price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying
the composition of the fund's net assets on both a dollar and per-share basis.
Because all income and any realized gains must be distributed to shareholders
each year, the bulk of net assets consists of Paid in Capital (money invested by
shareholders). The amounts shown for Undistributed Net Investment Income and
Accumulated Net Realized Gains usually approximate the sums the fund had
available to distribute to shareholders as income dividends or capital gains as
of the statement date, but may differ because certain investments or
transactions may be treated differently for financial statement and tax
purposes. Any Accumulated Net Realized Losses, and any cumulative excess of
distributions over net income or net realized gains, will appear as negative
balances. Unrealized Appreciation (Depreciation) is the difference between the
market value of the fund's investments and their cost, and reflects the gains
(losses) that would be realized if the fund were to sell all of its investments
at their statement-date values.
- --------------------------------------------------------------------------------
MARKET
VALUE*
WINDSOR FUND SHARES (000)
- --------------------------------------------------------------------------------
COMMON STOCKS (96.7%)+
- --------------------------------------------------------------------------------
AUTO & TRANSPORTATION (7.2%)
Compagnie Generale des
Etablissements Michelin
Class B 6,000,586 261,106
Canadian National
Railway Co. 5,042,100 153,784
Eaton Corp. 2,015,900 151,696
Delta Air Lines, Inc. 2,301,522 125,289
o(1) America West Holdings Corp.
Class B 3,484,500 72,086
Burlington Northern
Santa Fe Corp. 1,869,000 59,574
Union Pacific Corp. 1,059,300 59,056
General Motors Corp. 722,100 50,728
Delphi Automotive
Systems Corp. 2,937,059 48,278
Norfolk Southern Corp. 1,923,600 47,008
CSX Corp. 1,124,000 46,084
TRW, Inc. 909,000 38,973
Genuine Parts Co. 1,486,500 38,742
Ford Motor Co. 578,800 31,762
Dana Corp. 886,200 26,198
----------
1,210,364
----------
CONSUMER DISCRETIONARY (4.6%)
May Department Stores Co. 4,737,800 164,342
(1) Ross Stores, Inc. 6,509,600 134,261
o Republic Services, Inc.
Class A 8,091,500 99,121
o BJ's Wholesale Club, Inc. 2,224,800 68,552
TJX Cos., Inc. 1,928,200 52,302
- --------------------------------------------------------------------------------
MARKET
VALUE
SHARES (000)
- --------------------------------------------------------------------------------
o Federated Department
Stores, Inc. 1,100,300 46,969
Whirlpool Corp. 619,800 43,192
o Jones Apparel Group, Inc. 1,182,900 37,409
VF Corp. 994,300 29,891
Mattel, Inc. 2,231,300 29,844
Sears, Roebuck & Co. 841,800 23,728
o Saks Inc. 1,239,100 21,297
Dillard's Inc. 616,900 11,644
o(1) HomeBase, Inc. 2,307,100 8,796
----------
771,348
----------
CONSUMER STAPLES (1.1%)
Philip Morris Cos., Inc. 2,502,900 63,042
ConAgra, Inc. 2,175,800 56,707
Tyson Foods, Inc. 1,812,600 27,642
SuperValu Inc. 942,100 19,784
IBP, Inc. 736,500 17,630
----------
184,805
----------
FINANCIAL SERVICES (28.4%)
BANKS--NEW YORK CITY (0.2%)
The Chase Manhattan Corp. 197,800 17,283
J.P. Morgan & Co., Inc. 99,900 13,074
BANKS--OUTSIDE NEW YORK CITY (7.2%)
Bank of America Corp. 8,017,971 516,157
National City Corp. 5,172,800 152,598
UnionBanCal Corp. 3,213,000 139,565
U.S. Bancorp 3,643,900 135,052
Fleet Boston Corp. 2,009,530 87,666
Bank One Corp. 2,220,900 83,423
First Union Corp. 1,944,300 82,997
Regions Financial Corp. 583,200 17,532
14
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
DIVERSIFIED FINANCIAL SERVICES (6.8%)
Citigroup, Inc. 20,353,400 1,101,628
American General Corp. 637,000 47,257
FINANCIAL MISCELLANEOUS (2.8%)
Associates First Capital Corp. 10,034,900 366,274
MBIA, Inc. 803,800 45,867
AMBAC Financial Group Inc. 579,900 34,649
Fannie Mae 344,600 24,380
INSURANCE--MULTI-LINE (3.5%)
CIGNA Corp. 3,945,800 294,949
Allstate Corp. 7,075,400 203,418
American International
Group, Inc. 472,100 48,597
Torchmark Corp. 1,061,800 33,115
Horace Mann Educators Corp. 257,300 7,253
Old Republic International Corp. 383,800 5,253
INSURANCE--PROPERTY-CASUALTY (0.8%)
PartnerRe Ltd. 1,860,500 58,024
The Chubb Corp. 907,500 49,799
IPC Holdings Ltd. 1,649,800 28,047
REAL ESTATE INVESTMENT TRUST (2.8%)
Archstone Communities
Trust REIT 5,541,600 110,832
(1) Liberty Property Trust REIT 4,440,500 103,797
Equity Residential Properties
Trust REIT 2,370,900 99,133
Spieker Properties, Inc. REIT 1,292,300 45,150
CarrAmerica Realty Corp. REIT 1,372,400 30,536
Duke Realty Investments,
Inc. REIT 1,357,100 26,633
Avalonbay Communities,
Inc. REIT 796,336 25,732
Camden Property Trust REIT 870,000 23,544
SAVINGS & LOAN (4.3%)
Washington Mutual, Inc. 10,216,664 367,161
(1) Golden West Financial Corp. 3,145,100 351,465
----------
4,777,840
----------
HEALTH CARE (6.7%)
Columbia/HCA
Healthcare Corp. 16,020,800 386,502
Aetna Inc. 3,560,000 178,890
Pharmacia & Upjohn, Inc. 3,201,600 172,686
o Tenet Healthcare Corp. 6,792,800 132,035
o(1) PacifiCare Health Systems, Inc. 2,619,300 103,299
American Home Products Corp. 976,400 51,017
o(1) Foundation Health Systems
Class A 6,028,660 39,940
o(1) LifePoint Hospitals, Inc. 2,032,189 24,005
o(1) Triad Hospitals, Inc. 2,170,789 21,165
Bergen Brunswig Corp.
Class A 1,017,100 7,247
Rhone-Poulenc SA Class A 99,671 5,573
------------
1,122,359
------------
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
INTEGRATED OILS (2.7%)
USX-Marathon Group 4,897,700 142,646
Exxon Corp. 1,529,200 113,256
Occidental Petroleum Corp. 2,623,200 59,842
Shell Transport & Trading
Co. ADR 1,302,300 59,743
Phillips Petroleum Co. 1,105,400 51,401
Mobil Corp. 253,200 24,434
451,322
OTHER ENERGY (6.0%)
Burlington Resources, Inc. 6,729,800 234,702
Anderson Exploration Ltd. 11,672,400 150,379
Ultramar Diamond
Shamrock Corp. 4,547,400 111,411
Union Pacific Resources
Group, Inc. 7,333,900 106,342
Transocean Offshore, Inc. 3,434,200 93,367
Anadarko Petroleum Corp. 2,636,300 81,231
(1) Valero Energy Corp. 3,635,300 66,799
Alberta Energy Co. Ltd. 1,411,100 43,039
(1) Cabot Oil & Gas Corp. Class A 2,409,500 38,853
Tosco Corp. 1,279,300 32,382
Devon Energy Corp. 556,475 21,633
Ashland, Inc. 607,000 20,031
o(1) EEX Corp. 4,148,499 15,298
----------
1,015,467
----------
MATERIALS & PROCESSING (20.4%)
Rhone-Poulenc SA ADR 13,748,650 763,050
Alcoa Inc. 11,993,834 728,625
Air Products & Chemicals, Inc. 5,226,500 143,729
(1) Hercules, Inc. 5,500,600 132,358
o Smurfit-Stone Container Corp. 5,825,850 125,984
Sigma-Aldrich Corp. 4,326,800 123,314
Engelhard Corp. 6,276,900 110,630
Jefferson Smurfit Group
PLC ADR 3,997,541 102,937
Abitibi-Consolidated, Inc. 8,081,100 97,478
Pechiney SA ADR A 2,721,128 79,083
International Paper Co. 1,248,300 65,692
Dow Chemical Co. 543,300 64,245
(1) Phosphate Resources
Partners LP 6,302,400 63,418
Lafarge Corp. 1,918,300 56,950
AK Steel Corp. 3,167,852 54,843
Lyondell Chemical Co. 4,385,903 53,179
Praxair, Inc. 1,108,200 51,808
Donohue, Inc. Class A 3,097,600 49,279
Archer-Daniels-Midland Co. 3,798,715 46,772
Bowater Inc. 756,680 39,726
Nucor Corp. 732,600 38,004
Willamette Industries, Inc. 909,600 37,805
o(1) Kaiser Aluminum &
Chemical Corp. 5,789,334 37,269
Reynolds Metals Co. 541,600 32,733
o Owens-Illinois, Inc. 1,303,800 31,210
Champion International Corp. 493,400 28,525
Temple-Inland Inc. 467,800 27,191
o(1) Albany International Corp. 1,695,741 25,754
15
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
WINDSOR FUND SHARES (000)
- --------------------------------------------------------------------------------
Crown Cork & Seal Co., Inc. 986,900 23,624
o American Standard Cos., Inc. 591,400 22,584
Fluor Corp. 526,800 21,006
Sonoco Products Co. 823,000 19,752
(1) Century Aluminum Co. 2,000,000 18,000
Great Lakes Chemical Corp. 485,000 17,218
Boise Cascade Corp. 473,900 16,883
Ryerson Tull, Inc. 625,846 12,830
CK Witco Corp. 1,334,129 12,507
Deltic Timber Corp. 549,471 12,329
Cabot Corp. 553,300 10,305
Sherwin-Williams Co. 460,000 10,293
(1) Mississippi Chemical Corp. 1,685,300 9,374
o Burlington Industries, Inc. 2,383,700 8,790
Owens Corning 425,900 8,731
Georgia Pacific Group 100,000 3,969
Armstrong World Industries Inc. 54,300 2,029
----------
3,441,815
----------
PRODUCER DURABLES (3.2%)
Alcatel SA ADR 3,567,600 109,481
Case Corp. 1,611,500 85,410
o(1) Toll Brothers, Inc. 3,529,166 61,760
New Holland NV 3,865,100 58,701
Lockheed Martin Corp. 1,820,900 36,418
Kaufman & Broad Home Corp. 1,698,600 34,078
o(1) U.S. Home Corp. 1,168,495 32,718
Northrop Grumman Corp. 552,300 30,307
Thomas & Betts Corp. 475,800 21,352
(1) MDC Holdings, Inc. 1,156,300 18,067
o(1) Beazer Homes USA, Inc. 860,464 16,456
The BFGoodrich Co. 625,800 14,824
Centex Corp. 464,900 12,465
----------
532,037
----------
Technology (4.7%)
International Business
Machines Corp. 2,994,200 294,554
o(1) Arrow Electronics, Inc. 6,393,100 139,449
o Quantum Corp.- DLT &
Storage Systems 6,525,500 100,737
Avnet, Inc. 1,593,500 86,547
o Seagate Technology Inc. 1,473,800 43,385
o Adaptec, Inc. 873,700 39,317
o(1) General Semiconductor, Inc. 3,468,600 36,420
o Quantum Corp.-
Hard Disk Drive 2,424,000 14,847
Harris Corp. 627,900 14,089
o Litton Industries, Inc. 279,900 13,138
Scientific-Atlanta, Inc. 49,300 2,822
----------
785,305
----------
UTILITIES (9.4%)
AT&T Corp. 16,680,316 779,805
o MCI WorldCom, Inc. 3,947,093 338,710
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
FirstEnergy Corp. 1,704,100 44,413
PG&E Corp. 1,919,100 44,019
Ameren Corp. 1,152,100 43,564
SBC Communications Inc. 837,720 42,671
Central & South West Corp. 1,778,500 39,460
Bell Atlantic Corp. 585,800 38,040
Cinergy Corp. 1,334,900 37,711
New Century Energies, Inc. 1,065,300 34,689
GPU, Inc. 993,600 33,720
Allegheny Energy, Inc. 978,900 31,141
BellSouth Corp. 667,400 30,033
o MediaOne Group, Inc. 415,000 29,491
Alliant Energy Corp. 607,500 16,516
----------
1,583,983
----------
OTHER (2.3%)
Minnesota Mining &
Manufacturing Co. 857,200 81,488
Cooper Industries, Inc. 743,900 32,034
Allegheny Teledyne Inc. 1,586,200 24,090
Kemira Oyj ADR 628,200 7,758
Miscellaneous (1.5%) 250,391 395,761
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $14,280,126) 16,272,406
- --------------------------------------------------------------------------------
PREFERRED STOCK (1.0%)
News Corp. Ltd. ADR
(COST $92,778) 5,957,875 164,214
CONVERTIBLE PREFERRED STOCK (0.1%)
Kaufman & Broad Home Corp.
