<PAGE>
VANGUARD/TRUSTEES' EQUITY FUND
PROSPECTUS SUPPLEMENT
FEBRUARY 3, 1995
On January 5, 1995, Batterymarch Financial Management ("Batterymarch"),
investment adviser to the International Portfolio of Vanguard/Trustees' Equity
Fund (the "Fund"), and Dean LeBaron, the holder of all of the shares of
beneficial interest in Batterymarch, consummated an agreement with Legg Mason,
Inc. ("Legg Mason") and Batterymarch Financial, Inc. ("BFM, Inc."), a wholly
owned subsidiary of Legg Mason, under which BFM, Inc. acquired substantially
all of the operating assets and business of Batterymarch. Batterymarch has
served as the adviser to the International Portfolio (the "Portfolio") since
the Portfolio's inception in 1983.
The Board of Trustees approved a new advisory agreement with BFM, Inc. on
November 18, 1994. The terms of the new investment advisory agreement approved
by the Board have been amended to include a new fee schedule with BFM, Inc.
incorporating a performance fee into the original fee schedule. The approval
of the new fee schedule with BFM, Inc. did not require shareholder approval.
This procedure was approved by the Fund's shareholders at the April 12, 1993,
Annual Meeting and was authorized by an exemptive order issued by the
Securities and Exchange Commission on May 12, 1993.
DESCRIPTION OF NEW INVESTMENT ADVISORY FEE SCHEDULE
Under the terms of the new investment advisory fee schedule, the Fund will
pay BFM, Inc. a basic advisory fee at the end of each quarter, calculated by
applying a quarterly rate, based on the following annual percentage rates, to
the average month-end assets of the Portfolio for the quarter:
<TABLE>
<CAPTION>
NEW ASSETS ANNUAL RATE
---------- -----------
<S> <C>
First $10 million............................................ 0.85%
Next $10 million............................................. 0.45%
Next $30 million............................................. 0.35%
Next $450 million............................................ 0.15%
Next $500 million............................................ 0.12%
Over $1 billion.............................................. 0.10%
</TABLE>
INCENTIVE/PENALTY FEE. Effective with the quarter ending December 31, 1995,
the basic fee paid to BFM, Inc., as provided above, may be increased or
decreased by applying an incentive/penalty adjustment to the basic fee
reflecting the investment performance of the Portfolio relative to the return
of the Morgan Stanley Capital International Europe, Australia and Far East
Index ("EAFE"). Under the incentive/penalty fee schedule, the fee payable to
BFM, Inc. may represent as much as 150% or as little as 50% of the basic fee
depending on the net investment performance of the Portfolio.
(continued)
<PAGE>
The following table sets forth the incentive/penalty fee rates payable by
the Fund to BFM, Inc. under the new investment advisory fee schedule:
<TABLE>
<CAPTION>
THREE YEAR PERFORMANCE TOTAL FEE AS A
DIFFERENTIAL VS. THE EAFE PERCENTAGE OF BASIC FEE
------------------------- -----------------------
<S> <C>
(Less than) -9%.................................... 50%
(Greater than but equal to) -9 and
(Less than) 0%.................................... 75%
(Greater than but equal to) 0 and
(Less than) 4.5%.................................. 100%
(Greater than but equal to) 4.5 and
(Less than) 13.5%................................ 125%
(Greater than but equal to) 13.5%................. 150%
</TABLE>
Under the rules of the Securities and Exchange Commission, the
incentive/penalty fee will not be fully operable until the quarter ending
December 31, 1997, and until that date, will be calculated according to
certain transition rules. The advisory agreement with BFM, Inc. became
effective January 5, 1995. The Fund's Statement of Additional Information,
which is available without charge, on request, provides a detailed description
of the incentive/penalty fee schedule and the applicable transition rules.
RELATED INFORMATION CONCERNING BFM, INC. Batterymarch Financial Management,
Inc., a wholly owned subsidiary of Legg Mason, was formed for the purpose of
acquiring all of the operating assets and business of Batterymarch. Legg
Mason, headquartered at 111 South Calvert Street, Baltimore, Maryland, is a
publicly held, New York Stock Exchange listed, holding company that provides
securities brokerage, investment advisory, corporate and public finance, and
mortgage banking services to individuals, institutions, corporations and
municipalities, through its wholly owned subsidiaries.
Ancillary to the acquisition by Legg Mason, Inc., Deborah H. Miller, CPA,
who has actively participated as a member of Batterymarch's international team
for over seven years, will assume the duties of Jarrod Wilcox as co-manager of
the Portfolio.
PA25
<PAGE>
PART B
VANGUARD/TRUSTEES' EQUITY FUND
(FORMERLY KNOWN AS "TRUSTEES' COMMINGLED FUND")
STATEMENT OF ADDITIONAL INFORMATION
APRIL 22, 1994; REVISED FEBRUARY 3, 1995
This Statement is not a prospectus but should be read in conjunction with
the Fund's Prospectus dated April 22, 1994. To obtain the Prospectus, please
call the Investor Information Department:
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies.......................................... 1
Purchase of Shares......................................................... 6
Redemption of Shares....................................................... 6
Yield and Total Return..................................................... 7
Investment Limitations..................................................... 7
Management of the Fund..................................................... 10
Investment Advisory Services............................................... 12
Portfolio Transactions..................................................... 16
Performance Measures....................................................... 17
General Information........................................................ 19
Financial Statements....................................................... 20
</TABLE>
INVESTMENT OBJECTIVE AND POLICIES
The following policies supplement the investment objective and policies set
forth in the Fund's Prospectus:
FOREIGN INVESTMENTS
Investors should recognize that investing in foreign companies involves cer-
tain special considerations which are not typically associated with investing
in U.S. companies. Since the stocks of foreign companies are frequently denom-
inated in foreign currencies, and since the International Portfolio may tempo-
rarily hold uninvested reserves in bank deposits in foreign currencies, the
International Portfolio will be affected favorably or unfavorably by changes
in currency rates and in exchange control regulations, and may incur costs in
connection with conversions between various currencies. The investment poli-
cies of the International Portfolio permit it to enter into forward foreign
currency exchange contracts in order to hedge the Portfolio's holdings and
commitments against changes in the level of future currency rates. Such con-
tracts involve an obligation to purchase or sell a specific currency at a fu-
ture date at a price set at the time of the contract.
As foreign companies are not generally subject to uniform accounting, audit-
ing and financial reporting standards and practices comparable to those appli-
cable to domestic companies, there may be less publicly available information
about certain foreign companies than about domestic companies. Securities of
some foreign companies are generally less liquid and more volatile than secu-
rities of comparable domestic companies. There is generally less government
supervision and regulation of stock exchanges, brokers and listed companies
than in the U.S. In addition, with respect to certain
B-1
<PAGE>
foreign countries, there is the possibility of expropriation or confiscatory
taxation, political or social instability, or diplomatic developments which
could affect U.S. investments in those countries.
Although the International Portfolio will endeavor to achieve most favorable
execution costs in its portfolio transactions, fixed commissions on many for-
eign stock exchanges are generally higher than negotiated commissions on U.S.
exchanges. In addition, it is expected that the expenses for custodian ar-
rangements of the Portfolio's foreign securities will be somewhat greater than
the expenses for the custodian arrangements for handling the U.S. Portfolio's
securities of equal value.
Certain foreign governments levy withholding taxes against dividend and in-
terest income. Although in some countries a portion of these taxes are recov-
erable, the non-recovered portion of foreign withholding taxes will reduce the
income received from the companies comprising the Fund's International Portfo-
lio. However, these foreign withholding taxes are not expected to have a sig-
nificant impact on the International Growth Portfolio, since the Portfolio's
investment objective is to seek long-term capital appreciation and any income
should be considered incidental.
