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PART B
VANGUARD EXPLORER FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
FEBRUARY 10, 1995; REVISED FEBRUARY 22, 1995
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus (dated February 10, 1995). To obtain the
Prospectus please call the Investor Information Department:
1-800-662-7447
TABLE OF CONTENTS
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PAGE
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Investment Objective and Policies......................................................... 1
Purchase of Shares........................................................................ 5
Redemption of Shares...................................................................... 5
Dividends and Capital Gains Distributions................................................. 5
Yield and Total Return.................................................................... 6
Investment Limitations.................................................................... 6
Management of the Fund.................................................................... 8
Investment Advisory Services.............................................................. 10
Portfolio Transactions.................................................................... 15
General Information About the Fund........................................................ 15
Performance Measures...................................................................... 16
Financial Statements...................................................................... 17
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INVESTMENT OBJECTIVE AND POLICIES
The following policies supplement the Fund's investment objective and
policies set forth in the Prospectus.
REPURCHASE AGREEMENTS The Fund may invest in repurchase agreements with
commercial banks, brokers or dealers either for defensive purposes due to market
conditions or to generate income from its excess cash balances. A repurchase
agreement is an agreement under which the Fund acquires a money market
instrument (generally a security issued by the U.S. Government or an agency
thereof, a banker's acceptance or a certificate of deposit) from a commercial
bank, broker or dealer, subject to resale to the seller at an agreed upon price
and date (normally, the next business day). A repurchase agreement may be
considered a loan collateralized by securities. The resale price reflects an
agreed upon interest rate effective for the period the instrument is held by the
Fund and is unrelated to the interest rate on the underlying instrument. In
these transactions, the securities acquired by the Fund (including accrued
interest earned thereon) must have a total value in excess of the value of the
repurchase agreement and are held by the Fund's custodian bank until
repurchased. In addition, the Fund's Board of Directors will monitor the Fund's
repurchase agreement transactions generally and will establish guidelines and
standards for review by the investment adviser of the creditworthiness of any
bank, broker or dealer party to a repurchase agreement with the Fund. No more
than an aggregate of 15% of the Fund's assets, at the time of investment, will
be invested in repurchase agreements having maturities longer than seven days
and securities subject to legal or contractual restrictions on resale, or for
which there are no readily available market quotations.
The use of repurchase agreements involves certain risks. For example, if
the other party to the agreement defaults on its obligation to repurchase the
underlying security at a time when the value of the security has declined, the
Fund may incur a loss upon disposition of the security. If the other party to
the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a court may determine that the
underlying security is collateral for a loan by the Fund not within the control
of the Fund and therefore the realization by the Fund on such collateral may be
automatically stayed. Finally, it is possible that the Fund may not be able to
substantiate its interest in the underlying security and may be
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deemed an unsecured creditor of the other party to the agreement. While the
Fund's management acknowledges these risks, it is expected that they can be
controlled through careful monitoring procedures.
LENDING OF SECURITIES The Fund may lend its portfolio securities to
qualified institutional investors who need to borrow securities in order to
complete certain transactions, such as covering short sales, avoiding failures
to deliver securities, or completing arbitrage operations. By lending its
portfolio securities, the Fund attempts to increase its income through the
receipt of interest on the loan. Any gain or loss in the market price of the
securities loaned that might occur during the term of the loan would be for the
account of the Fund. The Fund may lend its portfolio securities to qualified
brokers, dealers, banks or other financial institutions, so long as the terms
and the structure of such loans are not inconsistent with the Investment Company
Act of 1940, or the Rules and Regulations or interpretations of the Securities
and Exchange Commission thereunder, which currently require that (a) the
borrower pledges and maintains with the Fund collateral consisting of cash, a
letter of credit, or securities issued or guaranteed by the United States
Government having a value at all times not less than 100% of the value of the
securities loaned, (b) the borrower adds to such collateral whenever the price
of the securities loaned rises (i.e., the borrower "marks to the market" on a
daily basis), (c) the loan is made subject to termination by the Fund at any
time, and (d) the Fund receives reasonable interest on the loan (which may
include the Fund's investing any cash collateral in interest bearing short-term
investments), any distributions on the loaned securities and any increase in
their market value. The Fund will not lend portfolio securities if, as a result,
the aggregate of such loans exceeds 33 1/3% of the Fund's total assets. Loan
arrangements made by the Fund will comply with all other applicable regulatory
requirements, including the rules of the New York Stock Exchange, which rules
presently require the borrower, after notice, to redeliver the securities within
the normal settlement time of five business days. All relevant facts and
circumstances, including the creditworthiness of the broker, dealer or
institution, will be considered in making decisions with respect to the lending
of securities, subject to review by the Fund's Board of Directors.
At the present time, the Staff of the Commission does not object if an
investment company pays reasonable negotiated fees in connection with loaned
securities, so long as such fees are set forth in a written contract and
approved by the investment company's directors (trustees). In addition, voting
rights may pass with the loaned securities, but if a material event will occur
affecting an investment on loan, the loan must be called and the securities
voted.
FUTURES CONTRACTS AND OPTIONS The Fund may enter into futures contracts,
options, and options on futures contracts for several reasons: to maintain cash
reserves while simulating full investment, to facilitate trading, to reduce
transaction costs, or to seek higher investment returns when a futures contract
is priced more attractively than the underlying equity security or index.
Futures contracts provide for the future sale by one party and purchase by
another party of a specified amount of a specific security at a specified future
time and at a specified price. Futures contracts which are standardized as to
maturity date and underlying financial instrument are traded on national futures
exchanges. Futures exchanges and trading are regulated under the Commodity
Exchange Act by the Commodity Futures Trading Commission ("CFTC"), a U.S.
Government agency.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out an open futures position is done by taking an opposite position ("buying" a
contract which has previously been "sold" or "selling" a contract previously
"purchased") in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on margin that
may range upward from less than 5% of the value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements,
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payment of additional "variation" margin will be required. Conversely, change in
the contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Fund
expects to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying the futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from fluctuations in
the underlying securities. The Fund intends to use futures contracts only for
bonafide hedging purposes.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bonafide hedging transactions. The Fund will
only sell futures contracts to protect securities it owns against price declines
or purchase contracts to protect against an increase in the price of securities
it intends to purchase. As evidence of this hedging interest, the Fund expects
that approximately 75% of its futures contract purchases will be "completed;"
that is, equivalent amounts of related securities will have been purchased or
are being purchased by the Fund upon sale of open futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control the Fund's exposure of market fluctuations, the use of
futures contracts may be a more effective means of hedging this exposure. While
the Fund will incur commission expenses in both opening and closing out futures
positions, these costs are lower than transaction costs incurred in the purchase
and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS The Fund will not enter into
futures contract transactions to the extent that, immediately thereafter, the
sum of its initial margin deposits on open contracts exceeds 5% of the market
value of the Fund's total assets. In addition, the Fund will not enter into
futures contracts to the extent that its outstanding obligations to purchase
securities under these contracts would exceed 20% of the Fund's total assets.
