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VANGUARD
INTERNATIONAL VALUE
PORTFOLIO
Annual Report - December 31, 1997
[PHOTO]
[THE VANGUARD GROUP LOGO]
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OUR CREW MAKES THE DIFFERENCE
Throughout our history, The Vanguard Group has received considerable attention
as the low-cost provider of mutual funds. While such accolades are gratifying,
we are most proud, not of our low operating expenses or the billions of dollars
we manage, but of our sterling reputation created by the Vanguard crew.
We recognize that it is our crew members--more than 6,000 highly
motivated men and women--who form the cornerstone of our operations. As with any
cornerstone, we could not survive long--let alone prosper--without it. That's
why we chose this fiscal year's annual report to celebrate the spirit,
enthusiasm, and achievements of our crew. (We call those who work at Vanguard
crew members, not employees, because they operate as a team to accomplish our
mission of serving you, our clients.)
But while we prize the collective contributions of our crew, we also
take time to recognize the importance of the individual. Each calendar quarter,
we present our Award For Excellence to a handful of crew members who have
demonstrated particular excellence in the performance of their jobs and who
embody "The Vanguard Spirit." Our report cover shows only a few of the more than
300 crew members who have received this distinction since 1984.
They, along with the rest of our valiant crew, look forward to serving
you in the years ahead.
[PHOTO] [PHOTO]
John C. Bogle John J. Brennan
Chairman President
CONTENTS
<TABLE>
<S> <C>
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
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
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FELLOW SHAREHOLDER,
International stock markets ranged from rewarding to rickety during 1997. But no
matter which outcome occurred in local-currency terms, a strong U.S. dollar cut
sharply into the returns received by U.S. investors. It was a difficult year for
Vanguard International Value Portfolio, and our -4.6% return lagged both of our
principal competitive benchmarks.
The table at right presents the total return (capital change plus
reinvested dividends) of the Portfolio and its benchmarks: the average
international equity fund and the unmanaged Morgan Stanley Capital International
Europe, Australasia, Far East (EAFE) Index. The Portfolio's return is based on a
change in net asset value from $27.54 per share on December 31, 1996, to $22.64
per share on December 31, 1997, adjusted for dividends of $0.69 per share paid
from net investment income and distributions totaling $2.955 per share paid from
net realized capital gains.
<TABLE>
<CAPTION>
- -----------------------------------------------------
TOTAL RETURNS
YEAR ENDED
DECEMBER 31, 1997
- -----------------------------------------------------
<S> <C>
Vanguard International
Value Portfolio* -4.6%
- -----------------------------------------------------
Average International Fund +5.1%
- -----------------------------------------------------
MSCI EAFE Index +2.1%
- -----------------------------------------------------
</TABLE>
*Known as Vanguard/Trustees' Equity Fund-International
Portfolio prior to April 30, 1997.
FINANCIAL MARKETS IN BRIEF
The U.S. and European stock markets continued their powerful advances during
1997, and stocks rose sharply in nearly every Latin American market. In stark
contrast, Asian stock markets were rocked by the actual and anticipated impacts
of a currency crisis that hit South Korea and most of Southeast Asia. A
pervasive rise in the dollar's value against other currencies reduced returns to
U.S. investors virtually across the board, and the overall impact was huge: It
converted the EAFE Index's +13.9% return in local currency terms into a gain of
just +2.1% for U.S. investors.
The adjacent table depicts the extent of this impact. It presents the
total returns earned on various international stock indexes in local currencies,
the reduction in returns due to the dollar's rise, and the net total return in
dollars.
<TABLE>
<CAPTION>
- --------------------------------------------------------
YEAR ENDED DECEMBER 31, 1997
-------------------------------
LOCAL U.S.
CURRENCY CURRENCY DOLLAR
STOCK MARKET INDEX RETURN IMPACT RETURN
- --------------------------------------------------------
<S> <C> <C> <C>
MSCI EAFE +13.9% -11.8% + 2.1%
- --------------------------------------------------------
MSCI Europe +38.4% -14.7% +23.7%
MSCI Pacific -15.6 -10.1 -25.7
MSCI Select
Emerging Markets +24.8 -41.2 -16.4
- --------------------------------------------------------
U.S. (S&P 500 Index) +33.4% -- +33.4%
- --------------------------------------------------------
</TABLE>
Currency losses caused by a rising dollar are a risk that U.S. investors
in international equities incur on top of normal stock-market risks. We note,
however, that currency fluctuations can work the other way, too: When the U.S.
dollar falls versus other currencies, returns from abroad are enhanced for U.S.
investors. The dollar's strength in 1997 was due partly to America's powerful
stock market and economy, where consumer confidence strengthened amid low
inflation and continued solid growth in employment, business activity, and
corporate earnings. These ideal conditions attracted overseas capital, boosting
the demand for dollars and the dollar's price in relation to other currencies.
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However, foreign currencies declined for other reasons as well. In
Europe, economic growth was spotty and there was anxiety about the coming of
European Monetary Union--the replacement of national currencies with a single
currency, the euro. Japan, still Asia's dominant player, continued to suffer
from economic weakness and fear that the government would not or could not
revive the economy. The dollar's value rose above 130 yen, the highest level in
more than five years. Asia's developing markets, which had grown dependent on
foreign capital, began to plummet in early July after Thailand quit trying to
prop up the value of its currency, the baht. Other nations followed suit, as
doubts spread about whether the region's companies could generate the cash flow
needed to repay their debts, many of which were denominated in dollars. Declines
in local stock prices and currencies fed off each other in a vicious cycle,
resulting in extraordinary declines exceeding -60% for the Asian emerging
markets.