FUTURES CONTRACTS
Each Portfolio may enter into futures contracts, options, options on futures
contracts and foreign currency futures contracts for several reasons: to main-
tain cash reserves while remaining fully invested, to facilitate trading, to
reduce transaction costs, or to seek higher investment returns when a futures
contract is priced more attractively than the underlying equity security or
index. Futures contracts provide for the future sale by one party and purchase
by another party of a specified amount of a specific security at a specified
future time and at a specified price. Futures contracts which are standardized
as to maturity date and underlying financial instrument are traded on national
futures exchanges. Futures exchanges and trading are regulated under the Com-
modity Exchange Act by the Commodity Futures Trading Commission ("CFTC"), a
U.S. Government Agency.
Although futures contracts by their terms call for actual delivery or ac-
ceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Clos-
ing out an open futures position is done by taking an opposite position ("buy-
ing" a contract which has previously been "sold," "selling" a contract previ-
ously purchased) in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure comple-
tion of the contract (delivery or acceptance of the underlying security) if it
is not terminated prior to the specified delivery date. Minimal initial margin
requirements are established by the futures exchange and may be changed. Bro-
kers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on margin de-
posits that may range upward from less than 5% of the value of the contract
being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent
that the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the con-
tract value may reduce the required margin, resulting in a repayment of excess
margin to the contract holder. Variation margin payments are made to and from
the futures broker for as long as the contract remains open. The Portfolio ex-
pects to earn interest income on its margin deposits.
B-2
<PAGE>
The Portfolios will not use futures and options for speculative purposes. A
Portfolio will use futures and options to simulate full investment in under-
lying securities while retaining a cash balance for fund management purposes.
Regulations of the CFTC applicable to the Company require that all of its
futures transactions constitute bona fide hedging transactions. Each Portfolio
will only sell futures contracts to protect securities it owns against price
declines or purchase contracts to protect against an increase in the price of
securities it intends to purchase. As evidence of this hedging interest, a
Portfolio expects that approximately 75% of its futures contract purchases
will be "completed"; that is, equivalent amounts of related securities will
have been purchased or are being purchased by the Portfolio upon sale of open
futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control the exposure of the Portfolio income to market fluc-
tuations, the use of futures contracts may be a more effective means of hedg-
ing this exposure. While the Portfolio will incur commission expenses in both
opening and closing out futures positions, these costs are lower than transac-
tion costs incurred in the purchase and sale of U.S. Government securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS
A Portfolio will not enter into futures contract transactions to the extent
that, immediately thereafter, the sum of its initial margin deposits on open
contracts exceeds 5% of the market value of the Portfolio's total assets. In
addition, a Portfolio will not enter into futures contracts to the extent that
its outstanding obligations to purchase securities under these contracts would
exceed 20% of the Portfolio's total assets.
RISK FACTORS IN FUTURES TRANSACTIONS
Positions in futures contracts may be closed out only on an Exchange which
provides a secondary market for such futures. However, there can be no assur-
ance that a liquid secondary market will exist for any particular futures con-
tract at any specific time. Thus, it may not be possible to close a futures
position. In the event of adverse price movements, a Portfolio would continue
to be required to make daily cash payments to maintain its required margin. In
such situations, if a Portfolio has insufficient cash, it may have to sell
portfolio securities to meet daily margin requirements at a time when it may
be disadvantageous to do so. In addition, a Portfolio may be required to make
delivery of the instruments underlying interest rate futures contracts it
holds. The inability to close options and futures positions also could have an
adverse impact on the ability to effectively hedge its portfolio. A Portfolio
will minimize the risk that it will be unable to close out a futures contract
by only entering into futures which are traded on national futures exchanges
and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be sub-
stantial, due both to the low margin deposits required, and the extremely high
degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and sub-
stantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the vale of the Futures Contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. However, because the futures
strategies of the Portfolio are engaged in only for hedging purposes, the Ad-
viser does not believe that the Portfolio is subject to the risks of loss fre-
quently associated with futures
B-3
<PAGE>
transactions. The Portfolio would presumably have sustained comparable losses
if, instead of the futures contract, it had invested in the underlying secu-
rity and sold it after the decline.
Utilization of futures transactions by the Portfolio does involve the risk
of imperfect or no correlation where the securities underlying futures con-
tracts have different maturities than the portfolio securities being hedged.
It is also possible that a Portfolio could both lose money on futures con-
tracts and also experience a decline in value of its portfolio securities.
There is also the risk of loss by a Portfolio of margin deposits in the event
of bankruptcy of a broker with whom the Portfolio has an open position in a
futures contract or related option. Additionally, investments in futures con-
tracts and options involve risk that the investment advisers will incorrectly
predict stock market and interest rate trends.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades
may be made on that day at a price beyond that limit. The daily limit governs
only price movement during a particular trading day and therefore does not
limit potential losses, because the limit may prevent the liquidation of unfa-
vorable positions. Futures contract prices have occasionally moved to the
daily limit for several consecutive trading days with little or no trading,
thereby preventing prompt liquidation of future positions and subjecting some
futures traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS
Except for transactions a Portfolio has identified as hedging transactions,
the Portfolio is required for Federal income tax purposes to recognize as in-
come for each taxable year its net unrealized gains and losses on futures con-
tracts as of the end of the year as well as those actually realized during the
year. In most cases, any gain or loss recognized with respect to a futures
contract is considered to be 60% long-term capital gain or loss and 40% short-
term capital gain or loss, without regard to the holding period of the con-
tract. Furthermore, sales of futures contracts which are intended to hedge
against a change in the value of securities held by the Portfolio may affect
the holding period of such securities and, consequently, the nature of the
gain or loss on such securities upon disposition.
In order for a Portfolio to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, and gains from the sale of
securities or foreign currencies or other income derived with respect to the
fund's business of investing in securities. In addition, gains realized on the
sale or other disposition of securities held for less than three months must
be limited to less than 30% of the Portfolio's annual gross income. It is an-
ticipated that any net gain realized from the closing out of futures contracts
will be considered gain from the sale of securities and therefore be qualify-
ing income for purposes of the 90% requirement. In order to avoid realizing
excessive gains on securities held less than three months, the Portfolio may
be required to defer the closing out of futures contracts beyond the time when
it would otherwise be advantageous to do so. It is anticipated that unrealized
gains on futures contracts, which have been open for less than three months as
of the end of the Portfolio's fiscal year and which are recognized for tax
purposes, will not be considered gains on sales of securities held less than
three months for the purpose of the 30% test.
The Portfolio will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes (including
unrealized gains at the end of the Portfolio's fiscal year) on futures trans-
actions. Such distributions will be combined with distributions of capital
gains realized on the Portfolio's other investments and shareholders will be
advised on the nature of the payments.
B-4
<PAGE>
REPURCHASE AGREEMENTS
Each Portfolio may invest in repurchase agreements with commercial banks,
brokers or dealers either for defensive purposes due to market conditions or
to generate income from its excess cash balances. A repurchase agreement is an
agreement under which the Portfolio acquires a money market instrument (gener-
ally a security issued by the U.S. Government or an agency thereof, a banker's
acceptance or a certificate of deposit) from a commercial bank, broker or
dealer, subject to resale to the seller at an agreed upon price and date (nor-
mally, the next business day). A repurchase agreement may be considered a loan
collateralized by securities. The resale price reflects an agreed upon inter-
est rate effective for the period the instrument is held by the Portfolio and
is unrelated to the interest rate on the underlying instrument. In these
transactions, the securities acquired by the Portfolio (including accrued in-
terest earned thereon) must have a total value in excess of the value of the
repurchase agreement and are held by the Fund's custodian bank until repur-
chased. In addition, the Fund's Board of Trustees will monitor a Portfolio's
repurchase agreement transactions generally and will establish guidelines and
standards for review by the investment adviser of the creditworthiness of any
bank, broker or dealer party to a repurchase agreement with the Portfolio. No
more than an aggregate of 15% of a Portfolio's assets, at the time of invest-
ment, will be invested in repurchase agreements having maturities longer than
seven days and in securities subject to legal or contractual restrictions on
resale, or for which there are no readily available market quotations.