RISK FACTORS IN FUTURES TRANSACTIONS Positions in futures contracts may be
closed out only on an Exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may not
be possible to close a futures position. In the event of adverse price
movements, the Fund would continue to be required to make daily cash payments to
maintain its required margin. In such situations, if the Fund has insufficient
cash, it may have to sell portfolio securities to meet daily margin requirements
at a time when it may be disadvantageous to do so. In addition, the Fund may be
required to make delivery of the instruments underlying futures contracts it
holds. The inability to close options and futures positions also could have an
adverse impact on the ability of the Fund to hedge its portfolio effectively.
The Fund will minimize the risk that it will be unable to close out a futures
contract by only entering into futures which are traded on national futures
exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due to both the low margin deposits required and the extremely high
degree of leverage involved in futures pricing. As a result, a relatively small
price movement in a futures contract may result in immediate and substantial
loss (as well as gain) to the investor. For example, if at the time of purchase,
10% of the value of the futures contract is deposited as margin, a subsequent
10% decrease in the value of the futures contract would result in a total loss
of the margin deposit, before any deduction for the transaction costs, if the
account were then closed out. A 15% decrease would result in a loss equal to
150% of the original margin deposit if the contract were closed out. Thus, a
purchase or sale of a futures contract may result in losses in excess of the
amount invested in the contract. The Fund also bears the risk that the Advisers
will incorrectly predict future market trends. However, because the futures
strategies of the Fund are engaged in only for hedging purposes, the Fund will
not be subject to the risks of loss frequently associated with futures
transactions. The Fund would presumably have sustained comparable losses if,
instead of the futures contract, it had invested in the underlying financial
instrument and sold it after the decline.
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Utilization of futures transactions by the Fund does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is also
possible that the Fund could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by the Fund of margin deposits in the event of bankruptcy of a
broker with whom the Fund has an open position in a futures contract or related
option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades may
be made on that day at a price beyond that limit. The daily limit governs only
price movement during a particular trading day and therefore does not limit
potential losses, because the limit may prevent the liquidation of unfavorable
positions. Futures contract prices have occasionally moved to the daily limit
for several consecutive trading days with little or no trading, thereby
preventing prompt liquidation of future positions and subjecting some futures
traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS The Fund is required for
federal income tax purposes to recognize as income for each taxable year its net
unrealized gains and losses on futures contracts held as of the end of the year
as well as those actually realized during the year. In most cases, any gain or
loss recognized with respect to a futures contract is considered to be 60%
long-term capital gain or loss and 40% short-term capital gain or loss, without
regard to the holding period of the contract. Furthermore, sales of futures
contracts which are intended to hedge against a change in the value of
securities held by the Fund may affect the holding period of such securities
and, consequently, the nature of the gain or loss on such securities upon
disposition. The Fund may be required to defer the recognition of losses on
futures contracts to the extent of any unrecognized gains on related positions
held by the Fund.
In order for the Fund to continue to qualify for federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, gains from the sale of
securities and other income derived with respect to its business of investing in
securities. In addition, gains realized on the sale or other disposition of
securities held for less than three months must be limited to less than 30% of
the Fund's annual gross income. It is anticipated that any net gain realized
from the closing out of futures contracts will be considered gain from the sale
of securities and therefore be qualifying income for purposes of the 90%
requirement. In order to avoid realizing excessive gains on securities held less
than three months, the Fund may be required to defer the closing out of futures
contracts beyond the time when it would otherwise be advantageous to do so. It
is anticipated that unrealized gains on futures contracts, which have been open
for less than three months as of the end of the Fund's fiscal year and which are
recognized for tax purposes, will not be considered gains on securities held
less than three months for the purpose of the 30% test.
The Fund will distribute to shareholders annually any net capital gains
which have been recognized for federal income tax purposes (including unrealized
gains at the end of the Fund's fiscal year) on futures transactions. Such
distributions will be combined with distributions of capital gains realized on
the Fund's other investments and shareholders will be advised on the nature of
the payments.
RESTRICTED SECURITIES The Fund is authorized to invest up to 15% of its
net assets in restricted securities. Restricted securities are those which are
not registered under the Securities Act of 1933 and which are generally issued
in small quantities to institutional or individual investors. Restricted
securities can be sold only in a privately negotiated transaction or after the
filing of a registration statement. The market for such securities is generally
illiquid.
If the Fund chooses to sell a restricted security by filing a registration
statement, the filing may involve a considerable delay, during which time the
market value of the security may decline. Because of the illiquid market for
restricted securities, the announcement of the Fund's decision to sell a
restricted security may also depress the security's price. In certain cases, the
Fund may also be obligated to pay all or part of the security's registration
expenses, which may be substantial.
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PURCHASE OF SHARES
The purchase price of shares of the Fund is the net asset value next
determined after the order is received. The net asset value is calculated as of
the close of the New York Stock Exchange on each day the Exchange is open for
business. An order received prior to the close of the Exchange (generally 4:00
P.M. Eastern time) will be executed at the price computed on the date of
receipt, and an order received after the close of the Exchange will be executed
at the price computed on the next day the Exchange is open.
The Fund reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interests of the Fund, and (iii) to
reduce or waive the minimum for initial and subsequent investments for certain
fiduciary accounts such as employee benefit plans or under circumstances where
certain economies can be achieved in sales of the Fund's shares.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading on
the Exchange is restricted as determined by the Securities and Exchange
Commission (the "Commission"), (ii) during any period when an emergency exists
as defined by the rules of the Commission as a result of which it is not
reasonably practicable for the Fund to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods as
the Commission may permit.
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during any
90-day period to the lesser of $250,000 or 1% of the net assets of the Fund at
the beginning of such period. Such commitment is irrevocable without the prior
approval of the Commission. Redemptions in excess of the above limits may be
paid in whole or in part in readily marketable investment securities or in cash,
as the Directors may deem advisable; however, payment will be made wholly in
cash unless the Directors believe that economic or market conditions exist which
would make such a practice detrimental to the best interests of the Fund. If
redemptions are paid in investment securities, such securities will be valued as
set forth in the Prospectus under "The Fund's Share Price" and a redeeming
shareholder would normally incur brokerage expenses if these securities were
converted to cash.