1997 PERFORMANCE OVERVIEW
The International Value Portfolio's -4.6% return in 1997 trailed that of the
EAFE Index by 6.7 percentage points and was nearly 10 percentage points behind
the return of the average international fund. Several factors caused our subpar
showing. In general, investors leaned toward large, multinational "growth"
stocks perceived as safe havens in a volatile year. Our Portfolio, on the other
hand, emphasizes "value" stocks, which were out of favor (temporarily, we
expect) and valued at lower price/earnings multiples. Just as in the U.S.
market, growth and value sectors abroad tend to change leadership from time to
time, and we are confident that the value style will, at some point, be
ascendant.
We also were hurt in 1997 by our above-market commitments to several
markets that had mediocre or poor years, as well as by our lighter-than-average
stakes in certain strong markets. In Europe, for example, we began the year with
nearly 17% of our assets in French stocks, more than twice France's share of the
EAFE Index. France's return, about +12% in U.S. dollar terms, was roughly half
the European average. Meanwhile, we held below-market weights in Germany,
Switzerland, and Italy, all of which had big gains.
As for Asia, we began the year with about 25% of our assets in Japan,
below the 32% weighting Japan then represented in EAFE, but still a considerably
larger stake than our peers held in that country. We were, therefore, hurt more
than our peers by Japanese stocks' negative return of nearly -24% in dollar
terms. Moreover, our stake in Australia and New Zealand (8.4% as the year began)
was more than twice the Index weighting for those markets. This weighting hurt
our relative results, even though Australia, off about -9.5% for the year, and
New Zealand, down -13%, were far less impaired than the East Asian markets hit
hardest by the "Asian contagion."
In addition, we proved premature in enlarging our small commitment to
emerging Asian markets such as Thailand and Korea. At midyear, we held about 5%
of our assets in these markets, which proceeded to suffer a disastrous second
half. Finally, we also were hurt in relation to peers by our lack of holdings in
Latin American markets--the year's "hottest" emerging markets. All in all, our
Fund's first full year under the direction of our new adviser, UBS International
Investment London, was not a success.
LONG-TERM PERFORMANCE OVERVIEW
Our 1997 showing detracted from our longer-term record. While we outperformed
the EAFE Index during the past decade, we failed to match the average
international fund's return, due in large part to our performance in the past
year. The table on page 3 displays the decade's results for the Portfolio, our
average peer, and the EAFE Index. It also
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shows how a hypothetical $10,000 investment in each would have grown since 1987,
assuming reinvestment of income dividends and capital gain distributions.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED DECEMBER 31, 1997
--------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- ------------------------------------------------------------------
<S> <C> <C>
Vanguard International
Value Portfolio +7.6% $20,870
- ------------------------------------------------------------------
Average International Fund +9.0% $23,712
- ------------------------------------------------------------------
MSCI EAFE Index +6.6% $18,877
- ------------------------------------------------------------------
</TABLE>
Our Portfolio was helped versus the EAFE Index during the decade by
having somewhat lighter holdings in Japan. Since peaking at the end of 1989,
Japan's stock market has lost well over half of its value in local-currency
terms, and its share of non-U.S. stock market capitalization has fallen from
about 50% to 25%. Through most of the decade, we held a larger stake in Japan
than our competitors held, a significant drawback for us. The meltdown in
Japanese stocks resulted in a negative average annual return of -2.8% over the
past decade for U.S. investors, far from the very solid +14.6% annual return
earned on European stocks. The net result was an average annual return of just
+6.6% for the EAFE Index, a fraction of the stupendous +18.1% annual return on
the Standard & Poor's 500 Composite Stock Price Index for the same period.
We emphasize, however, that future returns of our Portfolio and of
international stocks in general may prove to be higher or lower than the
disappointing results of the past decade. Although annual returns will fluctuate
markedly, we believe the Portfolio's cost advantage will endure and help us in
our quest to provide superior long-term returns. Our annual operating expenses
amounted in 1997 to 0.49% of net assets, more than a full percentage point below
the average international fund's expense ratio of about 1.70%.
IN SUMMARY
Some commentators, citing subpar returns from international stocks in recent
years, have concluded that U.S. investors should shun these stocks entirely.
We're not so sure. Only a few years ago, international stock markets appeared to
be the better-performing asset, and some "experts" were urging U.S. investors to
invest 30% or more of their equity portfolios in international stocks. We were
not so enthusiastic about international stocks then--indeed, our recommendation
to limit foreign stocks to 10% or 20% of investors' equity portfolios seemed
stodgy to some--and we are not overly pessimistic about them now. Nonetheless,
given the obvious economic, market, and currency risks involved, we believe most
investors should continue to adhere to those limits.
We believe that international stocks still make sense for U.S. investors
who understand the risks and who want the extra diversification that they bring
to a balanced core portfolio of U.S. stock funds, bond funds, and money market
funds. Investors who craft such diversified, balanced portfolios--in accordance
with their time horizon, financial situation, and tolerance for market
volatility--should be well prepared to "stay the course" toward long-term
financial goals.
/s/ JOHN C. BOGLE /S/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Chairman of the Board President
January 23, 1998
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THE MARKETS IN PERSPECTIVE
Year Ended December 31, 1997
U.S. EQUITY MARKETS
Despite some year-end rockiness, 1997 again provided U.S. equity investors with
exceptional returns, as illustrated by the 33.4% advance of the S&P 500 Index.
Investors' mettle was tested several times, however, and most severely by the
upheavals that devastated a number of Asian markets in the fourth quarter.
Beginning in late October, the U.S. market grew increasingly volatile, a direct
result of investors' struggle to understand the nature and implications of
Asia's economic turmoil. By the end of the year, it appeared that a new
consensus was emerging, grounded in two basic beliefs: (1) that the collapse of
currencies in the Far East would help keep inflation tame in the United States
and (2) that slower growth in Asia would most likely lead to weaker corporate
profits over the next several years.