The use of repurchase agreements involves certain risks. For example, if the
other party to the agreement defaults on its obligation to repurchase the un-
derlying security at a time when the value of the security has declined, the
Portfolio may incur a loss upon disposition of the security. If the other
party to the agreement becomes insolvent and subject to liquidation or reorga-
nization under the Bankruptcy Code or other laws, a court may determine that
the underlying security is collateral for a loan by the Portfolio not within
the control of the Portfolio and therefore the realization by the Portfolio on
such collateral may be automatically stayed. Finally, it is possible that the
Portfolio may not be able to substantiate its interest in the underlying secu-
rity and may be deemed an unsecured creditor of the other party to the agree-
ment. While the Fund's management acknowledges these risks, it is expected
that they can be controlled through careful monitoring procedures.
LENDING OF SECURITIES
Each Portfolio may lend its investment securities on a short-term or long-
term basis to qualified institutional investors who need to borrow securities
in order to complete certain transactions, such as covering short sales,
avoiding failures to deliver securities or completing arbitrage operations. By
lending its investment securities, a Portfolio attempts to increase its net
investment income through the receipt of interest on the loan. Any gain or
loss in the market price of the securities loaned that might occur during the
term of the loan would be for the account of the Portfolio. Each Portfolio may
lend its investment securities to qualified brokers, dealers, banks or other
financial institutions, so long as the terms, the structure and the aggregate
amount of such loans are not inconsistent with the Investment Company Act of
1940, or the Rules and Regulations or interpretations of the Securities and
Exchange Commission (the "Commission") thereunder, which currently require
that (a) the borrower pledge and maintain with the Portfolio collateral con-
sisting of cash, an irrevocable letter of credit issued by a domestic U.S.
bank, or securities issued or guaranteed by the United States Government hav-
ing a value at all times not less than 100% of the value of the securities
loaned, (b) the borrower add to such collateral whenever the price of the se-
curities loaned rises (i.e., the borrower "marks to the market" on a daily ba-
sis), (c) the loan be made subject to termination by the Portfolio at any
time, and (d) the Portfolio receive reasonable interest on the loan (which may
include the Portfolio's investing any cash collateral in interest bearing
short-term investments), any distribution on the loaned securities and any in-
crease in their market value. Loan arrangements made by a Portfolio will com-
ply with all other applicable regulatory requirements, including the rules of
the New York Stock Exchange, which rules presently require the borrower, after
notice, to redeliver the securities within
B-5
<PAGE>
the normal settlement time of five business days. All relevant facts and cir-
cumstances, including the creditworthiness of the broker, dealer or institu-
tion, will be considered in making decisions with respect to the lending of
securities, subject to review by the Fund's Board of Trustees.
At the present time, the Staff of the Commission does not object if an in-
vestment company pays reasonable negotiated fees in connection with loaned se-
curities, so long as such fees are set forth in a written contract and ap-
proved by the investment company's Directors (Trustees). In addition, voting
rights may pass with the loaned securities, but if a material event will occur
affecting an investment on loan, the loan must be called and the securities
voted.
PURCHASE OF SHARES
The purchase price of shares of each Portfolio of the Fund is the net asset
value next determined after the order is received. The net asset value is cal-
culated as of the close of regular trading on the New York Stock Exchange on
each day the Exchange is open for business, and on any other day on which
there is sufficient trading in a Portfolio's investment securities to materi-
ally affect the Portfolio's net asset value per share. An order received prior
to the close of the Exchange will be executed at the price computed on the
date of receipt; and an order received after the close of the Exchange will be
executed at the price computed on the next day the Exchange is open.
Each Portfolio reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Fund, and (iii) to
reduce or waive the minimum for initial and subsequent investments for certain
fiduciary accounts such as employee benefit plans or under circumstances where
certain economies can be achieved in sales of a Portfolio's shares.
REDEMPTION OF SHARES
Each Portfolio may suspend redemption privileges or postpone the date of
payment (i) during any period that the New York Stock Exchange is closed, or
trading on the Exchange is restricted as determined by the Securities and Ex-
change Commission (the "Commission"), (ii) during any period when an emergency
exists as defined by the rules of the Commission as a result of which it is
not reasonably practicable for a Portfolio to dispose of securities owned by
it, or fairly to determine the value of its assets, and (iii) for such other
periods as the Commission may permit.
The Fund has made an election with the Commission to pay in cash all redemp-
tions requested by any shareholder of record limited in amount during any 90-
day period to the lesser of $250,000 or 1% of the net assets of the Fund at
the beginning of such period. Such commitment is irrevocable without the prior
approval of the Commission. Redemptions in excess of the above limits may be
paid in whole or in part, in investment securities or in cash, as the Trustees
may deem advisable; however, payment will be made wholly in cash unless the
Trustees believe that economic or market conditions exist which would make
such a practice detrimental to the best interests of the Fund. If redemptions
are paid in investment securities, such securities will be valued as set forth
in the Prospectus under "The Share Price of Each Portfolio" and a redeeming
shareholder would normally incur brokerage expenses if he converted these se-
curities to cash.
No charge is made by a Portfolio for redemptions. Any redemption may be more
or less than the shareholder's cost depending on the market value of the secu-
rities held by the Portfolio.
SIGNATURE GUARANTEES. To protect your account, the Fund and Vanguard from
fraud, signature guarantees are required for certain redemptions. Signature
guarantees enable the Fund to verify the
B-6
<PAGE>
identity of the person who has authorized a redemption from your account. SIG-
NATURE GUARANTEES ARE REQUIRED IN CONNECTION WITH: (1) REDEMPTIONS INVOLVING
MORE THAN $25,000 ON THE DATE OF RECEIPT BY VANGUARD OF ALL NECESSARY DOCU-
MENTS; (2) ALL REDEMPTIONS, REGARDLESS OF THE AMOUNT INVOLVED, WHEN THE PRO-
CEEDS ARE TO BE PAID TO SOMEONE OTHER THAN THE REGISTERED OWNER(S) AND/OR TO
AN ADDRESS OTHER THAN THE ADDRESS OF RECORD; AND (3) SHARE TRANSFER REQUESTS.
These requirements are not applicable to redemptions in the Fund's Keogh, IRA,
and 403(b) plans except in connection with: (1) distributions made when the
proceeds are to be paid to someone other than the plan participant; (2) cer-
tain authorizations to effect exchanges by telephone; and (3) when proceeds
are to be wired. These requirements may be waived by the Fund in certain in-
stances.
A guarantor must be a bank, a trust company, a member firm of a domestic
stock exchange, or a foreign branch of any of the foregoing. NOTARIES PUBLIC
ARE NOT ACCEPTABLE GUARANTORS.
The signature guarantees must appear either: (1) on the written request for
redemption; (2) on a separate instrument for assignment ("stock power") which
should specify the total number of shares to be redeemed; or (3) on all stock
certificates tendered for redemption and, if shares held by Vanguard are also
being redeemed, on the letter or stock power.
YIELD AND TOTAL RETURN
The yield of the U.S. Portfolio of the Fund for the 30 day period ended De-
cember 31, 1993 was 1.03%.
The average annual total return of each Portfolio of the Fund for the fol-
lowing periods ending December 31, 1993 is set forth below:
<TABLE>
<CAPTION>
1 YEAR ENDED 5 YEARS ENDED 10 YEARS ENDED
12/31/93 12/31/93 12/31/93
------------ ------------- --------------
<S> <C> <C> <C>
U.S. Portfolio..................... +17.24% +11.16% +11.24%
International Portfolio............ +30.49% + 7.68% +16.16%
</TABLE>
Total return is computed by finding the average compounded rates of return
over the periods set forth above that would equate an initial amount invested
at the beginning of the periods to the ending redeemable value of the invest-
ment.