8.25% Cvt. Pfd.
(COST $23,120) 3,163,700 22,541
- --------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (2.1%)+
- --------------------------------------------------------------------------------
FEDERAL HOME LOAN MORTGAGE CORP.
(2) 5.64%, 2/2/2000 5,000 4,922
FEDERAL NATIONAL MORTGAGE ASSN.
(2 5.64%, 1/18/2000 10,000 9,868
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.24%, 11/1/1999 308,125 308,125
5.26%, 11/1/1999--Note F 30,270 30,270
- --------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $353,203) 353,185
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (99.9%)
(COST $14,749,227) 16,812,346
- --------------------------------------------------------------------------------
16
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
(000)
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.1%)
- --------------------------------------------------------------------------------
Other Assets--Note C 218,263
Liabilities--Note F (206,887)
11,376
- --------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------
Applicable to 994,989,422 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $16,823,722
================================================================================
NET ASSET VALUE PER SHARE $16.91
================================================================================
* See Note A in Notes to Financial Statements.
o Non-Income-Producing Security.
+ The fund invests a portion of its cash reserves in equity markets through
the use of index futures contracts. After giving effect to futures
investments, the fund's effective common stock and temporary cash
investment positions represent 97.6% and 1.2%, respectively, of net assets.
See Note E in Notes to Financial Statements.
(1) Considered an affiliated company as the fund owns more than 5% of the
outstanding voting securities of such companies. The total market value of
investments in affiliated companies was $1,570,807,000.
(2) Security segregated as initial margin for open futures contracts.
ADR--American Depositary Receipt.
REIT--Real Estate Investment Trust.
- --------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------------------
AT OCTOBER 31, 1999, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
Paid in Capital $12,801,594 $12.87
Undistributed Net
Investment Income 93,521 .09
Accumulated Net
Realized Gains 1,859,220 1.87
Unrealized Appreciation--
Note E
Investment Securities 2,063,119 2.07
Futures Contracts 6,268 .01
- --------------------------------------------------------------------------------
NET ASSETS $16,823,722 $16.91
================================================================================
17
<PAGE>
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the fund during the
reporting period, and details the operating expenses charged to the fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period. If the
fund invested in futures contracts during the period, the results of these
investments are shown separately.
- --------------------------------------------------------------------------------
WINDSOR FUND
YEAR ENDED OCTOBER 31, 1999
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends* $ 309,153
Interest 15,017
Security Lending 1,232
Total Income 325,402
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 22,023
Performance Adjustment (14,040)
The Vanguard Group--Note C
Management and Administrative 38,797
Marketing and Distribution 2,519
Custodian Fees 498
Auditing Fees 23
Shareholders' Reports 408
Trustees' Fees and Expenses 27
Total Expenses 50,255
Expenses Paid Indirectly--Note C (2,460)
Net Expenses 47,795
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 277,607
- --------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Investment Securities Sold* 1,952,962
Futures Contracts (12,431)
- --------------------------------------------------------------------------------
REALIZED NET GAIN 1,940,531
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 36,551
Futures Contracts 6,268
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 42,819
- --------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $2,260,957
================================================================================
*Dividend income and realized net gain from affiliated companies were
$86,331,000 and $567,678,000, respectively.
18
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
fund, either by purchasing shares or by reinvesting distributions, as well as
the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
- --------------------------------------------------------------------------------
WINDSOR FUND
YEAR ENDED OCTOBER 31,
--------------------------
1999 1998
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income 277,607 270,099
Realized Net Gain 1,940,531 1,346,037
Change in Unrealized Appreciation (Depreciation) 42,819 (1,700,942)
Net Increase (Decrease) in Net Assets
Resulting from Operations 2,260,957 (84,806)
DISTRIBUTIONS
Net Investment Income (255,285) (268,858)
Realized Capital Gain (1,341,486) (3,045,000)
Total Distributions (1,596,771) (3,313,858)
CAPITAL SHARE TRANSACTIONS1
Issued 1,402,297 1,632,455
Issued in Lieu of Cash Distributions 1,504,748 3,148,447
Redeemed (5,102,907) (3,704,909)
Net Increase (Decrease) from Capital Share
Transactions (2,195,862) 1,075,993
- --------------------------------------------------------------------------------
Total Decrease (1,531,676) (2,322,671)
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 18,355,398 20,678,069
End of Year $16,823,722 $18,355,398
================================================================================
1Shares Issued (Redeemed)
Issued 82,191 92,583
Issued in Lieu of Cash Distributions 100,940 187,538
Redeemed (311,166) (214,952)
NetIncrease (Decrease)in Shares Outstanding (128,035) 65,169
================================================================================
19
<PAGE>
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis. It also presents the fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the fund's total return; how much it costs to operate the fund;
and the extent to which the fund tends to distribute capital gains. The table
also shows the Portfolio Turnover Rate, a measure of trading activity. A
turnover rate of 100% means that the average security is held in the fund for
one year.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
WINDSOR FUND
YEAR ENDED OCTOBER 31,
---------------------------------------------
<S> <C> <C> <C> <C> <C>
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1999 1998 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $16.34 $19.55 $16.99 $15.55 $14.55
- -----------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .27 .23 .36 .43 .44
Net Realized and Unrealized Gain (Loss) on Investments 1.77 (.32) 3.94 2.85 1.86
---------------------------------------------
Total from Investment Operations 2.04 (.09) 4.30 3.28 2.30
---------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.24) (.24) (.41) (.46) (.44)
Distributions from Realized Capital Gains (1.23) (2.88) (1.33) (1.38) (.86)
---------------------------------------------
Total Distributions (1.47) (3.12) (1.74) (1.84) (1.30)
- -----------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $16.91 $16.34 $19.55 $16.99 $15.55
===========================================================================================================
TOTAL RETURN 13.74% -0.78% 27.04% 23.16% 17.80%
===========================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $16,824 $18,355 $20,678 $15,841 $13,008
Ratio of Total Expenses to Average Net Assets 0.28% 0.27% 0.27% 0.31% 0.45%
Ratio of Net Investment Income to Average Net Assets 1.56% 1.31% 1.89% 2.75% 3.01%
Portfolio Turnover Rate 56% 48% 61% 34% 32%
===========================================================================================================
</TABLE>
20
<PAGE>
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: Equity securities are valued at the latest quoted
sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date; such securities not
traded on the valuation date are valued at the mean of the latest quoted bid and
asked prices. Prices are taken from the primary market in which each security
trades. 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.
Securities for which market quotations are not readily available are valued by
methods deemed by the Board of Trustees to represent fair value.
2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
4. FUTURES CONTRACTS: The fund uses S&P 500 Index futures contracts to a
limited extent, with the objective 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 share 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. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes.
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. Wellington Management Company, LLP, and as of June 1, 1999, Sanford C.
Bernstein & Co., Inc., provide investment advisory services to the fund for fees
calculated at an annual percentage rate of average net assets. The basic fee of
Wellington Management Company, LLP, is subject to quarterly adjustments based on
performance relative to the S&P 500 Index for the preceding three years. For the
year ended October 31, 1999, the aggregate investment advisory fee represented
an effective annual basic rate of 0.12% of the fund's average net assets before
a decrease of $14,040,000 (0.08%) based on performance.
The Vanguard Group manages the cash reserves of the fund on an at-cost
basis.
21
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the Board of Trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At October 31, 1999, the fund had contributed capital of $3,551,000 to
Vanguard (included in Other Assets), representing 0.02% of net assets and 3.5%
of Vanguard's capitalization. The fund's Trustees and officers are also
Directors and officers of Vanguard.
Vanguard has asked the fund's investment advisers to direct certain
security trades, subject to obtaining the best price and execution, to brokers
who have agreed to rebate to the fund part of the commissions generated. Such
rebates are used solely to reduce the fund's management and administrative
expenses. For the year ended October 31, 1999, these arrangements reduced the
fund's expenses by $2,460,000 (an annual rate of 0.01% of average net assets).
D. During the year ended October 31, 1999, the fund purchased $9,799,245,000 of
investment securities and sold $13,843,338,000 of investment securities, other
than temporary cash investments.
During the year ended October 31, 1999, the fund realized $81,929,000 of
net capital gains resulting from in-kind redemptions--in which shareholders
exchanged fund shares for securities held by the fund rather than for cash.
Because such gains are not taxable to the fund, and are not distributed to
shareholders, they have been reclassified from accumulated net realized gains to
paid in capital.
E. At October 31, 1999, net unrealized appreciation of investment securities for
financial reporting and federal income tax purposes was $2,063,119,000,
consisting of unrealized gains of $3,767,787,000 on securities that had risen in
value since their purchase and $1,704,668,000 in unrealized losses on securities
that had fallen in value since their purchase.
At October 31, 1999, the aggregate settlement value of open futures
contracts expiring in December 1999 and the related unrealized appreciation
were:
- --------------------------------------------------------------------------------
(000)
------------------------------------
AGGREGATE
NUMBER OF SETTLEMENT UNREALIZED
FUTURES CONTRACTS LONG CONTRACTS VALUE APPRECIATION
- --------------------------------------------------------------------------------
S&P 500 Index 359 $123,514 $6,015
S&P MidCap 400 Index 130 26,081 253
- --------------------------------------------------------------------------------
Unrealized appreciation of $6,268,000 on open future contracts is required to be
treated as realized gain for tax purposes.
F. The market value of securities on loan to broker/dealers at October 31, 1999,
was $29,871,000, for which the fund held cash collateral of $30,270,000. Cash
collateral received is invested in repurchase agreements.
22
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Trustees of
Vanguard Windsor Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Windsor Fund (the "Fund") at October 31, 1999, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended and the financial highlights for each of
the five years in the period then ended, in conformity with generally accepted
accounting principles. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at October 31, 1999 by correspondence with the
custodian and brokers, provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
November 30, 1999
23
<PAGE>
- --------------------------------------------------------------------------------
SPECIAL 1999 TAX INFORMATION (UNAUDITED) FOR
VANGUARD WINDSOR FUND
This information for the fiscal year ended October 31, 1999, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $1,341,486,000 as capital gain dividends (from net
long-term capital gains) to shareholders in December 1998, all of which is
designated as a 20% rate gain distribution. For corporate shareholders, 32.4% of
investment income (dividend income plus short-term gains, if any) qualifies for
the dividends-received deduction.
- --------------------------------------------------------------------------------
24
<PAGE>
- --------------------------------------------------------------------------------
THE PEOPLE WHO GOVERN YOUR FUND
The Trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are part owner of
the fund. Your fund Trustees also serve on the Board of Directors of The
Vanguard Group, which is owned by the funds and exists solely to provide
services to them on an at-cost basis.
Seven of Vanguard's nine board members are independent, meaning that they
have no affiliation with Vanguard or the funds they oversee, apart from the
sizable personal investments they have made as private individuals. They bring
distinguished backgrounds in business, academia, and public service to their
task of working with Vanguard officers to establish the policies and oversee the
activities of the funds.
Among board members' responsibilities are selecting investment advisers for
the funds; monitoring fund operations, performance, and costs; reviewing
contracts; nominating and selecting new Trustees/Directors; and electing
Vanguard officers.
The list below provides a brief description of each Trustee's professional
affiliations. Noted in parentheses is the year in which the Trustee joined the
Vanguard Board.
TRUSTEES
JOHN C. BOGLE o (1967) Founder, Senior Chairman of the Board, and
Director/Trustee of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
JOHN J. BRENNAN o (1987) Chairman of the Board, Chief Executive Officer, and
Director/Trustee of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
JOANN HEFFERNAN HEISEN o (1998) Vice President, Chief Information Officer, and a
member of the Executive Committee of Johnson & Johnson; Director of Johnson &
JohnsonoMerck Consumer Pharmaceuticals Co., The Medical Center at Princeton, and
Women's Research and Education Institute.
BRUCE K. MACLAURY o (1990) President Emeritus of The Brookings Institution;
Director of American Express Bank Ltd., The St. Paul Companies, Inc., and
National Steel Corp.