No charge is made by the Fund for redemptions. Any redemption may be more
or less than the shareholder's cost depending on the market value of the Fund's
portfolio securities.
DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
The Fund's policy is to distribute annually substantially all of its net
investment income, if any, together with any net realized capital gains, after
the close of the Fund's fiscal year. Dividend income is expected to be
negligible, and the amount of any capital gains distributions cannot be
predicted.
Any dividend or distribution paid shortly after the purchase of shares by
an investor may have the effect of reducing the per share net asset value by the
per share amount of the dividend or distribution. Furthermore, such dividends or
distributions, although in effect a return of capital, are subject to income
taxes.
Unless the shareholder elects otherwise, dividends and capital gains
distributions are paid in additional shares which are credited to the
shareholder's account. Any dividend and distribution election will remain in
effect until the Fund's Transfer Agent is notified by the shareholder in writing
to change the election at least three days prior to the record date. An account
statement is sent to shareholders whenever an income dividend or capital gains
distribution is paid.
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YIELD AND TOTAL RETURN
The yield of the Fund for the thirty-day period ended October 31, 1994 was
0.31%.
The average annual total returns for the Fund for the one-, five- and
ten-year periods ending October 31, 1994, were +4.49%, +12.87% and +9.70%,
respectively. Total return is computed by determining the average compounded
rates of return over the one-, five- and ten-year periods set forth above that
would equate an initial amount invested at the beginning of the periods to the
ending redeemable value of the investment.
INVESTMENT LIMITATIONS
The Fund is subject to the following restrictions which may not be changed
without the approval of the lesser of (i) 67 percent or more of the voting
securities present at a meeting if the holders of more than 50 percent of the
outstanding voting securities of the Fund are present or represented by proxy,
or (ii) more than 50 percent of the outstanding voting securities of the Fund.
The Fund will not:
1) make investments in commodities or real estate, although it may
purchase and sell securities of companies which deal in real estate or
interests therein, and except that the Fund may invest in stock futures
contracts and stock options (only for hedging purposes) to the extent
that not more than 5% of its assets are required as deposit to secure
obligations under futures contracts and not more than 20% of its assets
are invested in futures contracts and options at any time;
2) make loans, except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements) which are either publicly
distributed or customarily purchased by institutional investors and
(ii) as provided under "Lending of Securities" (page 2);
3) engage in the business of underwriting securities issued by others
except to the extent that the Fund may technically be deemed to be an
underwriter under the Securities Act of 1933, as amended, in disposing
of portfolio securities;
4) purchase or otherwise acquire illiquid securities if, as a result, more
than 15% of its net assets would be invested in securities that are
illiquid (included in this limitation is the Fund's investment in The
Vanguard Group, Inc.);
5) purchase securities on margin or make short sales except as specified
in investment limitation No. 1 above;
6) invest more than 25% of its assets in any one industry;
7) invest for the purpose of exercising control over management of any
company;
8) invest its assets in the securities of other investment companies
except as may be acquired as part of a merger, consolidation or
acquisition of assets approved by the Fund's shareholders or otherwise
to the extent permitted by Section 12 of the Investment Company Act of
1940. The Fund will invest only in investment companies which have
investment objectives and investment policies consistent with those of
the Fund;
9) with respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States
government and its instrumentalities) if as a result the Fund would
hold more than 10% of the outstanding voting securities of the issuer,
or more than 5% of the value of the Fund's total assets would be
invested in the securities of such issuer;
10) pledge, mortgage, or hypothecate any of its assets to an extent greater
than 10% of its total assets at fair market value;
11) invest more than 25% of the value of its total assets in any one
industry; and
12) borrow money, except that the Fund may borrow from banks (or through
reverse repurchase agreements), for temporary or emergency (not
leveraging) purposes, including the meeting of redemption requests
which might otherwise require the untimely disposition of securities,
in an amount not
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exceeding 15% of the value of the Fund's net assets (including the
amount borrowed and the value of any outstanding reverse repurchase
agreements) at the time the borrowing is made. Whenever borrowings
exceed 5% of the value of the Fund's net assets, the Fund will not make
any additional investments.
Notwithstanding these limitations, the Fund may own all or any portion of
the securities of, or make loans to, or contribute to the costs or other
financial requirements of any company which will be wholly owned by the Fund and
one or more other investment companies and is primarily engaged in the business
of providing, at-cost, management, administrative or related services to the
Fund and other investment companies. See "Management of the Fund."
The above-mentioned limitations are considered at the time investment
securities are purchased.
Although not a fundamental policy subject to shareholder vote, as long as
the Fund's shares are registered for sale in certain states, the Fund will not
(i) except as permitted above in investment limitation No. 1; (ii) invest in
interests in oil, gas or other mineral exploration or development programs;
(iii) purchase securities of any company which has (with predecessors) a record
of less than three years continuous operation if as a result more than 5% of the
Fund's assets would be invested in securities of such companies; and (iv)
purchase or retain securities of an issuer if an officer or director of such
issuer is an officer or Director of the Fund or its investment adviser and one
or more of such officers or Directors of the Fund or its investment adviser owns
beneficially more than 1/2% of the shares or securities of such issuer and all
such Directors and officers owning more than 1/2% of such shares or securities
together own more than 5% of such shares or securities.
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MANAGEMENT OF THE FUND
OFFICERS AND DIRECTORS
The Fund's Officers, under the supervision of the Board of Directors,
manage the day-to-day operations of the Fund. The Directors, who are elected
annually by shareholders, set broad policies for the Fund and choose its
Officers. A list of the Directors and Officers of the Fund and a brief statement
of their present positions and principal occupations during the past five years
is set forth below.
The mailing address of the Fund's Directors and officers is Post Office Box
876, Valley Forge, PA 19482.
JOHN C. BOGLE, Chairman, Chief Executive Officer and Director*
Chairman, Chief Executive Officer, and Director of The Vanguard Group, Inc.
and of each of the investment companies in The Vanguard Group; Director of
The Mead Corporation, and General Accident Insurance.
JOHN J. BRENNAN, President & Director*
President and Director of The Vanguard Group, Inc. and of each of the
investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Director
Chairman of Rhone-Poulenc Rorer, Inc.; Director of Sun Company, Inc.