As the dust continued to settle, many investors sought havens
traditional in periods of high uncertainty: large-capitalization issues and
particularly the "defensive" sectors of the stock market, such as utilities,
consumer staples, and health care. The closing weeks of 1997 saw a broad advance
in these "safe" sectors, with utilities gaining 20.1% and consumer staples 10.4%
in the last quarter. By contrast, more economically sensitive sectors were
thrashed in the wake of the Asian crisis, with technology issues falling 12.3%
and producer durables down 9.0% over the three months. After posting strong
results in the third quarter, small-company stocks also suffered in the fourth,
falling 3.3%.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED DECEMBER 31, 1997
-------------------------------
1 YEAR 3 YEARS 5 YEARS
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 33.4% 31.2% 20.3%
Russell 2000 Index 22.4 22.3 16.4
MSCI EAFE Index 2.1 6.6 11.7
- ------------------------------------------------------------------------------
FIXED INCOME
Lehman Aggregate Bond Index 9.7% 10.4% 7.5%
Lehman 10-Year Municipal Bond Index 9.2 10.2 7.6
Salomon Brothers Three-Month
U.S. Treasury Bill Index 5.3 5.4 4.7
- ------------------------------------------------------------------------------
OTHER
Consumer Price Index 1.7% 2.5% 2.6%
- ------------------------------------------------------------------------------
</TABLE>
The year-end excitement did not detract from 1997's overall record as a
stellar year for U.S. stock investors. The best-performing sector was financial
services, which rose 46.9%. This sector benefited from a number of factors,
including the strength of the economy, the vibrant financial markets, and merger
activity. By contrast, the commodity-oriented materials & processing sector
posted a gain of "only" 12.3%--in itself more than a percentage point above the
long-term average return from common stocks. Small-cap stocks also fared well
overall, as illustrated by the 22.4% increase of the Russell 2000 Index.
Small-company technology issues were the most glaring exception, mustering a
gain in 1997 of just 1.1%.
U.S. FIXED-INCOME MARKETS
In a year characterized by exceptionally low inflation, interest rates fell,
providing investors with very attractive total returns. The Lehman Aggregate
Bond Index, for example,
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<PAGE> 7
posted a total return of 9.7% for 1997, comprising 7.2% in income return and
2.5% in capital appreciation. The decline in rates can be attributed largely to
better-than-expected reports about the inflation rate. Early in the year,
economists were projecting a 2.9% increase in the Consumer Price Index (CPI)
during 1997. In March, the Federal Reserve grew sufficiently concerned to boost
interest rates by 0.25% in an effort to temper economic growth and thereby ward
off inflation. By year-end, however, the worries seemed to have been
unnecessary, as the actual CPI increase was a mere 1.7%--its smallest increase
since 1986.
The bond market gradually gathered strength during the year as investors
grew more confident that four seemingly strange bedfellows--strong economic
growth, reasonable inflation, low unemployment, and stable wage growth--would
continue to coexist peacefully. In the fourth quarter, the market also was
bolstered by the "flight to quality" among investors concerned about Asia's
problems. Overall, the longest-maturity issues benefited most from the decline
in interest rates. The yield on the 30-year U.S. Treasury bond closed the year
at 5.92%, compared with 6.64% on December 31, 1996. Falling rates flattened the
yield curve considerably: Only 0.57% separated the yield on Treasury bills from
that on the 30-year issue, down from a spread of 1.47% at the end of 1996.
The best-performing sector in 1997 was long-term Treasuries, as
illustrated by the 15.1% return of the Lehman Long U.S. Treasury Index.
Investors in lower-quality securities also fared well, with the Lehman High
Yield Bond Index generating a 12.8% gain. The strength of the economy, together
with the lack of inflationary pressure, created an ideal environment for junk
bonds.
INTERNATIONAL EQUITY MARKETS
Arguably, investors' greatest disappointments were in international
markets--and, of course, Asian markets in particular. During the year, the
Morgan Stanley Capital International (MSCI) Pacific Index declined by 25.7% in
U.S. dollar terms; the Index fell 20.7% in the fourth quarter alone. Among
individual markets, the fiscal year saw sharp declines (in U.S. dollar terms) in
Japan, down 23.6% (including a 19.7% drop in the fourth quarter); Thailand, down
76.8%; and Malaysia, down 68.1%. The general slump in Asian markets began in
midsummer with currency devaluations by a number of countries.
By contrast, the European markets continued to provide U.S. investors
with solid returns, although they, too, stumbled in late October and
subsequently recovered. The MSCI Europe Index posted a gain of 23.7% for the 12
months. The robust character of the European markets reflected strong corporate
earnings and optimism that the European Monetary Union would provide a solid
framework for future fiscal responsibility and economic growth.
5
<PAGE> 8
REPORT FROM THE ADVISER
Vanguard International Value Portfolio provided a return of -4.6% during 1997.
This trailed both the 2.1% return of the MSCI EAFE Index and the 5.1% earned by
the average international equity fund. More details about the Portfolio's
performance are presented in the Message To Shareholders, which begins on
page 1.
We were, on balance, buyers of Japanese stocks during 1997, a decision
that kept the Portfolio's exposure to Japan roughly unchanged at around 25% of
net assets throughout the year. However, this seemingly static position actually
represents a significant change in view. During 1997, Japan declined from being
32.2% of the EAFE Index to 25.1%, reflecting the huge difference in performance
between Japan and Europe during the year. The decision to end the Portfolio's
underweighting in Japan was based on various fundamental valuation criteria,
such as the price-to-book and price-to-cash-flow ratios, by which the Japanese
market now looks cheap relative to its own history and reasonable in relation to
valuations in Western markets.
The continued depressed states of the domestic economy and the currency,
as well as economic upheavals elsewhere in Asia, are increasing pressure on the
Japanese government and on corporate Japan to make the changes required to
"reflate" the economy and to boost corporate profitability. Either result, or
both, would be good for the stock market. Within the Japanese part of the
Portfolio, we have been reducing exposure to exporters. Many of these are good
companies, but their share prices have risen to levels not justified by their
underlying prospects. The proceeds from our sales have been used to add shares
of companies more highly dependent on demand from the domestic economy. These
companies endured a difficult 1997, as the April increase in Japan's consumption
tax hurt consumer confidence. Now that stock prices have fallen dramatically,
they represent, for companies in the more cyclical areas, good value on a
medium-term view. We have also been buying Japanese bank shares following big
price declines, thus reducing our long-standing underweighting in this sector
versus the EAFE Index. Although the banks have by no means finished writing off
their bad debts, at least their share prices now more accurately reflect the
scale of the problem.