INVESTMENT LIMITATIONS
Each Portfolio of the Fund is subject to the following limitations which
(except as indicated otherwise below) may not be changed without the approval
of at least a majority of the outstanding voting securities (as defined in the
Investment Company Act of 1940) of the Fund. A Portfolio will not:
(1) Borrow money except that the Portfolio may borrow from banks (or
through reverse repurchase agreements), for temporary or emergency (not
leveraging) purposes, including the meeting of redemption requests which
might otherwise require the untimely disposition of securities, in an
amount not exceeding 10% of the value of the Portfolio's net assets (in-
cluding the amount borrowed and the value of any outstanding reverse repur-
chase agreements) at the time the borrowing is made. Whenever borrowings
exceed 5% of the value of the Portfolio's net assets, the Portfolio will
not make any additional investments;
(2) With respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States govern-
ment and its instrumentalities) if as a result the Portfolio would hold
more than 10% of the outstanding voting securities of the issuer, or more
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<PAGE>
than 5% of the value of the Portfolio's total assets would be invested in
the securities of such issuer;
(3) Invest in companies for the purpose of exercising control;
(4) Invest in securities of other investment companies, except as may be
acquired as a part of a merger, consolidation or acquisition of assets or
otherwise to the extent permitted by Section 12 of the Investment Company
Act of 1940. The Portfolio will invest only in investment companies which
have investment objectives and investment policies consistent with those of
the Portfolio;
(5) Engage in the business of underwriting securities issued by other
persons, except to the extent that the Portfolio may technically be deemed
to be an underwriter under the Securities Act of 1933, as amended, in dis-
posing of portfolio securities;
(6) Purchase or otherwise acquire any security if, as a result, more than
15% of its net assets would be invested in securities that are illiquid
(including the Fund's investment in The Vanguard Group, Inc., as discussed
on page 8);
(7) Purchase or sell real estate although it may purchase and sell secu-
rities of companies which deal in real estate or interests therein;
(8) Purchase securities on margin or sell any securities short except
that each Portfolio may invest in stock futures contracts, stock options,
options on stock futures contracts and foreign currency futures contracts
to the extent that not more than five percent of its total assets are re-
quired as margin deposit to secure obligations under futures contracts and
not more than twenty percent of its total assets are committed to such
transactions at any time;
(9) Invest more than 5% of the value of the total assets of the Portfolio
at the time of investment in the securities of any issuers which have rec-
ords of less than three years' continuous operation, including the opera-
tion of any predecessor, but this limitation does not apply to securities
issued or guaranteed as to interest and principal by the United States Gov-
ernment or its agencies or instrumentalities;*
(10) Purchase or retain any security if any officer, director, security
holder of the issuer of such security is at the same time an officer, di-
rector, or investment adviser of the Fund, or a partner or officer or di-
rector of such investment adviser and owns beneficially more than 1/2 of 1
percent of the securities of such issuer provided that the aggregate hold-
ings of such securities of all such persons so owning more than 1/2 of 1
percent of the outstanding stock or securities of such issuer exceed 5% of
the outstanding stock or securities of such issuer;*
(11) Make loans except by (i) purchasing a portion of an issue of bonds,
debentures or similar obligations which are either publicly distributed or
customarily purchased by institutional investors, (ii) entering into repur-
chase agreements, provided, however, that repurchase agreements maturing in
more than seven days, together with securities which do not have readily
available market quotations, will not exceed 10% of a Portfolio's total as-
sets, and (iii) lending its securities as provided under "Investment Objec-
tive and Policies";
(12) Purchase or write put or call options except as specified in "(8)"
above;
(13) Invest in interests in oil, gas, or other mineral exploration or de-
velopment programs;
(14) Purchase or sell commodities on commodity contracts except as speci-
fied in "(8)" above; and
(15) Concentrate its investments in a particular industry, although it
may invest up to 25% of the value of the Portfolio's total assets taken at
market in securities of issuers all of which conduct their principal busi-
ness activities in the same industry.
* These limitations are not fundamental and therefore may be changed by
the Fund's Trustees without a shareholder vote.
B-8
<PAGE>
Notwithstanding these limitations, the Fund may own all or any portion of
the securities of, or make loans to, or contribute to the costs or other fi-
nancial requirements of any company which will be wholly owned by the Fund and
one or more other investment companies and is primarily engaged in the busi-
ness of providing, at-cost, management, administrative or related services to
the Fund and other investment companies. See "MANAGEMENT OF THE FUND" on page
9.
The above-mentioned investment limitations are considered at the time in-
vestment securities are purchased.
B-9
<PAGE>
MANAGEMENT OF THE FUND
TRUSTEES AND OFFICERS
The Officers of the Fund manage its day-to-day operations and are responsi-
ble to the Fund's Board of Trustees. The Trustees set broad policies for the
Fund and choose its Officers. Following is a list of Trustees and Officers of
the Fund and a statement of their present positions and principal occupations
during the past five years. The mailing address of the Fund's Trustees and Of-
ficers is Post Office Box 876, Valley Forge, PA 19482.
JOHN C. BOGLE, Chairman, Chief Exec-
utive Officer and Trustee*
Chairman, Chief Executive Officer,
and Director of The Vanguard Group,
Inc., and of each of the investment
companies in The Vanguard Group. Di-
rector of The Mead Corporation and
General Accident Insurance.
JOHN J. BRENNAN, President & Trust-
ee*
President and Director of The Van-
guard Group, Inc., and of each of
the other investment companies in
The Vanguard Group.
ROBERT E. CAWTHORN, Trustee
Chairman of Rhone-Poulenc Rorer,
Inc.; Director of Sun Company, Inc.
BARBARA BARNES HAUPTFUHRER, Trustee
Director of The Great Atlantic and
Pacific Tea Company, Alco Standard
Corp., Raytheon Company, Knight-
Ridder, Inc., and Massachusetts Mu-
tual Life Insurance Co. and Trustee
Emerita of Wellesley College.
BRUCE K. MACLAURY, Trustee
President, The Brookings Institu-
tion; Director of American Express
Bank Ltd., The St. Paul Companies,
Inc. and Scott Paper Company.
BURTON G. MALKIEL, Trustee
Chemical Bank Chairman's Professor
of Economics, Princeton University;
Director of Prudential Insurance Co.
of America, Amdahl Corporation,
Baker Fentress & Co., The Jeffrey
Co., and Southern New England Commu-
nications Company.
ALFRED M. RANKIN, JR., Trustee
Chairman, President and Chief Execu-
tive Officer of NACCO Industries
Inc.; Director of The BFGoodrich
Company, The Standard Products Com-
pany and The Reliance Electric Com-
pany.
JOHN C. SAWHILL, Trustee
President and Chief Executive Of-
ficer, The Nature Conservancy;
formerly, Director and Senior
Partner, McKinsey & Co.; Presi-
dent, New York University; Direc-
tor of Pacific Gas and Electric
Company and NACCO Industries.
JAMES O. WELCH, JR., Trustee
Retired Chairman of Nabisco Brands
Inc., retired Vice Chairman and
Director of RJR Nabisco; Director
of TECO Energy, Inc.
J. LAWRENCE WILSON, Trustee
Chairman and Chief Executive Offi-
cer of Rohm & Haas Company; Direc-
tor of Cummins Engine Company;
Trustee of Vanderbilt University
and the Culver Educational Founda-
tion.
RAYMOND J. KLAPINSKY, Secretary*
Senior Vice President and Secre-
tary of The Vanguard Group, Inc.;
Secretary of each of the invest-
ment companies in The Vanguard
Group.
RICHARD F. HYLAND, Treasurer*
Treasurer of The Vanguard Group,
Inc. and of each of the investment
companies in The Vanguard Group.
KAREN E. WEST, Controller*
Vice President of The Vanguard
Group, Inc.; Controller of each of
the investment companies in The
Vanguard Group.