BURTON G. MALKIEL o (1977) Chemical Bank Chairman's Professor of Economics,
Princeton University; Director of Prudential Insurance Co. of America, Banco
Bilbao Gestinova, Baker Fentress & Co., The Jeffrey Co., and Select Sector SPDR
Trust.
ALFRED M. RANKIN, JR. o (1993) 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 o (1991) President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and
President of New York University; Director of Pacific Gas and Electric Co.,
Procter & Gamble Co., NACCO Industries, and Newfield Exploration Co.
JAMES O. WELCH, JR. o (1971) Retired Chairman of Nabisco Brands, Inc.; retired
Vice Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc., and
Kmart Corp.
J. LAWRENCE WILSON o (1985) Retired Chairman of Rohm & Haas Co.; Director of
Cummins Engine Co. and The Mead Corp.; Trustee of Vanderbilt University.
- --------------------------------------------------------------------------------
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY o Secretary; Managing
Director and Secretary of The Vanguard Group,
Inc.; Secretary of each of the investment companies
in The Vanguard Group.
THOMAS J. HIGGINS o Treasurer; Principal of The
Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
VANGUARD MANAGING DIRECTORS
R. GREGORY BARTON o Legal Department.
ROBERT A. DISTEFANO o Information Technology.
JAMES H. GATELY o Individual Investor Group.
KATHLEEN C. GUBANICH o Human Resources.
IAN A. MACKINNON o Fixed Income Group.
F. WILLIAM MCNABB, III o Institutional Investor Group.
MICHAEL S. MILLER o Planning and Development.
RALPH K. PACKARD o Chief Financial Officer.
GEORGE U. SAUTER o Core Management Group.
<PAGE>
ABOUT OUR COVER
Our cover art, depicting HMS Vanguard at sea, is a
reproduction of Leading the Way, a 1984 work created
and copyrighted by noted naval artist Tom Freeman,
of Forest Hill, Maryland.
All comparative mutual fund data are from Lipper Inc. or Morningstar,
Inc., unless otherwise noted.
"Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500,"
and "500" are trademarks of The McGraw-Hill Companies, Inc.
Frank Russell Company is the owner of trademarks and copyrights
relating to the Russell Indexes. "Wilshire 4500" and "Wilshire 5000"
are trademarks of Wilshire Associates.
[SHIP LOGO]
[THE VANGUARD GROUP(R) LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482-2600
WORLD WIDE WEB
www.vanguard.com
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
This report is intended for the fund's
shareholders. It may not be distributed
to prospective investors unless it
is preceded or accompanied by the
current fund prospectus.
Q220-12/09/1999
(C) 1999 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
<PAGE>
VANGUARD(R)
WINDSOR II
FUND
Annual Report
October 31, 1999
[SHIP GRAPHIC]
[A MEMBER OF THE VANGUARD GROUP LOGO]
<PAGE>
[PHOTO OF JOHN C. BOGLE]
JOHN C. BOGLE
FELLOW SHAREHOLDERS:
TWO ROADS DIVERGED IN A WOOD, AND I--I TOOK THE ONE LESS TRAVELED BY, AND
THAT HAS MADE ALL THE DIFFERENCE.
I can think of no better words than those of Robert Frost to begin this special
letter to our shareholders, who have placed such extraordinary trust in me and
in Vanguard over the past quarter century. When the firm was founded 25 years
ago, we deliberately took a new road to managing a mutual fund enterprise.
Instead of having the funds controlled by an outside management company with its
own financial interests, the Vanguard funds--there were only 11 of them
then--would be controlled by their own shareholders and operate solely in their
financial interests. The outcome of our unprecedented decision was by no means
certain. We described it then as "The Vanguard Experiment."
Well, I guess it's fair to say it's an experiment no more. During the past
25 years, the assets we hold in stewardship for investors have grown from $1
billion to more than $500 billion, and I believe that our reputation for
integrity, fair-dealing, and sound investment principles is second to none in
this industry. Our staggering growth--which I never sought--has come in
important part as a result of the simple investment ideas and basic human values
that are the foundation of my personal philosophy. I have every confidence that
they will long endure at Vanguard, for they are the right ideas and right
values, unshakable and eternal.
While Emerson believed that "an institution is the lengthened shadow of one
man," Vanguard today is far greater than any individual. The Vanguard crew has
splendidly implemented and enthusiastically supported our founding ideas and
values, and deserves the credit for a vital role in forging our success over the
years. It is a dedicated crew of fine human beings, working together in an
organization that is well prepared to press on regardless long after I am gone.
Creating and leading this enterprise has been an exhilarating run. Through it
all, I've taken the kudos and the blows alike, enjoying every moment to the
fullest, and even getting a second chance at life with a heart transplant three
years ago. What more could a man ask?
While I shall no longer be serving on the Vanguard Board, I want to assure
you that I will remain vigorous and active in a newly created Vanguard unit,
researching the financial markets, writing, and speaking. I'll continue to focus
whatever intellectual power and ethical strength I possess on my mission to
assure that mutual fund investors everywhere receive a fair shake. In the spirit
of Robert Frost:
BUT I HAVE PROMISES TO KEEP, AND MILES TO GO BEFORE I SLEEP, AND MILES TO
GO BEFORE I SLEEP.
You have given me your loyalty and friendship over these long years, and I
deeply appreciate your thousands of letters of support. For my part, I will
continue to keep an eagle eye on your interests, for you deserve no less. May
God bless you all, always.
- --------------------------------------------------------------------------------
CONTENTS
REPORT FROM THE CHAIRMAN ........... 1 FUND PROFILE .......................10
AFTER-TAX RETURNS REPORT ........... 5 PERFORMANCE SUMMARY ................12
THE MARKETS IN PERSPECTIVE ......... 6 FINANCIAL STATEMENTS ...............13
ADVISER'S REPORT ................... 8 REPORT OF INDEPENDENT ACCOUNTANTS ..22
- --------------------------------------------------------------------------------
<PAGE>
[PHOTO OF JOHN J. BRENNAN]
JOHN J. BRENNAN
REPORT FROM THE CHAIRMAN
Vanguard Windsor II Fund made a poor showing during its 1999 fiscal year,
returning 4.6% during the 12 months ended October 31, when broad stock market
measures advanced nearly 26%.
The table at right presents the fiscal-year total returns (capital change
plus reinvested dividends) for the Windsor II Fund, the average
large-capitalization value mutual fund, the unmanaged S&P 500 Index, and the
value stock component of the S&P 500. As you can see, your fund's return was a
full 13 percentage points behind that of its average peer, and more than 21
percentage points behind that of the S&P 500 Index, which was propelled by a
roaring market for large technology stocks. Windsor II's return was 14.4
percentage points behind the return of the S&P 500/BARRA Value Index, which is a
good measure of the types of stocks that Windsor II emphasizes. It was, by far,
the fund's worst performance ever relative to the S&P 500 Index and to the S&P
500/BARRA Value Index.
- --------------------------------------------
TOTAL RETURNS
FISCAL YEAR ENDED
OCTOBER 31, 1999
- --------------------------------------------
Vanguard Windsor II Fund 4.6%
- --------------------------------------------
Average Large-Cap Value Fund* 17.6%
- --------------------------------------------
S&P 500 Index 25.7%
- --------------------------------------------
S&P 500/BARRA Value Index 19.0%
- --------------------------------------------
*Derived from data provided by Lipper Inc.
The fund's total return is based on net asset values of $31.07 per share on
October 31, 1998, and $29.03 per share on October 31, 1999, and is adjusted for
dividends totaling $0.74 per share paid from net investment income and a
distribution of $2.67 per share paid from net realized capital gains. We
estimate that the fund will make a distribution of approximately $2.40 from net
realized capital gains in December 1999.
FINANCIAL MARKETS IN REVIEW
The fiscal year ended October 31 comprised two distinctly different halves. For
most of the first half, stock prices worldwide were rebounding strongly from a
slump in the summer of 1998 that had been prompted by economic crises in Asia,
Russia, and parts of Latin America. The stock market's comeback was aided by a
pickup in global economic activity and by interest rate reductions by the
Federal Reserve Board that autumn. These developments--and the continued
ebullience of the U.S. economy--erased investors' fears that the troubles abroad
would depress business activity and profits at home. Even though interest rates
rose during the six months from October 31 through April 30, the stock market,
as measured by the Wilshire 5000 Total Market Index, gained 22.8% and the S&P
500 Index was up 22.3%. The returns of value stocks and growth stocks were
nearly identical during the six months, with the S&P 500's growth component
returning 22.6% and its value component earning 21.7%.
However, during the second half of our fiscal year, most stock prices
stagnated or fell (with the notable exception of technology stocks). The
Wilshire 5000 advanced 2.3%, bringing its full-year return to 25.7%. The S&P
500's second-half return of 2.7% brought it to an identical 25.7% return for our
fiscal year. The second half was particularly tough on large value stocks, which
returned -2.2% from May through October, compared with a 7.3% return for the S&P
500's growth stocks. Large-cap growth stocks were the strongest
1
<PAGE>
market sector during the fiscal year, led by simply stupendous gains for a
number of technology stocks, such as QUALCOMM (700%), Sun Microsystems (263%),
Cisco Systems (135%), Microsoft (75%), and Intel (74%). The growth stocks within
the S&P 500 Index gained 31.6%, while the index's value stocks returned 19.0%.
One factor restraining the stock market in general was a strong uptrend in
interest rates starting in February. The Federal Reserve encouraged this move,
acting in late June and again in August to boost short-term interest rates by a
total of 0.5 percentage point. Fears of a global economic slump were supplanted
by worries that economic growth--especially in the United States--was so strong
that it would cause wages and commodity prices to surge, pushing up inflation.
For the full year, yields on long-term U.S. Treasury bonds rose
significantly. The yield of the 30-year Treasury increased exactly 1 percentage
point (100 basis points) to 6.16% on October 31, 1999. Bond prices, which move
in the opposite direction from interest rates, fell during the year. The Lehman
Brothers Aggregate Bond Index, a benchmark for taxable bonds, eked out a return
of 0.5% for the year, as its interest income of 6.2% only barely offset price
declines of -5.7%.
FISCAL 1999 PERFORMANCE OVERVIEW
Vanguard Windsor II Fund's 4.6% total return during the 1999 fiscal year was
mediocre on an absolute basis and even worse relative to competing mutual funds
and market indexes.
The fund got off to a relatively strong start, returning 6.5% during the
first two months of the period and 17.3% for the first half of the fiscal year.
But the second half was a different, and very disappointing, story. The fund
posted a negative total return of -10.8% from May through October, well below
the 2.7% return of the S&P 500 Index, and the -2.2% return of the S&P 500/BARRA
Value Index, which is a better measure of the types of stocks that Windsor II
emphasizes.
Though the market's tilt toward growth stocks over value stocks was a
detriment to your fund during the period, our difficulties went far beyond
investment style. Even when compared specifically to the Value Index, our
performance was disappointing. Our return was 14.4 percentage points lower than
the 19.0% return of the index. As a value fund, Windsor II focuses on stocks
that are relatively cheap in terms of measures such as price/earnings ratios and
book value and that pay dividend yields considerably above the market average.
This mandate naturally steered the fund toward certain market segments
(financial services and utilities) and away from others, particularly technology
stocks, which at present carry sky-high valuations and pay little or no
dividends. On a relative basis, our small commitment to the top-performing
technology sector (about 4% of our average assets, versus 18% for the S&P 500
Index) meant big trouble for the fund, given the sector's return of 67%. Our big
stake in the financial-services group (26% of average assets for Windsor II; 16%
for the index) was also troublesome because of the relatively low returns earned
by many bank stocks during the period.
The bulk of our shortfall, however, stemmed from the inferior performance
of stocks selected by our investment advisers, particularly among issues in the
consumer-discretionary group and the utilities sector. As always, the
performances of the stocks selected by each of our four advisers varied from the
others during fiscal 1999. The prices of many of the stocks we own--including
some of our biggest holdings--declined sharply during the fiscal year because
the market had expected better earnings. Waste Management Inc., one of our ten
largest holdings six months ago, was hit especially hard. The
2
<PAGE>
company's share price plummeted about 70% during the period--much of that during
a brief span this fall--in response to the revelation of accounting problems,
losses, and the departure of its chairman. Other big names that suffered sharp
drops included Xerox, Service Corporation International, and J.C. Penney. The
Adviser's Report beginning on page 8 provides further details.
