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[PHOTO]
VANGUARD/TRUSTEES'
EQUITY FUND-
INTERNATIONAL PORTFOLIO
Annual Report
December 31, 1996
THE VANGUARD GROUP: LINKING TRADITION AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our course
toward the twenty-first century. Our Report cover reflects that blending of
tradition and innovation, of past, present, and future. The montage includes a
bronze medallion with a likeness of our namesake, HMS Vanguard (Lord Nelson's
flagship at The Battle of the Nile); a clock built circa 1816 in Scotland,
featuring a portrait of Nelson (who is also shown, accepting a surrender, in a
detail from a nineteenth-century engraving); and several views of our recently
completed campus, which is steeped in nautical imagery--from our buildings named
after Nelson's warships (Victory, Majestic, and Goliath are three shown), to our
artwork and ornamental compass rose.
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[PHOTO]
VANGUARD HAS ALWAYS STRIVED TO BE THE STANDARD-BEARER for mutual fund
disclosure, going well beyond the "letter of the law" in our shareholder
communications. During the past year, we raised the standard once again by
rewriting and reformatting our Fund prospectuses. They are designed to ensure
that prospective investors fully understand, before they make an investment,
each Fund's investment strategies, risks, and costs. In that spirit, we have
redesigned our Annual Reports to shareholders, which provide a comprehensive
discussion and analysis of the year's results in the context of each Fund's
investment objectives and policies. Since Vanguard has long been recognized for
the quality and content of these Fund Reports, our overriding objective was to
maintain the character of the previous Reports, while adding information to
assist shareholders in understanding the investment characteristics of their
Fund.
THE NEW FUND REPORTS INCLUDE A MESSAGE TO SHAREHOLDERS from Chairman John
C. Bogle and President John J. Brennan. This Message continues to provide a
candid assessment of the Fund's performance relative to an appropriate unmanaged
market benchmark and a peer group of mutual funds with similar investment
policies. It also reviews the principal factors contributing to--and detracting
from--the returns earned by the Fund. To help you evaluate your Fund's
current-year performance, the Message includes a discussion of the Fund's
long-term investment results, as well as a look ahead to the prospects for the
coming year. A recap of the financial markets, which had been included as part
of the Chairman's letter, now appears in The Markets In Perspective. This
overview covers the world's financial markets, putting the results of the Fund's
strategy in a global perspective.
THE PORTFOLIO PROFILE REPRESENTS AN ADDITION TO OUR FUND REPORTS. In this day
and age, many investors use detailed statistical information to evaluate their
mutual fund holdings, and our new Portfolio Profile furnishes shareholders with
comprehensive data on key characteristics--sector diversification, volatility,
top-ten holdings, among others--that ultimately define how a Fund is likely to
perform in various market environments. For this information to be used
effectively, we include a brief description of the profiled characteristics. The
Report From The Adviser (for our traditionally managed Funds) now covers
specific topics that we have defined as being the important ones for the adviser
to address--and we do our best to ensure that this Report is written in the same
simple and candid manner that characterizes all Vanguard communications.
Finally, each Adviser's Report will include an inset reminder of the adviser's
basic investment philosophy.
WE TRUST THAT THIS REDESIGNED FUND REPORT will continue to meet your need for a
fair, candid, and clear presentation of your Fund's investment results and a
thorough portfolio review. We welcome any comments that you might have at any
time regarding these Reports.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
4
Report From
The Adviser
6
Portfolio
Profile
8
Performance
Summary
11
Financial
Statements
12
Report Of
Independent
Accountants
20
Trustees And
Officers
INSIDE BACK COVER
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[PHOTO]
John C. Bogle
[PHOTO]
John J. Brennan
FELLOW SHAREHOLDER,
International stock markets, with the notable exception of Japan, generally
rose strongly during 1996, though their results lagged the stellar +23.0% return
on U.S. stocks. The International Portfolio of Vanguard/Trustees' Equity Fund
returned +10.2%, well ahead of broad international stock indexes, but behind the
return of the average international fund.
The following table shows the total return (capital change plus reinvested
dividends) of the Portfolio and its principal benchmarks, the average
international fund as well as the unmanaged Morgan Stanley Capital
International-Europe, Australasia, and Far East Index.
<TABLE>
<CAPTION>
- ------------------------------------------------------
TOTAL RETURN
YEAR ENDED
DECEMBER 31, 1996
- ------------------------------------------------------
<S> <C>
Vanguard/Trustees' Equity Fund-
International Portfolio +10.2%
- ------------------------------------------------------
Average International Fund +11.8%
- ------------------------------------------------------
MSCI-EAFE Index + 6.4%
- ------------------------------------------------------
</TABLE>
The Portfolio's return is based on a change in net asset value from $31.11
per share on December 31, 1995, to $27.54 per share on December 31, 1996, with
the latter figure adjusted for dividends of $0.82 per share paid from net
investment income and distributions totaling $5.77 per share paid from net
realized capital gains.
1996 PERFORMANCE OVERVIEW
In aggregate, the world's stock markets enjoyed a solid year during 1996,
albeit well short of the +23.0% return on the U.S. Standard & Poor's 500
Composite Stock Price Index. In local currency terms, the MSCI-EAFE Index
returned +11.6%, but a generally strong U.S. dollar reduced the return to +6.4%
for U.S. investors.
Europe's bourses were, on average, in a remarkably steady uptrend, with
positive returns for the MSCI-Europe Index in every month but July. On balance,
that Index showed a return of +23.4%, reduced to +21.4% in dollar terms. The
bullishness owed something to lower interest rates but also was due, in part,
to signs that corporate managements in Europe are adopting an American-style
focus on increasing shareholder value through such steps as corporate
restructurings.
In Japan, stocks fizzled after a springtime rally and ended the year with
a -4.8% loss in yen terms. However, the U.S. dollar's sharp rise in value
against the yen deepened the loss to -15.4% in dollar terms. Although Japan's
economy grew during 1996, investors apparently were concerned about whether the
expansion would continue and about the financial condition of Japan's banks,
which are saddled with large potential losses on loans.
Returns from most emerging markets were strong, though they varied widely
from country to country (Hong Kong and Brazil up by one-third or more, Thailand
and Korea down by one-third). Overall, the MSCI-Select Emerging Markets Index
(not included in the EAFE Index) provided a +25.5% local currency return that
was slashed to +15.2% for U.S. investors.
Our new adviser, UBS International Investment London Ltd., assumed
management of the Portfolio on April 1 and quickly reduced its holdings in
Japan, redirecting assets to
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continental Europe, the United Kingdom, and Australia. These moves helped the
Portfolio achieve a margin of +3.8% over the MSCI-EAFE Index for the full year.