As European stock markets rose during the year, we continued to take
profits on many holdings, although the Portfolio's exposure to Europe remained
at around 60% of assets. This represented a move from being 3.5% overweighted in
Europe versus the Index to being 7.4% underweighted.
Within Europe, the Portfolio was invested less heavily than the MSCI
EAFE Index in the United Kingdom and more heavily in Continental Europe, where
valuations were lower and prospects for restructuring were greater. We saw a
continuation of a trend among Continental European corporations to focus on
improving returns to shareholders. This was particularly evident in the
financial sector and in France, which experienced three "hostile" takeovers, a
new phenomenon in Paris. We believe that several forces will continue to provide
momentum for restructurings and mergers leading to greater profitability for
many
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Continental European companies. Among these forces are globalization, whereby
companies embrace opportunities outside their domestic markets; the move toward
European Monetary Union and the deregulation of the European market; and the
ascendancy of a new generation of manager. After the exceptional rise in many
European markets during 1997, much--but not all--of the good news is already
reflected in share prices. Many of our European holdings are under new
management that is committed to doing that bit extra to improve returns for
shareholders.
SIZE MATTERS
- --------------------------------------------------------------------------------
1997 total return, in U.S. dollars, of the median stock in each decile, or 10%
segment, by market capitalization, of the MSCI EAFE Index.
<TABLE>
<CAPTION>
TOTAL RETURNS
<S> <C>
1st Decile 26.8
2nd 27.3
3rd Decile 23.9
4th 16.9
5th Decile 11.9
6th 11.3
7th Decile 10.2
8th -4.6
9th Decile -13.1
10th -53.1
Total MSCI EAFE Index 2.1
</TABLE>
The Portfolio's large exposure to France (15.7% versus an Index
weighting of 8%), which is based on the outlook for individual holdings and not
on a general view of corporate France, has started to pay dividends. Many of
these positions are performing well.
The Portfolio's exposure to emerging markets not included in the EAFE
Index ranged between 4% and 5% of assets throughout most of 1997. Cash from
European stocks sold went to four Asian markets: Korea, Indonesia, the
Philippines, and Thailand. While not wishing to minimize the macroeconomic
problems in the region, we expect a return to above-par economic growth in the
medium term. We increased the Portfolio's exposure to these four markets from
3.3% of assets to 3.9% during the year. In the past, we were unwilling to commit
heavily to the region, but the current loss of confidence provides a good buying
opportunity.
Across the world, we continue to see big disparities between the
valuations of large, internationally owned companies and those of smaller
companies. Broadly speaking, the larger the company, the more expensive its
valuation, which we believe is a relatively new and unsustainable phenomenon.
There are probably two reasons for the disparities. First is a search by
investors for certainty (reliable growth in earnings) in an uncertain world.
Second is that international investors who need to gain exposure to markets
rapidly because of very strong cash inflows naturally turn toward stocks with
high market capitalizations, since these are relatively liquid securities. The
market's tilt toward the big multinationals--as shown in the chart above--made
1997 an extremely difficult year for the true value investor. However, this also
presents an opportunity for value investors, because a large number of companies
are trading below fair value. We believe that by focusing on these--and avoiding
high-priced growth stocks--the Portfolio is well placed for the future.
Wilson Phillips, Portfolio Manager
Robin Apps, Portfolio Manager
UBS International Investment London Limited
January 13, 1998
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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PORTFOLIO PROFILE
International Value Portfolio
This Profile provides a snapshot of the Portfolio's characteristics as of
December 31, 1997, compared where appropriate to an unmanaged index. Key
elements of this Profile are defined on page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- ---------------------------------------------------------
INTERNATIONAL
VALUE MSCI EAFE
- ---------------------------------------------------------
<S> <C> <C>
Number of Stocks 152 1,088
Turnover Rate 37% --
Expense Ratio 0.49% --
Cash Reserves 1.3% --
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION BY REGION
- -------------------------------
<S> <C>
Europe 61%
Japan 26%
Pacific (minus Japan) 9%
Emerging Markets 4%
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- ---------------------------------------------------------
INTERNATIONAL
VALUE MSCI EAFE
- ---------------------------------------------------------
<S> <C> <C>
R-Squared 0.85 1.00
Beta 0.83 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- ---------------------------------------------------------
<S> <C>
Groupe Danone SA 4.8%
Nestle SA (Registered) 3.8
Bayer AG 3.6
Elf Aquitaine SA 3.0
Electrolux AB B Shares 2.9
BTR PLC 2.6
Allied Domecq PLC 2.5
Akzo Nobel NV 2.4
AXA-UAP SA 2.1
BG PLC 2.1
- ---------------------------------------------------------
Top Ten 29.8%
</TABLE>
Country Diversification (% of Common Stock) can be found on page 10.
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BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a 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 securities.
COUNTRY DIVERSIFICATION. The percentages of a 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 geographic distribution 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 net assets that a portfolio has invested
in its ten largest holdings. (The average for stock mutual funds is about 30%.)
As this percentage rises, a portfolio's returns are likely to be more volatile
because they are more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year.
Portfolios with high turnover rates incur higher transaction costs and are more
likely to distribute capital gains (which are taxable to investors).