While none of us on the Windsor II team is happy with our results for the
fiscal year, our belief in the fund's value-oriented investment strategy is not
shaken. Since its inception in June 1985, Windsor II has enjoyed periods of
outperformance (it topped the S&P 500 Index from fiscal 1991 through fiscal
1993) as well as underperformance (it trailed large-cap stocks in 1997 and
1998). These variations from the broad market are the nature of active portfolio
management and the fund's emphasis on out-of-favor stocks. The challenge of
active management, naturally, is to make those variations positive. We are
closely monitoring the portfolio, and we remain confident in the abilities of
the four investment advisers who select stocks for Windsor II. We fully expect
the fund to provide competitive returns over the long run.
- --------------------------------------------------------------------------------
TOTAL ASSETS MANAGED
AS OF OCTOBER 31, 1999
------------------------
$ MILLION PERCENTAGE
- --------------------------------------------------------------------------------
Barrow, Hanley, Mewhinney & Strauss, Inc. $19,733 64%
Equinox Capital Management, Inc. 4,135 14
Tukman Capital Management, Inc. 3,716 12
Vanguard Core Management Group 1,781 6
Cash Reserve* 1,176 4
- --------------------------------------------------------------------------------
Total $30,541 100%
- --------------------------------------------------------------------------------
* This cash reserve is invested in equity index futures to simulate
investment in stocks; each adviser may also maintain a modest cash reserve.
The table above shows the share of assets supervised by each adviser at the
end of the fiscal year.
LONG-TERM PERFORMANCE OVERVIEW
Any annual review of a mutual fund's performance should also include a look at
the fund's longer-term record. The table below presents the average annual
returns of the Windsor II Fund and its comparative benchmarks for the past ten
years. It also presents the results of hypothetical $10,000 investments made a
decade ago in the fund, its average competitor, the S&P 500 Index, and the S&P
500/BARRA Value Index.
- --------------------------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED OCTOBER 31, 1999
-----------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- --------------------------------------------------------------------------------
Vanguard Windsor II Fund 14.5% $38,787
- --------------------------------------------------------------------------------
Average Large-Cap Value Fund 15.2% $41,026
- --------------------------------------------------------------------------------
S&P 500 Index 17.8% $51,526
- --------------------------------------------------------------------------------
S&P 500/BARRA Value Index 15.4% $41,790
- --------------------------------------------------------------------------------
As you might expect, your fund's poor performance over the past 12 months
had a considerable negative impact on its longer-term results. One year ago--at
the end of the 1998 fiscal year--Windsor II's average annual return over the
previous decade was 1.8 percentage points better than that of its average peer.
Now, just 12 months later, our annualized return over the past ten years comes
up short by 0.7 percentage point. A $10,000 investment in the Windsor II Fund
would have grown to $38,787, compared with the $41,026 that would have
accumulated in the average large-cap value fund over the same period.
3
<PAGE>
A similar investment in the large-cap-dominated S&P 500 Index would have
amounted to $51,526, a terrific--and I'd say unsustainable--average annual
return of 17.8%.
Our ultimate goal, of course, is to provide performance that is superior to
that of comparable mutual funds over long periods. We are aided in this
objective by our low expenses, which provide us with an advantage over
higher-cost funds. Our expense ratio (expenses as a percentage of average net
assets) is 0.37%, nearly a full percentage point lower than the 1.26% charged by
the average peer mutual fund. Our low costs may provide little comfort during a
period when our performance lags, but rest assured that this cost advantage
remains a powerful ally in our quest to provide superior long-term returns.
The returns earned by stocks--particularly large growth stocks--over the
past decade were high by historical standards and will probably be lower in the
future. This is not a prediction, but rather a prudent assumption that should be
a part of every investor's long-range investment planning. The long-term average
return for stocks is about 11%, but that average includes lean years as well as
the fabulous decade of the 1990s.
IN SUMMARY
Though the U.S. stock market was rewarding as a whole during the past 12 months,
the narrow nature of the market's gains highlighted the fact that investing in
stocks is a risky endeavor. Individual stocks, and even entire industry groups,
move in different directions at different times and in varying degrees, just as
the returns of stocks, bonds, and short-term investments diverge and fluctuate.
That is why building and maintaining an investment program that has exposure to
the different asset classes, as well as to a variety of issues within each
class, is the surest road to long-term investing success. Creating such a
program tailored to your objectives, time horizon for investing, and tolerance
for risk--and sticking with it through good times and bad--is a sound approach
to participating in the rewards of the financial markets while limiting the
risk.
/S/
John J. Brennan
Chairman and Chief Executive Officer
November 12, 1999
================================================================================
A NOTE OF THANKS TO OUR FOUNDER
================================================================================
As you may have read on the inside cover of our report, our founder, John C.
Bogle, is retiring December 31, 1999, as Senior Chairman of our Board after
nearly 25 years of devoted service to Vanguard and our shareholders. Vanguard
investors have Jack to thank for creating a truly mutual mutual fund company
that operates solely in the interest of its fund shareholders. And mutual fund
investors everywhere have benefited from his energetic efforts to improve this
industry. Finally, on a personal note, I am forever grateful to Jack for giving
me the opportunity to join this great company in 1982.
4
<PAGE>
A REPORT ON YOUR FUND'S AFTER-TAX RETURNS
Beginning with this annual report, Vanguard is pleased to provide a review of
the Windsor II Fund's after-tax performance. The figures on this page
demonstrate the considerable impact that federal income taxes can have on a
fund's return--an important consideration for investors who own mutual funds in
taxable accounts. While the pretax return is most often used to tally a fund's
performance, the fund's after-tax return, which accounts for taxes on
distributions of capital gains and income dividends, is a better representation
of the return that many investors actually received. IF YOU OWN THE WINDSOR II
FUND IN A TAX-DEFERRED ACCOUNT SUCH AS AN INDIVIDUAL RETIREMENT ACCOUNT OR A
401(K), THIS INFORMATION DOES NOT APPLY TO YOU. SUCH ACCOUNTS ARE NOT SUBJECT TO
CURRENT TAXES.
The table below presents the pretax and after-tax returns for your fund and
an appropriate peer group of mutual funds. Two things to keep in mind:
o The after-tax return calculations use the top federal income tax rates in
effect at the time of each distribution. The tax burden, therefore, would be
somewhat less, and the after-tax return somewhat more, for those in lower tax
brackets.
o The peer funds' returns are provided by Morningstar, Inc. (Elsewhere in
this report, returns for comparable mutual funds are derived from data provided
by Lipper Inc., which differs somewhat.)
- --------------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS: PRETAX AND AFTER-TAX
PERIODS ENDED OCTOBER 31, 1999
-----------------------------------------------------
1 YEAR 5 YEARS 10 YEARS
---------------- ---------------- -----------------
PRETAX AFTER-TAX PRETAX AFTER-TAX PRETAX AFTER-TAX
- --------------------------------------------------------------------------------
Vanguard Windsor II Fund 4.6% 1.6% 20.1% 17.3% 14.5% 11.9%
Average Large Value Fund* 12.2 10.3 18.2 15.3 14.0 11.4
- --------------------------------------------------------------------------------
*Based on data from Morningstar, Inc.
As you can see, the Windsor II Fund's pretax total return of 4.6% for the
12 months ended October 31, 1999, was reduced by taxes to 1.6%. In other words,
for investors in the highest tax bracket, the fund's pretax return was cut by 3
percentage points. In comparison, the average comparable fund earned a pretax
return of 12.2% and an after-tax return of 10.3%, a difference of 1.9 percentage
points.
Over longer periods, the fund has fared better. Over the five- and ten-year
periods ended October 31, 1999, our fund generated slightly higher returns than
the peer-group average, both before and after taxes.
We stress that because many interrelated factors affect how tax-friendly a
fund may be, it's very difficult to predict tax efficiency. A fund's tax
efficiency can be influenced by its turnover rate, the types of securities it
holds, the accounting practices it uses when selling shares, and the net cash
flow it receives.
Finally, it's important to understand that our calculation does not reflect
the tax effect of your own investment activities. Specifically, you may incur
additional capital gains taxes--thereby lowering your after-tax return--if you
decide to sell all or some of your shares.
A NOTE ABOUT OUR CALCULATIONS: Pretax total returns assume that all
distributions received (income dividends, short-term capital gains, and
long-term capital gains) are reinvested in new shares, while our after-tax
returns assume that distributions are reduced by any taxes owed on them before
reinvestment. When calculating the taxes due, we used the highest individual
federal income tax rates at the time of the distributions. Those rates are
currently 39.6% for dividends and short-term capital gains and 20% for long-term
capital gains. State and local income taxes were not considered. The competitive
group returns provided by Morningstar are calculated in a manner consistent with
that used for Vanguard funds.
5
<PAGE>
THE MARKETS IN PERSPECTIVE
YEAR ENDED OCTOBER 31, 1999
Caution followed exuberance in the U.S. stock market during the fiscal year
ended October 31, 1999. Improving economic conditions during the first half of
the year set off a raucous rally from the lows of summer 1998, when fears of a
global economic slump swept world markets. However, during the second half of
the fiscal year, interest rates kept rising, pulling down bond prices and
tempering the stock market's optimism. The notion of a global slump was replaced
by worries that economic growth might be so strong as to threaten a surge in
inflation.
U.S. STOCK MARKETS
A booming U.S. economy and solid increases in corporate earnings lifted the U.S.
stock market, especially during the first half of the fiscal year. The nation's
economic output increased by about 4% during the year. Consumer spending, which
accounts for roughly two-thirds of economic activity, powered the expansion.
Americans spent virtually every dollar they earned, encouraged by rising wealth
from a long bull market, plentiful employment, and rising incomes. (After-tax
personal income rose about 5% during the year; unemployment fell to a 30-year
low of 4.1% of the workforce in October.)
- --------------------------------------------------------------------------------
AVERAGE ANNUAL RETURNS
PERIODS ENDED OCTOBER 31, 1999
------------------------------
1 YEAR 3 YEARS 5 YEARS
- --------------------------------------------------------------------------------
STOCKS
S&P 500 Index 25.7% 26.5% 26.0%
Russell 2000 Index 14.9 9.4 12.6
Wilshire 5000 Index 25.7 23.8 23.8
MSCI EAFE Index 23.4 12.5 9.5
- --------------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 0.5% 6.2% 7.9%
Lehman 10 Year Municipal Bond Index -1.2 5.2 7.0
Salomon Smith Barney 3-Month U.S. Treasury Bill Index 4.6 5.0 5.2
- --------------------------------------------------------------------------------
OTHER
Consumer Price Index 2.6% 2.0% 2.4%
- --------------------------------------------------------------------------------
From October 31, 1998, through April 30, 1999, the stock market rose 22.8%,
as measured by the Wilshire 5000 Total Market Index. Investor confidence,
already high due to the booming economy, was bolstered by easier monetary
policy--the Federal Reserve cut short-term interest rates in November 1998 for
the third time in less than two months. But by summer, the Fed reversed course,
twice boosting its target for short-term interest rates to slow the economy and
reduce inflationary pressures.
Higher interest rates helped take the steam out of the stock market's rally
during the second half of the fiscal year, even though estimates of corporate
earnings kept rising. Higher rates tend to hurt stocks because many investors
use current interest rates to discount the value of a stock's projected earnings
and dividends. The higher the rate, the more future earnings are discounted, and
the less investors will pay for the stock now. After a second-half gain of 2.3%,
the Wilshire 5000 Index recorded a 25.7% return for the full fiscal year.
Big stocks outperformed small stocks in fiscal 1999, and growth stocks
outpaced value stocks. The S&P 500 Index, which is dominated by
large-capitalization stocks, gained
6
<PAGE>
25.7%, while the small-cap Russell 2000 Index was up 14.9%. Growth stocks--whose
high prices in relation to earnings, book value, and dividends indicate high
expectations for future growth--lost none of their appeal, despite soaring
valuations for many. Both large- and small-cap growth issues gained roughly 30%,
while value stocks within the S&P 500 Index were up 19.0%, and the Russell
2000's value stocks had a scant 0.7% return.
The growth/value gap was due partly to the incredible performance of
technology stocks, most of which are classified as growth issues. Within the S&P
500 Index, tech stocks gained 67% during the fiscal year. Advances of about 30%
were recorded by retailers and other consumer-discretionary stocks and by the
utilities sector, where gains were concentrated in telecommunications stocks.
The only sector with a loss was consumer staples (-8%), where food and beverage
company stocks suffered from falling profits.Other laggards were the auto &
transportation sector (+6%) and health-care stocks (+9%).
U.S. BOND MARKETS
Rapid economic growth was a help to the stock market but a hindrance to bonds.
Investors worried that, with unemployment so low, growth above the 2.5% to 3%
range would cause wages and prices to accelerate. Indeed, inflation did rise a
bit, although the Consumer Price Index was up a relatively modest 2.6% during
the 12-month period.