The Portfolio's return for the nine months under UBSII management was +6.1%,
compared with +3.3% for the MSCI-EAFE Index and +7.0% for the average
international equity mutual fund.
Our performance relative to our competitors was hampered by the transaction
costs of the substantial changes our new adviser made after assuming
responsibility for the management of the Portfolio. While those costs, which are
of a non-recurring nature, reduced our return by an estimated -1%, our Portfolio
is now aligned to reflect a UBSII strategy designed to provide strong relative
returns in the years ahead. Profits were realized on many holdings sold by
UBSII, leading to the unusually high distribution of $5.77 per share from net
realized capital gains during 1996.
LONG-TERM PERFORMANCE OVERVIEW
Over the past decade, the return on the International Portfolio has exceeded the
results of the average international fund and the MSCI-EAFE Index, our primary
comparative standards. The table at left tells the tale. It shows the average
annual return for the Portfolio, the average international fund, and the Index.
It also shows the results over the past decade of hypothetical $10,000
investments made in each, assuming reinvestment of all income and capital gains
distributions. As you can see, the extra margin of return we provided versus our
peers amounted over the decade to the not-inconsiderable sum of $2,706, more
than one-quarter of the initial stake.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
TOTAL RETURN
10 YEARS ENDED DECEMBER 31, 1996
--------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- --------------------------------------------------------------------
<S> <C> <C>
Vanguard/Trustees' Equity Fund-
International Portfolio +10.5% $27,095
- --------------------------------------------------------------------
Average International Fund + 9.3% $24,389
- --------------------------------------------------------------------
MSCI-EAFE Index + 8.7% $23,108
- --------------------------------------------------------------------
</TABLE>
That said, one factor explains just about all of our +1.2% annual
advantage over our peers during the decade: cost. Our expense ratio, currently
at 0.50% of assets, is more than one percentage point below the 1.58% ratio of
our average competitor. It is both our hope and expectation that our new
adviser will succeed in building on that advantage in coming years.
We acknowledge that the returns shown above may seem like weak tea in
comparison with the average annual return of +15.3% provided by the S&P 500
Index over the past decade. Nonetheless, we believe that the case for
international investing--improved diversification, moderated volatility, and
the prospect of competitive long-term returns--is still valid. Of course,
returns from international stocks fluctuate widely from year to year, and
future returns may be higher or lower than those shown above.
In any event, with the revamping of the Portfolio and the associated costs
now behind us, we look to the Portfolio's future with optimism.
IN SUMMARY
Dazzling returns from U.S. stocks--the S&P 500 Index provided a cumulative
return of nearly +70% in 1995 and 1996--have left international markets, with
the MSCI-EAFE Index rising just +19% over the same two-year period, looking
tarnished by comparison. But we note that financial market returns have a
strong tendency--for better or for
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worse--to revert toward long-term norms over time. We continue to believe that
international equities still are a sound choice as part of a balanced
investment program that also includes U.S. stock funds, bond funds, and money
market funds.
"Stay the course" has proven to be wise counsel in the past, and we see no
reason why it should not continue to be in the years ahead.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
Chairman of the Board President
January 24, 1997
NOTE: The Board of Trustees of Trustees' Equity Fund has approved designating
the International Portfolio as Vanguard International Value Portfolio, effective
April 30, to better reflect its investment approach. UBS International
Investment London will continue to manage the Portfolio with a value approach to
selecting stocks.
3
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THE MARKETS IN PERSPECTIVE: YEAR ENDED DECEMBER 31, 1996
[PHOTO]
U.S. EQUITY MARKETS
The stock market in 1996 could not match its astonishing 37.6% return of the
previous year--but it made a good run, with the Standard & Poor's 500 Composite
Stock Price Index up by 23.0%. When the two years are considered cumulatively,
the S&P 500 Index has risen 69.2%. Not surprisingly, many of the factors that
drove the market higher in 1995 were still at work: Once again, steady economic
growth, low inflation, and solid earnings growth were powerful motivators.
The market's gains, however, were far from evenly distributed. Investors
strongly favored larger companies, such as those that dominate the S&P 500
Index. In fact, even within the Index, it was the largest companies that
prevailed: The 50 biggest (which account for roughly half the Index's market
value) gained 26.7% in 1996, compared with an increase of 23.0% for the entire
Index. Looking at the S&P 500 Index's performance by sector, technology stocks
were strongest, closing the year with a 42.5% gain. Financial stocks were a
close second, gaining 35.5%. Utilities, plagued early in the year by higher
interest rates and a rapidly changing competitive landscape, eked out a meager
1.8% return, the lowest within the Index.
With the largest companies performing so well, most smaller issues could
not keep pace. This was evidenced in the considerable difference between the
23.0% return of the S&P 500 Index and the 16.5% return of the Russell 2000
Index of small stocks. Even for the smaller companies, there was a significant
range of performance among sectors. Energy stocks led the Russell 2000 Index
with a 62.0% gain for the year. Here, rising prices, limited exposure to the
cyclical refining business, and a reduced number of competitors created a
favorable environment for the stocks. At the other end of the spectrum were
health-care stocks, which showed a loss of -3.3%.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
Average Annualized Returns
Periods Ended December 31, 1996
----------------------------------
1 Year 3 Years 5 Years
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Equity
S&P 500 Index 23.0% 19.7% 15.2%
Russell 2000 Index 16.5 13.7 15.6
MSCI-EAFE Index 6.4 8.6 8.5
- -------------------------------------------------------------------------------
Fixed-Income
Lehman Aggregate Bond Index 3.6% 6.0% 7.0%
Lehman 10-Year Municipal
Bond Index 4.5 5.3 7.5
Salomon 90-Day U.S. Treasury Bills 5.3 5.1 4.4
- -------------------------------------------------------------------------------
Other
Consumer Price Index 3.3% 2.8% 2.8%
- -------------------------------------------------------------------------------
</TABLE>
U.S. FIXED-INCOME MARKETS
At year-end, the yield on the 30-year U.S. Treasury bond was 6.64%, noticeably
higher than its 5.95% level on December 31, 1995. The change in rates during
1996 reflects increased concern about the prospects for rising inflation, due
to indications of greater than expected strength in the economy.
When the year began, the general expectation was that modest economic
growth and benign inflation would continue, giving the Federal Reserve no
reason to boost inter-
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est rates. That complacency was shattered by an exceptionally strong February
jobs report, the first of what turned out to be a succession of signs that in
fact the economy was growing at a much faster--and potentially
inflation-inducing--pace. The bond market reacted swiftly to meet the perceived
risk: The 30-year Treasury bond's yield jumped from just below 6.0% at the end
of 1995 to 6.7% in late March. The next several months saw a consistent pattern
in which bond yields rose on the Friday of the jobs-report release only to fall
back by the middle of the month. Hindsight shows that most of the worry was
wasted: Inflation, as measured by the Consumer Price Index, remained near an
annualized rate of 3.3%. But increasing signs of growth in late November and
December reignited inflation concerns and caused bonds to finish the year on a
sour note.