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PORTFOLIO PROFILE (CONTINUED)
<TABLE>
<CAPTION>
COUNTRY DIVERSIFICATION (% OF COMMON STOCK)
- ------------------------------------------------------------------------
DECEMBER 31, 1996 DECEMBER 31, 1997
-----------------------------------------------
INTERNATIONAL INTERNATIONAL
VALUE VALUE MSCI EAFE
-----------------------------------------------
<S> <C> <C> <C>
Australia ............... 7.4% 5.9% 2.8%
Austria ................. 0.0 0.0 0.4
Belgium ................. 0.6 0.0 1.3
Denmark ................. 2.0 2.4 1.1
Finland ................. 0.0 0.0 0.8
France .................. 16.8 15.9 8.0
Germany ................. 6.5 8.1 9.8
Greece .................. 0.2 0.0 0.0
Hong Kong ............... 0.0 0.0 2.8
Indonesia ............... 1.2 0.4 0.0
Ireland ................. 0.2 0.0 0.4
Italy ................... 1.6 1.5 4.0
Japan ................... 25.0 26.0 25.1
Korea ................... 1.0 1.4 0.0
Malaysia ................ 0.6 0.2 0.8
Netherlands ............. 3.2 5.3 5.7
New Zealand ............. 1.0 0.8 0.3
Norway .................. 1.9 0.4 0.5
Philippines ............. 0.6 0.8 0.0
Portugal ................ 0.4 0.7 0.6
Singapore ............... 0.5 2.1 0.9
Spain ................... 2.4 0.0 2.7
Sweden .................. 5.7 5.1 2.6
Switzerland ............. 4.6 4.6 7.8
Thailand ................ 0.5 1.3 0.0
Turkey .................. 0.5 0.0 0.0
United Kingdom .......... 15.6 17.1 21.6
- ------------------------------------------------------------------------
Total ................... 100.0% 100.0% 100.0%
</TABLE>
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PERFORMANCE SUMMARY
International Value 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 an investment in the
Portfolio could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: MAY 16, 1983-DECEMBER 31, 1997
- --------------------------------------------------------------
INTERNATIONAL VALUE 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
1997 -7.2 2.6 -4.6 2.1
- --------------------------------------------------------------
</TABLE>
See Financial Highlights table on page 17 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: DECEMBER 31, 1987-DECEMBER 31, 1997
- -------------------------------------------------------------------------
INTERNATIONAL VALUE LIPPER INTERNATIONAL MSCI EAFE
PORTFOLIO FUND INDEX
- -------------------------------------------------------------------------
<S> <C> <C> <C>
1987 12 10000 10000 10000
1988 03 10869 10904 11532
1988 06 11118 10836 11033
1988 09 10904 10624 11111
1988 12 11878 11653 12859
1989 03 12170 12123 12902
1989 06 12274 12042 12113
1989 09 14439 13582 13622
1989 12 14963 14246 14247
1990 03 14222 13440 11438
1990 06 15431 14450 12540
1990 09 12653 11963 9891
1990 12 13128 12543 10942
1991 03 13637 13395 11766
1991 06 13184 13007 11133
1991 09 14173 13825 12097
1991 12 14435 14094 12310
1992 03 13640 13595 10859
1992 06 14313 14272 11098
1992 09 13604 13535 11276
1992 12 13176 13376 10851
1993 03 14498 14511 12162
1993 06 15527 15411 13395
1993 09 16539 16794 14293
1993 12 17194 18644 14426
1994 03 17682 18103 14940
1994 06 18327 18509 15713
1994 09 18565 19058 15739
1994 12 18098 18514 15589
1995 03 18122 17724 15892
1995 06 18715 18681 16020
1995 09 19261 19620 16700
1995 12 19844 20226 17390
1996 03 20610 20592 17905
1996 06 20971 21601 18202
1996 09 20964 21467 18193
1996 12 21871 22619 18496
1997 03 22107 22417 18219
1997 06 24576 25133 20598
1997 09 23933 25423 20466
1997 12 20870 23768 18877
- -------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1997
----------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
International Value Portfolio -4.58% 9.63% 7.63% $20,870
Average International Fund 5.08 12.15 9.02 23,712
MSCI EAFE Index 2.06 11.71 6.56 18,877
- ------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997
- -------------------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION --------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
International Value Portfolio 5/16/1983 -4.58% 9.63% 4.79% 2.84% 7.63%
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
11
<PAGE> 14
FINANCIAL STATEMENTS
December 31, 1997
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 sub-tracted 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
INTERNATIONAL VALUE*
VALUE PORTFOLIO SHARES (000)
- -----------------------------------------------------------------------
COMMON STOCKS (98.7%)
- -----------------------------------------------------------------------
<S> <C> <C>
AUSTRALIA (5.8%)
Australia & New Zealand
Bank Group Ltd. 591,000 $ 3,905
Burns Philp & Co., Ltd. 2,304,020 360
Coles Myer Ltd. 1,000,000 4,802
Foster's Brewing Group Ltd. 2,844,000 5,411
Goodman Fielder Ltd. 3,027,000 4,812
Mount Isa Mines Holdings Ltd. 12,148,873 7,441
Pacific Dunlop Ltd. 2,300,000 4,871
Pasminco Ltd. 5,883,000 6,746
Stockland Trust Group 2,023,400 4,690
- - Stockland Trust Group (New) 74,658 168
WMC Ltd. 507,000 1,767
----------
44,973
----------
DENMARK (2.4%)
BG Bank A/S 69,310 4,667
Tele Danmark A/S B Shares 224,100 13,910
----------
18,577
----------
FRANCE (15.7%)
AXA-UAP SA 210,000 16,257
Alcatel Alsthom SA 30,535 3,883
- - Banque Nationale de Paris SA 172,871 9,193
Compagnie de Saint-Gobain SA 86,852 12,344
Elf Aquitaine SA 199,700 23,237
Esso SA 8,063 662
Groupe Danone SA 208,882 37,326
Lafarge SA 50,000 3,282
Societe National d'Exploitation
Industrielle de Tabacs et
Allumettes SA 137,844 4,949
Total SA B Shares 97,800 10,648
----------
121,781
----------
GERMANY (8.0%)
Bayer AG 745,030 27,845
Man AG 32,700 9,475
Schering AG 87,530 8,446
- - Varta AG 15,480 2,238
Volkswagen AG 25,000 14,071
----------
62,075
----------
INDONESIA (0.4%)
PT Bank Dagang Nasional
Indonesia (Foreign) 3,100,998 198
PT Bank Internasional
Indonesia (Foreign) 14,342,000 848
PT Indah Kiat Pulp &
Paper Corp. 7,786,985 1,382
- - PT Indah Kiat Pulp &
Paper Corp.