As mentioned, the Fed sought to combat inflationary pressures by increasing
short-term interest rates by a quarter-point on June 30 and again on August 24.
The bond market was already pushing up rates well before the Fed acted. Yields
of long-term U.S. Treasury bonds began rising significantly in February. By
fiscal year-end, the 30-year Treasury bond's yield was 6.16%, up precisely 1
percentage point for the year. The 10-year Treasury's yield rose 1.41 percentage
points, from 4.61% to 6.02%. Short-term interest rates didn't rise as far, and
3-month Treasury bill yields were up 0.77 point to 5.09% at fiscal year-end.
Rising interest rates mean lower prices for existing bonds, of course.
Price declines were higher for longer-term bonds, which are most sensitive to
changing rates. For the taxable bond market as a whole, as measured by the
Lehman Aggregate Bond Index, prices fell -5.7%, resulting in a total return of
just 0.5% for the fiscal year. High-yield (junk) bonds and mortgage-backed
securities posted higher returns than Treasuries.
INTERNATIONAL STOCK MARKETS
International markets soared in local currencies during the 12 months ended
October 31, with European stocks gaining 22.7% and Pacific-region stocks
advancing 37.8%. The U.S. dollar rose in value against most European currencies
but fell against the Japanese yen. For U.S. investors, the upshot of these
currency fluctuations was to trim returns from Europe to 12.7% in dollar terms
and to boost returns from the Pacific to 50.5%.
In the major developed international markets, U.S. investors earned 23.4%,
as measured by the Morgan Stanley Capital International Europe, Australasia, Far
East (EAFE) Index. The bull markets in most nations stemmed from a renewed
appetite for risk on the part of investors encouraged by clear signs of
expanding business activity and generally easier monetary policy. Japan and the
rest of Asia, which were hit hardest by currency and economic crises in 1997 and
1998, saw the biggest gains. In Japan, massive government spending programs
appeared to be working--at least in the short run--to lift that nation out of a
recession.
Emerging markets, as measured by the Select Emerging Markets Free Index,
gained 34.1% for U.S. investors, as local returns of better than 70% were cut
nearly in half by weaker currencies in Latin America and eastern Europe.
7
<PAGE>
ADVISER'S REPORT
We have been writing shareholder letters for a long time, but this is by far the
most difficult. Vanguard Windsor II Fund declined -10.8% during the second half
of the fiscal year ended October 31, while the S&P 500 Index gained 2.7% and the
S&P 500/BARRA Value Index declined -2.2%. Results for the full fiscal year were
equally disappointing, with a 4.6% return for the fund versus gains of 25.7% for
the S&P 500 and 19.0% for the Value Index. We are not doing things differently,
and our holdings have not radically changed, but the stock market surely has.
The economy continues to be vigorous, with employment high and inflation
reputed to be very low. Despite a benign Consumer Price Index, prices have been
rising for certain items, such as airline tickets, hotel rooms, energy,
chemicals, housing, building materials, and health care. Plainly, for the
average consumer, increases in such products more than offset the decline in
computer prices. In a very real way, the stock market has been responsible for
much of the good economic news--including the federal budget surplus and strong
consumer spending. Therefore, the Federal Reserve follows equities with more
intense interest than ever before.
The top 10% of stocks in the Value Index, in terms of their contribution to
its fiscal-year return, account for 41% of the index's market weight. Those
companies, on average, sell at 43.5 times next year's estimated earnings and 5.0
times current book value. On average, they have a 1.1% dividend yield. Because
we emphasize stocks with low price/earnings ratios (the fund's average P/E is
65% of the market's), low price/book ratios (53% of the market's), and high
current yields (twice the market's), we did not participate much in that top
tenth of the Value Index. If we had known how "cheap" they were in the eyes of
the market, this letter would have been easier to write.
For the past year, investors have been drawn to growth as never before.
They seemed to feel required to sell, at any price, any stock that fell short of
expectations in revenues or earnings. Even small disappointments were punished
by instantaneous declines of 25% or more. Our problem issues of Waste
Management, Raytheon, Xerox, Allstate, Service Corporation International, and
J.C. Penney lost 40% within a day or two of announcing earnings disappointments.
Waste Management continues to struggle through consolidation problems, the
loss of its CEO, who stepped down due to illness, and problems with legacy
accounting systems. Management twice lowered earnings expectations, causing Wall
Street to lose confidence. The directors have stepped in and are selling
underperforming assets, hiring consultants to solve the information technology
problems, and bringing on a new CEO with an outstanding reputation.
Raytheon recently acquired E-Systems, Hughes, and a division of Texas
Instruments, and has been one of the fastest-growing and highest-margin defense
companies. In September, its new chairman announced that Raytheon would take
additional restructuring charges and that its revenue was slipping because of
procurement delays by the U.S. Defense Department and foreign governments.
Raytheon's market-leading
- -------------------------------------------
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.
- -------------------------------------------
8
<PAGE>
products, combined with projected increases in defense spending, will drive this
stock going forward.
Xerox suffered from falling prices in the digital copier market and higher
expenses associated with its new "Solutions Approach" sales program. The
management had been unwilling or unable to inform the investment community about
problems, and investors dumped the stock. We feel this situation can improve
fairly soon.
We purchased Allstate because of its industry-leading position, improving
business mix, low-cost operations, energized management, and powerful generation
of cash (which it is using to make acquisitions and buy back stock). The stock
was selling at a huge discount to the market based on its price/earnings and
price/book ratios. Still, Allstate operates in a competitive and challenging
industry. In 1999, price competition remained high, claims costs rose (partly
due to Hurricane Floyd), and management decided to substantially boost marketing
expenditures to sell auto insurance on the Internet and via 800-type offerings.
The net effect was that earnings estimates fell by about 15%--but the stock fell
twice as much! Allstate now sells for less than 9 times current earnings, at a
mere 12% premium to book value. It has a 2.5% dividend yield.
Service Corporation International, the world's largest funeral company, is
undergoing a transformation from an acquisition story to an operational one. Its
investments in personnel, training, and infrastructure have raised current
costs, but will have substantial future benefits. Several other factors are
hurting revenue growth: Death rates have declined; price competition is tougher;
and there is a trend toward cremations. However, we believe the stock will
perform much better as the company's transformation is completed and the
environment improves.
J.C. Penney stock fell due to disappointing sales growth and expectations
that higher interest rates will slow consumer spending. The company is going to
spin off the Eckerd drug stores, and we expect results to improve.
These six companies are industry leaders providing real services. However,
they have lost earnings and price momentum, which leads believers in Wall
Street's "new paradigm" to sell them. A number of stocks that have
underperformed are now significantly undervalued and have become takeover
targets for companies that will seek to turn them around and/or sell off pieces.
The question arises: "What is the value in value investing?" We continue to
believe that price is a very important component of any buying decision, whether
a stock or a meal. In relation to the broad market, our holdings are cheaper
than at almost any time in the past. On an industry basis, we have
concentrations in banks, energy, utilities, and insurance. Our underweighting in
technology reflects the fact that few of those issues have value
characteristics. We have been through periods like this before, though those
memories are not nearly so painful as 1999. For the most part, we are sticking
with our holdings. Indeed, we're adding to the cheaper ones.
Barrow, Hanley, Mewhinney & Strauss, Inc.
November 12, 1999
9
<PAGE>
FUND PROFILE
WINDSOR II FUND
This Profile provides a snapshot of the fund's characteristics as of October 31,
1999, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 11.
- ---------------------------------------------
PORTFOLIO CHARACTERISTICS
- ---------------------------------------------
WINDSOR II S&P 500
- ---------------------------------------------
Number of Stocks 282 500
Median Market Cap $28.3B $72.6B
Price/Earnings Ratio 18.0x 27.7x
Price/Book Ratio 2.7x 5.1x
Yield 2.4% 1.2%
Return on Equity 18.8% 23.0%
Earnings Growth Rate 8.6% 15.0%
Foreign Holdings 1.4% 1.5%
Turnover Rate 26% --
Expense Ratio 0.37% --
Cash Reserves 3.2% --
INVESTMENT FOCUS
- ---------------------------------------------
[GRID]
STYLE.........VALUE
MARKET CAP....LARGE
VOLATILITY MEASURES
- ---------------------------------------------
WINDSOR II S&P 500
- ---------------------------------------------
R-Squared 0.87 1.00
Beta 0.90 1.00
TEN LARGEST HOLDINGS
(% OF TOTAL NET ASSETS)
- ---------------------------------------------
The Chase Manhattan Corp. 3.2%
Bank of America Corp. 2.9
SBC Communications Inc. 2.7
GTE Corp. 2.7
Honeywell, Inc. 2.5
Atlantic Richfield Co. 2.4
Citigroup, Inc. 2.1
Washington Mutual, Inc. 2.1
Anheuser-Busch Cos., Inc. 2.1
Baker Hughes, Inc. 2.0
Top Ten 24.7%
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- --------------------------------------------------------------------------------
OCTOBER 31, 1998 OCTOBER 31, 1999
- --------------------------------------------------------------------------------
WINDSOR II WINDSOR II S&P 500
- --------------------------------------------------------------------------------
Auto & Transportation ............ 4.8% 3.4% 2.2%
Consumer Discretionary ........... 11.0 10.7 12.5
Consumer Staples ................. 8.4 6.9 7.2
Financial Services ............... 24.0 27.9 16.1
Health Care ...................... 1.8 2.6 11.0
Integrated Oils .................. 3.6 7.4 5.2
Other Energy ..................... 7.9 8.5 1.4
Materials & Processing ........... 3.7 4.2 3.2
Producer Durables ................ 4.8 4.5 3.3
Technology ....................... 3.6 4.4 20.5
Utilities ........................ 18.5 15.1 11.2
Other ............................ 7.9 4.4 6.2
- --------------------------------------------------------------------------------
10
<PAGE>
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a fund with a beta
of 1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities. This
figure does not include cash invested in futures contracts to simulate stock
investment.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or American Depositary Receipts of companies based outside the United States.
INVESTMENT FOCUS. This grid indicates the focus of a fund in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds,
the more diversified it is and the more likely to perform in line with the
overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds. Price/Earnings Ratio. The ratio of a stock's current price to
its per-share earnings over the past year. For a fund, the weighted average P/E
of the stocks it holds. P/E is an indicator of market expectations about
corporate prospects; the higher the P/E, the greater the expectations for a
company's future growth.
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund's returns bore no relationship to the
market's returns, its R-squared would be 0.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a fund's common stocks that come from
each of the major industry groups that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of net assets that a fund has invested in
its ten largest holdings. (The average for stock mutual funds is about 35%.) As
this percentage rises, a fund's returns are likely to be more volatile because
they are more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year. Funds
with high turnover rates incur higher transaction costs and are more likely to
distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a fund's income from interest and dividends. The yield,
expressed as a percentage of the fund's net asset value, is based on income
earned over the past 30 days and is annualized, or projected forward for the
coming year. The index yield is based on the current annualized rate of
dividends paid on stocks in the index.
11
<PAGE>
PERFORMANCE SUMMARY
WINDSOR II FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the fund. Note, too, that both
share price and return can fluctuate widely. An investor's shares, when
redeemed, could be worth more or less than their original cost.