Despite the numerous setbacks suffered by the bond market in 1996, indexes
were able to finish the year with positive total returns. Although the specter
of the Federal Reserve Board loomed large during the year, in fact the Board
acted only once, lowering the federal funds rate by a total of 0.25% in January.
Corporate bonds, mortgage-backed issues, and municipals were three
relatively bright spots in 1996. The strength in earnings that benefited stock
prices extended to the corporate bond sector as well. These bonds, especially
those of lower credit quality, performed well relative to Treasuries, supported
by general confidence in companies' ability to meet payments. The
stable-to-rising interest-rate environment throughout most of the year
benefited another large segment of the bond market--mortgage-backed
securities--as the threat of refinancings receded. Finally, municipal bonds
outpaced their U.S. Treasury counterparts. The sector was shielded to a certain
extent from the inflation wars of the Treasury market, as demand outstripped
supply for much of the year.
INTERNATIONAL EQUITY MARKETS
Investors who assess international markets by the often-cited EAFE
benchmark--the Morgan Stanley Capital International-Europe, Australasia, Far
East Index, with its 1996 return of 6.4%--could have overlooked a striking
regional disparity between the Euro-pean and Pacific markets. Europe's markets
gained 21.4% during the year, while their Pacific counterparts posted a decline
of -8.2%. Clearly, the outlook and environments that characterized the European
and Far East markets were quite different.
The poor returns in the Pacific region largely reflected ongoing concern
about the health of the Japanese economy. Growth in Japan has remained modest
at best for several years despite government efforts to stimulate the economy
through public works programs and tax incentives. In Europe, the picture was
dramatically different, with the region benefiting from a variety of factors.
Among the most important were (1) ongoing efforts to lower government deficits
consistent with the Maastricht Treaty guidelines, (2) improving economic
growth, and (3) a greater commitment by corporate executives to increasing
"shareholder value."
5
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REPORT FROM THE ADVISER
[PHOTO]
The International Portfolio of Vanguard/Trustees' Equity Fund provided a
total return of 10.2% during 1996, which compares with 6.4% for the Morgan
Stanley Capital International-Europe, Australasia, Far East (MSCI-EAFE) Index
and 11.8% for the average international equity mutual fund. The return from
April 1, when UBS International Investment London Ltd. took over responsibility
for the Portfolio, through December 31 was 6.1%, compared with 3.3% for the
MSCI-EAFE Index and 7.0% for the average international equity mutual fund. More
details about the Portfolio's performance are presented in the Message To
Shareholders, which begins on page 1.
Upon assuming responsibility for the Portfolio, we made a number of
significant changes to its geographic allocation and holdings of individual
securities. The vast majority of these changes were completed within the first
two weeks of our management and resulted in approximately half the existing
holdings being switched into stocks we preferred. The total cost of this
reorganization was equivalent to around 1% of the Portfolio's asset value.
In summary, the major initial changes we made were to: (1) reduce Japanese
holdings from 32% of assets to 25%; (2) reduce exposure to markets not in the
MSCI-EAFE Index (mainly emerging markets) from 9% to 4%; (3) increase United
Kingdom holdings from 8% to 16%; (4) increase Australian stocks from 2% to 7%;
and (5) increase exposure to continental Europe, with French holdings in
particular rising from 8% to 17%. At the same time, the number of securities in
the Portfolio was reduced from 300 to around 160.
When we reduced the exposure to Japan to 25%, that market's weight in the
MSCI-EAFE Index was 40%. (Japan's underperformance versus the rest of the Index
is shown in the graph on page 7.) Earlier in 1996, many international investors
trying to discern which market would next recover were comparing the level of
the Japanese market (then around 21,000 on the Nikkei 225 Average) with its
historic peak (near 40,000). Their buying pushed foreigners' ownership of
Japanese equities to a historic high. However, one should remember that the
records in Japanese stock prices were set in a period of high speculation and
are out of line with long-term averages.
The subsequent declines in the Japanese market have led us to add to the
holdings there but the position, remaining at approximately 25% of the
Portfolio's assets, is still below the index weight, which has fallen to 35%.
Our Japanese holdings are balanced between exporters and companies focused
on the domestic economy. The exporters are relatively lowly valued companies
with strong global franchises; they include Sony and MEI (consumer
electronics), Yamaha Motor (motorbikes), and Fuji Photo (film). Among the
domestics, which is where our more recent purchases have been targeted, our
emphasis has been on market segments that have underperformed, such as heavy
industrials, textiles, food, and recently-privatized companies. We
do not believe that the banks are free of their bad-debt
INVESTMENT PHILOSOPHY
The Portfolio reflects a belief that superior long-term
investment results can be achieved by investing in a diversified
portfolio of international stocks that are generally out of favor or
undervalued by fundamental measures such as price/earnings ratio or
dividend yield.
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<PAGE> 9
crisis, which will be compounded by a falling stock market. Consequently, we
have only limited exposure to Japanese financial equities.
MSCI-JAPAN RELATIVE TO MSCI-EAFE (EXCLUDING JAPAN)
[GRAPH]
During the reorganization, we significantly increased the Portfolio's
exposure to European markets, in particular France, which rose from 8% to 17%
versus the Index weighting of 7%. Despite that country's well-known problems,
both economic and social, we are finding a number of interesting individual
stocks of companies where management action is changing the business prospects.
In the industrial sector, these include such well-known names as Pechiney
(aluminum and packaging), Elf (oil), and Danone (food).
In continental Europe, we have taken a larger position than the Index
weighting for that area because of the relatively low valuations of stocks
there. Our decision is reinforced by the way that managements are embracing the
concept of moving shareholder returns up the list of corporate responsibilities.
The signs of this process are numerous and include (1) the adoption of U.S.
accounting principles, the introduction of stock options, the creation of funded
pension plans, and the move in Germany to allow companies to repurchase shares
of their stock; (2) the first contested takeover bid in Switzerland and,
separately, the very logical merger of Sandoz and Ciba, two large Swiss
pharmaceutical/chemical companies; and (3) campaigns against incumbent
managements by French small-shareholders acting as a group, which has led to the
first large-scale corporate de-merger. But perhaps the most powerful evidence
supporting our contention that Europe is changing is that we have seen more
forced changes of management at continental companies in the past two years than
we had seen in the previous seven. Although some stocks are beginning to respond
to this new treatment, it is only the start of a fundamental change. We expect
to see the process accelerate over the coming years.
