<PAGE> 1
VANGUARD
INTERNATIONAL VALUE
FUND
[PHOTO]
ANNUAL
REPORT
DECEMBER 31, 1998
[THE VANGUARD GROUP LOGO]
<PAGE> 2
AT VANGUARD, WE BELIEVE THAT TRADITION MATTERS
Our 8,000 crew members embrace the traditional values on which our success is
built, including integrity, hard work, thrift, teamwork, and fair dealing on
behalf of our clients.
This year, our report cover pays homage to three anniversaries, each of great
significance to The Vanguard Group:
- - The 200th anniversary of the Battle of the Nile, which commenced on August 1,
1798. HMS Vanguard, the victorious British flagship at the Nile, is our
namesake. And its motto--"Leading the way"--serves as a guiding principle for
our company.
- - The 100th birthday, on July 23, of Walter L. Morgan, founder of Wellington
Fund, the oldest member of what became The Vanguard Group. Mr. Morgan was
friend and mentor to Vanguard founder John C. Bogle, and helped to shape the
standards and business principles that Mr. Bogle laid down for Vanguard at
its beginning nearly 25 years ago: a stress on balanced, diversified
investments; insistence on fair dealing and candor with clients; and a focus
on long-term investing. To our great regret, Mr. Morgan died on September 2.
- - The 70th anniversary, on December 28, of the incorporation of Vanguard
Wellington Fund. It is the nation's oldest balanced mutual fund, and one of
only a handful of funds created in the 1920s that are still in operation.
Although Vanguard constantly tackles new challenges, adopts new technology, and
develops new services, we treasure the traditions and values that set us apart
in a crowded, competitive industry. And we salute our shareholders, whose
support and trust we strive to earn each and every day.
[PHOTO]
CONTENTS
A MESSAGE TO
OUR SHAREHOLDERS
1
THE MARKETS IN
PERSPECTIVE
4
REPORT FROM
THE ADVISER
6
FUND PROFILE
8
PERFORMANCE SUMMARY
11
FINANCIAL STATEMENTS
12
REPORT OF
INDEPENDENT ACCOUNTANTS
20
All comparative mutual fund data
are from Lipper or Morningstar,
unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
[PHOTO] [PHOTO]
John J. Brennan John C. Bogle
Chairman & CEO Senior Chairman
Vanguard International Value Fund sailed adroitly through choppy seas to produce
strong returns during 1998. Your fund earned +19.5%, fully 1 1/2 times the
return of the average international mutual fund but slightly behind the return
of its unmanaged index.
The table below presents the total return (capital change plus reinvested
dividends) of International Value Fund, the average international equity fund,
and the unmanaged Morgan Stanley Capital International Europe, Australasia, Far
East (EAFE) Index. The fund's return is based on an increase in net asset value
from $22.64 per share on December 31, 1997, to $25.09 per share on December 31,
1998, adjusted for income dividends totaling $1.06 per share paid from net
investment income and distributions totaling $0.90 per share paid from net
realized capital gains.
<TABLE>
<CAPTION>
- -----------------------------------------------------------
TOTAL RETURNS
YEAR ENDED
DECEMBER 31, 1998
- -----------------------------------------------------------
<S> <C>
Vanguard International Value Fund +19.5%
- -----------------------------------------------------------
Average International Fund +13.0%
- -----------------------------------------------------------
MSCI EAFE Index +20.3%
- -----------------------------------------------------------
</TABLE>
FINANCIAL MARKETS IN BRIEF
European stocks once again rose smartly during 1998, gaining about +23% in
local-currency terms. Pacific-region stocks, which are dominated by Japan,
declined -7% in terms of their local currencies. For U.S. investors, however,
returns from European and Pacific stocks were boosted by a fall in the value of
the U.S. dollar versus the Japanese yen and most European currencies. The result
was a solid gain of +28.7% for the European component of the EAFE Index and a
meager +2.6% rise for the Pacific component. U.S. investors in emerging-market
stocks were hit with a double whammy: Declines of about -6% in local currencies
were worsened by a stronger dollar, resulting in a drop of -18.4% for U.S.
investors.
As demonstrated in 1998, fluctuations in currency values can add to or
detract from returns that U.S. investors receive on international investments.
These currency fluctuations are a risk that U.S. investors incur in addition to
the substantial risk of stock-price fluctuations. The table at right presents
the impact of currency fluctuations on returns during 1998. It shows the total
returns of various international stock indexes in local currencies, the effect
on returns of currency fluctuations, and the net returns for dollar-based
investors.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
TOTAL RETURNS
12 MONTHS ENDED DECEMBER 31, 1998
-----------------------------------------
LOCAL
CURRENCY CURRENCY U.S. DOLLAR
STOCK MARKET INDEX RETURNS IMPACT RETURNS
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
MSCI EAFE +13.0% + 7.3% +20.3%
- ----------------------------------------------------------------------------------
MSCI Europe +22.8% + 5.9% +28.7%
MSCI Pacific - 7.2 + 9.8 + 2.6
MSCI Select Emerging Markets - 6.1 -12.3 -18.4
- ----------------------------------------------------------------------------------
U.S. (S&P 500 Index) +28.6% -- +28.6%
- ----------------------------------------------------------------------------------
</TABLE>
European stocks benefited from several developments during 1998. First
was an expansion in economic activity in the region. Europe's central banks cut
short-term
1
<PAGE> 4
interest rates to encourage continued growth. Another influence was optimism
about the long-term effects of the euro, the common currency adopted by 11
European nations beginning in 1999. Investors also were encouraged by increased
merger-and-acquisition activity and by continuing signs that European
corporations are more focused on boosting share prices.
Most Asian markets--including Tokyo--continued to be weighed down by
severe economic troubles. Japan's economy shrank, which was bad news for the
rest of the region because of Japan's key role as a market and source of
financing for many of its Asian neighbors. On the other hand, there were signs
even in Japan that some companies are moving toward a U.S.-style corporate
emphasis on providing value for shareholders rather than on building market
share or protecting corporate allies. Except for South Korea and the
Philippines, Asia's developing markets declined during 1998, although most of
the damage occurred during the first half of the year. Latin America's emerging
markets suffered from the same lack of confidence that afflicted Asia.
1998 PERFORMANCE OVERVIEW
Thanks primarily to the strong rise in European stocks during 1998, the
International Value Fund earned +19.5%. Our return was 6.5 percentage points
higher than the +13.0% earned by the average international fund, though we
trailed by 0.8 percentage point the EAFE Index's +20.3% gain.
A number of factors account for our lead over our average peer. First,
the stock selections of our adviser, Phillips & Drew, were generally quite good.
Our weightings in various countries--which are driven primarily by our adviser's
company-by-company analysis of stock values--had mixed effects on performance.
We held about 15% of our equities in French stocks, versus 9% for the index,
which was helpful given that market's +42% return (in U.S. dollars). A listing
of the country weightings of our fund and the EAFE Index is presented on page
10.