Warrants Exp. 7/11/2002 96,504 3
- - PT Inti Indorayon Utama 545,000 55
PT Kalbe Farma 706,000 125
PT Pabrik Kertas Tjiwi Kimia 2,788,466 685
- - PT Pabrik Kertas Tjiwi Kimia
Warrants Exp. 7/15/2002 387,285 21
PT Unilever Indonesia 9,900 54
----------
3,371
----------
ITALY (1.4%)
Ente Nazionale Idrocarburi SPA 1,960,800 11,204
----------
JAPAN (25.8%)
Chugoku Electric Power Co., Ltd. 184,100 2,662
Fuji Photo Film Co., Ltd. 230,000 8,845
Hitachi Ltd. 1,731,000 12,381
Hokkaido Electric Power
Co., Ltd. 68,400 968
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- -----------------------------------------------------------------------
<S> <C> <C>
Ishikawajima-Harima
Heavy Industries Co. 1,179,000 $ 1,768
Itoham Foods, Inc. 333,000 1,583
JGC Corp. 698,000 1,476
Japan Tobacco, Inc. 537 3,824
Japan Wool Textile Co., Ltd. 257,000 889
Kajima Corp. 600,000 1,518
Kansai Paint Co., Ltd. 1,050,000 2,544
Koito Manufacturing Co., Ltd. 827,000 3,307
Kyudenko Corp. 172,000 872
Kyushu Electric Power Co., Inc. 215,200 3,112
- - Marudai Food Co., Ltd. 796,000 1,751
Matsushita Electric Industrial
Co., Ltd. 670,000 9,842
Mitsubishi Chemical Corp. 3,387,000 4,871
Mitsubishi Estate Co., Ltd. 1,135,000 12,396
Mitsubishi Heavy
Industries Ltd. 650,000 2,720
Mitsubishi Materials Corp. 1,840,000 2,972
Nihon Cement Co., Ltd. 1,530,000 3,165
Nikko Securities Co., Ltd. 2,315,000 6,160
Nippon Yusen Kabushiki
Kaisha Co. 2,708,000 7,456
Nishimatsu Construction Co. 671,000 2,116
Nissan Fire & Marine
Insurance Co., Ltd. 1,154,000 3,524
Nisshin Oil Mills Ltd. 297,000 740
Nisshinbo Industries, Inc. 1,145,000 4,843
Okumura Corp. 300,000 715
Sakura Finance Ltd.
0.75% Cvt. Pfd. 273 9,071
Sanwa Bank Ltd. 395,000 4,010
Sekisui House Ltd. 335,000 2,162
Sharp Corp. 560,000 3,868
Sumitomo Forestry Co. 143,000 698
Sumitomo Marine & Fire
Insurance Co. 1,350,000 7,164
Sony Corp. 50,000 4,461
Tokyo Gas Co., Ltd. 3,067,000 6,982
Tokyo Steel Manufacturing Co. 725,000 2,459
Tokyu Construction Co., Ltd. 595,000 421
Toppan Printing Co., Ltd. 750,000 9,806
Toray Industries, Inc. 684,000 3,078
Tostem Corp. 721,000 7,763
Toyo Seikan Kaisha Ltd. 455,000 6,509
West Japan Railway Co. 2,908 9,304
Yamaha Motor Co., Ltd. 919,000 6,185
Yamanouchi Pharmaceuticals
Co., Ltd. 358,000 7,710
----------
200,671
----------
KOREA (1.4%)
Housing & Commercial Bank 16,610 112
Hyundai Motor Co., Ltd. 113,110 1,248
- - Hyundai Motor Co., Ltd. GDR 380,000 637
- - Korean Airlines Co. 139,560 586
LG Chemical Ltd. 200,000 920
Pohang Iron & Steel Co., Ltd. 840 24
SK Telecom Co. 5,562 1,774
Samsung Electronics 1,026 23
- - Samsung Heavy Industries Co. 101,580 225
Shinhan Bank Co. 574,174 2,558
Yukong Ltd. 370,600 2,952
----------
11,059
----------
MALAYSIA (0.2%)
Hong Leong Industries Bhd. 417,200 424
Malaysia International
Shipping Corp., Bhd. (Foreign) 530,666 777
----------
1,201
----------
NETHERLANDS (5.2%)
Akzo Nobel NV 106,400 18,349
ING Groep NV 181,099 7,629
Koninklijke KNP BT NV 250,000 5,759
Koninklijke PTT Nederland NV 126,838 5,293
Philips Electronics NV 55,000 3,299
----------
40,329
----------
NEW ZEALAND (0.8%)
Brierley Investments Ltd. 2,736,300 1,954
Fletcher Challenge Ltd. Forest 18,168 15
Fletcher Challenge Ltd. Paper 454,200 593
Lion Nathan Ltd. 1,516,100 3,398
----------
5,960
----------
NORWAY (0.4%)
Den Norske Bank ASA 586,900 2,770
----------
PHILIPPINES (0.7%)
EEI Corp. 4,435,000 89
JG Summit Holdings Inc.