Outside Europe and Japan, we significantly reduced holdings in many
emerging markets and in the Far Eastern "tiger" economies, but raised our
exposure to Australia from 2% to 7%, compared with an Index weight of 3%. We
believe that the outlook for Australia's resource sector is good, given our
expectation of continued economic expansion. In addition, the election of a
non-Socialist government should allow corporate Australia to accelerate
reorganization of the labor force. This is not reflected in equity valuations,
in stark contrast to the Far Eastern tiger economies.
A general bias within the Portfolio toward cyclical companies reflects our
expectation that economies will continue to grow, a fact not yet built into the
valuation of many companies that are more sensitive to the economic cycle.
Wilson Phillips, Portfolio Manager
Robin Apps, Portfolio Manager
UBS International Investment London Ltd.
January 13, 1997
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PORTFOLIO PROFILE: INTERNATIONAL PORTFOLIO
DECEMBER 31, 1996
This Profile provides a snapshot of the Portfolio's characteristics, compared
where appropriate to an unmanaged index. Key elements of this Profile are
defined on page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- ------------------------------------------------------------
INTERNATIONAL MSCI-EAFE
- ------------------------------------------------------------
<S> <C> <C>
Number of Stocks 158 1,098
Turnover Rate 82% --
Expense Ratio 0.50% --
Cash Reserves 0.5% --
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- --------------------------------------------
INTERNATIONAL MSCI-EAFE
- --------------------------------------------
<S> <C> <C>
R-Squared 0.93 1.00
Beta 0.82 1.00
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION BY REGION
- --------------------------------------------
<S> <C>
EMERGING MARKETS 4%
PACIFIC (MINUS JAPAN) 10%
JAPAN 25%
EUROPE 61%
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- ----------------------------------------------------
<S> <C>
Elf Aquitaine SA 2.9%
British Gas PLC 2.9
Total SA B Shares 2.7
Groupe Danone SA 2.5
Nestle SA (Registered) 2.3
BTR PLC 2.2
Bayer AG 2.1
Yamanouchi Pharmaceuticals Co., Ltd. 2.0
MEPC PLC 1.9
Mount Isa Mines Holdings Ltd. 1.8
- ----------------------------------------------------
Top Ten 23.3%
</TABLE>
"Country Diversification (% of Common Stock)" can be found on page 10.
8
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[PHOTO]
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the fluctuations in the overall market (or appropriate market
index). The market, or index, has a beta of 1.00, so a portfolio with a beta of
1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing investments.
COUNTRY DIVERSIFICATION. The percentage of a global or international portfolio's
common stock invested in securities of various countries.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified it is and the more likely to perform in line with
the overall stock market.
PORTFOLIO ALLOCATION BY REGION. This chart shows the distribution, by
geographic region, of a portfolio's holdings.
R-SQUARED. A measure of how much of a portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio's returns bore no
relationship to the market's returns, its R-squared would be 0.
TEN LARGEST HOLDINGS. The percentage of a portfolio's total net assets in its
ten largest investments (the average for stock mutual funds is about 25%). As
this percentage rises, a portfolio's returns are likely to be more volatile
since they are more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year.
Portfolios with high turnover rates incur higher transaction costs and are more
likely to realize and distribute capital gains (which are taxable to
investors).
9
<PAGE> 12
<TABLE>
<CAPTION>
COUNTRY DIVERSIFICATION (% OF COMMON STOCK)
- ----------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 1995 DECEMBER 31, 1996
----------------------------------------------------------------------
INTERNATIONAL INTERNATIONAL MSCI-EAFE
----------------------------------------------------------------------
<S> <C> <C> <C>
Australia.................................... 1.8% 7.4% 3.0%
Austria...................................... 0.2 -- 0.4
Belgium...................................... -- 0.6 1.2
Canada....................................... 1.6 -- --
Denmark...................................... 0.2 2.0 0.9
Finland...................................... -- -- 0.6
France....................................... 8.5 16.8 6.9
Germany...................................... 5.2 6.5 7.3
Greece....................................... 1.4 0.2 --
Hong Kong.................................... 3.6 -- 3.8
Indonesia.................................... 1.6 1.2 --
Ireland...................................... 1.1 0.2 0.3
Italy........................................ 2.7 1.6 2.8
Japan........................................ 35.8 25.0 34.6
Korea........................................ -- 1.0 --
Malaysia..................................... 1.7 0.6 2.6
Mexico....................................... 1.4 -- --
Netherlands.................................. 5.1 3.2 4.6
New Zealand.................................. 0.8 1.0 0.4
Norway....................................... 0.8 1.9 0.5
Philippines.................................. 0.9 0.6 --
Portugal..................................... 0.9 0.4 --
Singapore.................................... 1.7 0.5 1.3
Spain........................................ 7.8 2.4 2.1
Sweden....................................... 0.5 5.7 2.5
Switzerland.................................. 2.2 4.6 5.7
Thailand..................................... 2.1 0.5 --
Turkey....................................... 1.3 0.5 --
United Kingdom............................... 9.1 15.6 18.5
- -----------------------------------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0%
</TABLE>
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<PAGE> 13
PERFORMANCE SUMMARY: INTERNATIONAL PORTFOLIO
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the Portfolio. Note, too, that
both share price and return can fluctuate widely so that an investment in the