We avoided big losses in Latin American stocks because our adviser saw no
compelling values there--the region had been the world's top performer in 1997.
Also, we held a smaller stake in Asian emerging markets than the typical peer
fund, especially during the first half of 1998, when losses were most severe in
these countries. On the other hand, 20% to 25% of our holdings were in Japanese
stocks during the year, a much-heavier stake than our typical peers had in
Japan. Fortunately, our Japanese holdings earned +13%, well ahead of the +5%
return on the Japanese market as a whole.
Our fund also benefited from its low operating costs. In 1998, these
amounted to 0.52% of average net assets ($5.20 per $1,000), less than one-third
the 1.67% ($16.70 per $1,000 of assets) expense ratio charged by the average
international stock fund. Even our low operating costs are a handicap in
comparison with the EAFE Index, which exists only on paper and incurs no
operating expenses or transaction costs.
LONG-TERM PERFORMANCE OVERVIEW
Returns in 1998 for international markets generally and our fund specifically
were higher than in any year since 1993. For the decade ended December 31, 1998,
our average annual return of +7.7% was well ahead of the lackluster +5.9% annual
return for the EAFE Index, but trailed the +8.6% annual return for our average
peer.
The table on the facing page displays the ten-year results for the fund,
our average peer, and the EAFE Index. It also shows how hypothetical $10,000
investments in each would have grown since 1988, assuming that income dividends
and capital gain distributions had been reinvested. Our +7.7% annual return
meant that a $10,000 investment would have grown over the decade to $20,990.
That is $3,325 more than the ending
2
<PAGE> 5
value of a $10,000 investment in the index, but $1,865 less than would have
accumulated in our average peer. Our goal, of course, is to outperform our
peers, and we hope that our excellent performance against competitors during
1998--only the second full year of operations under the Phillips & Drew advisory
team--is a start in that direction. For the record, the fund has earned an
annualized average return of +7.2% since Phillips & Drew assumed management on
April 1, 1996, compared with +9.0% for the EAFE Index and +9.1% for the average
international fund. (Phillips & Drew formerly was known as UBS International
Investment London Limited.)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED DECEMBER 31, 1998
--------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- ----------------------------------------------------------------------
<S> <C> <C>
International Value Fund +7.7% $20,990
- ----------------------------------------------------------------------
Average International Fund +8.6% $22,855
- ----------------------------------------------------------------------
MSCI EAFE Index +5.9% $17,665
- ----------------------------------------------------------------------
</TABLE>
We can point to one factor--the relative weighting of our investment in
Japanese stocks--as the main cause for both our leading the index and our
lagging the average peer during the last ten years. Since peaking at the end of
1989, Japanese stock prices have fallen on average by more than 60% in
local-currency terms. Through most of the decade, Vanguard International Value
Fund owned more Japanese stocks than the typical international fund, a
disadvantage given the average annual return of -5.2% for Japanese stocks.
Collectively, the average annual return of international stocks during the
decade was less than one-third the remarkable +19.2% return of the S&P 500
Index.
Of course, basing investment decisions solely on past returns--even
returns over periods as long as a decade--is apt to be a mistake. Past
performance truly does not tell you what the future will bring: After all,
Japan's stock market was the best performer during the 1978-1988 decade.
IN SUMMARY
Returns on international stocks have paled in recent years beside the gaudy
gains achieved by U.S. stocks. But we believe that international stocks still
can bring helpful diversification to a balanced portfolio with core holdings of
U.S. stock funds, bond funds, and money market funds. However, the market,
currency, and economic risks of international stocks are substantial, so we
repeat our long-standing view that foreign stocks should be limited to 10% or
20% of investors' equity portfolios.
The key is for investors to construct investment programs suited to their
own time horizon, financial situation, and tolerance for market fluctuations and
then to stick with their plans. In the same vein, Vanguard International Value
Fund will "stay the course" in providing a low-cost, diversified, professionally
managed portfolio of international equities.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
Chief Executive Officer
January 19, 1999
NOTE: You'll observe that we have made a minor change in the name of the
International Value Fund. We replaced the word "portfolio" with "fund" as part
of a broader effort to simplify the names in our fund lineup.
3
<PAGE> 6
THE MARKETS IN PERSPECTIVE
YEAR ENDED DECEMBER 31, 1998
[PHOTO]
Financial markets continued to produce solid overall gains during 1998. After
overcoming a sharp, six-week setback in July and August, the S&P 500 Index
gained 28.6% for the year, marking the first time the index had produced returns
of 20% or more in four consecutive years. Bond prices rose as interest rates
generally declined over the year. Returns from overseas stock markets varied
widely, with big gains in Europe, small gains in the Pacific, and losses in most
emerging markets.
U.S. STOCK MARKETS
Large-capitalization stocks--especially those of large growth companies--were
the best performers during 1998. The 50 largest stocks within the S&P 500 Index
earned more than 40%, while the return of the other 450 stocks was less than
17%. The stock market as a whole, as measured by the Wilshire 5000 Equity Index,
earned 23.4%. Small-cap stocks, represented by the Russell 2000 Index, declined
2.5% for the year.
The huge gap between returns of large and small stocks was not the only
oddity during the year. Among large stocks there also was a large disparity in
performance between growth and value stocks. Within the S&P 500 Index, growth
stocks rose 42.2%, while value stocks were up 14.7%. The gap of 27.5 percentage
points is the largest in the 23 years that the growth and value components have
been tracked.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED DECEMBER 31, 1998
----------------------------------------
1 YEAR 3 YEARS 5 YEARS
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
STOCKS
S&P 500 Index 28.6% 28.2% 24.1%
Russell 2000 Index -2.5 11.6 11.9
MSCI EAFE Index 20.3 9.3 9.5
- ---------------------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 8.7% 7.3% 7.3%
Lehman 10 Year Municipal Bond Index 6.8 6.8 6.4
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 5.1 5.2 5.1
- ---------------------------------------------------------------------------------------
OTHER
Consumer Price Index 1.6% 2.2% 2.4%
- ---------------------------------------------------------------------------------------
</TABLE>
Stocks rose strongly during the first half of the year. But after hitting
a then-record high on July 17, the S&P 500 Index fell by 19.2% during the
following six weeks. Declines were steeper for most smaller stocks. The Russell
2000 Index fell nearly 40% from its peak in April before climbing back during
the fourth quarter.
The summer slump in stock prices reflected several factors that raised
anxiety among investors and prompted a reconsideration of risk that extended
past stocks to bonds. Among these factors were deteriorating corporate earnings;
Russia's default on its debts; sharp swings in currency exchange rates; and
lingering economic weakness in Asia.