TOTAL INVESTMENT RETURNS: JUNE 24, 1985-OCTOBER 31, 1999
- ---------------------------------------|----------------------------------------
WINDSOR II FUND S&P 500 | WINDSOR II FUND S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL |FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN |YEAR RETURN RETURN RETURN RETURN
- ---------------------------------------|----------------------------------------
1985 -0.9% 1.1% 0.2% 1.8% |1993 15.8% 3.7% 19.5% 14.9%
1986 31.2 4.4 35.6 33.2 |1994 -0.8 3.0 2.2 3.9
1987 -0.6 1.5 0.9 6.4 |1995 19.2 3.9 23.1 26.4
1988 14.5 6.0 20.5 14.8 |1996 23.8 3.4 27.2 24.1
1989 19.5 5.2 24.7 26.4 |1997 28.1 3.2 31.3 32.1
1990 -21.5 4.0 -17.5 -7.5 |1998 14.1 2.4 16.5 22.0
1991 29.4 7.2 36.6 33.5 |1999 2.2 2.4 4.6 25.7
1992 7.9 4.6 12.5 10.0 |
- ---------------------------------------|----------------------------------------
See FINANCIAL HIGHLIGHTS table on page 19 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE: OCTOBER 31, 1989 -- OCTOBER 31, 1999
[MOUNTAIN CHART]
- --------------------------------------------------------------------------------
WINDSOR II AVERAGE LARGE-CAP S&P 500
FUND VALUE FUND INDEX
- --------------------------------------------------------------------------------
1989/10 10000 10000 10000
1990/01 9614 9681 9747
1990/04 9382 9770 9882
1990/07 9763 10463 10738
1990/10 8252 8965 9252
1991/01 9733 10401 10566
1991/04 10779 11322 11623
1991/07 11168 11729 12108
1991/10 11273 12106 12351
1992/01 11785 12704 12963
1992/04 12216 12931 13253
1992/07 12747 13142 13656
1992/10 12683 13128 13581
1993/01 13527 13964 14334
1993/04 13860 14238 14478
1993/07 14449 14578 14849
1993/10 15157 15483 15610
1994/01 15567 16037 16180
1994/04 14763 15189 15248
1994/07 15100 15404 15615
1994/10 15493 15917 16214
1995/01 15396 15812 16266
1995/04 16911 17275 17911
1995/07 18204 18724 19692
1995/10 19069 19423 20501
1996/01 21407 21230 22555
1996/04 22317 22008 23323
1996/07 21920 21448 22954
1996/10 24250 23741 25441
1997/01 26848 26244 28497
1997/04 27138 26559 29184
1997/07 31954 31345 34922
1997/10 31835 30500 33610
1998/01 33519 32162 36165
1998/04 38787 35948 41169
1998/07 37820 35210 41657
1998/10 37092 34883 41001
1999/01 39817 39029 47915
1999/04 43497 41258 50154
1999/07 41820 40773 50073
1999/10 38787 41026 51526
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED OCTOBER 31, 1999
------------------------------------ FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- --------------------------------------------------------------------------------
Windsor II Fund 4.57% 20.15% 14.52% $38,787
Average Large-Cap Value Fund* 17.61 20.85 15.16 41,026
S&P 500 Index 25.67 26.02 17.82 51,526
- --------------------------------------------------------------------------------
*Derived from data provided by Lipper Inc.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1999*
- --------------------------------------------------------------------------------
10 YEARS
INCEPTION ----------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------
Windsor II Fund 6/24/1985 10.33% 20.10% 10.19% 3.75% 13.94%
- --------------------------------------------------------------------------------
*SEC rules require that we provide this average annual total return information
through the last calendar quarter.
12
<PAGE>
FINANCIAL STATEMENTS
OCTOBER 31, 1999
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.) and by
industry sector. Other assets are added to, and liabilities are subtracted from,
the value of TOTAL INVESTMENTS to calculate the fund's NET ASSETS. Finally, NET
ASSETS are divided by the outstanding shares of the fund to arrive at its share
price, or NET ASSET VALUE (NAV) PER SHARE.
At the end of the Statement of Net Assets, you will find a table displaying
the composition of the fund's net assets on both a dollar and per-share basis.
Because all income and any realized gains must be distributed to shareholders
each year, the bulk of net assets consists of PAID IN CAPITAL (money invested by
shareholders). The amounts shown for UNDISTRIBUTED NET INVESTMENT INCOME and
ACCUMULATED NET REALIZED GAINS usually approximate the sums the fund had
available to distribute to shareholders as income dividends or capital gains as
of the statement date, but may differ because certain investments or
transactions may be treated differently for financial statement and tax
purposes. Any ACCUMULATED NET REALIZED LOSSES, and any cumulative excess of
distributions over net income or net realized gains, will appear as negative
balances. UNREALIZED APPRECIATION (DEPRECIATION) is the difference between the
market value of the fund's investments and their cost, and reflects the gains
(losses) that would be realized if the fund were to sell all of its investments
at their statement-date values.
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
WINDSOR II FUND
- --------------------------------------------------------------------------------
COMMON STOCKS (92.9%)+
- --------------------------------------------------------------------------------
AUTO & TRANSPORTATION (3.1%)
Ford Motor Co. 8,675,800 476,085
General Motors Corp. 5,972,300 419,554
Burlington Northern Santa Fe Corp. 333,300 10,624
Delta Air Lines, Inc. 151,600 8,253
Tidewater Inc. 224,600 6,738
o UAL Corp. 88,900 6,051
TRW, Inc. 141,100 6,050
PACCAR, Inc. 122,300 5,763
o Continental Airlines, Inc. Class B 128,000 5,184
o SPX Corp. 59,400 5,034
o Navistar International Corp. 117,300 4,890
Autoliv, Inc. 146,470 4,678
Cooper Tire & Rubber Co. 98,600 1,658
-----------
960,562
-----------
CONSUMER DISCRETIONARY (9.9%)
o(1) Kmart Corp. 41,622,500 418,826
Waste Management, Inc. 22,355,297 410,779
Sears, Roebuck & Co. 14,335,200 404,073
Gannett Co., Inc. 4,105,200 316,614
Wal-Mart Stores, Inc. 5,282,300 299,440
(1) Service Corp. International 23,045,900 220,376
Time Warner, Inc. 2,491,000 173,592
o The Walt Disney Co. 6,074,932 160,226
J.C. Penney Co., Inc. 5,878,200 149,159
Eastman Kodak Co. 1,942,700 133,925
Kimberly-Clark Corp. 1,728,200 109,093
Newell Rubbermaid, Inc. 2,990,600 103,550
Dayton Hudson Corp. 680,300 43,964
o Viacom Inc. Class B 200,800 8,986
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
Hasbro, Inc. 321,200 6,625
o AT&T Corp.-Liberty Media Group Class A 152,000 6,033
The Limited, Inc. 141,200 5,807
o Tricon Global Restaurants, Inc. 143,300 5,759
Darden Restaurants Inc. 295,100 5,625
o Mandalay Resort Group 274,500 5,113
Galileo International, Inc. 166,400 5,002
McDonald's Corp. 120,600 4,975
R.R. Donnelley & Sons Co. 203,600 4,937
Premark International, Inc. 85,700 4,692
o Toys R Us, Inc. 294,800 4,164
Maytag Corp. 100,300 4,018
o Cendant Corp. 213,600 3,524
The Warnaco Group, Inc. Class A 226,600 3,229
May Department Stores Co. 74,037 2,568
American Greetings Corp. Class A 98,600 2,551
o Outback Steakhouse Inc. 85,300 1,962
o The Neiman Marcus Group, Inc. Class A 55,600 1,331
Dillard's Inc. 68,800 1,299
VF Corp. 24,300 731
o ACNielson Corp. 28,600 629
IKON Office Solutions, Inc. 58,500 402
Hertz Corp. Class A 5,200 226
-----------
3,033,805
-----------
CONSUMER STAPLES (6.4%)
Anheuser-Busch Cos., Inc. 8,956,000 643,153
Philip Morris Cos., Inc. 22,592,000 569,036
Imperial Tobacco Group ADR 12,448,100 259,854
13
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
WINDSOR II FUND SHARES (000)
- --------------------------------------------------------------------------------
PepsiCo, Inc. 6,186,600 214,598
H.J. Heinz Co. 2,802,200 133,805
Sara Lee Corp. 2,896,300 78,381
Nabisco Group Holdings Corp. 3,220,600 41,264
IBP, Inc. 249,700 5,977
Tyson Foods, Inc. 294,400 4,490
SuperValu Inc. 157,000 3,297
ConAgra, Inc. 50,000 1,303
Brown-Forman Corp. Class B 15,100 1,019
Dean Foods Corp. 9,900 458
-----------
1,956,635
-----------
FINANCIAL SERVICES (26.0%)
BANKS--NEW YORK CITY (3.4%)
The Chase Manhattan Corp. 11,352,956 991,965
The Bank of New York Co., Inc. 366,400 15,343
J.P. Morgan & Co., Inc. 104,400 13,663
Republic New York Corp. 90,700 5,731
BANKS--OUTSIDE NEW YORK CITY (10.1%)
Bank of America Corp. 13,714,212 882,852
First Union Corp. 13,769,602 587,790
PNC Bank Corp. 9,687,900 577,641
Bank One Corp. 11,199,283 420,673
Wells Fargo Co. 8,329,100 398,756
SunTrust Banks, Inc. 1,687,000 123,467
Fleet Boston Corp. 443,084 19,330
Wachovia Corp. 130,200 11,230
KeyCorp 327,200 9,141
AmSouth Bancorp 278,100 7,161
UnionBanCal Corp. 146,678 6,371
Old Kent Financial Corp. 145,500 5,929
Pacific Century Financial Corp. 203,000 4,631
City National Corp. 105,400 4,084
Peoples Heritage Financial Group Inc. 170,300 3,236
U.S. Bancorp 86,300 3,198
Huntington Bancshares Inc. 99,400 2,945
SouthTrust Corp. 61,300 2,452
Commerce Bancshares, Inc. 34,860 1,351
Provident Financial Group, Inc. 29,600 1,271
National City Corp. 27,900 823
DIVERSIFIED FINANCIAL SERVICES (3.4%)
Citigroup, Inc. 12,070,880 653,336
Morgan Stanley Dean Witter & Co. 1,773,800 195,672
American General Corp. 1,965,400 145,808
Merrill Lynch & Co., Inc. 200,300 15,724
PaineWebber Group, Inc. 155,100 6,320
The CIT Group, Inc. 216,900 5,178
American Express Co. 23,700 3,650
Marsh & McLennan Cos., Inc. 13,900 1,099
Household International, Inc. 17,400 776
FINANCE COMPANIES
Mellon Financial Corp. 325,400 12,019
o FIRSTPLUS Financial Group, Inc. 319,300 42
FINANCIAL DATA PROCESS SERVICES
First Data Corp. 126,900 5,798
Deluxe Corp. 176,000 4,972
o DST Systems, Inc. 53,000 3,375
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
FINANCIAL INFORMATION SERVICES
Dow Jones & Co., Inc. 98,000 6,027
Dun & Bradstreet Corp. 107,400 3,155
FINANCIAL MISCELLANEOUS (1.7%)
Fannie Mae 7,173,500 507,525
Nationwide Financial Services, Inc. 134,400 5,090
AMBAC Financial Group Inc. 73,900 4,416
Associates First Capital Corp. 24,900 909
INSURANCE--LIFE
Jefferson-Pilot Corp. 118,300 8,880
INSURANCE--MULTILINE (4.9%)
Allstate Corp. 19,282,044 554,359
(1) Aon Corp. 13,202,862 468,702
American International Group, Inc. 4,186,361 430,934
The Hartford Financial Services
Group Inc. 185,600 9,616
CIGNA Corp. 118,000 8,821
Hartford Life, Inc. 122,000 6,375
Old Republic International Corp. 267,100 3,656
American National Insurance Co. 4,700 322
INSURANCE--PROPERTY-CASUALTY (0.1%)
Travelers Property Casualty Corp. 188,200 6,775
The PMI Group Inc. 109,350 5,673
Everest Reinsurance Holdings, Inc. 152,900 3,937
REAL ESTATE INVESTMENT TRUST (0.1%)
Equity Office Properties Trust REIT 309,400 6,845
Equity Residential Properties Trust REIT 158,100 6,611
Simon Property Group, Inc. REIT 197,000 4,543
Host Marriott Corp. REIT 434,300 3,909
Spieker Properties, Inc. REIT 43,500 1,520
RENT & LEASE SERVICES--COMMERCIAL
Ryder System, Inc. 227,200 4,856
SAVINGS & LOAN (2.2%)
Washington Mutual, Inc. 17,993,194 646,630
Golden West Financial Corp. 65,600 7,331
o Golden State Bancorp Inc. 298,400 6,229
Dime Bancorp, Inc. 309,000 5,523
Sovereign Bancorp, Inc. 506,600 4,464
Charter One Financial, Inc. 59,745 1,467
Peoples Bank Bridgeport 47,000 1,190
SECURITIES BROKERS & SERVICES (0.1%)
Bear Stearns Co., Inc. 171,000 7,289
A.G. Edwards & Sons, Inc. 229,850 6,910
Legg Mason Inc. 145,600 5,296
Countrywide Credit Industries, Inc. 148,800 5,050
-----------
7,915,638
-----------
14
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
HEALTH CARE (2.4%)
American Home Products Corp. 4,861,900 254,034
Bristol-Myers Squibb Co. 2,254,000 173,135
Columbia/HCA Healthcare Corp. 6,676,500 161,071
Aetna Inc. 1,831,500 92,033
Abbott Laboratories 296,000 11,951
United Healthcare Corp. 119,300 6,166
Johnson & Johnson 54,600 5,719
o Chiron Corp. 188,900 5,395
o IVAX Corp. 298,600 5,244
C.R. Bard, Inc. 96,100 5,183
o Tenet Healthcare Corp. 251,900 4,896
Mylan Laboratories, Inc. 241,600 4,334
Pharmacia & Upjohn, Inc. 69,700 3,759
o Genzyme Corp. 13,200 505
-----------
733,425
-----------
INTEGRATED OILS (6.9%)
Atlantic Richfield Co. 8,029,000 748,202
(1) Occidental Petroleum Corp. 20,894,900 476,665
Phillips Petroleum Co. 9,517,500 442,564
Mobil Corp. 1,980,100 191,080
Exxon Corp. 2,466,100 182,646
Conoco Inc. Class B 1,341,500 36,388
Chevron Corp. 177,200 16,181
Texaco Inc. 111,200 6,825
Amerada Hess Corp. 109,100 6,260
-----------
2,106,811
-----------
OTHER ENERGY (7.9%)
(1) Baker Hughes, Inc. 21,645,400 604,718
Schlumberger Ltd. 8,854,500 536,251
Halliburton Co. 14,083,900 530,787
Williams Cos., Inc. 13,044,046 489,152
Enron Corp. 5,502,600 219,760
Tosco Corp. 261,100 6,609
Apache Corp. 117,200 4,571
Ashland, Inc. 122,700 4,049
Sunoco, Inc. 159,000 3,836
Ultramar Diamond Shamrock Corp. 145,700 3,570
Union Pacific Resources Group, Inc. 198,900 2,884
EOG Resources, Inc. 81,700 1,700
Dynegy, Inc. 30,500 698
-----------
2,408,585
-----------
MATERIALS & PROCESSING (3.9%)