Portfolio could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: 5/16/83-12/31/96
- -----------------------------------------------------
INTERNATIONAL PORTFOLIO MSCI-EAFE
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- -----------------------------------------------------
<S> <C> <C> <C> <C>
1983 4.0% 1.8% 5.8% 11.0%
1984 -4.9 4.1 -0.8 7.9
1985 36.1 4.2 40.3 56.7
1986 46.8 3.9 50.7 69.9
1987 22.1 1.8 23.9 24.9
1988 14.8 4.0 18.8 28.6
1989 22.8 3.2 26.0 10.8
1990 -15.1 2.8 -12.3 -23.2
1991 6.9 3.1 10.0 12.5
1992 -11.0 2.3 -8.7 -11.8
1993 27.0 3.5 30.5 32.9
1994 3.5 1.8 5.3 8.1
1995 7.0 2.6 9.6 11.6
1996 7.5 2.7 10.2 6.4
- ------------------------------------------------------
</TABLE>
See Financial Highlights table on page 17 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE: 12/31/86-12/31/96
[GRAPH]
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1996
---------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INTERNATIONAL PORTFOLIO 10.22% 8.67% 10.48% $27,095
AVERAGE INTERNATIONAL FUND 11.83 9.89 9.32 24,389
MSCI-EAFE INDEX 6.36 8.48 8.74 23,108
- ---------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED 12/31/96
- ------------------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION --------------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
International Portfolio 5/16/83 10.22% 8.67% 7.70% 2.78% 10.48%
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
11
<PAGE> 14
FINANCIAL STATEMENTS
DECEMBER 31, 1996
[PHOTO]
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Portfolio'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
country. Other assets are added to, and liabilities are subtracted from, the
value of Total Investments to calculate the Portfolio's Net Assets. Finally, Net
Assets are divided by the outstanding shares of the Portfolio 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 Portfolio'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 Portfolio 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 Portfolio's investments and their
cost, and reflects the gains (losses) that would be realized if the Portfolio
were to sell all of its investments at their statement-date values.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------
MARKET
VALUE*
INTERNATIONAL PORTFOLIO SHARES (000)
- ------------------------------------------------------------------------
COMMON STOCKS (99.5%)
- ------------------------------------------------------------------------
<S> <C> <C>
AUSTRALIA (7.3%)
Australia & New Zealand Bank
Group Ltd. 1,357,100 $ 8,547
Burns Philp & Co., Ltd. 2,257,000 4,015
Coles Myer Ltd. 1,503,000 6,184
Foster's Brewing Group Ltd. 2,844,000 5,760
Goodman Fielder Ltd. 5,000,000 6,195
Mount Isa Mines Holdings Ltd. 11,950,083 16,705
Pacific Dunlop Ltd. 2,300,000 5,846
Pasminco Ltd. 5,572,000 8,763
Stockland Trust Group Ltd. 2,023,400 5,223
-------------
67,238
-------------
BELGIUM (0.5%)
Societe Generale de
Belgique SA 64,300 5,040
DENMARK (2.0%)
BG Bank A/S 49,200 2,302
Tele Danmark A/S B Shares 287,100 15,818
-------------
18,120
-------------
FRANCE (16.7%)
Alcatel Alsthom SA 30,535 2,448
Banque Nationale de Paris SA 113,282 4,375
Elf Aquitaine SA 291,700 26,500
Eridania Beghin-Say SA 31,900 5,124
Esso SA 10,900 1,115
Etablissements Economiques du
Casino Guichard-Perrachon SA 192,000 8,923
Groupe Danone SA 162,692 22,626
Pechiney SA A Shares 170,000 7,109
Pernod Ricard SA 115,000 6,349
Societe Generale SA 125,000 13,489
Thomson-CSF SA 417,759 13,524
Total SA B Shares 309,986 25,163
Union des Assurances de
Paris SA 657,000 16,366
-------------
153,111
-------------
GERMANY (6.4%)
Bayer AG 477,900 19,475
BHF-Bank AG 193,400 4,430
Hoechst AG 162,800 7,680
# Varta AG 15,480 2,772
Veba AG 250,000 14,438
Volkswagen AG 25,000 10,382
-------------
59,177
-------------
GREECE (0.2%)
Aegek SA 267,260 986
Aegek SA Pfd. 63,120 187
Alpha Credit Bank SA 6,090 387
-------------
1,560
-------------
INDONESIA (1.2%)
PT Astra International (Foreign) 1,368,000 3,764
PT Bank Dagang Nasional
Indonesia (Foreign) 775,250 787
PT Bank Internasional Indonesia
(Foreign) 1,281,384 1,261
PT Indah Kiat Pulp & Paper
(Foreign) 362,180 264
# PT Indah Kiat Pulp & Paper
Warrants Exp. 4/13/01 240,970 74
PT Indosat (Foreign) 262,000 721
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- -----------------------------------------------------------------
<S> <C> <C>
PT Inti Indorayon Utama (Foreign) 545,000 $ 404
PT Kalbe Farma (Foreign) 706,000 807
PT Matahari Putra Prima
(Foreign) 1,219,500 1,420
PT Pabrik Kertas Tjiwi Kimia
(Foreign) 1,549,155 1,541
PT Unilever Indonesia (Foreign) 9,900 173
-------------
11,216
-------------
IRELAND (0.2%)
Greencore Group PLC 283,200 1,797
-------------
ITALY (1.6%)
La Rinascente SPA 589,000 3,376
Stet-Societa Finanziaria
Telefonica SPA 500,000 1,685
Telecom Italia SPA 3,732,000 9,670
-------------
14,731
-------------
JAPAN (25.0%)
# Aoki Corp. 1,628,000 3,380
Calsonic Corp. 81,000 449
Chudenko Corp`. 24,000 691
Chugoku Electric Power Co., Ltd. 184,100 3,585
Fuji Photo Film Co., Ltd. 290,000 9,544
Fujisawa Pharmaceutical
Co., Ltd. 242,000 2,168
Hitachi Ltd. 1,500,000 13,957
Hokkaido Electric Power Co., Ltd. 68,400 1,344
House Foods Industry Corp. 350,000 5,639
Ishikawajima-Harima Heavy
Industries 1,179,000 5,231
Itoham Foods, Inc. 333,000 2,060
JGC Corp. 500,000 3,743
Japan Tobacco, Inc. 500 3,382
Japan Wool Textile Co., Ltd. 207,000 1,705
Kansai Paint Co., Ltd. 300,000 1,344
Koito Manufacturing Co., Ltd. 127,000 848
Kyudenko Corp. 172,000 1,778
Kyushu Electric Power Co., Inc. 215,200 4,172
Marudai Food Co., Ltd. 796,000 4,245
Matsushita Electric Industrial
Co., Ltd. 563,000 9,167
Mitsubishi Chemical Corp. 1,500,000 4,846
Mitsubishi Estate Co., Ltd. 850,000 8,715
Mitsubishi Heavy Industries Ltd. 650,000 5,152
Mitsubishi Materials Corp. 1,840,000 7,419
Nihon Cement Co., Ltd. 750,000 3,819
Nippon Yusen Kabushiki
Kaisha Co. 1,939,000 8,754
Nishimatsu Construction Co. 671,000 5,839
Nissan Fire & Marine Insurance
Co., Ltd. 1,100,000 6,065
Nisshin Oil Mills Ltd. 297,000 1,868
Nisshinbo Industries, Inc. 1,080,000 8,393
Okumura Corp. 300,000 1,820
Sakura Finance Ltd.