Class B 3,226,000 267
Metropolitan Bank & Trust Co. 1,266 9
- - Philex Mining Corp. Class B 5,710,500 143
Philippine Long Distance
Telephone Co. 86,000 1,897
San Miguel Corp. Class B 2,714,000 3,367
----------
5,772
----------
PORTUGAL (0.7%)
Electricidade de Portugal SA 300,000 5,687
----------
SINGAPORE (2.1%)
Dairy Farm International
Holdings Ltd. 1,585,740 1,713
Development Bank of
Singapore Ltd. (Foreign) 208,000 1,778
Hongkong Land Holdings, Ltd. 2,000,000 3,840
Jardine Strategic Holdings Ltd. 651,000 1,719
Keppel Corp., Ltd. 1,465,250 4,209
Rothmans Industries Ltd. 267,000 1,394
United Overseas Land Ltd. 1,500,000 1,264
----------
15,917
----------
SWEDEN (5.0%)
Astra AB A Shares 288,000 4,991
Electrolux AB B Shares 325,695 22,618
Foreningsbank Kredit
AB A Shares 130,000 2,957
Stora Kopparbergs Berglags
AB A Shares 660,000 8,318
----------
38,884
----------
SWITZERLAND (4.5%)
Nestle SA (Registered) 19,700 29,566
Schindler Holding AG (Ptg. Ctf.) 5,530 5,771
----------
35,337
----------
</TABLE>
13
<PAGE> 16
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------
MARKET
INTERNATIONAL VALUE*
VALUE PORTFOLIO SHARES (000)
- -----------------------------------------------------------------------
<S> <C> <C>
THAILAND (1.3%)
Bangkok Bank PLC (Foreign) 955,000 $ 2,380
Italian-Thai Development
PLC (Foreign) 221,100 69
Shinawatra Computer &
Communications PLC (Foreign) 795,400 2,643
Siam Pulp & Paper PLC (Foreign) 251,100 163
TPI Polene PLC (Foreign) 91,875 4
- - TelecomAsia PLC (Foreign) 4,618,000 882
Thai Farmers Bank
PLC (Foreign) 1,737,000 3,157
Thai Military Bank
PLC (Foreign) 1,106,400 234
Thai Plastic & Chemical
PLC (Foreign) 187,850 339
- - Thai Telephone &
Telecommunication
PLC (Foreign) 140,625 18
----------
9,889
----------
UNITED KINGDOM (16.9%)
Allied Domecq PLC 2,209,400 19,049
B.A.T. (British American
Tobacco) Industries PLC 1,500,000 13,673
BG PLC 3,557,000 16,036
BTR PLC 6,566,314 19,880
Coats Viyella PLC 1,691,500 2,533
Iceland Group PLC 312,750 679
MEPC PLC 1,500,000 12,538
Marley PLC 3,500,000 5,413
Peninsular & Oriental Steam
Navigation Co. 115,451 1,316
Safeway PLC 1,145,150 6,463
Severn Trent PLC 322,925 5,197
T & N PLC 2,101,638 8,818
- - Tarmac PLC 2,655,000 4,980
United Biscuits Holdings PLC 2,613,000 9,674
United Utilities PLC 265,000 3,401
Williams PLC 306,100 1,702
----------
131,352
----------
- ----------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $865,847) 766,809
- ----------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE MARKET
AMOUNT VALUE*
(000) (000)
- ----------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (12.1%)
- ----------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
6.54%, 1/2/1998 $ 7,349 $ 7,349
6.50%, 1/2/1998--Note F 86,473 86,473
- ----------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $93,822) 93,822
- ----------------------------------------------------------------------
TOTAL INVESTMENTS (110.8%)
(COST $959,669) 860,631
- ----------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-10.8%)
- ----------------------------------------------------------------------
Other Assets--Note C 13,485
Security Lending Collateral
Payable to Brokers--Note F (86,473)
Other Liabilities (10,881)
----------
(83,869)
- ----------------------------------------------------------------------
NET ASSETS (100%)
- ----------------------------------------------------------------------
Applicable to 34,303,996 outstanding
shares of beneficial interest
(unlimited authorization) $776,762
======================================================================
NET ASSET VALUE PER SHARE $22.64
======================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
- -Non-Income-Producing Security.
GDR--Global Depositary Receipt.
(Ptg. Ctf.)--Participating Certificate.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
AT DECEMBER 31, 1997, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ----------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $862,286 $25.14
Overdistributed Net Investment
Income--Note D (115) --
Accumulated Net Realized
Gains--Note D 13,857 .40
Unrealized Depreciation--Note E
Investment Securities (99,038) (2.89)
Foreign Currencies (228) (.01)
- ----------------------------------------------------------------------
NET ASSETS $776,762 $22.64
======================================================================
</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. Cur-rency 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 VALUE PORTFOLIO
YEAR ENDED DECEMBER 31, 1997
(000)
- --------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends* $ 24,363
Interest 1,307
----------
Total Income 25,670
----------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 1,371
Performance Adjustment --
The Vanguard Group--Note C
Management and Administrative 2,299
Marketing and Distribution 193
Custodian Fees 493
Auditing Fees 9
Shareholders' Reports 33
Annual Meeting and Proxy Costs 11
Trustees' Fees and Expenses 2
----------
Total Expenses 4,411
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 21,259
- --------------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 83,703
Foreign Currencies 30
- --------------------------------------------------------------------------------
REALIZED NET GAIN 83,733
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities (141,106)
Foreign Currencies (295)
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (141,401)
- --------------------------------------------------------------------------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (36,409)
================================================================================
</TABLE>
*Dividends are net of foreign withholding taxes of $3,161,000.