Although these sources of uncertainty remained as the year went on, many
investors reacted not by abandoning stocks, but by selecting large, well-known
stocks they perceived as reliable vehicles for long-term growth. The strong
rebound in prices during the fourth quarter was due in large part to the calming
influence on jittery markets of the Federal Reserve Board's decision to cut
short-term interest rates by 0.75 percentage point.
4
<PAGE> 7
Technology stocks led the market's advance during 1998, rising 83%.
Investors were attracted by rapid revenue growth and a belief that consumers and
businesses will keep spending freely on computers, software, and computer
services. Speculation also played a role in the surge. Burgeoning activity on
the Internet sent many stocks, even those with no hint of profitability,
skyrocketing. The bulge in Internet stock prices prompted comparisons with such
historic asset "bubbles" as Japan's stock market in the late 1980s and the
tulip-bulb mania in Holland in the 1630s.
Health care and utilities, especially telecommunications providers, also
soared, achieving returns of more than 43%. Both sectors benefited from rising
demand for their products and a perception that they are somewhat protected from
foreign economic troubles and foreign competition. Consumer-related stocks such
as retailers also did well, reflecting strength in consumer spending. Americans
spent almost every after-tax dollar they earned during 1998. Jobs were abundant;
unemployment fell to 4.3% by year-end.
The worst-performing groups were two directly harmed by falling commodity
prices: oil drilling and services firms in the "other energy" category (-36%)
and materials & processing firms (-1%), such as paper, steel, and chemical
makers. Producer-durables companies, such as machinery and aircraft makers, eked
out a 2% return as companies saw falling sales abroad and rising competition at
home from foreign firms.
U.S. BOND MARKETS
The fall in interest rates during 1998 was steepest for U.S. Treasury
securities, which benefited from heightened aversion to risk among investors and
from a slight decrease in supply, thanks to a $70 billion federal budget
surplus. The low inflation rate--consumer prices were up just 1.6%--gave the
Federal Reserve the flexibility to cut short-term rates even though economic
growth was strong.
Yields on long-term Treasury issues fell by roughly 1 percentage point,
and the 30-year Treasury bond's yield was 5.09% on December 31. Lower rates mean
higher bond prices, and the Lehman Brothers Long U.S. Treasury Index earned a
total return of 13.5%, an astounding margin of nearly 12 percentage points over
the inflation rate.
Bonds lacking the unquestioned credit quality of Treasuries did not fare
as well, reflecting a repricing of risk and a "flight to quality" by investors
who began to feel they had been underestimating risk. One result was price
declines that nearly offset the interest earned on high-yield "junk" bonds.
However, high-quality corporate bonds and mortgage-backed securities generally
held up well. The Lehman Aggregate Bond Index, which encompasses Treasury,
mortgage, and high-quality corporate securities and has an intermediate-term
average maturity, earned a solid 8.7%.
Yields on long-term municipal bonds declined only slightly during the
year, and by December 31 were only a tad lower than yields on long-term
Treasuries. This was striking because the interest on municipals is exempt from
federal income tax.
INTERNATIONAL STOCK MARKETS
Europe's stock markets beat even the S&P 500 Index's gaudy return, gaining 28.7%
in U.S.-dollar terms, with about 5% of the gain due to a fall in the dollar
versus most European currencies. Pacific-region stocks rose 2.6%, although it
took a fall in the dollar's value versus the Japanese yen to overcome losses in
local-currency terms. Overall, developed international markets, as measured by
the MSCI EAFE Index, earned 20.3%.
Investors' confidence in emerging markets continued to evaporate in 1998,
and stocks in these markets fell about 25% as a group. The few bright spots
included South Korea (+141%) and the Philippines (+13%), which had suffered big
declines in 1997.
5
<PAGE> 8
REPORT FROM THE ADVISER
[PHOTO]
Vanguard International Value Fund provided a return of 19.5% during 1998. This
was comfortably ahead of the average international equity fund's return of 13.0%
but slightly behind the 20.3% return of the MSCI EAFE Index.
We believe that the best investment returns are achieved by buying
companies that have underperformed and whose valuations are depressed, and
selling those that have risen to high valuations, even if their immediate
prospects for higher profits look assured.
We entered 1998 on the back of an exceptionally strong performance from
European markets, where investors had acknowledged the many improvements that
have taken place in the corporate landscape. At the same time, many Asian
markets were on their knees. We felt that the pessimism in Asia was overdone and
had been reducing our exposure to Europe to add to the fund's Asian holdings.
This pattern continued into early 1998.
Among Asian emerging markets, the fund's weighting varied during 1998
from a low of 3% of assets to a high of 7%. At the low, after witnessing
indiscriminate selling in the region, we bought many good companies with stable
core businesses, good management, and sound finances that had been given a
competitive advantage by the devaluation of their local currencies. However,
most of these nations (except for Thailand) have failed to pursue the structural
economic reform that is needed, while investors' expectations remain very high.
Consequently, after we had benefited from exceptional rises in these non-EAFE
markets, we reduced the fund's exposure to less than 5% of fund assets.
Another success in 1998 was our experience in Hong Kong. We had no
investments there at the start of the year, but later purchased some shares of
real estate conglomerates that were selling at a 50% discount to their
underlying asset value. Three months later, after these stocks had risen in
price, we reduced the position. The outlook in Hong Kong today is as poor as it
was six months ago but, thanks to the intervention of the Hong Kong Monetary
Authority, the stock market is 50% higher.
The fund's position in Japan, which at about 22% of net assets is
slightly larger than Japan's 21% position in the EAFE Index, naturally raises
lots of questions. The average international fund's position in Japan is about
11% of assets. That nation's poor economic outlook is well documented and does
not provide much comfort, but is probably already reflected in depressed stock
prices. By most valuation measures, Japanese stocks are at a 25-year low
relative to stocks elsewhere in the world. The chart on page 7 shows how Japan's
share of the global stock market has fallen. Even allowing for Japan's bubble in
the late 1980s, stock prices there have rarely been as cheap as today. We
recognize the severity of Japan's economic problems, but believe our position is
justified by the low valuations and, more important, by growing signs that
change is happening. Recent moves include the restructuring of the banking
system and a large increase in corporate merger-and-acquisition activity,
including a welcome acceptance of foreigners as partners. Share buybacks and
share options have become more accepted, which should give profits a higher
priority on the list of corporate objectives.
6
<PAGE> 9
The Japanese yen strengthened considerably late in 1998, augmenting the
fund's return. This trend has probably gone too far, so, while we wish to
maintain full exposure to Japanese equities, we have reduced exposure to the yen
by using a forward currency contract.
<TABLE>
<CAPTION>
U.S., U.K., AND JAPANESE WEIGHTINGS IN THE MSCI WORLD INDEX
- --------------------------------------------------------------------------------
The U.K.'s weight now exceeds Japan's, even though Japan's economic output is
three times larger than Britain's.