BARBARA BARNES HAUPTFUHRER, Director
Director of The Great Atlantic and Pacific Tea Company, ALCO Standard
Corp., Raytheon Company, Knight-Ridder, Inc., and Massachusetts Mutual Life
Insurance Co. and Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY, Director
President, The Brookings Institution; Director of American Express Bank,
Ltd., The St. Paul Companies, Inc., and Scott Paper Company.
BURTON G. MALKIEL, Director
Chemical Bank Chairman's Professor of Economics, Princeton University;
Director of Prudential Insurance Co. of America, Amdahl Corporation, Baker
Fentress & Co., The Jeffrey Co., and Southern New England Communications
Company.
ALFRED M. RANKIN, JR., Director
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of The BFGoodrich Company, The Standard Products Company and The
Reliance Electric Company.
JOHN C. SAWHILL, Director
President and Chief Executive Officer, The Nature Conservancy; formerly,
Director and Senior Partner, McKinsey & Co.; President, New York
University; Director of Pacific Gas and Electric Company and NACCO
Industries.
JAMES O. WELCH, JR., Director
Retired Chairman of Nabisco Brands, Inc. retired Vice Chairman and Director
of RJR Nabisco; Director of TECO Energy, Inc.
J. LAWRENCE WILSON, Director
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of
Cummins Engine Company; Trustee of Vanderbilt University and the Culver
Educational Foundation.
RAYMOND J. KLAPINSKY, Secretary*
Senior Vice President and Secretary of The Vanguard Group, Inc.; Secretary
of each of the investment companies in The Vanguard Group.
RICHARD F. HYLAND, Treasurer*
Treasurer of The Vanguard Group, Inc. and of each of the investment
companies in The Vanguard Group.
KAREN E. WEST, Controller*
Vice President of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
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*Officers of the Fund are "interested persons" as defined in the Investment
Company Act of 1940.
VANGUARD GROUP
Vanguard Explorer Fund is a member of The Vanguard Group of Investment
Companies, which consists of more than 30 investment companies. Through their
jointly-owned subsidiary, The Vanguard Group, Inc. ("Vanguard"), the Fund and
the other Funds in the Group obtain at cost virtually all of their corporate
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management, administrative and distribution services. Vanguard also provides
investment advisory services on an at-cost basis to some of the Vanguard Funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the Funds and also
furnishes the Funds with necessary office space, furnishings and equipment. Each
Fund pays its share of Vanguard's total expenses, which are allocated among the
Funds under procedures approved by the Board of Directors (Trustees) of each
Fund. In addition, each Fund bears its own direct expenses, such as legal,
auditing and custodian fees.
The Fund's Officers are also Officers and employees of Vanguard. No Officer
or employee owns, or is permitted to own, any securities of any external adviser
for the Funds.
The Vanguard Group adheres to a Code of Ethics established pursuant to Rule
17j-1 under the Investment Company Act of 1940. The Code is designed to prevent
unlawful practices in connection with the purchase or sale of securities by
persons associated with Vanguard. Under Vanguard's Code of Ethics certain
officers and employees of Vanguard who are considered access persons are
permitted to engage in personal securities transactions. However, such
transactions are subject to procedures and guidelines substantially similar to
those recommended by the mutual fund industry and approved by the U.S.
Securities and Exchange Commission.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
Fund's Service Agreement was amended on May 15, 1993 to provide as follows: (a)
each Vanguard Fund may invest up to .40% of its current net assets in Vanguard,
and (b) there is no limit on the amount that each Vanguard Fund may contribute
to Vanguard's capitalization. The amounts which each of the Funds have invested
are adjusted from time to time in order to maintain the proportionate
relationship between each Fund's relative net assets and its contribution to
Vanguard's capital. At October 31, 1994, Vanguard Explorer Fund had contributed
capital of $169,000 to Vanguard, representing .8% of Vanguard's capitalization.
MANAGEMENT Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Funds by third parties. During the
fiscal year ended October 31, 1994, the Fund's share of Vanguard's actual net
costs of operation relating to management and administrative services (including
transfer agency) totaled approximately $3,472,000.
DISTRIBUTION Vanguard provides all distribution and marketing activities
for the Funds in the Group. Vanguard Marketing Corporation, a wholly-owned
subsidiary of The Vanguard Group, Inc., acts as Sales Agent for shares of the
Funds, in connection with any sales made directly to investors in the states of
Florida, Missouri, New York, Ohio, Texas and such other states as it may be
required.
The principal distribution expenses are for advertising, promotional
materials and marketing personnel. Distribution services may also include
organizing and offering to the public, from time to time, one or more new
investment companies which will become members of the Group. The Directors and
officers of Vanguard determine the amount to be spent annually on distribution
activities, the manner and amount to be spent on each Fund, and whether to
organize new investment companies.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Funds based upon their relative net assets. The remaining
one half of these expenses is allocated among the Funds based upon each Fund's
sales for the preceding 24 months relative to the total sales of the Funds as a
Group, provided, however, that no Fund's aggregate quarterly rate of
contribution for distribution expenses of a marketing and promotional nature
shall exceed 125% of the average distribution expense rate for the Group, and
that no Fund shall incur annual distribution expenses in excess of 20/100 of 1%
of its average month-end net assets. During the fiscal year ended October 31,
1994, the Fund paid approximately $170,000 of the Group's distribution and
marketing expenses, which represented an effective annual rate of .02 of 1% of
the Fund's average net assets.
9
<PAGE> 10
INVESTMENT ADVISORY SERVICES Vanguard also provides investment advisory
services to: Vanguard Money Market Reserves; Vanguard Municipal Bond Fund,
several Portfolios of Vanguard Fixed Income Securities Fund; Vanguard Bond Index
Fund; Vanguard California Tax-Free Fund; Vanguard New Jersey Tax-Free Fund;
Vanguard Florida Insured Tax-Free Fund; Vanguard New York Insured Tax-Free Fund;
Vanguard Pennsylvania Tax-Free Fund; Vanguard Ohio Tax-Free Fund; Vanguard
Institutional Money Market Portfolio; Vanguard Index Trust; Vanguard
International Equity Index Fund; Vanguard Balanced Index Fund; Vanguard
Institutional Index Fund; several Portfolios of Vanguard Variable Insurance
Fund, Vanguard Admiral Funds, Vanguard Tax-Managed Fund, Vanguard Horizon Fund,
a portion of Vanguard/Windsor II, a portion of Vanguard/Morgan Growth Fund as
well as several indexed separate accounts. These services are provided on an
at-cost basis from a money management staff employed directly by Vanguard. The
compensation and other expenses of this staff are paid by the Funds utilizing
these services.