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
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 VALUE PORTFOLIO
YEAR ENDED DECEMBER 31,
-----------------------------
1997 1996
(000) (000)
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 21,259 $ 23,802
Realized Net Gain 83,733 184,635
Change in Unrealized Appreciation (Depreciation) (141,401) (115,067)
-----------------------------
Net Increase (Decrease) in Net Assets Resulting from Operations (36,409) 93,370
-----------------------------
DISTRIBUTIONS
Net Investment Income (21,269) (23,772)
Realized Capital Gain (91,909) (162,857)
-----------------------------
Total Distributions (113,178) (186,629)
-----------------------------
CAPITAL SHARE TRANSACTIONS1
Issued 208,395 166,785
Issued in Lieu of Cash Distributions 105,942 176,984
Redeemed (304,542) (322,082)
-----------------------------
Net Increase from Capital Share Transactions 9,795 21,687
- -------------------------------------------------------------------------------------------------------------
Total Decrease (139,792) (71,572)
- -------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 916,554 988,126
-----------------------------
End of Year $ 776,762 $ 916,554
=============================================================================================================
(1)Shares Issued (Redeemed)
Issued 7,512 5,237
Issued in Lieu of Cash Distributions 4,564 6,434
Redeemed (11,052) (10,158)
-----------------------------
Net Increase in Shares Outstanding 1,024 1,513
=============================================================================================================
</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 Securities and Exchange
Commission 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 VALUE PORTFOLIO
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $27.54 $31.11 $31.48 $31.04 $24.44
- ------------------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .690 .82 .750 .55 .50
Net Realized and Unrealized Gain (Loss) on Investments (1.945) 2.20 2.185 1.08 6.91
---------------------------------------------------------------
Total from Investment Operations (1.255) 3.02 2.935 1.63 7.41
---------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.690) (.82) (.790) (.56) (.81)
Distributions from Realized Capital Gains (2.955) (5.77) (2.515) (.63) --
---------------------------------------------------------------
Total Distributions (3.645) (6.59) (3.305) (1.19) (.81)
- ------------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $22.64 $27.54 $31.11 $31.48 $31.04
====================================================================================================================================
TOTAL RETURN -4.58% 10.22% 9.65% 5.25% 30.49%
====================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $777 $917 $988 $1,053 $982
Ratio of Total Expenses to Average Net Assets 0.49% 0.50% 0.47% 0.34% 0.40%
Ratio of Net Investment Income to Average Net Assets 2.36% 2.50% 2.29% 1.71% 1.76%
Portfolio Turnover Rate 37% 82% 47% 40% 39%
Average Commission Rate Paid $.0147 $.0582 N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
17
<PAGE> 20
NOTES TO FINANCIAL STATEMENTS
Vanguard International Value Portfolio (formerly 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. 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.
4. 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.
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. UBS International Investment London Ltd. provides investment advisory
services to the Portfolio for a fee calculated at an annual percentage rate of
average net assets. The basic advisory fee is subject to quarterly adjustments
based on performance relative to the Morgan Stanley Capital International
Europe, Australasia, Far East Index. For the year ended December 31, 1997, the
advisory fee represented an effective annual basic rate of 0.15% of the
Portfolio's average net assets, with no adjustment required 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, 1997, the Portfolio had contributed capital of $55,000 to
Vanguard (included in Other Assets), representing 0.3% of Vanguard's
capitalization. The Portfolio's Trustees and officers are also Directors and
officers of Vanguard.
18
<PAGE> 21
D. During the year ended December 31, 1997, the Portfolio purchased
$327,660,000 of investment securities and sold $414,222,000 of investment
securities, other than temporary cash investments.
During the year ended December 31, 1997, the Portfolio realized net
foreign currency gains of $30,000, which increased distributable net income for
tax purposes; accordingly, such gains have been reclassified from accumulated
net realized gains to undistributed net investment income.
E. At December 31, 1997, net unrealized depreciation of investment
securities for financial reporting and federal income tax purposes was
$99,038,000, consisting of unrealized gains of $102,076,000 on securities that
had risen in value since their purchase and $201,114,000 in unrealized losses on
securities that had fallen in value since their purchase.
The Portfolio had net unrealized foreign currency losses of $228,000
resulting from the translation of other assets and liabilities at December 31,
1997.
F. The market value of securities on loan to brokers/dealers at December
31, 1997, was $80,582,000, for which the Portfolio held cash collateral of
$86,473,000. Cash collateral received is invested in repurchase agreements.
19
<PAGE> 22
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Trustees of
Vanguard International Value Portfolio
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 International Value Portfolio (formerly Vanguard/Trustees' Equity
Fund-International Portfolio, hereafter referred to as the "Portfolio") at
December 31, 1997, the results of its operations for the year then ended, the
changes in its net assets for each of the two years in the period then ended and
the financial highlights for each of the five years in the period then ended, in
conformity with generally accepted accounting principles. These financial
statements and financial highlights (hereafter referred to as "financial
statements") are the responsibility of the 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, 1997 by correspondence with the custodian and the application of
alternative auditing procedures where securities purchased had not been settled,
provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
February 6, 1998
SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR VANGUARD INTERNATIONAL VALUE
PORTFOLIO
This information for the fiscal year ended December 31, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Portfolio designates $70,038,000 as capital gain dividends (from net
long-term capital gains), of which $58,571,000 was distributed to shareholders
in December 1997 and $11,467,000 will be distributed in March 1998. Of the
$70,038,000 capital gain dividends, the Portfolio designates $26,148,000 as a
20% rate gain distribution.
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 1997 Form 1099-DIV.
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.; Managing
Director of Global Health Care Partners/DLJ Merchant Banking Partners; Director
of Sun Company, Inc., and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions, Inc.,
Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance Co., and
Ladies Professional Golf Association; Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
BURTON G. MALKIEL
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Amdahl Corp., Baker Fentress & Co., The
Jeffrey Co., and Southern New England Telecommunications 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. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
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
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM MCNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," and
"500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell Company
is the owner of trademarks and copyrights relating to the Russell
Indexes. "Wilshire 4500" and "Wilshire 5000" are trademarks of
Wilshire Associates.
<PAGE> 24
VANGUARD FAMILY OF FUNDS
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State Tax-Free Funds
(CA, NJ, NY, OH, PA)
Q460-12/1997
(C) 1998 Vanguard Marketing
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[THE VANGUARD GROUP LOGO]
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and should be read carefully before you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