.75% Cvt. Pfd. 175 9,272
Sekisui House Ltd. 335,000 3,406
Sony Corp. 50,000 3,270
Sumitomo Forestry Co. 143,000 1,737
Sumitomo Marine & Fire
Insurance Co. 1,350,000 8,374
Tokyu Construction Co., Ltd. 595,000 1,768
Toppan Printing Co., Ltd. 750,000 9,369
Toray Industries, Inc. 1,566,000 9,647
West Japan Railway Co. 2,908 9,395
Yamaha Motor Co., Ltd. 1,559,000 13,969
Yamanouchi Pharmaceuticals
Co., Ltd. 875,000 17,942
-------------
229,271
-------------
KOREA (1.0%)
Hyundai Motor Co., Ltd.
Sponsored GDR 224,500 1,673
# Hyundai Motor Co., Ltd.
Sponsored GDR Rfd. 19,500 145
Korean Air Co. 36,150 595
LG Chemical Ltd. 200,000 1,928
Samsung Heavy Industries Co. 101,580 1,051
Shinhan Bank Co. 122,314 1,955
Yukong Ltd. 100,000 1,892
-------------
9,239
-------------
MALAYSIA (0.6%)
DCB Holdings Bhd. 815,000 2,791
Hong Leong Industries Bhd. 417,200 1,421
Malaysia International Shipping
Corp. Bhd. (Foreign) 530,666 1,576
-------------
5,788
-------------
NETHERLANDS (3.2%)
ABN AMRO Holding NV 224,000 14,556
Internationale Nederlanden
Groep NV 267,338 9,613
Koninklijke KNP BT NV 230,000 5,013
-------------
29,182
-------------
NEW ZEALAND (1.0%)
Brierley Investments Ltd. 4,866,300 4,504
Fletcher Challenge Paper Ltd. 454,200 934
Lion Nathan Ltd. 1,516,100 3,631
-------------
9,069
-------------
NORWAY (1.9%)
Den Norske Bank ASA 586,900 2,243
Norsk Hydro ASA 281,000 15,182
-------------
17,425
-------------
PHILIPPINES (0.6%)
Engineering & Equipment Corp. 8,870,000 587
JG Summit Holdings Inc.
Class B 3,226,000 908
Metropolitan Bank & Trust Co. 32,596 806
# Philex Mining Corp. Class B 3,807,000 434
Philippine Long Distance
Telephone Co. 43,000 2,362
-------------
5,097
-------------
PORTUGAL (0.4%)
Sociedade Construcoes Soares
de Costa SA 84,500 990
# Sonae Industria-Sociedade
Gestora de Participacoes
Sociais SA 54,700 511
Sonae Investimentos-Sociedade
Gestora de Participacoes SA 58,820 1,861
-------------
3,362
-------------
</TABLE>
13
<PAGE> 16
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
MARKET
VALUE*
INTERNATIONAL PORTFOLIO SHARES (000)
- -----------------------------------------------------------------
<S> <C> <C>
SINGAPORE (0.5%)
Dairy Farm International
Holdings Ltd. 1,585,740 $ 1,276
Jardine Strategic Holdings Ltd. 651,000 2,357
Rothmans Industries Ltd. 267,000 1,136
-------------
4,769
-------------
SPAIN (2.4%)
Argentaria SA 158,600 7,084
Aumar-Autopistas del Mare
Nostrum SA (Registered) 471,800 7,400
Repsol SA 200,000 7,657
-------------
22,141
-------------
SWEDEN (5.7%)
Astra AB A Shares 328,000 16,189
Electrolux AB B Shares 218,000 12,643
Marieberg Tidnings AB A Shares 55,000 1,345
SKF AB A Shares 236,000 5,409
Stora Kopparbergs Berglags
AB A Shares 1,206,000 16,603
-------------
52,189
-------------
SWITZERLAND (4.6%)
Georg Fischer AG (Bearer) 3,630 3,758
Kuoni Reisen Holding AG
(Registered) 935 2,263
Nestle SA (Registered) 20,000 21,404
# Novartis AG (Registered) 11,733 13,395
Sulzer AG (Registered) 1,875 1,079
-------------
41,899
-------------
THAILAND (0.5%)
Shinawatra Computer &
Communications PLC (Foreign) 133,000 1,608
Shinawatra Computer &
Communications PLC (Local) 105,000 1,270
Siam Pulp & Paper PLC (Foreign) 251,100 490
Thai Plastic & Chemical PLC
(Foreign) 187,850 641
# Thai Telephone &
Telecommunication PLC
(Foreign) 93,750 84
TPI Polene PLC (Foreign) 91,875 170
-------------
4,263
-------------
TURKEY (0.5%)
Akbank TAS 14,550,000 1,967
Altinyildiz Mensucat Ve
Konfeksiyon Fabrikalari AS 9,965,500 1,348
Netas-Northern Elektrik
Telekomunikasyon AS 3,705,850 832
-------------
4,147
-------------
UNITED KINGDOM (15.5%)
Allied Domecq PLC 1,914,000 15,002
Anglian Water PLC 422,000 4,246
B.A.T. (British American
Tobacco) Industries PLC 1,500,000 12,424
BTR PLC 4,046,000 19,733
British Gas PLC 6,850,000 26,258
Iceland Group PLC 282,400 411
MEPC PLC 2,391,000 17,758
Marley PLC 3,500,000 7,517
National Grid Group PLC 98,673 329
Severn Trent PLC 328,300 3,758
South West Water PLC 244,400 2,522
T & N PLC 1,728,500 5,147
United Biscuits Holdings PLC 2,903,000 10,482
United Utilities PLC 265,000 2,807
Whitbread PLC 805,800 10,852
Williams Holdings PLC 531,100 3,127
-------------
142,373
-------------
- -----------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $870,136) 912,204
- -----------------------------------------------------------------
<CAPTION>
- -----------------------------------------------------------------
FACE
AMOUNT
(000)
- -----------------------------------------------------------------
TEMPORARY CASH INVESTMENT (1.9%)
- -----------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
6.39%, 1/2/97
(COST $17,705) $17,705 17,705
- -----------------------------------------------------------------
TOTAL INVESTMENTS (101.4%)
(COST $887,841) 929,909
- -----------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-1.4%)
- -----------------------------------------------------------------
Other Assets--Notes C and F 201,417
Liabilities--Note F (214,772)
-------------
(13,355)
- -----------------------------------------------------------------
NET ASSETS (100%)
- -----------------------------------------------------------------
Applicable to 33,279,864 outstanding
shares of beneficial interest
(unlimited authorization) $916,554
-------------
=================================================================
NET ASSET VALUE PER SHARE $27.54
=================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
#Non-Income Producing Security.