REMUNERATION OF DIRECTORS AND OFFICERS The Fund pays each Director, who is
not also an Officer, an annual fee plus travel and other expenses incurred in
attending Board meetings. The Fund's Officers and employees are paid by Vanguard
which, in turn, is reimbursed by the Fund, and each other Fund in the Group, for
its proportionate share of Officers' and employees' salaries and retirement
benefits.
Under its retirement plan, Vanguard contributes annually an amount equal to
10% of each eligible Officer's annual compensation plus 7% of that part of the
eligible Officer's compensation during the year, if any, that exceeds the Social
Security Taxable Wage Base then in effect. Under Vanguard's thrift plan, all
eligible Officers are permitted to make pre-tax basic contributions in a maximum
amount equal to 4% of total compensation which are matched by Vanguard on a 100%
basis. Directors who are not Officers are paid an annual fee based on the number
of years of service on the board, up to 15 years of service, upon retirement.
The fee is equal to $1,000 for each year of service and each investment company
member of The Vanguard Group contributes a proportionate amount to this fee
based on its relative net assets. This fee is paid, subsequent to a Director's
retirement, for a period of ten years or until the death of a retired Director.
The following table provides detailed information with respect to the
amounts paid or accrued for the Directors, and the Officers of the Fund for whom
the Fund's proportionate share of remuneration exceeded $60,000, for the fiscal
year ended October 31, 1994.
VANGUARD EXPLORER FUND
COMPENSATION TABLE
<TABLE>
<CAPTION>
AGGREGATE PENSION OR RETIREMENT ESTIMATED TOTAL COMPENSATION
COMPENSATION BENEFITS ACCRUED AS ANNUAL BENEFITS FROM ALL VANGUARD FUNDS
NAMES OF DIRECTORS FROM FUND PART OF FUND EXPENSES UPON RETIREMENT PAID TO DIRECTORS(2)
- --------------------------- ------------ --------------------- --------------- -----------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) -- -- -- --
John J. Brennan(1) -- -- -- --
Barbara Barnes Hauptfuhrer $333 $67 $15,000 $50,000
Robert E. Cawthorn $333 $56 $13,000 $50,000
Bruce K. MacLaury $299 $56 $12,000 $45,000
Burton G. Malkiel $333 $45 $15,000 $50,000
Alfred M. Rankin, Jr. $333 $36 $15,000 $50,000
John C. Sawhill $333 $42 $15,000 $50,000
James O. Welch, Jr. $319 $52 $15,000 $48,000
J. Lawrence Wilson $326 $37 $15,000 $49,000
</TABLE>
(1)As "Interested Directors," Messrs. Bogle and Brennan receive no compensation
for their service as directors. Compensation amounts reported for Messrs.
Bogle and Brennan relate to their respective positions as Chief Executive
Officer and President of the Fund.
(2)The amounts reported in this column reflect the total compensation paid to
each Director for their service as Director or Trustee of 33 Vanguard Funds
(32 in the case of Mr. MacLaury).
10
<PAGE> 11
INVESTMENT ADVISORY SERVICES
The Fund currently employs two investment advisers: Wellington Management
Company ("WMC"), 75 State Street, Boston, MA 02109; and Granahan Investment
Management, Inc. ("Granahan"), 303 Wyman Street, Waltham, MA 02154. Until
February 28, 1990, when the Fund acquired the assets of Explorer II, WMC was
sole investment adviser to the Fund (then known simply as Explorer Fund), and
Granahan served as sole investment adviser to Explorer II, the acquired fund.
The proportion of the net assets of the Fund managed by each adviser was
established by the Board of Directors effective with the acquisition of Explorer
II, and may be changed in the future by the Board of Directors as circumstances
warrant. Investors will be advised of any substantive change in the proportions
managed by each adviser. Because the Fund employs two advisers it is possible
that the advisers would purchase or sell the same security at the same time.
Such a situation might result in increased brokerage costs or adverse tax
consequences to the Fund. The Board of Directors monitors portfolio activity in
order to minimize any possible adverse consequences.
WELLINGTON MANAGEMENT COMPANY
The Fund has entered into an advisory agreement with WMC under which WMC
manages the investment and reinvestment of a portion of the Fund's assets (the
"WMC Portfolio") and continuously reviews, supervises and administers the Fund's
investment program with respect to those assets. As of October 31, 1994, WMC
managed approximately 48% of the Fund's net assets. WMC discharges its
responsibilities subject to the control of the officers and Directors of the
Fund.
WMC is a professional investment counseling firm which provides investment
services to investment companies, other institutions and individuals. WMC is a
Massachusetts general partnership of which the following persons are managing
partners: Robert W. Doran, Duncan M. McFarland and John B. Neff.
The Fund pays WMC a Basic Fee at the end of each fiscal quarter, calculated
by applying a quarterly rate, based on the following annual percentage rates, to
the average month-end net assets of the WMC Portfolio for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
-------------------- -----
<S> <C>
First $100 million 0.35%
Next $250 million 0.30%
Over $350 million 0.25%
</TABLE>
The Basic Fee paid to WMC may be increased or decreased by applying an
adjustment formula based on the investment performance of the net assets of the
WMC Portfolio. Such formula provides for an increase or decrease in WMC's Basic
Fee in an amount equal to .075% per annum (.01875 of 1% per quarter) of the
average month-end net assets of the WMC Portfolio if the investment performance
of the WMC Portfolio for the thirty-six months preceding the end of the quarter
is twelve percentage points or more above or below, respectively, the investment
record of the Russell 2000 Small Company Index (the "Russell 2000") for the same
period; or by an amount equal to .0375% per annum (.009375 of 1% per quarter) if
the investment performance of the WMC Portfolio for such thirty-six months is
six or more but less than twelve percentage points above or below, respectively,
the investment record of the Russell 2000 for the same period. The incentive
portion of the fee may be earned even if the performance of the WMC Portfolio
for the period is negative provided that the Portfolio's performance exceeds the
Russell 2000 by the required percentage.
The investment performance of the WMC Portfolio for any period, expressed
as a percentage of the "WMC Portfolio unit value" at the beginning of such
period, is the sum of: (i) the change in the WMC Portfolio unit value during
such period; (ii) the unit value of the Fund's cash distributions from the WMC
Portfolio net investment income and realized net capital gains (whether
long-term or short-term) having an ex-dividend date occurring within such
period; and (iii) the unit value of capital gains taxes paid or accrued during
such period by the Fund for undistributed realized long-term capital gains
realized from the WMC Portfolio.