(1) Fort James Corp. 18,728,600 492,796
(1) Millennium Chemicals, Inc. 7,719,942 142,819
Phelps Dodge Corp. 2,523,400 142,257
Dow Chemical Co. 1,187,100 140,375
Hanson PLC ADR 3,426,750 132,572
CK Witco Corp. 5,020,069 47,063
E.I. du Pont de Nemours & Co. 212,787 13,711
The Mead Corp. 179,500 6,462
The Timber Co. 258,000 6,160
Praxair, Inc. 130,800 6,115
USG Corp. 119,000 5,898
USX-U.S. Steel Group 228,800 5,849
Lafarge Corp. 171,000 5,077
- --------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------------
Solutia, Inc. 286,600 4,926
Avery Dennison Corp. 63,500 3,969
Louisiana-Pacific Corp. 284,300 3,607
Armstrong World Industries Inc. 96,500 3,607
Engelhard Corp. 190,100 3,351
Boise Cascade Corp. 92,400 3,292
IMC Global Inc. 224,000 2,856
Alcoa Inc. 41,800 2,539
Johns Manville Corp. 220,000 2,406
International Paper Co. 29,200 1,537
Owens Corning 30,800 631
Westvaco Corp. 18,500 549
-----------
1,180,424
-----------
PRODUCER DURABLES (4.1%)
(1) Honeywell, Inc. 7,242,700 763,652
Xerox Corp. 13,739,742 384,713
Lockheed Martin Corp. 3,502,800 70,056
Emerson Electric Co. 135,900 8,162
The Boeing Co. 170,300 7,844
United Technologies Corp. 123,696 7,484
o Teradyne, Inc. 143,100 5,509
Northrop Grumman Corp. 73,300 4,022
Pitney Bowes, Inc. 86,600 3,946
Molex, Inc. 67,500 2,464
Pentair, Inc. 58,000 2,182
Caterpillar, Inc. 23,600 1,304
o Howmet International Inc. 77,100 1,137
Centex Corp. 40,800 1,094
Diebold, Inc. 32,300 848
Tecumseh Products Co. Class A 9,160 439
The BFGoodrich Co. 15,100 358
-----------
1,265,214
-----------
TECHNOLOGY (4.1%)
Electronic Data Systems Corp. 7,873,500 460,600
Raytheon Co. Class B 10,916,600 317,946
Intel Corp. 2,730,000 211,404
International Business Machines Corp. 2,053,500 202,013
o Apple Computer, Inc. 129,100 10,344
Motorola, Inc. 86,800 8,458
o Safeguard Scientifics, Inc. 85,300 7,176
o National Semiconductor Corp. 217,100 6,499
o General Instrument Corp. 106,600 5,736
o NCR Corp. 143,500 4,753
Hewlett-Packard Co. 55,000 4,073
o SCI Systems, Inc. 78,300 3,866
o Seagate Technology Inc. 109,200 3,215
o SDL, Inc. 15,900 1,961
Compaq Computer Corp. 20,300 386
-----------
1,248,430
-----------
UTILITIES (14.0%)
SBC Communications Inc. 16,023,947 816,220
GTE Corp. 10,872,600 815,445
(1) Entergy Corp. 19,851,400 594,301
(1) American Electric Power Co., Inc. 10,090,300 348,115
Reliant Energy, Inc. 10,869,900 296,205
FirstEnergy Corp. 10,629,177 277,023
(1) Central & South West Corp. 12,443,000 276,079
AT&T Corp. 4,613,317 215,673
15
<PAGE>
- --------------------------------------------------------------------------------
MARKET
VALUE*
WINDSOR II FUND SHARES (000)
- --------------------------------------------------------------------------------
o MCI WorldCom, Inc. 2,435,648 209,009
Public Service Enterprise Group, Inc. 5,263,300 208,229
BellSouth Corp. 764,800 34,416
Bell Atlantic Corp. 467,136 30,335
Sprint Corp. 315,880 23,474
Southern Co. 415,600 11,039
Telephone & Data Systems, Inc. 72,900 8,402
Edison International 283,200 8,390
o MediaOne Group, Inc. 110,200 7,831
PG&E Corp. 327,600 7,514
CenturyTel, Inc. 171,650 6,941
o U.S. Cellular Corp. 73,500 6,505
GPU, Inc. 188,300 6,390
Ameren Corp. 168,200 6,360
o Cox Communications, Inc. Class A 138,800 6,307
Energy East Corp. 248,000 6,231
MidAmerican Energy Holdings Co. 184,900 6,217
DTE Energy Co. 187,100 6,209
PP&L Resources Inc. 222,288 6,016
Constellation Energy Group 195,600 6,002
Unicom Corp. 140,700 5,391
ALLTEL Corp. 64,600 5,378
Pinnacle West Capital Corp. 109,000 4,019
Consolidated Edison Inc. 99,200 3,788
FPL Group, Inc. 59,500 2,994
Duke Energy Corp. 46,700 2,639
o Citizens Utilities Co. Class B 185,000 2,139
Allegheny Energy, Inc. 52,600 1,673
Cinergy Corp. 50,000 1,413
U S WEST, Inc. 10,300 629
PECO Energy Corp. 15,000 573
-----------
4,281,514
-----------
OTHER (4.2%)
General Electric Co. 2,784,200 377,433
AlliedSignal Inc. 5,603,200 319,032
(1) ITT Industries, Inc. 9,282,100 317,332
(1) Tenneco, Inc. 13,588,800 217,421
Minnesota Mining & Manufacturing Co. 230,500 21,912
Textron, Inc. 97,300 7,510
Loews Corp. 63,000 4,465
Johnson Controls, Inc. 57,500 3,493
Fortune Brands, Inc. 70,800 2,509
Brunswick Corp. 98,600 2,231
Crane Co. 91,950 1,879
o FMC Corp. 38,800 1,579
Lancaster Colony Corp. 39,500 1,380
-----------
1,278,176
-----------
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $22,960,628) 28,369,219
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (7.4%)+
- --------------------------------------------------------------------------------
FEDERAL HOME LOAN MORTGAGE CORP.
(2) 5.57%, 2/3/2000 10,000 9,843
FEDERAL NATIONAL MORTGAGE ASSN.
(2) 5.53%, 1/28/2000 17,200 16,944
(2) 5.64%, 1/21/2000 55,000 54,246
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.24%, 11/1/1999 2,170,817 2,170,817
5.26%, 11/1/1999--Note G 2,215 2,215
- --------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $2,254,166) 2,254,065
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.3%)
(COST $25,214,794) 30,623,284
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.3%)
- --------------------------------------------------------------------------------
Other Assets--Note C 125,688
Liabilities--Note G (208,143)
-----------
(82,455)
- --------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------
Applicable to 1,051,864,256 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $30,540,829
================================================================================
NET ASSET VALUE PER SHARE $29.03
================================================================================
* See Note A in Notes to Financial Statements.
o Non-Income-Producing Security.
+ The fund invests a portion of its cash reserves in equity markets through
the use of index futures contracts. After giving effect to futures
investments, the fund's effective common stock and temporary cash
investment positions represent 96.8% and 3.5%, respectively, of net assets.
See Note F in Notes to Financial Statements.
(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 $5,341,802,000.
(2) Security segregated as initial margin for open futures contracts.
ADR--American Depositary Receipt.
REIT--Real Estate Investment Trust.
- --------------------------------------------------------------------------------
AT OCTOBER 31, 1999, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------------------
Paid in Capital $22,391,512 $21.28
Undistributed Net
Investment Income 223,131 .21
Accumulated Net
Realized Gains 2,498,602 2.38
Unrealized Appreciation--
Note F
Investment Securities 5,408,490 5.14
Futures Contracts 19,094 .02
- --------------------------------------------------------------------------------
NET ASSETS $30,540,829 $29.03
================================================================================
16
<PAGE>
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the fund during the
reporting period, and details the operating expenses charged to the fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period. If the
fund invested in futures contracts during the period, the results of these
investments are shown separately.
- --------------------------------------------------------------------------------
WINDSOR II FUND
YEAR ENDED OCTOBER 31, 1999
(000)
- --------------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
Dividends* 676,050
Interest 111,896
Security Lending 161
-----------
Total Income 788,107
-----------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 39,214
Performance Adjustment (1,642)
The Vanguard Group--Note C
Management and Administrative 76,419
Marketing and Distribution 5,283
Custodian Fees 74
Auditing Fees 27
Shareholders' Reports 732
Trustees' Fees and Expenses 49
-----------
Total Expenses 120,156
Expenses Paid Indirectly--Note D (2,051)
-----------
Net Expenses 118,105
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 670,002
- --------------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold* 2,259,982
Futures Contracts 340,033
- --------------------------------------------------------------------------------
REALIZED NET GAIN 2,600,015
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities (1,852,721)
Futures Contracts (78,391)
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (1,931,112)
- --------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $1,338,905
================================================================================
*Dividend income and realized net gain from affiliated companies were
$165,984,000 and $34,822,000, respectively.
17
<PAGE>
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
fund, either by purchasing shares or by reinvesting distributions, as well as
the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
- --------------------------------------------------------------------------------
WINDSOR II FUND
YEAR ENDED OCTOBER 31,
----------------------
1999 1998
(000) (000)
- --------------------------------------------------------------------------------
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income 670,002 589,221
Realized Net Gain 2,600,015 2,457,628
Change in Unrealized Appreciation (Depreciation) (1,931,112) 694,834
----------------------
Net Increase in Net Assets Resulting from Operations 1,338,905 3,741,683
----------------------
DISTRIBUTIONS
Net Investment Income (741,695) (541,835)
Realized Capital Gain (2,559,664) (1,694,611)
----------------------
Total Distributions (3,301,359) (2,236,446)
----------------------
CAPITAL SHARE TRANSACTIONS1
Issued 6,123,676 7,469,255
Issued in Lieu of Cash Distributions 3,148,067 2,144,820
Redeemed (6,407,121) (4,048,511)
----------------------
Net Increase from Capital Share Transactions 2,864,622 5,565,564
Total Increase 902,168 7,070,801
- --------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 29,638,661 22,567,860
----------------------
End of Year $30,540,829 $29,638,661
================================================================================
1Shares Issued (Redeemed)
Issued 198,010 243,421
Issued in Lieu of Cash Distributions 109,009 75,460
Redeemed (209,049) (133,672)
Net Increase in Shares Outstanding 97,970 185,209
================================================================================
18
<PAGE>
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis. It also presents the fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the fund's total return; how much it costs to operate the fund;
and the extent to which the fund tends to distribute capital gains. The table
also shows the Portfolio Turnover Rate, a measure of trading activity. A
turnover rate of 100% means that the average security is held in the fund for
one year.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
WINDSOR II FUND
YEAR ENDED OCTOBER 31,
----------------------------------------------
<S> <C> <C> <C> <C> <C>
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1999 1998 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $31.07 $29.36 $24.04 $20.06 $17.33
- -----------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .64 .65 .64 .62 .58
Net Realized and Unrealized Gain (Loss) on Investments .73 3.91 6.47 4.63 3.17
----------------------------------------------
Total from Investment Operations 1.37 4.56 7.11 5.25 3.75
----------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.74) (.66) (.63) (.58) (.55)
Distributions from Realized Capital Gains (2.67) (2.19) (1.16) (.69) (.47)
Total Distributions (3.41) (2.85) (1.79) (1.27) (1.02)
- -----------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $29.03 $31.07 $29.36 $24.04 $20.06
===========================================================================================================
TOTAL RETURN 4.57% 16.51% 31.27% 27.17% 23.08%
===========================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $30,541 $29,639 $22,568 $14,758 $10,272
Ratio of Total Expenses to Average Net Assets 0.37% 0.41% 0.37% 0.39% 0.40%
Ratio of Net Investment Income to Average Net Assets 2.08% 2.16% 2.49% 2.92% 3.27%
Portfolio Turnover Rate 26% 31% 30% 32% 30%
===========================================================================================================
</TABLE>
19
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Vanguard Windsor II 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: Equity securities are valued at the latest quoted
sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date; such securities not
traded on the valuation date are valued at the mean of the latest quoted bid and
asked prices. Prices are taken from the primary market in which each security
trades. 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.