GDR--Global Depository Receipt.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
AT DECEMBER 31, 1996, NET ASSETS CONSISTED OF:
- -----------------------------------------------------------------
AMOUNT PER
(000) SHARE
- -----------------------------------------------------------------
<S> <C> <C>
Paid in Capital--Note D $852,491 $25.62
Overdistributed Net Investment
Income--Note D (135) --
Accumulated Net Realized
Gains--Note D 22,063 .66
Unrealized Appreciation--Note E
Investment Securities 42,068 1.26
Foreign Currencies 67 --
- -----------------------------------------------------------------
NET ASSETS $916,554 $27.54
=================================================================
</TABLE>
14
<PAGE> 17
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Portfolio
during the reporting period, and details the operating expenses charged to the
Portfolio. 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--these amounts include the effect of foreign currency movements on
the value of the Portfolio's securities. Currency gains (losses) on the
translation of other assets and liabilities, combined with the results of any
investments in forward currency contracts during the period, are shown
separately.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
INTERNATIONAL PORTFOLIO
YEAR ENDED DECEMBER 31, 1996
(000)
- ----------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends* $ 26,293
Interest 2,313
----------
Total Income 28,606
----------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 1,464
Performance Adjustment (94)
The Vanguard Group--Note C
Management and Administrative 2,371
Marketing and Distribution 196
Taxes (other than income taxes) 82
Custodian Fees 674
Auditing Fees 8
Shareholders' Reports 86
Annual Meeting and Proxy Costs 14
Trustees' Fees and Expenses 3
----------
Total Expenses 4,804
- ----------------------------------------------------------------------------
NET INVESTMENT INCOME 23,802
- ----------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 182,286
Foreign Currencies and Forward Currency Contracts 2,349
- ----------------------------------------------------------------------------
REALIZED NET GAIN 184,635
- ----------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities (114,284)
Foreign Currencies and Forward Currency Contracts (783)
- ----------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (115,067)
- ----------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 93,370
============================================================================
</TABLE>
*Dividends are net of foreign withholding taxes of $3,274,000.
15
<PAGE> 18
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Portfolio's total net assets changed during the
two most recent reporting periods. The Operations section summarizes
information that is detailed in the Statement of Operations. The amounts shown
as Distributions to shareholders from the Portfolio'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 Portfolio, either by purchasing
shares or by reinvesting distributions, as well as the amounts redeemed. The
corresponding numbers of Shares Issued and Redeemed are shown at the end of the
Statement.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------
INTERNATIONAL PORTFOLIO
YEAR ENDED DECEMBER 31,
--------------------------
1996 1995
(000) (000)
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 23,802 $ 23,153
Realized Net Gain 184,635 72,176
Change in Unrealized Appreciation (Depreciation) (115,067) (3,263)
--------------------------
Net Increase in Net Assets Resulting from Operations 93,370 92,066
--------------------------
DISTRIBUTIONS
Net Investment Income (23,772) (24,492)
Realized Capital Gain (162,857) (74,633)
--------------------------
Total Distributions (186,629) (99,125)
--------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 166,785 181,298
Issued in Lieu of Cash Distributions 176,984 93,901
Redeemed (322,082) (333,139)
--------------------------
Net Increase (Decrease) from Capital Share Transactions 21,687 (57,940)
- --------------------------------------------------------------------------------------------------------------------------
Total Increase (Decrease) (71,572) (64,999)
- --------------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 988,126 1,053,125
--------------------------
End of Year $916,554 $ 988,126
==========================================================================================================================
(1)Shares Issued (Redeemed)
Issued 5,237 5,672
Issued in Lieu of Cash Distributions 6,434 3,046
Redeemed (10,158) (10,409)
--------------------------
Net Increase (Decrease) in Shares Outstanding 1,513 (1,691)
==========================================================================================================================
</TABLE>
16
<PAGE> 19
FINANCIAL HIGHLIGHTS
This table summarizes the Portfolio's investment results and distributions to
shareholders on a per-share basis. It also presents the Portfolio'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 Portfolio's net
income and total returns from year to year; the relative contributions of net
income and capital gains to the Portfolio's total return; how much it costs to
operate the Portfolio; and the extent to which the Portfolio 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 Portfolio for one year. Finally, the table lists the Portfolio's Average
Commission Rate Paid, a disclosure required by the SEC beginning in 1996. This
rate is calculated by dividing total commissions paid on portfolio securities
by the total number of shares purchased and sold on which commissions were
charged.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
INTERNATIONAL PORTFOLIO
YEAR ENDED DECEMBER 31,
------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, BEGINNING OF YEAR $31.11 $31.48 $31.04 $24.44 $27.78
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INVESTMENT OPERATIONS
Net Investment Income .82 .750 .55 .50 .66
Net Realized and Unrealized Gain (Loss) on Investments 2.20 2.185 1.08 6.91 (3.05)
--------------------------------------------------
Total from Investment Operations 3.02 2.935 1.63 7.41 (2.39)
--------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.82) (.790) (.56) (.81) (.67)
Distributions from Realized Capital Gains (5.77) (2.515) (.63) -- (.28)
--------------------------------------------------
Total Distributions (6.59) (3.305) (1.19) (.81) (.95)
- ------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $27.54 $31.11 $31.48 $31.04 $24.44
========================================================================================================================
TOTAL RETURN 10.22% 9.65% 5.25% 30.49% -8.72%
========================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $917 $988 $1,053 $982 $678
Ratio of Total Expenses to Average Net Assets 0.50% 0.47% 0.34% 0.40% 0.42%
Ratio of Net Investment Income to Average Net Assets 2.50% 2.29% 1.71% 1.76% 2.48%
Portfolio Turnover Rate 82% 47% 40% 39% 51%
Average Commission Rate Paid $.0582 N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
17
<PAGE> 20
NOTES TO FINANCIAL STATEMENTS
Vanguard/Trustees' Equity Fund-International Portfolio is registered under the
Investment Company Act of 1940 as a diversified open-end investment company, or
mutual fund. The Portfolio invests in securities of foreign issuers, which may
subject it to investment risks not normally associated with investing in
securities of United States corporations.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The Portfolio consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Foreign securities listed on an exchange are valued
at the latest quoted sales prices on the appropriate exchange as of the close
of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on
the valuation date. Securities not listed on an exchange are valued at the
latest quoted bid prices. Temporary cash investments are valued at cost, which
approximates market value.
2. FOREIGN CURRENCY: Securities and other assets and liabilities
denominated in foreign currencies are translated into U.S. dollars at the bid
prices of those currencies against U.S. dollars last quoted by major banks as
of 5:00 p.m. Geneva time on the valuation date.
Realized gains (losses) and unrealized appreciation (depreciation) on
investment securities include the effects of changes in exchange rates since
the securities were purchased, combined with the effects of changes in security
prices. Fluctuations in the value of other assets and liabilities resulting
from changes in exchange rates are recorded as unrealized foreign currency
gains (losses) until the asset or liability is settled in cash, when they are
recorded as realized foreign currency gains (losses).