11
<PAGE> 12
The "WMC Portfolio unit value" is determined by dividing the total net
assets of the WMC Portfolio by a given number of units. On the initial date of
the agreement, the number of units in the WMC Portfolio will equal the total
shares outstanding of the Fund. After such initial date, as assets are added to
or are withdrawn from the WMC Portfolio, the number of units of the WMC
Portfolio is adjusted based on the unit value of the WMC Portfolio on the day
such changes are executed.
The investment record of the Russell 2000 for any period, expressed as a
percentage of the Russell 2000 at the beginning of such period, is the sum of
(i) the change in the level of the Russell 2000 during such period and (ii) the
value, computed consistently with the Russell 2000, of cash distributions having
an ex-dividend date occurring within such period made by companies whose
securities comprise the Russell 2000. For this purpose cash distributions on the
securities which comprise the Russell 2000 shall be treated as reinvested in the
Russell 2000 at least as frequently as the end of each calendar quarter
following the payment of the dividend.
For the purposes of determining the fee adjustment for investment
performance, the net assets of the WMC Portfolio are averaged over the same
period as the investment performance of the WMC Portfolio and the investment
record of the Russell 2000 are computed.
Any computation of the investment performance of the WMC Portfolio and the
investment record of the Russell 2000 shall be subject to and in accordance with
any then applicable rules of the Securities and Exchange Commission.
During the fiscal years ended October 31, 1992, 1993, and 1994, the Fund
paid WMC approximately the following advisory fees:
<TABLE>
<CAPTION>
1992 1993 1994
---------- ---------- ----------
<S> <C> <C> <C>
Basic Fee........................... $ 918,671 $1,181,674 $1,362,455
Increase (Decrease) for Performance
Adjustment........................ 82,994 (79,280) (61,905)
---------- ---------- ----------
Total.......................... $1,001,665 $1,102,394 $1,300,550
========== ========== ==========
</TABLE>
The agreement with WMC continues until February 27, 1995. The agreement is
renewable thereafter, for successive one year periods, only if each renewal is
specifically approved by a vote of the Fund's Board of Directors, including the
affirmative votes of a majority of the Directors who are not parties to the
contract or "interested persons" (as defined in the Investment Company Act of
1940) of any such party, cast in person at a meeting called for the purpose of
considering such approval. In addition, the question of continuance of the
agreement may be presented to the shareholders of the Fund; in such event
continuance shall be effected only if approved by the affirmative vote of a
majority of the outstanding voting securities of the Fund. The agreement is
automatically terminated if assigned, and may be terminated without penalty at
any time (1) either by vote of the Board of Directors of the Fund or by vote of
its outstanding voting securities on sixty (60) days' written notice to WMC, or
(2) by WMC upon ninety (90) days' written notice to the Fund.
GRANAHAN INVESTMENT MANAGEMENT, INC.
On February 28, 1990, effective with the acquisition of the assets of
Explorer II, the Fund retained Granahan Investment Management, Inc. ("Granahan")
as a second investment adviser. Under its advisory agreement with the Fund,
Granahan manages the investment and reinvestment of a portion of the Fund's
assets (the "Granahan Portfolio") and continuously reviews, supervises and
administers the Fund's investment program with respect to those assets. As of
October 31, 1994, Granahan managed approximately 47% of the Fund's net assets.
Granahan discharges its responsibilities subject to the control of the officers
and Directors of the Fund.
12
<PAGE> 13
The Fund pays Granahan a Basic Fee at the end of each fiscal quarter,
calculated by applying a quarterly rate, based on the following annual
percentage rates, to the average month-end net assets of the Granahan Portfolio
for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
-------------------- -----
<S> <C>
First $50 million 0.45%
Next $50 million 0.40%
Next $100 million 0.35%
Over $200 million 0.25%
</TABLE>
The Basic Fee paid to Granahan may be increased or decreased by applying an
adjustment formula based on the investment performance of the net assets of the
Granahan Portfolio. Such formula provides for an increase or decrease in
Granahan's Basic Fee in an amount equal to .075% per annum (.01875 of 1% per
quarter) of the average month-end net assets of the Granahan Portfolio if the
investment performance of the Granahan Portfolio for the thirty-six months
preceding the end of the quarter is twelve percentage points or more above or
below, respectively, the investment record of the Russell 2000 Small Company
Index (the "Russell 2000") for the same period; or by an amount equal to .0375%
per annum (.009375 of 1% per quarter) if the investment performance of the
Granahan Portfolio for such thirty-six months is six or more but less than
twelve percentage points above or below, respectively, the investment record of
the Russell 2000 for the same period. The incentive portion of the fee may be
earned even if the performance of the Granahan Portfolio for the period is
negative provided that the Portfolio's performance exceeds the Russell 2000 by
the required percentage.
The investment performance of the Granahan Portfolio for any period,
expressed as a percentage of the "Granahan Portfolio unit value" at the
beginning of such period, is the sum of: (i) the change in the Granahan
Portfolio unit value during such period; (ii) the unit value of the Fund's cash
distributions from the Granahan Portfolio net investment income and realized net
capital gains (whether long-term or short-term) having an ex-dividend date
occurring within such period; and (iii) the unit value of capital gains taxes
paid or accrued during such period by the Fund for undistributed realized
long-term capital gains realized from the Granahan Portfolio.
The "Granahan Portfolio unit value" is determined by dividing the total net
assets of the Granahan Portfolio by a given number of units. On the initial date
of the agreement, the number of units in the Granahan Portfolio equalled the
total shares outstanding of the Fund. After such initial date, as assets are
added to or are withdrawn from the Granahan Portfolio, the number of units of
the Granahan Portfolio is adjusted based on the unit value of the Granahan
Portfolio on the day such changes are executed.
The investment record of the Russell 2000 for any period, expressed as a
percentage of the Russell 2000 at the beginning of such period, is the sum of
(i) the change in the level of the Russell 2000 during such period and (ii) the
value, computed consistently with the Russell 2000, of cash distributions having
an ex-dividend date occurring within such period made by companies whose
securities comprise the Russell 2000. For this purpose cash distributions on the
securities which comprise the Russell 2000 shall be treated as reinvested in the
Russell 2000 at least as frequently as the end of each calendar quarter
following the payment of the dividend.
For the purposes of determining the fee adjustment for investment
performance, the net assets of the Granahan Portfolio are averaged over the same
period as the investment performance of the Granahan Portfolio and the
investment record of the Russell 2000 are computed.