- --------
* Officers of the Fund are "inter-
ested persons" as defined in the
Investment Company Act of 1940.
B-10
<PAGE>
THE VANGUARD GROUP
Vanguard/Trustees' Equity Fund is a member of The Vanguard Group of Invest-
ment Companies. Through their jointly-owned subsidiary, The Vanguard Group,
Inc. ("Vanguard"), the Fund and the other Funds in the Group obtain at cost
virtually all of their corporate management, administrative and distribution
services. Vanguard also provides investment advisory services on an at-cost
basis to several of the Vanguard Funds.
Vanguard employs a supporting staff of management and administrative person-
nel needed to provide the requisite services to the Funds and also furnishes
the Funds with necessary office space, furnishings and equipment. Each Fund
pays its share of Vanguard's net expenses which are allocated among the Funds
under methods approved by the Board of Trustees (Directors) of each Fund. In
addition, each Fund bears its own direct expenses, such as legal, auditing and
custodian fees.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
amounts which each of the Funds have invested are adjusted from time to time
in order to maintain the proportionate relationship between each Fund's rela-
tive net assets and its contribution to Vanguard's capital. At December 31,
1993, the Fund had contributed capital of $168,000 to Vanguard, representing
.8% of Vanguard's capitalization. The Funds' Service Agreement provides as
follows: (a) each Vanguard Fund may invest up to .40% of its current assets in
Vanguard, and (b) there is no other limitation on the amount that each Van-
guard Fund may contribute to Vanguard's capitalization.
MANAGEMENT. Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian rela-
tionships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. During the
fiscal year ended December 31, 1993, the Fund's share of Vanguard's actual net
costs of operation relating to management and administrative services (includ-
ing transfer agency) totaled approximately $1,314,000.
DISTRIBUTION. Vanguard provides all distribution and marketing activities
for the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of Vanguard, acts as Sales Agent for shares of the Funds in connec-
tion with any sales made directly to investors in the states of Florida, Mis-
souri, New York, Ohio, Texas and such other states as it may be required.
The principal distribution expenses are for advertising, promotional materi-
als and marketing personnel. Distribution services may also include organizing
and offering to the public, from time to time, one or more new investment com-
panies which will become members of the Group. The Directors and Officers of
Vanguard determine the amount to be spent annually on distribution activities,
then manner and amount to be spent on each Fund, and whether to organize new
investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Funds based upon their relative net assets. The remain-
ing one half of these expenses is allocated among the Funds based upon each
Fund's sales for the preceding 24 months relative to the total sales of the
Funds as a Group, provided, however, that no Fund's aggregate quarterly rate
of contribution for distribution expenses of a marketing and promotional na-
ture shall exceed 125% of the average distribution expense rate for the Group,
and that no Fund shall incur annual distribution expenses in excess of 20/100
of 1% of its average month-end net assets. During the fiscal year ended Decem-
ber 31, 1993, the Fund paid approximately $202,000 of the Group's distribution
and marketing expenses.
INVESTMENT ADVISORY SERVICES. Vanguard also provides investment advisory
services to Vanguard Money Market Reserves, Vanguard Institutional Money Mar-
ket Portfolio, Vanguard Municipal Bond Fund, Vanguard Admiral Funds, several
Portfolios of Vanguard Fixed Income Securities Fund, Vanguard's State Tax-Free
Funds, Vanguard Index Trust, Vanguard International Equity Index Fund, Van-
guard Balanced Index Fund, Vanguard Bond Index Fund, Vanguard Institutional
Index Fund,
B-11
<PAGE>
several Portfolios of Vanguard Variable Insurance Fund and a portion of
Vanguard/Windsor II, as well as several indexed separate accounts. These serv-
ices are provided on an at-cost basis from a money management staff employed
directly by Vanguard. The compensation and other expenses of this staff are
paid by the Funds utilizing these services.
REMUNERATION OF TRUSTEES AND OFFICERS. The Fund pays each Trustee, who is
not also an Officer, an annual fee plus travel and other expenses incurred in
attending Board meetings. The Fund's Officers and employees are paid by Van-
guard which, in turn, is reimbursed by the Fund, and each other Fund in the
Group, for its proportionate share of Officers' and employees' salaries and
retirement benefits.
During the fiscal year ended December 31, 1993, the Fund paid approximately
$3,000 in fees and expenses to its "non-interested" Trustees. The Fund's pro-
portionate share of remuneration paid by Vanguard (and reimbursed by the Fund)
during the fiscal year to all Officers of the Fund, as a group, was approxi-
mately $40,631.
Trustees who are not Officers are paid an annual fee upon retirement equal
to $1,000 for each year of service on the Board up to a maximum of $15,000.
Under its retirement plan, Vanguard contributes annually an amount equal to
10% of each Officer's annual compensation plus 5.7% of that part of the eligi-
ble Officer's compensation during the year, if any, that exceeds the Social
Security Taxable Wage Base then in effect. Under its thrift plan, all eligible
officers are permitted to make pre-tax contributions in an amount equal to 4%
of total compensation which are matched by Vanguard on a 100% basis. The
Fund's proportionate share of retirement contributions made by Vanguard under
its retirement and thrift plans on behalf of all eligible Officers of the
Fund, as a group, during the 1993 fiscal year was approximately $4,910.
INVESTMENT ADVISORY SERVICES
The investment adviser to the Fund's International Portfolio is a wholly-
owned subsidiary of Legg Mason, Inc. doing business under the name
"Batterymarch Financial Management, Inc." ("BFM, Inc."), 200 Clarendon Street,
Boston, Massachusetts 02216. BFM, Inc. provides investment management services
to numerous institutional accounts, such as corporate pension plans, endowment
funds and individual investors. Under an Investment Advisory Agreement
("Agreement") with the Fund, dated January 5, 1995, Batterymarch, Inc. , sub-
ject to the control and supervision of the Fund's Board of Trustees and in
conformance with the stated investment objective and policies of the Interna-
tional Portfolio, manages the investment and reinvestment of the assets of the
International Portfolio. In this regard, it is the responsibility of BFM, Inc.
to make investment decisions for the International Portfolio and to place the
Portfolio's purchase and sale orders for investment securities.
As compensation for the services rendered by BFM, Inc. under the Agreement
and the assumption by BFM, Inc. of the expenses related thereto (other than
the cost of securities purchased for the International Portfolio and the taxes
and brokerage commissions, if any, payable in connection with the purchase
and/or sale of such securities), the International Portfolio pays BFM, Inc. an
advisory fee calculated by applying various percentage rates to the average
month-end assets of the International Portfolio, and then apportioning that
fee to the International Portfolio, according to its net assets. The fee
schedule is as follows:
<TABLE>
<CAPTION>
NET ASSETS RATE
---------- -----
<S> <C>
First $10 million.................................................. 0.85%
Next $10 million................................................... 0.45%
Next $30 million................................................... 0.35%
Next $450 million.................................................. 0.15%
Next $500 million.................................................. 0.12%
Over $1 billion.................................................... 0.10%
</TABLE>
B-12
<PAGE>
Although the base advisory fee rate on the first $10 million of the Interna-
tional Portfolio's net assets is in excess of the fee rate paid by many other
mutual funds, it is substantially reduced as the value of the Portfolio's as-
sets increases. For example, it will result in an effective fee rate of .59%
at $25 million of assets, .47% at $50 million of assets, and .31% at $100 mil-
lion of assets. During the years ended December 31, 1991, 1992 and 1993, the
International Portfolio paid Batterymarch Financial Management predecessor to
BFM, Inc. advisory fees totaling $1,252,000 (.14 of 1% of average net assets),
$1,246,000 (.15 of 1% of average net assets) and $1,326,000 (.16 of 1% of av-
erage net assets), respectively.