Time US UK Japan
<S> <C> <C> <C>
Q3 87 36.6 9.4 33.7
Q4 87 32.8 9.3 39.4
Q1 88 30.5 8.6 43
Q2 88 32.1 8.4 40.6
Q3 88 32 8.3 41
Q4 88 29.1 7.9 44.1
Q1 89 30 8.4 42.9
Q2 89 32.4 8 39.6
Q3 89 31.8 8.2 39.8
Q4 89 30.9 8.3 39.6
Q1 90 34.5 9.3 31.6
Q2 90 33.8 9.6 32.6
Q3 90 35.5 10.5 29.8
Q4 90 35 10.8 31.2
Q1 91 36.2 10.6 30.9
Q2 91 37.1 9.9 30.4
Q3 91 36.4 11.1 30.1
Q4 91 37.8 10.7 28.9
Q1 92 40 10.9 24.4
Q2 92 40 12.2 22
Q3 92 40.3 11.2 24.6
Q4 92 42.2 10.9 23.8
Q1 93 40.4 10.3 25.9
Q2 93 37.8 10 28.8
Q3 93 36.7 10 28.5
Q4 93 36.7 11 23.9
Q1 94 35 10 27.6
Q2 94 35.1 9.1 30.3
Q3 94 36.1 9.4 28.2
Q4 94 36.4 9.6 28
Q1 95 38 9.8 26.3
Q2 95 39.8 9.7 23.7
Q3 95 40.4 9.6 23.4
Q4 95 40.8 9.6 23.4
Q1 96 41.4 9.2 22.5
Q2 96 41.5 9.1 22.3
Q3 96 42.2 9.6 20.8
Q4 96 43.2 10.4 17.5
Q1 97 44.4 10.3 15.4
Q2 97 45.5 9.5 17.3
Q3 97 47.2 10.2 14.7
Q4 97 49.8 10.3 12
Q1 98 49.5 10.5 10.7
Q2 98 49.6 10.7 9.9
Q3 98 51.1 10.7 9.5
</TABLE>
We have been negative on the U.K. equity market since we began managing
the International Value Fund, but that market's recent relatively poor
performance, particularly by many of the mid-sized and smaller companies, has
caused us to change our view. Like most major markets, Britain's market has been
driven recently by a narrow focus on large growth companies in a few sectors,
such as telecommunications, financials, and pharmaceuticals. We own none of
these overpriced companies, but have been buying medium-sized engineering firms,
utilities, and food retailers--all companies that have good cash flows and had
been overlooked by the market. These purchases resulted in an increase in the
fund's U.K. exposure from 16.9% at the start of the year to 23.6% at the end.
Interestingly, several of our holdings have recently been targets of takeover
activity, reflecting their undervalued share prices.
The great imponderable in Europe is the effect of the euro on European
economies and the currency markets. We acknowledge that the chances of early
success outweigh those of early failure while the long-term probabilities are
the reverse. Remember, this creation of a common currency is an unprecedented
experiment.
Against this rather uncertain background, we expect the consolidation of
European industry to continue, as competitive pressures increase and the
complications of cross-border mergers ease under the single currency. The main
emphasis of our continental European holdings is on companies with good
management that are positioned to take advantage of the opportunities that the
new Europe offers.
It is hard to find absolute value at a time when corporate profits are
coming under pressure and many stock indexes are at record highs. Much of this
bull-market euphoria has been fueled by a global trend toward index investing
and by the desire of institutional investors to retain exposure to
large-capitalization stocks in various markets. We find it difficult to justify
the valuation of these large, liquid stocks and have tended to avoid them. Our
focus is on mid-sized and smaller companies that are more fairly priced.
The fund's underweight position in financial stocks versus the EAFE Index
reflects our view that Japanese banks have not fully acknowledged their bad-debt
problems and that European financials have risen to very high valuations on the
back of merger speculation.
Wilson Phillips, Portfolio Manager
Phillips & Drew
January 11, 1999
INVESTMENT PHILOSOPHY
The fund 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.
7
<PAGE> 10
FUND PROFILE
INTERNATIONAL VALUE FUND
This Profile provides a snapshot of the fund's characteristics as of December
31, 1998, 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 125 1,032
Turnover Rate 39% --
Expense Ratio 0.52% --
Cash Reserves 0.6% --
Portfolio Allocation by Region
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
INTERNATIONAL
VALUE MSCI EAFE
- ----------------------------------------------------------------------
<S> <C> <C>
R-Squared 0.87 1.00
Beta 0.98 1.00
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION BY REGION
- ------------------------------
<S> <C>
EUROPE 65%
PACIFIC 30%
EMERGING MARKETS 5%
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- ------------------------------------------------------------------
<S> <C>
Nestle SA (Registered) 3.3%
Bayer AG 3.1
Novartis AG (Registered) 2.9
Elf Aquitaine SA 2.9
Allied Domecq PLC 2.8
Electrolux AB Series B 2.8
Akzo Nobel NV 2.8
Shell Transport & Trading Co. 2.4
Matsushita Electric Industrial Co., Ltd. 2.3
BG PLC 2.3
- ------------------------------------------------------------------
Top Ten 27.6%
</TABLE>
COUNTRY DIVERSIFICATION (% OF COMMON STOCKS) can be found on page 10.
8
<PAGE> 11
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a fund with a beta
of 1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%. Cash Reserves. The percentage of a fund's net assets
invested in "cash equivalents"--highly liquid, short-term, interest-bearing
securities. This figure does not include cash invested in futures contracts to
simulate stock investment.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities This
figure does not include cash invested in futures contracts to simulate stock
investment.
COUNTRY DIVERSIFICATION. The percentages of a fund's common stock invested in
securities of various countries.
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds,
the more diversified it is and the more likely to perform in line with the
overall stock market.
PORTFOLIO ALLOCATION BY REGION. This chart shows the geographic distribution of
a fund's holdings.
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund's returns bore no relationship to the
market's returns, its R-squared would be 0.
TEN LARGEST HOLDINGS. The percentage of net assets that a fund has invested in
its ten largest holdings. (The average for stock mutual funds is about 30%.) As
this percentage rises, a fund's returns are likely to be more volatile because
they are more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year. Funds
with high turnover rates incur higher transaction costs and are more likely to
distribute capital gains (which are taxable to investors).