Any computation of the investment performance of the Granahan Portfolio and
the investment record of the Russell 2000 shall be subject to and in accordance
with any then applicable rules of the Securities and Exchange Commission.
13
<PAGE> 14
During the fiscal years ended October 31, 1992, 1993 and 1994, the Fund
paid Granahan approximately the following advisory fees:
<TABLE>
<CAPTION>
1992 1993 1994
-------- ---------- ----------
<S> <C> <C> <C>
Basic Fee....................... $673,252 $ 936,872 $1,397,812
Increase (Decrease) for
Performance Adjustment........ 87,536 116,432 40,525
-------- ---------- ----------
Total...................... $760,788 $1,053,304 $1,438,337
========= ========== ==========
</TABLE>
The agreement continues until February 27, 1995 and will be renewable
thereafter for successive one year periods, only if each renewal is specifically
approved by a vote of the Fund's Board of Directors, including the affirmative
votes of a majority of the Directors who are not parties to the contract or
"interested persons" (as defined in the Investment Company Act of 1940) of any
such party, cast in person at a meeting called for the purpose of considering
such approval. In addition, the question of continuance of the agreement may be
presented to the shareholders of the Fund; in such event, such continuance shall
be effected only if approved by the affirmative vote of a majority of the
outstanding voting securities of the Fund. The agreement is automatically
terminated if assigned, and may be terminated without penalty at any time (1)
either by vote of the Board of Directors of the Fund or by vote of its
outstanding voting securities on 60 days' written notice to Granahan, or (2) by
Granahan upon 90 days' written notice to the fund.
In April 1972, the Securities and Exchange Commission ("SEC") issued
Release No. 7113 under the Investment Company Act of 1940 to call attention of
directors and investment advisers to certain factors which must be considered in
connection with investment company incentive fee arrangements. One of these
factors is to "avoid basing significant fee adjustments upon random or
insignificant differences" between the investment performance of a fund and that
of the particular index with which it is being compared. The Release provides
that "preliminary studies (of the SEC staff) indicate that as a 'rule of thumb'
the performance difference should be at least 10 percentage points" annually
before the maximum performance adjustment may be made. However, the Release also
states that "because of the preliminary nature of these studies, the Commission
is not recommending, at this time, that any particular performance difference
exist before the maximum fee adjustment may be made." The Release concludes that
the directors of a fund "should satisfy themselves that the maximum performance
adjustment will be made only for performance differences that can reasonably be
considered "significant." The Board of Directors of Vanguard Explorer Fund has
fully considered the SEC Release and believes that the performance adjustments
as included in the above mentioned agreements are appropriate, although not
within the 10 percentage point per year range suggested in the Release. Under
the proposed investment advisory agreement between Vanguard Explorer Fund and
Granahan, and Vanguard Explorer Fund and WMC, the maximum performance adjustment
is made at a difference of 12 percentage points from the performance of the
index over a thirty-six month period, which would effectively be the equivalent
of approximately 4 percentage points difference per year.
The Fund's Board of Directors may, without the approval of shareholders,
provide for:
A. The employment of a new investment adviser pursuant to the terms of
a new advisory agreement, either as a replacement for an existing
adviser or as an additional adviser.
B. A change in the terms of an advisory agreement.
C. The continued employment of an existing adviser on the same
advisory contract terms where a contract has been assigned because
of a change in control of the adviser.
Any such change will only be made upon not less than 30 days prior written
notice to shareholders, which shall include the information concerning the
adviser that would have normally been included in a proxy statement.
14
<PAGE> 15
PORTFOLIO TRANSACTIONS
The investment advisory agreements authorize WMC and Granahan (with the
approval of the Fund's Board of Directors) to select the brokers or dealers that
will execute the purchases and sales of portfolio securities for the Fund and
direct the advisers to use their best efforts to obtain the best available price
and most favorable execution as to all transactions for the Fund. WMC and
Granahan have undertaken to execute each investment transaction at a price and
commission which provides the most favorable total cost or proceeds reasonably
obtainable under the circumstances.
In placing portfolio transactions, WMC and Granahan will use their best
judgment to choose the broker most capable of providing the brokerage services
necessary to obtain best available price and most favorable execution. The full
range and quality of brokerage services available will be considered in making
these determinations. In those instances where it is reasonably determined that
more than one broker can offer the brokerage services needed to obtain the best
available price and most favorable execution, consideration may be given to
those brokers which supply investment research and statistical information and
provide other services in addition to execution services to the Fund and/or WMC
or Granahan. WMC and Granahan consider such information useful in the
performance of its obligations under the agreement but are unable to determine
the amount by which such services may reduce its expenses.
The investment advisory agreement also incorporates the concepts of Section
28(e) of the Securities Exchange Act of 1934 by providing that, subject to the
approval of the Fund's Board of Directors, WMC and Granahan may cause the Fund
to pay a broker-dealer which furnishes brokerage and research services a higher
commission than that which might be charged by another broker-dealer for
effecting the same transaction; provided that such commission is deemed
reasonable in terms of either that particular transaction or the overall
responsibilities of WMC and Granahan to the Fund and the other Funds in the
Group.
Currently, it is the Fund's policy that WMC and Granahan may at times pay
higher commissions in recognition of brokerage services felt necessary for the
achievement of better execution of certain securities transactions that
otherwise might not be available. The advisers will only pay such higher
commissions if they believe this to be in the best interest of the Fund. Some
brokers or dealers who may receive such higher commissions in recognition of
brokerage services related to execution of securities transactions are also
providers of research information to WMC, Granahan and/or the Fund.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be through such firms.
However, the Fund may place portfolio orders with qualified broker-dealers who
recommend the Fund to other clients, or who act as agent in the purchase of the
Fund's shares for their clients, and may, when a number of brokers and dealers
can provide comparable best price and execution on a particular transaction,
consider the sale of Fund shares by a broker or dealer in selecting among
qualified broker-dealers.
During the fiscal years ended October 31, 1992, 1993 and 1994 the Fund paid
$336,169, $452,558 and $1,627,910 in brokerage commissions, respectively.
Some securities considered for investment by the Fund may also be
appropriate for other Funds and/or clients served by WMC or Granahan. If
purchase or sale of securities consistent with the investment policies of the
Fund and one or more of these other Funds or clients served by the advisers are
considered at or about the same time, transactions in such securities will be
allocated among the several Funds and clients in a manner deemed equitable by
WMC or Granahan.