Effective with the quarter ending December 31, 1995, the basic fee paid to
BFM, Inc. ("Basic Fee"), shall be increased or decreased by applying an
incentive/penalty adjustment to the Basic Fee reflecting the investment per-
formance of the Portfolio relative to the return of the Morgan Stanley Capital
International Europe, Australia and Far East Index ("EAFE"). The following ta-
ble sets forth the fee payable by the Fund to BFM, Inc. based upon the
incentive/penalty adjustment:
<TABLE>
<CAPTION>
AVERAGE ANNUAL PERFORMANCE TOTAL FEE AS A
DIFFERENTIAL VS. THE EAFE PERCENTAGE OF BASIC FEE
-------------------------- -----------------------
<S> <C>
(Less than) -3%...................................... 50%
(Greater than but equal to) -3 and (Less than) 0%.... 75%
(Greater than but equal to) 0 and (Less than) 1.5%... 100%
(Greater than but equal to) 1.5 and (Less than) 4.5%. 125%
(Greater than but equal to) 4.5%..................... 150%
</TABLE>
Through the quarter ending December 31, 1997, the incentive/penalty fee for
BFM, Inc. will be calculated according to the following transition rules:
(a) Prior to October 1, 1995. The incentive/penalty fee adjustment will
not be operable for the quarters ending prior to October 1, 1995. However,
the advisory fee payable for the first quarter of 1995 shall be reduced to
75% of the Basic Fee payable for the quarter if the performance of the
Portfolio for the quarter is less than that of the EAFE; the advisory fee
payable at the end of the second quarter of 1995 shall be reduced to 75% of
the Basic Fee payable for the quarter if the performance of the Portfolio
for the first six months of 1995 is less than that of the EAFE; and the ad-
visory fee payable at the end of the third quarter of 1995 shall be reduced
to 75% of the Basic Fee payable for the quarter if the performance of the
Portfolio for the first nine months of 1995 is less than that of the EAFE.
(b) October 1, 1995 through December 31, 1997. Beginning with the quarter
ending December 31, 1995 and through the quarter ending December 31, 1997,
the incentive/penalty fee will be computed based upon a comparison of the
investment performance of the Portfolio and that of the EAFE over the num-
ber of months that have elapsed between January 1, 1995 and the end of the
quarter for which the fee is computed. Performance differentials vs. the
EAFE listed above shall increase proportionately from quarter to quarter
from 4.5 and -3, respectively, for the twelve months ending December 31,
1995, to 13.5 and -9, respectively, for the thirty-six months ending Decem-
ber 31, 1997. The Fund will provide to BFM, Inc. a schedule of the fee cal-
culation.
(c) After December 31, 1997. For the quarter ending March 31, 1998 and
thereafter, the period used to calculate the incentive/penalty fee shall be
the 36 months through and including the end of the quarter for which the
fee is being computed, based on the following schedule:
<TABLE>
<CAPTION>
THREE YEAR
PERFORMANCE
DIFFERENTIAL VS. THE TOTAL FEE AS A
EAFE PERCENTAGE OF BASIC FEE
-------------------- -----------------------
<S> <C>
(Less than) -9% 50%
(Greater than but equal to) -9
and (Less than) 0% 75%
(Greater than but equal to) 0 and
(Less than) 4.5% 100%
(Greater than but equal to) 4.5
and (Less than) 13.5% 125%
(Greater than but equal to) 13.5% 150%
</TABLE>
B-13
<PAGE>
The investment performance of the Portfolio, for any period, expressed as a
percentage of the "Portfolio Unit Value" at the beginning of such period, will
be the sum of: (i) the change in the Portfolio Unit Value during such period;
(ii) the unit value of the Fund's cash distributions from the Portfolio's net
investment income and realized net capital gains (whether long-term or short-
term) having an ex-dividend date occurring within such period; and (iii) the
unit value of taxes paid including withholding taxes and capital gains taxes
paid or accrued during such period by the Fund for undistributed realized
long-term capital gains realized from the Portfolio.
The "Portfolio Unit Value" will be determined by dividing the total net as-
sets of the Portfolio by a given number of units. On the initial date of the
agreement, the number of units in the Portfolio will equal the total shares
outstanding of the Fund. After such initial date, as assets are added to or
withdrawn from the Portfolio, the number of units of the Portfolio will be ad-
justed based on the unit value of the Portfolio on the day such changes are
executed.
For the purposes of determining the incentive/penalty fee adjustment, the
Portfolio's net assets will be averaged over the same period as the investment
performance of those assets and the investment record of the EAFE are comput-
ed.
RELATED INFORMATION CONCERNING BFM, INC. Batterymarch Financial Management,
Inc. a wholly owned subsidiary of Legg Mason, was formed for the purpose of
acquiring all of the operating assets and business of Batterymarch. Legg Ma-
son, headquartered at 111 South Calvert Street, Baltimore, Maryland, is a pub-
licly held, New York Stock Exchange listed, holding company that provides se-
curities brokerage, investment advisory, corporate and public finance, and
mortgage banking services to individuals, institutions, corporations and mu-
nicipalities, through its wholly owned subsidiaries.
Until April 1, 1992 Batterymarch Financial Management served as investment
adviser to the U.S. Portfolio according to the terms of the fee schedule set
forth above. For the fiscal years ended December 31, 1991 and 1992 the U.S.
Portfolio paid Batterymarch advisory fees totaling $245,000 (.22 of 1% of av-
erage net assets) and $325,000 (.35 of 1% of average net assets), respective-
ly.
On April 1, 1992, the U.S. Portfolio entered into an Investment Advisory
Agreement with Geewax, Terker & Co. ("Geewax Terker"), 99 Starr Street, Phoe-
nixville, Pa. 19460. Under the terms of the Agreement Geewax Terker, subject
to the control and supervision of the Fund's Board of Trustees and in confor-
mance with the Fund's investment objective and policies, manages the invest-
ment and reinvestment of the assets of the Fund's U.S. Portfolio. In this re-
gard it is the responsibility of Geewax Terker to make investment decisions
for the U.S. Portfolio and to place the Portfolio's purchase and sale orders
for investment securities. For the fiscal year ended December 31, 1993, U.S.
Portfolio paid Geewax advisory fees totaling $507,000 .59 of 1% of average net
assets.
As compensation for the services rendered by Geewax Terker under the Agree-
ment and the assumption by Geewax Terker of the expenses related thereto
(other than the cost of securities purchased for the U.S. Portfolio) and the
taxes and brokerage commissions, if any, payable in connection with such
transactions), the U.S. Portfolio pays Geewax Terker an investment advisory
fee which represents a percentage of the Portfolio's average net assets ad-
justed for the investment performance of the Portfolio relative to that of the
Standard & Poor's 500 Composite Stock Price Index ("S&P 500") over the preced-
ing 36-month period as follows:
<TABLE>
<CAPTION>
CUMULATIVE THREE YEAR PERFORMANCE INCENTIVE/PENALTY
DIFFERENTIAL VS. THE S&P 500 FEE ADJUSTMENT
--------------------------------- -----------------
<S> <C>
+4.5% points or more above........................... 0.60%
+2.25% points but less than +4.5% points above....... 0.40%
Less than +2.25% points above........................ 0.20%
</TABLE>
B-14
<PAGE>
Until the quarter ending March 31, 1993, the investment advisory fee was
calculated according to the following transition rules:
(a) April 1, 1992 through December 31, 1992. For the quarters ending on
or prior to December 31, 1992, the incentive/penalty fee was not operable.
The advisory fee was payable at the annual rate of .40% of the U.S. Portfo-
lio's net assets.
(b) For the calendar quarter ended March 31, 1993 if the investment per-
formance of the Portfolio for the 12 consecutive months then ended exceeded
the investment performance of the S&P 500 by:
(i) less than .75%, the fee rate payable to Geewax Terker was .05%
(annual rate of .20%); or
(ii) not less than .75% but not more than 1.5%, the fee rate payable
to Geewax Terker was .10% (annual rate of .40%); or
(iii) more than 1.5%, the fee rate payable to Geewax Terker was .15%
(annual rate of .60%).