9
<PAGE> 12
FUND PROFILE (continued)
<TABLE>
<CAPTION>
COUNTRY DIVERSIFICATION (% OF COMMON STOCKS)
- --------------------------------------------------------------------------------------------------
DECEMBER 31, 1997 DECEMBER 31, 1998
------------------------------------------------------------------
INTERNATIONAL INTERNATIONAL
VALUE VALUE MSCI EAFE
------------------------------------------------------------------
<S> <C> <C> <C>
Australia ....................... 5.9% 3.9% 2.6%
Austria ......................... 0.0 0.0 0.3
Belgium ......................... 0.0 0.0 1.9
Denmark ......................... 2.4 0.0 0.9
Finland ......................... 0.0 0.0 1.6
France .......................... 15.9 13.2 9.4
Germany ......................... 8.1 8.1 10.7
Greece .......................... 0.0 0.3 0.0
Hong Kong ....................... 0.0 1.3 2.1
Indonesia ....................... 0.4 0.5 0.0
Ireland ......................... 0.0 0.0 0.5
Italy ........................... 1.5 1.3 5.2
Japan ........................... 26.0 22.1 21.0
Malaysia ....................... 0.2 0.0 0.0
Netherlands ..................... 5.3 5.9 6.5
New Zealand ..................... 0.8 0.2 0.2
Norway .......................... 0.4 0.0 0.4
Philippines ..................... 0.8 0.4 0.0
Portugal ........................ 0.7 0.3 0.7
Singapore ....................... 2.1 2.0 0.8
South Korea ..................... 1.4 2.3 0.0
Spain ........................... 0.0 0.6 3.4
Sweden ......................... 5.1 5.2 2.6
Switzerland ..................... 4.6 7.4 8.1
Thailand ........................ 1.3 1.2 0.0
United Kingdom .................. 17.1 23.8 21.1
- -------------------------------------------------------------------------------------------------
Total 100.0% 100.0% 100.0%
</TABLE>
10
<PAGE> 13
PERFORMANCE SUMMARY
INTERNATIONAL VALUE FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the fund. Note, too, that both
share price and return can fluctuate widely, so an investment in the fund could
lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: MAY 16, 1983-DECEMBER 31, 1998
- ------------------------------------------------------------------
International Value Fund 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
1998 14.7 4.8 19.5 20.3
- ------------------------------------------------------------------
</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, 1988-DECEMBER 31, 1998
- -----------------------------------------------------------
International Average MSCI EAFE
Value Fund International Fund Index
<S> <C> <C> <C>
1988 12 10000 10000 10000
1989 03 10246 10257 10033
1989 06 10333 10193 9420
1989 09 12156 11553 10593
1989 12 12597 12067 11080
1990 03 11974 11412 8895
1990 06 12992 12380 9753
1990 09 10653 10189 7692
1990 12 11053 10650 8510
1991 03 11481 11381 9150
1991 06 11099 11063 8658
1991 09 11932 11838 9408
1991 12 12153 12010 9573
1992 03 11484 11597 8444
1992 06 12050 12140 8631
1992 09 11454 11590 8769
1992 12 11093 11399 8439
1993 03 12206 12379 9458
1993 06 13072 13108 10417
1993 09 13925 14380 11116
1993 12 14476 15888 11219
1994 03 14886 15443 11618
1994 06 15429 15743 12220
1994 09 15630 16322 12240
1994 12 15237 15751 12123
1995 03 15257 15120 12359
1995 06 15757 15890 12458
1995 09 16216 16803 12988
1995 12 16706 17208 13524
1996 03 17352 17567 13925
1996 06 17655 18373 14155
1996 09 17650 18384 14148
1996 12 18414 19244 14384
1997 03 18612 19123 14169
1997 06 20691 21377 16019
1997 09 20149 21773 15916
1997 12 17570 20222 14680
1998 03 20793 22777 16851
1998 06 20643 23173 17041
1998 09 17402 19508 14630
1998 12 20990 22855 17665
</TABLE>
Phillips & Drew becomes adviser
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED DECEMBER 31, 1998
---------------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
International Value Fund 19.46% 7.71% 7.70% $20,990
Average International Fund 13.02 7.54 8.62 22,855
MSCI EAFE Index 20.33 9.50 5.85 17,665
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1998
- -------------------------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION -----------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
International Value Fund 5/16/1983 19.46% 7.71% 4.78% 2.92% 7.70%
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
11
<PAGE> 14
FINANCIAL STATEMENTS
DECEMBER 31, 1998
[PHOTO]
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.) and by
country. Other assets are added to, and liabilities are subtracted from, the
value of Total Investments to calculate the fund's Net Assets. Finally, Net
Assets are divided by the outstanding shares of the fund to arrive at its share
price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the fund's net assets on both a dollar and
per-share basis. Because all income and any realized gains must be distributed
to shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the fund had available to distribute to shareholders as income dividends or
capital gains as of the statement date, but may differ because certain
investments or transactions may be treated differently for financial statement
and tax purposes. Any Accumulated Net Realized Losses, and any cumulative excess
of distributions over net income or net realized gains, will appear as negative
balances. Unrealized Appreciation (Depreciation) is the difference between the
market value of the fund's investments and their cost, and reflects the gains
(losses) that would be realized if the fund were to sell all of its investments
at their statement-date values.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
MARKET
VALUE*
INTERNATIONAL VALUE FUND SHARES (000)
- ----------------------------------------------------------------------
COMMON STOCKS (99.2%)
- ----------------------------------------------------------------------
<S> <C> <C>
AUSTRALIA (3.9%)
Australia & New Zealand
Bank Group Ltd. 1,381,000 $ 9,047
- - Burns Philp & Co., Ltd. 2,304,020 184
Coles Myer Ltd. 430,000 2,255
Goodman Fielder Ltd. 3,167,000 3,205
Mount Isa Mines Holdings Ltd. 12,354,090 5,456
Pacific Dunlop Ltd. 1,500,000 2,429
Pasminco Ltd. 5,883,000 4,474
WMC Ltd. 1,498,000 4,521
-------------
31,571
-------------
DENMARK
Kapital Holding 6,749 334