GENERAL INFORMATION ABOUT THE FUND
DESCRIPTION OF SHARES AND VOTING RIGHTS
The Fund was established under Pennsylvania law under a Declaration of
Trust dated April 17, 1984. The Fund was reorganized as a Maryland corporation
on December 31, 1986. On February 28, 1990, the Fund acquired the assets of
Explorer II, Inc., an investment company that was a member of The Vanguard Group
15
<PAGE> 16
and that had investment objectives and policies similar to those of the Fund.
Also, on that date the Fund retained Granahan Investment Management Inc.,
investment adviser to Explorer II, as the Fund's second adviser and adopted its
new name.
The Fund's Amended and Restated Articles of Incorporation permit the
Directors to issue 100,000,000 shares of common stock, with a $.001 par value.
The Board of Directors has the power to designate one or more classes
("Portfolios") of shares of common stock and to classify or reclassify any
unissued shares with respect to such Portfolios. Currently, the Fund is offering
one class of shares.
The shares of the Fund are fully paid and nonassessable, and have no
preferences as to conversion, exchange, dividends, retirement or other features.
The shares have no pre-emptive rights. Such shares have non-cumulative voting
rights, which means that the holders of more than 50% of the shares voting for
the election of Directors can elect 100% of the Directors if they choose to do
so. A shareholder is entitled to one vote for each full share held (and a
fractional vote for each fractional share held), then standing in his name on
the books of the Fund.
PERFORMANCE MEASURES
The Fund may use one or more, either singularly or in a composite, of the
following unmanaged indexes for comparative performance purposes:
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX -- is a well-diversified list
of 500 companies representing the U.S. Stock Market.
WILSHIRE 5000 EQUITY INDEX -- consists of more than 6,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
WILSHIRE 4500 EQUITY INDEX -- consists of all stocks in the Wilshire 5000 except
for the 500 stocks in the Standard & Poor's 500 Index.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX -- is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia and the Far East.
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX -- currently includes 67 bonds and 33
preferreds. The original list of names was generated by screening for
convertible issues of 100 million or greater in market capitalization. The index
is priced monthly.
SALOMON BROTHERS GNMA INDEX -- includes pools of mortgages originated by private
lenders and guaranteed by the mortgage pools of the Government National Mortgage
Association.
SALOMON BROTHERS HIGH-GRADE CORPORATE BOND INDEX -- consists of publicly issued,
non-convertible corporate bonds rated AA or AAA. It is a value-weighted, total
return index, including approximately 800 issues with maturities of 12 years or
greater.
LEHMAN LONG-TERM TREASURY BOND -- is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND -- consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
LEHMAN CORPORATE (BAA) BOND INDEX -- all publicly offered fixed rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
BOND BUYER MUNICIPAL INDEX (20 YEAR) BOND -- is a yield index on current coupon
high grade general obligation municipal bonds.
STANDARD & POOR'S PREFERRED INDEX -- is a yield index based upon the average
yield of four high grade, noncallable preferred stock issues.
16
<PAGE> 17
NASDAQ INDUSTRIAL INDEX -- is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
COMPOSITE INDEX -- 70% Standard & Poor's 500 Index and 30% NASDAQ Industrial
Index.
COMPOSITE INDEX -- 35% Standard & Poor's 500 Index and 65% Salomon Brothers
High-Grade Bond Index.
COMPOSITE INDEX -- 65% Standard & Poor's 500 Index and 35% Salomon Brothers
High-Grade Bond Index.
LEHMAN BROTHERS AGGREGATE BOND INDEX -- is a market weighted index that contains
individually priced U.S. Treasury, agency, corporate, and mortgage pass through
securities corporate rated BBB- or better. The index has a market value of over
$4 trillion.
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5) GOVERNMENT/CORPORATE INDEX -- is a
market weighted index that contains individually priced U.S. Treasury, agency,
and corporate investment grade bonds rated BBB- or better with maturities
between 1 and 5 years. The index has a market value of over $1.3 trillion.
LEHMAN BROTHERS MUTUAL FUND INTERMEDIATE (5-10) GOVERNMENT/CORPORATE INDEX -- is
a market weighted index that contains individually priced U.S. Treasury, agency,
and corporate securities rated BBB- or better with maturities between 5 and 10
years. The index has a market value of over $600 billion.
LEHMAN BROTHERS MUTUAL FUND LONG (10+) GOVERNMENT/CORPORATE INDEX -- is a market
weighted index that contains individually priced U.S. Treasury, agency and
corporate securities rated BBB- or better with maturities greater than 10 years.
The index has a market value of over $900 billion.
LIPPER SMALL COMPANY GROWTH FUND AVERAGE -- the average performance of small
company growth funds as defined by Lipper Analytical Services, Inc. Lipper
defines a small company growth fund as a fund that by prospectus or portfolio
practice, limits its investments to companies on the basis of the size of the
company. From time to time, Vanguard may advertise using the average performance
and/or the average expense ratio of the small company growth funds. (This fund
category was first established in 1982. For years prior to 1982, the results of
the Lipper Small Company Growth category were estimated using the returns of the
Funds that constituted the Group at its inception.)
RUSSELL 3000 INDEX -- consists of approximately the 3,000 largest stocks of
U.S.-domiciled companies commonly traded on the New York and American Stock
Exchanges or the NASDAQ over-the-counter market, accounting for over 90% of the
market value of publicly traded Stocks in the U.S.
RUSSELL 2000 SMALL COMPANY STOCK INDEX -- consists of the smallest 2,000 stocks
within the Russell 3000; a widely used benchmark for small capitalization common
stocks.
LIPPER BALANCED FUND AVERAGE -- An industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper
Analytical Services, Inc.
LIPPER NON-GOVERNMENT MONEY MARKET FUND AVERAGE -- An industry benchmark of
average non-government money market funds with similar investment objectives and
policies, as measured by Lipper Analytical Services, Inc.
LIPPER GOVERNMENT MONEY MARKET FUND AVERAGE -- An industry benchmark of average
government money market funds with similar investment objectives and policies,
as measured by Lipper Analytical Services, Inc.
FINANCIAL STATEMENTS
The Fund's Financial Statements for the year ended October 31, 1994,
including the financial highlights for each of the five fiscal years in the
period ended October 31, 1994, appearing in the Vanguard Explorer Fund 1994
Annual Report to Shareholders, and the report thereon of Price Waterhouse LLP,
independent accountants, also appearing therein, are incorporated by reference
in this Statement of Additional Information. The Fund's 1994 Annual Report to
Shareholders is enclosed with this Statement of Additional Information.
17