(c) For each calendar quarter ended after March 31, 1993, the fee payable
to Geewax Terker shall be paid on the same basis as provided in the previ-
ous paragraph except that each of the investment performance percentages
set forth in (i), (ii) and (iii) above (the "original percentages") shall
be replaced by a new percentage that is equal to the product obtained by
multiplying each such original percentage by a fraction whose numerator is
the number of calendar quarters, not exceeding 12, that have elapsed since
April 1, 1992 and whose denominator is 4. For example, for the quarter
ended March 31, 1994 (the eighth quarter), the fee rate will be calculated
based on the performance of the Portfolio relative to that of the S&P 500
as follows:
(i) .05% (.20% annual rate) if the return of the Portfolio for the
preceding 24 months does not exceed that of the S&P 500 by more than
1.5%;
(ii) .10% (.40% annual rate) if the return of the Portfolio for the
preceding 24 months exceeds that of the S&P 500 by more than 1.5% but
not more than 3.0%;
(iii) .15% (.60% annual rate) if the return of the Portfolio for the
preceding 24 months exceeds that of the S&P 500 by more than 3.0%.
The period of time which shall be used to compare the investment performance
of the Portfolio with the investment performance of the S&P 500 shall be the
number of consecutive months that this Agreement has been in effect as of the
end of the quarter for which such fee is being calculated, but not longer than
the most recent 36 months.
The investment performance of the Portfolio and the S&P 500 shall be calcu-
lated (i) as of the end of each calendar quarter on a total return basis and
(ii) for the same period of time. In calculating the investment performance of
the Portfolio for any period, the value of the Portfolio's cash distributions
from net investment income and realized net capital gains (whether long-term
or short-term) having an ex-dividend date occurring within such period and the
value of capital gains taxes paid or accrued during such period by the Portfo-
lio for undistributed realized long-term capital gains realized from the Port-
folio, shall be included.
The agreement with Geewax Terker continues until March 31, 1994 and the
agreement with Batterymarch continues until January 4, 1997. Each agreement
may be terminated sooner, as provided herein.
In April 1972, the Securities and Exchange Commission ("SEC") issued Release
No. 7113 under the Investment Company Act of 1940 to call attention of direc-
tors and investment advisers to certain factors which must be considered in
connection with investment company incentive fee arrangements. One of these
factors is to "avoid basing significant fee adjustments upon random or insig-
nificant differences" between the investment performance of a fund and that of
the particular index with which it is being compared. The Release provides
that "preliminary studies (of the SEC staff) indicate that as a "rule of
thumb' the performance difference should be as least +10 percentage points"
B-15
<PAGE>
annually before the maximum performance adjustment may be made. However, the
Release also states that "because of the preliminary nature of these studies,
the Commission is not recommending, at this time, that any particular perfor-
mance difference exist before the maximum fee adjustment may be made". The Re-
lease concludes that the directors of a fund "should satisfy themselves that
the maximum performance adjustment will be made only for performance differ-
ences that can reasonably be considered significant." The Board of Trustees of
the Fund has fully considered the SEC Release and believes that the perfor-
mance adjustments as included in the advisory agreements are entirely appro-
priate although not within the +10 percentage points per year range suggested
in the Release. Under the Fund's investment advisory agreement with Geewax
Terker, the maximum performance adjustment is made at a difference of +4.5
percentage points from the performance of the index over a thirty-six month
period, which would effectively be the equivalent of approximately +1.125 per-
centage points difference per year. The Fund's investment advisory agreements
provide for no performance adjustment at a difference of less than +2.25 per-
centage points from the performance of the index over a thirty-six month peri-
od, which would be the equivalent of approximately +.56 percentage points per
year. Under the Fund's investment advisory agreement with BFM, Inc., the maxi-
mum performance adjustment is made at a difference of ^11.25 percentage points
from the performance of the index over a thirty-six month period, which would
effectively be the equivalent of approximately ^3.75 percentage points differ-
ence per year.
The Agreements are renewable thereafter, for successive one year periods, so
long as such renewal is specifically approved at least annually by vote of a
majority of those members of the Board of Trustees of the Fund who are not
parties to the Agreements or interested persons of any such party, cast in
person at a meeting called for the purpose of voting such approval. In addi-
tion, the question of continuance of the agreements may be presented to share-
holders of either of the Portfolios; in such event, continuance shall be ef-
fected only if approved by vote of a majority of the outstanding shares of the
respective Portfolio. If the holders of the Portfolio fail to approve the
agreement, the adviser of the Portfolio may continue to serve as investment
adviser until new arrangements have been made. The Agreements may be termi-
nated at any time, without penalty, by vote of the Board of Trustees of the
Fund or by vote of a majority of the outstanding shares of the Portfolio on 60
days' written notice to the investment advisers, or by the investment advisers
on 90 days' written notice to the Fund. The Agreements will automatically ter-
minate in the event of its assignment.
CONTROL OF THE ADVISERS
John J. Geewax and Bruce E. Terker, Partners, are the "controlling persons"
(as that term is defined in the rules and regulations of the Securities and
Exchange Commission) of Geewax Terker.
The Fund's Board of Trustees may, without the approval of shareholders, pro-
vide for:
A. The employment of a new investment adviser pursuant to the terms of a
new advisory agreement, either as a replacement for an existing adviser or
as an additional adviser.
B. A change in the terms of an advisory agreement.
C. The continued employment of an existing adviser on the same advisory
contract terms where a contract has been assigned because of a change in
control of the adviser.
Any such change will only be made upon not less than 30 days' prior written
notice to shareholders of the affected Portfolio, which shall include the in-
formation concerning the adviser that would have normally been included in a
proxy statement.
PORTFOLIO TRANSACTIONS
The investment advisory agreement authorizes the investment adviser to se-
lect the brokers or dealers that will execute the purchases and sales of in-
vestment securities for the Portfolios and directs the investment adviser to
use its best efforts to obtain the best available price and most favorable ex-
ecution with respect to all transactions for the Portfolios.
B-16
<PAGE>
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be made through such
firms. However, the Fund may place portfolio orders with qualified broker-
dealers who recommend the Fund to clients, and may, when a number of brokers
and dealers can provide comparable best price and execution on a particular
transaction, consider the sale of Fund shares by a broker or dealer in select-
ing among qualified broker-dealers.
Some securities considered for investment by one of the Portfolios may also
be appropriate for other clients served by the investment advisers. If pur-
chase or sale of securities consistent with the investment policies of the
Portfolio and one or more of these other clients served by the investment ad-
viser is considered at or about the same time, transactions in such securities
will be allocated among the Portfolio and clients in a manner deemed fair and
reasonable by the investment adviser. Although there is no specified formula
for allocating such transactions, the various allocation methods used by the
investment advisers, and the results of such allocations, are subject to peri-
odic review by the Fund's Board of Trustees.
During the years ended December 31, 1991, 1992 and 1993 the Fund paid
$184,013, $879,366 and $753,881, respectively, in brokerage commissions.
PERFORMANCE MEASURES
Vanguard/Trustees' Equity Fund may use one or more, of the following unman-
aged indexes for comparative performance purposes:
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX--is a well diversified list
of 500 companies representing the U.S. Stock Market.
WILSHIRE 5000 EQUITY INDEXES--consists of nearly 5,000 common equity securi-
ties, covering all stocks in the U.S. for which daily pricing is available.
WILSHIRE 4500 EQUITY INDEX--consists of all stocks in the Wilshire 5000 except
for the 500 stocks in the Standard and Poor's 500 Index.
RUSSELL 3000 STOCK INDEX--a diversified portfolio of over 3,000 common stocks
accounting for over 90% of the market value of publicly traded stocks in the
U.S.