-------------
FRANCE (13.1%)
AXA-UAP SA 70,000 10,150
Alcatel 100,535 12,310
Banque Nationale de Paris SA 160,418 13,216
Compagnie de Saint-Gobain SA 86,852 12,268
Elf Aquitaine SA 199,700 23,095
Esso SA 8,063 684
Groupe Danone SA 41,220 11,807
Lafarge SA 89,166 8,476
Societe National d'Exploitation
Industrielle des Tabacs et
Allumettes SA 58,213 3,647
Total SA B Shares 97,800 9,910
-------------
105,563
-------------
GERMANY (8.0%)
Bayer AG 589,100 24,600
RWE AG 300,400 16,458
Schering AG 72,530 9,112
Varta AG 15,480 2,537
Volkswagen AG 151,730 12,116
-------------
64,823
-------------
GREECE (0.3%)
- - STET Hellas
Telecommunications SA ADR 73,664 2,385
-------------
HONG KONG (1.3%)
Hong Kong Land Holdings Ltd. 6,167,100 7,277
Wharf Holdings Ltd. 2,000,000 2,917
-------------
10,194
-------------
INDONESIA (0.5%)
- - PT Bank Dagang Nasional
Indonesia (Foreign) 3,100,998 0
- - PT Bank Internasional
Indonesia (Foreign) 23,408,000 663
- - PT Indah Kiat Pulp &
Paper Corp. 7,786,985 2,130
- - PT Indah Kiat Pulp &
Paper Corp. Warrants
Exp. 7/11/2002 96,504 13
- - PT Inti Indorayon Utama 545,000 34
- - PT Kalbe Farma 706,000 36
- - PT Pabrik Kertas Tjiwi Kimia 3,175,751 829
PT Unilever Indonesia 9,900 37
-------------
3,742
-------------
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ----------------------------------------------------------------------
<S> <C> <C>
ITALY (1.3%)
Telecom Italia SpA 1,232,100 $ 10,536
-------------
JAPAN (21.9%)
Fuji Photo Film Co., Ltd. 70,000 2,606
Hitachi Ltd. 1,731,000 10,742
Ishikawajima-Harima
Heavy Industries Co. 256,000 454
Japan Wool Textile Co., Ltd. 326,000 1,772
Kajima Corp. 600,000 1,569
Kansai Paint Co., Ltd. 1,167,000 3,394
Koito Manufacturing Co., Ltd. 922,000 3,915
Marudai Food Co., Ltd. 897,000 1,726
Matsushita Electric
Industrial Co., Ltd. 1,066,000 18,892
Mitsubishi Estate Co., Ltd. 1,344,000 12,070
Mitsubishi Heavy
Industries Ltd. 1,150,000 4,486
Nikko Securities Co., Ltd. 1,457,000 4,069
Nippon Telegraph and
Telephone Corp. 401 3,100
Nippon Yusen Kabushiki
Kaisha Co. 2,708,000 8,571
Nissan Fire & Marine
Insurance Co., Ltd. 1,154,000 3,478
Nisshinbo Industries, Inc. 1,284,000 4,485
Sakura Bank Ltd. 3,979,000 9,136
Sanwa International Trust
1.25% Cvt. Pfd. 82 1,690
Sharp Corp. 560,000 5,059
Sony Corp. 100,900 7,362
Sumitomo Marine &
Fire Insurance Co. 1,350,000 8,569
Taiheiyo Cement Corp 2,080,800 5,221
Tokyo Gas Co., Ltd. 6,518,000 17,162
Tokyo Steel Manufacturing Co. 725,000 3,638
Toray Industries, Inc. 684,000 3,578
Toyo Seikan Kaisha Ltd. 597,000 10,151
Uny Co., Ltd. 180,000 3,295
West Japan Railway Co. 2,290 10,151
Yamaha Motor Co., Ltd. 971,000 6,276
-------------
176,617
-------------
MALAYSIA
Hong Leong Industries Bhd. 401,200 202
-------------
NETHERLANDS (5.9%)
Akzo Nobel NV 493,500 22,484
Buhrmann NV 200,000 3,581
ING Groep NV 151,099 9,219
Koninklijke KPN NV 128,384 6,431
Philips Electronics NV 30,850 2,071
TNT Post Group NV 108,983 3,513
-------------
47,299
-------------
NEW ZEALAND (0.2%)
Brierley Investments Ltd. 2,736,300 622
Fletcher Challenge Ltd. Forest 18,168 6
Fletcher Challenge Ltd. Paper 1,954,200 1,311
-------------
1,939
-------------
PHILIPPINES (0.4%)
- - EEI Corp. 4,435,000 139
- - JG Summit Holdings Inc.
Class B 3,226,000 199
- - Philex Mining Corp. Class B 5,710,500 46
Philippine Long Distance
Telephone Co. 86,000 2,211
San Miguel Corp. Class B 266,060 513
-------------
3,108
-------------
PORTUGAL (0.3%)
Electricidade de Portugal SA 100,000 2,202
-------------
SINGAPORE (2.0%)
Dairy Farm International
Holdings Ltd. 1,585,740 1,824
Development Bank of
Singapore Ltd. (Foreign) 515,000 4,651
Jardine Strategic Holdings Ltd. 651,000 944
Keppel Corp., Ltd. 2,962,250 7,935
United Overseas Land Ltd. 1,500,000 1,018
-------------
16,372
-------------
SOUTH KOREA (2.3%)
Hyundai Motor Co., Ltd. 320,718 5,708
Hyundai Motor Co., Ltd. GDR 380,000 1,207
LG Chemical Ltd. 200,000 2,179
SK Telecom Co. 5,478 4,062
Shinhan Bank Co. 660,000 5,050
-------------
18,206
-------------
SPAIN (0.6%)
Endesa SA 170,528 4,525
-------------
SWEDEN (5.1%)
Astra AB A Shares 459,200 9,376
Electrolux AB Series B 1,309,775 22,542
ForeningsSparbanken AB 130,000 3,368
Stora Kopparbergs Berglags
AB A Shares 550,000 6,039
-------------
41,325
-------------
SWITZERLAND (7.3%)
Nestle SA (Registered) 12,170 26,493
Novartis AG (Registered) 12,080 23,747
Schindler Holding AG (Ptg. Ctf.) 5,530 8,858
-------------
59,098
-------------
THAILAND (1.2%)
- - Bangkok Bank PLC (Foreign) 1,832,700 3,783
- - Shinawatra Computer &
Communications PLC (Foreign) 795,600 2,737
- - Siam Pulp & Paper PLC (Foreign) 200,500 259
- - TPI Polene PLC (Foreign) 91,875 15
- - Thai Farmers Bank PLC
(Foreign) 1,500,000 2,642
- - Thai Plastic & Chemical PLC
(Foreign) 187,850 331
-------------
9,767
-------------
UNITED KINGDOM (23.6%)
Allied Domecq PLC 2,464,800 22,740
- - Allied Zurich PLC 567,071 8,458
- - BG PLC 2,922,000 18,438
</TABLE>
13
<PAGE> 16
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
MARKET
VALUE*
INTERNATIONAL VALUE FUND SHARES (000)
- ----------------------------------------------------------------------
<S> <C> <C>
BOC Group PLC 432,044 $ 6,178
BPB PLC 523,050 1,978
BTR PLC 6,968,810 14,377
British American Tobacco PLC 1,137,571 10,003
Coats Viyella PLC 1,734,500 779
IMI PLC 981,000 3,852
MEPC PLC 1,814,912 12,079
- - Marley PLC 3,000,000 6,090
Peninsular & Oriental Steam
Navigation Co. 118,197 1,397
Rank Group PLC 727,800 2,803
Safeway PLC 1,800,320 9,046
Scottish & Newcastle PLC 1,019,135 11,836
Scottish Power PLC 1,368,100 14,056
Shell Transport & Trading Co. 3,115,800 19,142
Smith & Nephew PLC 1,328,650 4,134
Tarmac PLC 2,816,036 5,271
United Biscuits Holdings PLC 2,322,666 9,139
United Utilities PLC 592,580 8,213
-------------
190,009
-------------
<CAPTION>
- ----------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $784,679) 799,817
- ----------------------------------------------------------------------
FACE
AMOUNT
(000)
- ----------------------------------------------------------------------
<S> <C> <C>
CONVERTIBLE BOND (0.2%)
- ----------------------------------------------------------------------
Burns, Philp & Co. Ltd.