Securities for which market quotations are not readily available are valued by
methods deemed by the Board of Trustees to represent fair value.
2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
4. FUTURES CONTRACTS: The fund uses S&P 500 Index and S&P MidCap 400 Index
futures contracts to a limited extent, with the objective 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 share 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. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes.
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.
20
<PAGE>
The Vanguard Group provides investment advisory services to a portion of
the fund on an at-cost basis; the fund paid Vanguard advisory fees of $511,000
for the year ended October 31, 1999.
For the year ended October 31, 1999, the aggregate investment advisory fee
represented an effective annual basic rate of 0.12% of average net assets before
a decrease of $1,642,000 (0.01%) based on performance.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the Board of Trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At October 31, 1999, the fund had contributed capital of $6,582,000 to
Vanguard (included in Other Assets), representing 0.02% of the fund's net assets
and 6.6% of Vanguard's capitalization. The fund's Trustees and officers are also
Directors and officers of Vanguard.
D. Vanguard has asked the fund's investment advisers 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 management and administrative expenses. The
fund's custodian has also agreed to reduce its fees when the fund maintains cash
on deposit in the non-interest-bearing custody account. For the year ended
October 31, 1999, these arrangements reduced expenses by $2,045,000 and $6,000
respectively. The total expense reduction represented an effective annual rate
of 0.01% of the fund's average net assets.
E. During the year ended October 31, 1999, the fund purchased $8,073,231,000 of
investment securities and sold $7,658,527,000 of investment securities, other
than temporary cash investments.
F. At October 31, 1999, net unrealized appreciation of investment securities for
financial reporting and federal income tax purposes was $5,408,490,000,
consisting of unrealized gains of $8,450,647,000 on securities that had risen in
value since their purchase and $3,042,157,000 in unrealized losses on securities
that had fallen in value since their purchase.
At October 31, 1999, the aggregate settlement value of open futures
contracts expiring in December 1999 and the related unrealized appreciation
(depreciation) were:
- --------------------------------------------------------------------------------
(000)
-----------------------------------
AGGREGATE UNREALIZED
NUMBER OF SETTLEMENT APPRECIATION
FUTURES CONTRACTS LONG CONTRACTS VALUE (DEPRECIATION)
- --------------------------------------------------------------------------------
S&P 500 Index 3,028 $1,041,783 $22,378
S&P MidCap 400 Index 710 142,444 (3,284)
- --------------------------------------------------------------------------------
Net unrealized appreciation on open futures contracts is required to be treated
as realized gain for tax purposes.
G. The market value of securities on loan to broker/dealers at October 31, 1999,
was $40,000, for which the fund held cash collateral of $2,215,000. Cash
collateral received is invested in repurchase agreements.
21
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Trustees of
Vanguard Windsor II Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Windsor II Fund (the "Fund") at October 31, 1999, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended and the financial highlights for each of
the five years in the period then ended, in conformity with generally accepted
accounting principles. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at October 31, 1999 by correspondence with the
custodian and brokers, provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
November 30, 1999
22
<PAGE>
- --------------------------------------------------------------------------------
SPECIAL 1999 TAX INFORMATION (UNAUDITED) FOR
VANGUARD WINDSOR II FUND
This information for the fiscal year ended October 31, 1999, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $2,166,607,000 as capital gain dividends (from net
long-term capital gains) to shareholders in December 1998, all of which is
designated as a 20% rate gain distribution.
For corporate shareholders, 61.2% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
- --------------------------------------------------------------------------------
23
<PAGE>
THE VANGUARD FAMILY OF FUNDS
STOCK FUNDS
- --------------------------------------------------------------------------------
500 Index Fund
Aggressive Growth Fund
Capital Opportunity Fund
Convertible Securities Fund
Emerging Markets Stock Index Fund
Energy Fund
Equity Income Fund
European Stock Index Fund
Explorer Fund
Extended Market Index Fund*
Global Equity Fund
Gold and Precious Metals Fund
Growth and Income Fund
Growth Index Fund*
Health Care Fund
Institutional Index Fund*
International Growth Fund
International Value Fund
Mid-Cap Index Fund*
Morgan Growth Fund
Pacific Stock Index Fund
PRIMECAP Fund
REIT Index Fund
Selected Value Fund
Small-Cap Growth Index Fund*
Small-Cap Index Fund*
Small-Cap Value Index Fund*
Tax-Managed Capital Appreciation Fund*
Tax-Managed Growth and Income Fund*
Tax-Managed International Fund
Tax-Managed Small-Cap Fund*
Total International Stock Index Fund
Total Stock Market Index Fund*
U.S. Growth Fund
Utilities Income Fund
Value Index Fund*
Windsor Fund
Windsor II Fund
BALANCED FUNDS
- --------------------------------------------------------------------------------
Asset Allocation Fund
Balanced Index Fund
Global Asset Allocation Fund
LifeStrategy Conservative Growth Fund
LifeStrategy Growth Fund
LifeStrategy Income Fund
LifeStrategy Moderate Growth Fund
STAR Fund
Tax-Managed Balanced Fund
Wellesley Income Fund
Wellington Fund
BOND FUNDS
- --------------------------------------------------------------------------------
Admiral Intermediate-Term Treasury Fund
Admiral Long-Term Treasury Fund
Admiral Short-Term Treasury Fund
GNMA Fund
High-Yield Corporate Fund
High-Yield Tax-Exempt Fund
Insured Long-Term Tax-Exempt Fund
Intermediate-Term Bond Index Fund
Intermediate-Term Corporate Fund
Intermediate-Term Tax-Exempt Fund
Intermediate-Term Treasury Fund
Limited-Term Tax-Exempt Fund
Long-Term Bond Index Fund
Long-Term Corporate Fund
Long-Term Tax-Exempt Fund
Long-Term Treasury Fund
Preferred Stock Fund
Short-Term Bond Index Fund
Short-Term Corporate Fund*
Short-Term Federal Fund
Short-Term Tax-Exempt Fund
Short-Term Treasury Fund
State Tax-Exempt Bond Funds
(California, Florida, Massachusetts, New Jersey,
New York, Ohio, Pennsylvania)
Total Bond Market Index Fund*
MONEY MARKET FUNDS
- --------------------------------------------------------------------------------
Admiral Treasury Money Market Fund
Federal Money Market Fund
Prime Money Market Fund*
State Tax-Exempt Money Market Funds
(California, New Jersey, New York, Ohio, Pennsylvania)
Tax-Exempt Money Market Fund
Treasury Money Market Fund
VARIABLE ANNUITY PLAN
- --------------------------------------------------------------------------------
Balanced Portfolio
Diversified Value Portfolio
Equity Income Portfolio
Equity Index Portfolio
Growth Portfolio
High-Grade Bond Portfolio
High Yield Bond Portfolio
International Portfolio
Mid-Cap Index Portfolio
Money Market Portfolio
REIT Index Portfolio
Short-Term Corporate Portfolio
Small Company Growth Portfolio
*Offers Institutional Shares.
For information about Vanguard funds, including charges and expenses, obtain a
prospectus from The Vanguard Group, P.O. Box 2600, Valley Forge, PA 19482-2600.
Read it carefully before you invest or send money.
<PAGE>
- --------------------------------------------------------------------------------
THE PEOPLE WHO GOVERN YOUR FUND
The Trustees of your mutual fund are there to see that the fund is operated and
managed in your best interests since, as a shareholder, you are part owner of
the fund. Your fund Trustees also serve on the Board of Directors of The
Vanguard Group, which is owned by the funds and exists solely to provide
services to them on an at-cost basis.
Seven of Vanguard's nine board members are independent, meaning that they
have no affiliation with Vanguard or the funds they oversee, apart from the
sizable personal investments they have made as private individuals. They bring
distinguished backgrounds in business, academia, and public service to their
task of working with Vanguard officers to establish the policies and oversee the
activities of the funds.
Among board members' responsibilities are selecting investment advisers for
the funds; monitoring fund operations, performance, and costs; reviewing
contracts; nominating and selecting new Trustees/Directors; and electing
Vanguard officers.
The list below provides a brief description of each Trustee's professional
affiliations. Noted in parentheses is the year in which the Trustee joined the
Vanguard Board.
- --------------------------------------------------------------------------------
TRUSTEES
JOHN C. BOGLE (1967) Founder, Senior Chairman of the Board, and Director/Trustee
of The Vanguard Group, Inc., and each of the investment companies in The
Vanguard Group.
JOHN J. BRENNAN (1987) Chairman of the Board, Chief Executive Officer, and
Director/Trustee of The Vanguard Group, Inc., and each of the investment
companies in The Vanguard Group.
JOANN HEFFERNAN HEISEN (1998) Vice President, Chief Information Officer, and a
member of the Executive Committee of Johnson & Johnson; Director of Johnson &
JohnsonoMerck Consumer Pharmaceuticals Co., The Medical Center at Princeton, and
Women's Research and Education Institute.
BRUCE K. MACLAURY (1990) President Emeritus of The Brookings Institution;
Director of American Express Bank Ltd., The St. Paul Companies, Inc., and
National Steel Corp.
BURTON G. MALKIEL (1977) Chemical Bank Chairman's Professor of Economics,
Princeton University; Director of Prudential Insurance Co. of America, Banco
Bilbao Gestinova, Baker Fentress & Co., The Jeffrey Co., and Select Sector SPDR
Trust.
ALFRED M. RANKIN, JR. (1993) Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Co., and
The Standard Products Co.
JOHN C. SAWHILL (1991) President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and
President of New York University; Director of Pacific Gas and Electric Co.,
Procter & Gamble Co., NACCO Industries, and Newfield Exploration Co.
JAMES O. WELCH, JR. (1971) Retired Chairman of Nabisco Brands, Inc.; retired
Vice Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc., and
Kmart Corp.
J. LAWRENCE WILSON (1985) Retired Chairman of Rohm & Haas Co.; Director of
Cummins Engine Co. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY Secretary; Managing Director and Secretary of The Vanguard
Group, Inc.; Secretary of each of the investment companies in The Vanguard
Group.
THOMAS J. HIGGINS Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of
each of the investment companies in The Vanguard Group.
VANGUARD MANAGING DIRECTORS
R. GREGORY BARTON o Legal Department.
ROBERT A. DISTEFANO o Information Technology.
JAMES H. GATELY o Individual Investor Group.
KATHLEEN C. GUBANICH o Human Resources.
IAN A. MACKINNON o Fixed Income Group.
F. WILLIAM MCNABB, III o Institutional Investor Group.
MICHAEL S. MILLER o Planning and Development.
RALPH K. PACKARD o Chief Financial Officer.
GEORGE U. SAUTER o Core Management Group.
<PAGE>
ABOUT OUR COVER
Our cover art, depicting HMS Vanguard at sea, is a
reproduction of Leading the Way, a 1984 work created and
copyrighted by noted naval artist Tom Freeman,
of Forest Hill, Maryland.
All comparative mutual fund data are from Lipper Inc. or Morningstar,
Inc., unless otherwise noted.
"Standard & Poor's(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500,"
and "500" are trademarks of The McGraw-Hill Companies, Inc.
Frank Russell Company is the owner of trademarks and copyrights
relating to the Russell Indexes. "Wilshire 4500" and "Wilshire 5000"
are trademarks of Wilshire Associates.
[SHIP LOGO]
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482-2600
WORLD WIDE WEB
www.vanguard.com
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
This report is intended for the fund's
shareholders. It may not be distributed
to prospective investors unless it
is preceded or accompanied by the
current fund prospectus.
Q730-12/09/1999
(C) 1999 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing
Corporation, Distributor.