RUSSELL 2000 STOCK INDEX--a subset of approximately 2,000 of the smallest
stocks contained in the Russell 3000; a widely used benchmark for small capi-
talization common stocks.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX--is an arithmetic, market val-
ue-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia and the Far East.
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX--currently includes 67 bonds and 33
preferreds. The original list of names was generated by screening for convert-
ible issues of 100 million or greater in market capitalization. The index is
priced monthly.
SALOMON BROTHERS GNMA INDEX--includes pools of mortgages originated by private
lenders and guaranteed by the mortgage pools of the Government National Mort-
gage Association.
SALOMON BROTHERS HIGH-GRADE CORPORATE BOND INDEX--consists of publicly issued,
non-convertible corporate bonds rated AA or AAA. It is a value-weighted, total
return index, including approximately 800 issues with maturities of 12 years
or greater.
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SHEARSON LEHMAN LONG-TERM TREASURY BOND--is composed of all bonds covered by
the Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND--consists of over 4,500 U.S. Trea-
sury, Agency and investment grade corporate bonds.
SHEARSON LEHMAN CORPORATE (BAA) BOND INDEX--all publicly offered fixed rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index in-
cludes over 1,000 issues.
BOND BUYER MUNICIPAL INDEX (20 YEAR) BOND--is a yield index on current coupon
high grade general obligation municipal bonds.
STANDARD & POOR'S PREFERRED INDEX--is a yield index based upon the average
yield of four high grade, non-callable preferred stock issues.
NASDAQ INDUSTRIAL INDEX--is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
COMPOSITE INDEX--70% Standard & Poor's 500 Index and 30% NASDAQ Industrial In-
dex.
COMPOSITE INDEX--35% Standard & Poor's 500 Index and 65% Salomon Brothers
High-Grade Bond Index.
COMPOSITE INDEX--65% Standard & Poor's 500 Index and 35% Salomon Brothers
High-Grade Bond Index.
LEHMAN BROTHERS AGGREGATE BOND INDEX--is a market weighted index that contains
individually priced U.S. Treasury, agency, corporate, and mortgage pass-
through securities corporate rated BBB- or better. The Index has a market
value of over $4 trillion.
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5) GOVERNMENT/CORPORATE INDEX--is a mar-
ket weighted index that contains individually priced U.S. Treasury, agency,
and corporate investment grade bonds rated BBB- or better with maturities be-
tween 1 and 5 years. The index has a market value of over $1.3 trillion.
LEHMAN BROTHERS MUTUAL FUND INTERMEDIATE (5-10) GOVERNMENT/CORPORATE INDEX--is
a market weighted index that contains individually priced U.S. Treasury, agen-
cy, and corporate securities rated BBB- or better with maturities between 5
and 10 years. The index has a market value of over $600 billion.
LEHMAN BROTHERS MUTUAL FUND LONG (10+) GOVERNMENT/CORPORATE INDEX--is a market
weighted index that contains individually priced U.S. Treasury, agency, and
corporate securities rated BBB- or better with maturities greater than 10
years. The index has a market value of over $900 billion.
LIPPER SMALL COMPANY GROWTH FUND AVERAGE--the average performance of small
company growth funds as defined by Lipper Analytical Services, Inc. Lipper de-
fines a small company growth fund as a fund that by prospectus or portfolio
practice, limits its investments to companies on the basis of the size of the
company. From time to time, Vanguard may advertise using the average perfor-
mance and/or the average expenses ratio of the small company growth funds.
(This fund category was first established in 1982. For years prior to 1982,
the results of the Lipper Small Company Growth category were estimated using
the returns of the Funds that constituted the Group at its inception.)
LIPPER BALANCED FUND AVERAGE--An industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper Analyt-
ical Services, Inc.
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LIPPER NON-GOVERNMENT MONEY MARKET FUND AVERAGE--An industry benchmark of av-
erage non-government money market funds with similar investment objectives and
policies, as measured by Lipper Analytical Services, Inc.
LIPPER GOVERNMENT MONEY MARKET FUND AVERAGE--An industry benchmark of average
government money market funds with similar investment objectives and policies,
as measured by Lipper Analytical Services, Inc.
GENERAL INFORMATION
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund was established as a "business trust" under Pennsylvania law under
a Declaration of Trust dated May 16, 1984. The Declaration of Trust permits
the Trustees to issue an unlimited number of shares of beneficial interest,
without par value, from an unlimited number of separate classes ("Portfolios")
of shares. Currently the Fund is offering shares of two Portfolios.
The shares of each Portfolio are fully paid and non-assessable, except as
set forth under "Shareholder and Trustee Liability," and have no preference as
to conversion, exchange, dividends, retirement or other features. The shares
have no preemptive rights. The shares have non-cumulative voting rights, which
means that the holders of more than 50% of the shares voting for the election
of Trustees can elect 100% of the Trustees if they choose to do so. A share-
holder is entitled to one vote for each full share held (and a fractional vote
for each fractional share held), then standing in his name on the books of the
Fund. On any matter submitted to a vote of shareholders, all shares of the
Fund then issued and outstanding and entitled to vote, irrespective of the
class, shall be voted in the aggregate and not by class: except (i) when re-
quired by the Investment Company Act of 1940, shares shall be voted by indi-
vidual class; and (ii) when the matter does not affect any interest of a par-
ticular class, then only shareholders of the affected class or classes shall
be entitled to vote thereon.
The Fund will continue without limitation of time, provided however that:
1) Subject to the majority vote of the holders of shares of any Portfolio
of the Fund outstanding, the Trustees may sell or convert the assets of
such Portfolio to another investment company in exchange for shares of such
investment company, and distribute such shares, ratably among the share-
holders of such Portfolio; and
2) Subject to the majority of shares of any Portfolio of the Fund out-
standing, the Trustees may sell and convert into money the assets of such
Portfolio and distribute such assets ratably among the shareholders of such
Portfolio.
Upon completion of the distribution of the remaining proceeds or the remain-
ing assets of any Portfolio as provided in paragraphs 1) and 2) above, the
Fund shall terminate as to that Portfolio and the Trustees shall be discharged
of any and all further liabilities and duties hereunder and the right, title
and interest of all parties shall be cancelled and discharged.
SHAREHOLDER AND TRUSTEE LIABILITY
Under Pennsylvania law, shareholders of a trust may, under certain circum-
stances, be held personally liable as partners for the obligations of the
Trust. Therefore, the Declaration of Trust contains an express disclaimer of
shareholder liability for acts or obligations of the Fund and requires that
notice of such disclaimer be given in each agreement, obligation, or instru-
ment entered into or executed by the Fund or the Trustees. The Declaration of
Trust provides for indemnification out of the Fund property of any shareholder
held personally liable for the obligations of the Fund. The Declaration of
Trust also provides that the Fund shall, upon request, assume the defense of
any claim made
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against any shareholder for any act or obligation of the Fund and satisfy any
judgment thereon. Thus, the risk of a shareholder incurring financial loss on
account of shareholder liability is limited to circumstances in which the Fund
itself would be unable to meet its obligations. The Trustees and officers of
the Fund believe that, in view of the above, the risk of personal liability to
shareholders is remote.
The Declaration of Trust further provides that the Trustees will not be lia-
ble for errors of judgment or mistakes of fact or law, but nothing in the Dec-
laration of Trust protects a Trustee against any liability to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross negli-
gence, or reckless disregard of the duties involved in the conduct of his of-
fice.
FINANCIAL STATEMENTS
The Fund's financial statements for the year ended December 31, 1993, in-
cluding the financial highlights for each of the five years in the year ended
December 31, 1993, appearing in the Fund's 1993 Annual Report to Shareholders,
and the report thereon of Price Waterhouse, independent accountants, also ap-
pearing therein, are incorporated by reference in this Statement of Additional
Information. The Fund's 1993 Annual Report to Shareholders is enclosed with
this Statement of Additional Information.
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