7.50%, 8/15/2003
(COST $1,325) AUD 11,129 1,365
- ----------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (4.6%)
- ----------------------------------------------------------------------
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
4.76%, 1/4/1999 $11,639 11,639
4.77%, 1/4/1999--Note F 26,010 26,010
- ----------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $37,649) 37,649
- ----------------------------------------------------------------------
TOTAL INVESTMENTS (104.0%)
(COST $823,653) $838,831
- ----------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-4.0%)
- ----------------------------------------------------------------------
Other Assets--Note C 6,063
Security Lending Collateral
Payable to Brokers--Note F (26,010)
Other Liabilities (12,581)
-------------
(32,528)
- ----------------------------------------------------------------------
NET ASSETS (100%)
- ----------------------------------------------------------------------
Applicable to 32,138,350 outstanding $.001
par value shares of beneficial interest
(unlimited authorization) $806,303
======================================================================
NET ASSET VALUE PER SHARE $25.09
======================================================================
*See Note A in Notes to Financial Statements.
- -Non-Income-Producing Security.
ADR--American Depositary Receipt.
AUD--Australian Dollar.
GDR--Global Depositary Receipt.
(Ptg. Ctf.)--Participating Certificate.
- ----------------------------------------------------------------------
AT DECEMBER 31, 1998, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ----------------------------------------------------------------------
Paid in Capital $810,566 $25.23
Overdistributed Net Investment
Income--Note D (10,845) (.34)
Accumulated Net Realized
Losses--Note D (6,647) (.21)
Unrealized Appreciation
(Depreciation)--Note E
Investment Securities 15,178 .47
Foreign Currencies and
Forward Currency Contracts (1,949) (.06)
- ----------------------------------------------------------------------
NET ASSETS $806,303 $25.09
======================================================================
</TABLE>
14
<PAGE> 17
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the fund during the
reporting period, and details the operating expenses charged to the fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period--these
amounts include the effect of foreign currency movements on the value of the
fund'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 VALUE FUND
YEAR ENDED DECEMBER 31, 1998
(000)
- ---------------------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends* $ 25,076
Interest 1,203
Security Lending 962
------------
Total Income 27,241
------------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 1,321
Performance Adjustment (353)
The Vanguard Group--Note C
Management and Administrative 2,529
Marketing and Distribution 190
Custodian Fees 559
Auditing Fees 8
Shareholders' Reports 9
Annual Meeting and Proxy Costs 6
Trustees' Fees and Expenses 2
------------
Total Expenses 4,271
- ---------------------------------------------------------------------------------------------------
NET INVESTMENT INCOME 22,970
- ---------------------------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Investment Securities Sold 8,303
Foreign Currencies (1,403)
- ---------------------------------------------------------------------------------------------------
REALIZED NET GAIN 6,900
- ---------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 114,216
Foreign Currencies and Forward Currency Contracts (1,721)
- ---------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 112,495
- ---------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $142,365
===================================================================================================
*Dividends are net of foreign withholding taxes of $5,512,000.
</TABLE>
15
<PAGE> 18
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
fund, either by purchasing shares or by reinvesting distributions, as well as
the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
INTERNATIONAL VALUE FUND
YEAR ENDED DECEMBER 31,
------------------------------------
1998 1997
(000) (000)
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 22,970 $ 21,259
Realized Net Gain 6,900 83,733
Change in Unrealized Appreciation (Depreciation) 112,495 (141,401)
------------------------------------
Net Increase (Decrease) in Net Assets Resulting from Operations 142,365 (36,409)
------------------------------------
DISTRIBUTIONS
Net Investment Income (32,297) (21,269)
Realized Capital Gain (28,807) (91,909)
------------------------------------
Total Distributions (61,104) (113,178)
------------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 247,777 208,395
Issued in Lieu of Cash Distributions 56,521 105,942
Redeemed (356,018) (304,542)
------------------------------------
Net Increase (Decrease) from Capital Share Transactions (51,720) 9,795
- ---------------------------------------------------------------------------------------------------------------------------
Total Increase (Decrease) 29,541 (139,792)
- ---------------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 776,762 916,554
------------------------------------
End of Year $806,303 $776,762
===========================================================================================================================
(1)Shares Issued (Redeemed)
Issued 9,809 7,512
Issued in Lieu of Cash Distributions 2,217 4,564
Redeemed (14,192) (11,052)
------------------------------------
Net Increase (Decrease) in Shares Outstanding (2,166) 1,024
===========================================================================================================================
</TABLE>
16
<PAGE> 19
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis. It also presents the fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the fund's total return; how much it costs to operate the fund;
and the extent to which the fund tends to distribute capital gains. The table
also shows the Portfolio Turnover Rate, a measure of trading activity. A
turnover rate of 100% means that the average security is held in the fund for
one year.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
INTERNATIONAL VALUE FUND
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $22.64 $27.54 $31.11 $31.48 $31.04
- ----------------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .77 .690 .82 .750 .55
Net Realized and Unrealized Gain (Loss) on Investments 3.64 (1.945) 2.20 2.185 1.08
----------------------------------------------------------------------
Total from Investment Operations 4.41 (1.255) 3.02 2.935 1.63
----------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (1.06) (.690) (.82) (.790) (.56)
Distributions from Realized Capital Gains (.90) (2.955) (5.77) (2.515) (.63)
----------------------------------------------------------------------
Total Distributions (1.96) (3.645) (6.59) (3.305) (1.19)
- ----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $25.09 $22.64 $27.54 $31.11 $31.48
==================================================================================================================================
TOTAL RETURN 19.46% -4.58% 10.22% 9.65% 5.25%
==================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $806 $777 $917 $988 $1,053
Ratio of Total Expenses to Average Net Assets 0.52% 0.49% 0.50% 0.47% 0.34%
Ratio of Net Investment Income to Average Net Assets 2.77% 2.36% 2.50% 2.29% 1.71%
Portfolio Turnover Rate 39% 37% 82% 47% 40%
==================================================================================================================================
</TABLE>
17
<PAGE> 20
NOTES TO FINANCIAL STATEMENTS
Vanguard International Value Fund is registered under the Investment Company Act
of 1940 as a diversified open-end investment company, or mutual fund. The fund
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 fund consistently follows
such policies in preparing its financial statements.
1. SECURITY VALUATION: Equity securities are valued at the latest quoted
sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date; such securities not
traded on the valuation date are valued at the mean of the latest quoted bid and
asked prices. Prices are taken from the primary market in which each security
trades. Temporary cash investments are valued at cost, which approximates market
value. Securities for which market quotations are not readily available are
valued by methods deemed by the Board of Trustees to represent fair value.