3. FORWARD CURRENCY CONTRACTS: The Portfolio enters into forward currency
contracts to protect the value of securities and related receivables and
payables against changes in foreign exchange rates. The Portfolio's risks in
using these contracts include movement in the values of the foreign currencies
relative to the U.S. dollar and the ability of the counterparties to fulfill
their obligations under the contracts.
Forward currency 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 forward currency
contract gains (losses).
4. FEDERAL INCOME TAXES: The Portfolio 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.
5. REPURCHASE AGREEMENTS: The Portfolio, 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.
6. 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. See Note D.
7. 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.
18
<PAGE> 21
B. Under a contract that expires March 30, 1998, the Portfolio pays UBS
International Investment London Ltd. an investment advisory fee calculated at
an annual percentage rate of average net assets. Prior to April 1, 1996,
Batterymarch Financial Management served as adviser to the Portfolio. The basic
advisory fee paid to Batterymarch was subject to quarterly adjustments based on
performance relative to the Morgan Stanley Capital International-Europe,
Australasia, and Far East Index. For the year ended December 31, 1996, the
aggregate advisory fee represented an effective annual basic rate of 0.15% of
the Portfolio's average net assets before a decrease of $94,000 (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 Portfolio under methods approved by the Board of Trustees. At December
31, 1996, the Portfolio had contributed capital of $84,000 to Vanguard (included
in Other Assets), representing 0.4% of Vanguard's capitalization. The
Portfolio's trustees and officers are also directors and officers of Vanguard.
D. During the year ended December 31, 1996, the Portfolio purchased
$756,928,000 of investment securities and sold $848,169,000 of investment
securities, other than temporary cash investments. Certain of the Portfolio's
investments are in securities considered to be "passive foreign investment
companies," for which any unrealized appreciation and/or realized gains are
required to be included in distributable net investment income for tax purposes.
During the year ended December 31, 1996, the Portfolio realized gains on the
sale of passive foreign investment companies of $706,000 which were included in
1996 and prior years' distributable net income for tax purposes; accordingly
such gains have been reclassified from accumulated net realized gains to
undistributed net investment income.
During the year ended December 31, 1996, the Portfolio realized net foreign
currency losses of $119,000, which decreased distributable net income for tax
purposes; accordingly such losses have been reclassified from accumulated net
realized gains to undistributed net investment income.
During the year ended December 31, 1996, the Portfolio realized $1,860,000
of net capital gains resulting from in-kind redemptions--in which shareholders
exchanged Portfolio shares for securities held by the Portfolio rather than for
cash. Because such gains are not taxable to the Portfolio, and are not
distributed to shareholders, they have been reclassified from accumulated net
realized gains to paid in capital.
E. At December 31, 1996, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $42,068,000,
consisting of unrealized gains of $104,077,000 on securities that had risen in
value since their purchase and $62,009,000 in unrealized losses on securities
that had fallen in value since their purchase. The Portfolio had net unrealized
foreign currency gains of $67,000 resulting from the translation of other assets
and liabilities at December 31, 1996.
F. The market value of securities on loan to broker/dealers at December 31,
1996, was $186,017,000, for which the Portfolio held cash collateral of
$195,275,000.
19
<PAGE> 22
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Trustees of
Vanguard/Trustees' Equity 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/Trustees' Equity Fund-International Portfolio (the "Portfolio") at
December 31, 1996, and the results of its operations, the changes in its net
assets and the financial highlights for each of the periods indicated, in
conformity with generally accepted accounting principles. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the Portfolio's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits, which included confirmation of securities at
December 31, 1996 by correspondence with the custodian and, with respect to
unsettled securities transactions, the application of alternative auditing
procedures, provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
January 31, 1997
SPECIAL 1996 TAX INFORMATION (UNAUDITED)
VANGUARD/TRUSTEES' EQUITY FUND-INTERNATIONAL PORTFOLIO
This information for the fiscal year ended December 31, 1996, is included
pursuant to provisions of the Internal Revenue Code.
The Portfolio designates $158,676,000 as capital gain dividends (from net
long-term capital gains), of which $147,297,000 was distributed to shareholders
in December 1996 and $11,379,000 will be distributed in March 1997.
The Portfolio has elected to pass through the credit for taxes paid in
foreign countries. Shareholders receive detailed information on foreign income
and foreign tax per share by country along with their 1996 Form 1099-DIV.
All comparative mutual fund data are from Lipper Analytical Services, Inc. or
Morningstar unless otherwise noted.
20
<PAGE> 23
TRUSTEES AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director of The Vanguard Group, Inc.
and of each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN, President, Chief Executive Officer, and Director of The
Vanguard Group, Inc. and of each of the investment companies in The
Vanguard Group.
ROBERT E. CAWTHORN, Chairman Emeritus and Director of Rhone-Poulenc Rorer
Inc.; Director of Sun Company, Inc. and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea
Co., Alco Standard Corp., Raytheon Co., Knight-Ridder, Inc., and
Massachusetts Mutual Life Insurance Co.
BRUCE K. MACLAURY, President Emeritus of The Brookings Institution; Director
of American Express Bank Ltd., The St. Paul Companies, Inc., and
National Steel Corp.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl
Corp., Baker Fentress & Co., The Jeffrey Co., and Southern New
England Communications Co.
ALFRED M. RANKIN, JR., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Co.,
and The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and
President of New York University; Director of Pacific Gas and Electric
Co., Procter & Gamble Co., and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc. and
Kmart Corp.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas Co.;
Director of Cummins Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies in
The Vanguard Group.
RICHARD F. HYLAND, Treasurer; Principal of The Vanguard Group, Inc.;
Treasurer of each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller; Principal of The Vanguard Group, Inc.; Controller
of each of the investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President, Information Technology.
JAMES H. GATELY, Senior Vice President, Individual Investor Group.
IAN A. MACKINNON, Senior Vice President, Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President, Institutional.
RALPH K. PACKARD, Senior Vice President and Chief Financial Officer.
[VANGUARD GROUP LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
[email protected] http://www.vanguard.com
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before investing or sending money. Prospectuses
may be obtained directly from The Vanguard Group.
(C) 1996 Vanguard Marketing Corporation, Distributor
<PAGE> 24
THE VANGUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard Selected Value Portfolio
Vanguard/Trustees' Equity-U.S. Portfolio
Vanguard Convertible Securities Fund
BALANCED FUNDS
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LifeStrategy Portfolios
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity-International
Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Treasury Money Market Portfolio
Vanguard Admiral Funds
INCOME FUNDS
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
Q460-12/96
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