2. FOREIGN CURRENCY: Securities and other assets and liabilities
denominated in foreign currencies are translated into U.S. dollars at the
exchange rate on the valuation date as employed by Morgan Stanley Capital
International in the calculation of its indexes.
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 fund enters into forward currency
contracts to protect the value of securities and related receivables and
payables against changes in future foreign exchange rates. The fund'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 fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
5. REPURCHASE AGREEMENTS: The fund, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other party
to the agreement, retention of the collateral may be subject to legal
proceedings.
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.
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. Phillips & Drew (formerly known as UBS International Investment London
Ltd.) provides investment advisory services to the fund 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, 1998, the advisory fee represented an effective annual basic
rate of 0.16% of the fund's average net assets, before a decrease of $353,000
(0.04%) based on performance.
C. The Vanguard Group furnishes at cost corporate management,
administrative, marketing, and distribution services. The costs of such services
are allocated to the fund under methods approved by the Board of Trustees. The
fund has committed to provide up to 0.40% of its net assets in capital
contributions to Vanguard. At December 31, 1998, the fund had contributed
capital of $147,000 to Vanguard (included in Other Assets), representing 0.02%
of the fund's net assets and 0.2% of Vanguard's capitalization. The fund's
Trustees and officers are also Directors and officers of Vanguard.
D. During the year ended December 31, 1998, the fund purchased $315,031,000
of investment securities and sold $392,572,000 of investment securities, other
than temporary cash investments.
For federal tax purposes, capital gains required to be distributed in
December 1998 included net gains realized through October 31, 1998.
Subsequently, the fund realized capital losses of $8,677,000 which are available
to offset future capital gains.
During the year ended December 31, 1998, the fund realized net foreign
currency losses of $1,403,000, 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, 1998, the fund received securities
with a value of $10,586,000 in a corporate spinoff that increased taxable income
and the tax basis cost of investments, but had no effect on net investment
income or the cost of investments for financial statement purposes. The required
distribution of this taxable income is reflected in the balance of
overdistributed net investment income, and the difference between the
securities' cost for financial statement and tax purposes is reflected in
unrealized appreciation, at December 31, 1998.
E. At December 31, 1998, net unrealized appreciation of investment
securities for federal income tax purposes was $4,592,000, consisting of
unrealized gains of $141,505,000 on securities that had risen in value since
their purchase and $136,913,000 in unrealized losses on securities that had
fallen in value since their purchase.
At December 31, 1998, the fund had open forward currency contracts to
deliver foreign currency in exchange for U.S. dollars as follows:
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
(000)
-----------------------------------------------------------------------------
CONTRACT AMOUNT
-------------------------
CONTRACT FOREIGN U.S. MARKET VALUE IN UNREALIZED
SETTLEMENT DATE CURRENCY DOLLARS U.S. DOLLARS DEPRECIATION
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Deliver:
1/13/1999 JPY 5,387,000 $45,802 $47,810 $(2,008)
--------------------------------------------------------------------------------------------------------------------------
JPY--Japanese yen.
</TABLE>
Unrealized depreciation of $2,008,000 related to open forward currency contracts
is required to be treated as realized loss for tax purposes.
The fund had net unrealized foreign currency gains of $59,000 resulting
from the translation of other assets and liabilities at December 31, 1998.
F. The market value of securities on loan to broker/dealers at December 31,
1998, was $24,797,000, for which the fund held cash collateral of $26,010,000.
Cash collateral received is invested in repurchase agreements.
19
<PAGE> 22
REPORT OF INDEPENDENT
ACCOUNTANTS
[PHOTO]
To the Shareholders and Trustees of
Vanguard International Value 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 International Value Fund (the "Fund") at December 31, 1998, the results
of its operations for the year then ended, the changes in its net assets for
each of the two years in the period then ended and the financial highlights for
each of the five years in the period then ended, in conformity with generally
accepted accounting principles. These financial statements and financial
highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits, which included confirmation of securities at December 31, 1998 by
correspondence with the custodian and brokers, provide a reasonable basis for
the opinion expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
February 2, 1999
SPECIAL 1998 TAX INFORMATION (UNAUDITED) FOR VANGUARD INTERNATIONAL VALUE FUND
This information for the fiscal year ended December 31, 1998, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $21,623,000 as capital gain dividends (from net
long-term capital gains) to shareholders during the fiscal year ended December
1998, all of which is designated as a 20% rate gain distribution.
The fund 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 1998 Form 1099-DIV.
20
<PAGE> 23
TRUSTEES AND OFFICERS
JOHN C. BOGLE
Founder, Senior Chairman of the Board, and Director/Trustee of The Vanguard
Group, Inc., and each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN
Chairman of the Board, Chief Executive Officer, and Director/Trustee of The
Vanguard Group, Inc., and each of the investment companies in The Vanguard
Group.
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.
JOANN HEFFERNAN HEISEN
Vice President, Chief Information Officer, and a member of the Executive
Committee of Johnson & Johnson; Director of Johnson & JohnsonoMerck Consumer
Pharmaceuticals Co., Women First HealthCare, Inc., Recording for the Blind and
Dyslexic, The Medical Center at Princeton, and Women's Research and Education
Institute.
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, Banco Bilbao Gestinova, 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.,
NACCO Industries, and Newfield Exploration Co.
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.
THOMAS J. HIGGINS
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(R)," "S&P(R)," "S&P 500(R)," "Standard & Poor's 500," and
"500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell
Company is the owner of trademarks and copyrights relating to the
Russell Indexes. "Wilshire 4500" and "Wilshire 5000" are
trademarks of Wilshire Associates.
<PAGE> 24
VANGUARD
MILESTONES
[GRAPHIC]
The Vanguard Group is
named for HMS Vanguard,
Admiral Horatio Nelson's flagship
at the Battle of the Nile on
August 1, 1798. Our founder,
John C. Bogle, chose the name
after reading Nelson's inspiring
tribute to his fleet: "Nothing could
withstand the squadron . . .
with the judgment of the captains,
together with their valour, and that
of the officers and men of every
description, it was absolutely irresistible."
[GRAPHIC]
Walter L. Morgan, founder of
Wellington Fund, the nation's
oldest balanced mutual fund
and forerunner of today's family
of some 100 Vanguard funds,
celebrated his 100th birthday on
July 23, 1998. Mr. Morgan,
a true investment pioneer, died
six weeks later on September 2.
[GRAPHIC]
Wellington Fund,
The Vanguard Group's oldest fund,
was incorporated by Mr. Morgan
70 years ago, on December 28, 1928.
The fund was named after
the Duke of Wellington,
whose forces defeated
Napoleon Bonaparte at the
Battle of Waterloo in 1815.
[THE VANGUARD GROUP LOGO]
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
www.vanguard.com
[email protected]
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
Q460-02/17/1999
(C) 1999 Vanguard Marketing Corporation, Distributor. All rights reserved.
