<PAGE> 1
VANGUARD
EXPLORER FUND
ANNUAL REPORT
OCTOBER 31, 1996
THE VANGUARD GROUP:
LINKING TRADITION
AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our
course toward the twenty-first century. Our Report cover reflects that blending
of tradition and innovation, of past, present, and future.
The montage includes a bronze medallion with a likeness of our namesake, HMS
Vanguard (Lord Nelson's flagship at The Battle of the Nile); a clock built
circa 1816 in Scotland, featuring a portrait of Nelson (who is also shown,
accepting a surrender, in a detail from a nineteenth-century engraving); and
several views of our recently completed campus, which is steeped in nautical
imagery--from our buildings named after Nelson's warships (Victory, Majestic,
and Goliath are three shown), to our artwork and ornamental compass rose.
[PHOTO]
<PAGE> 2
[PHOTO]
VANGUARD HAS ALWAYS STRIVED TO BE THE STANDARD-BEARER for mutual fund
disclosure, going well beyond the "letter of the law" in our shareholder
communications. During the past year, we raised the standard once again by
rewriting and reformatting our Fund prospectuses. They are designed to ensure
that prospective investors fully understand, before they make an investment,
each Fund's investment strategies, risks, and costs. In that spirit, we have
redesigned our Annual Reports to shareholders, which provide a comprehensive
discussion and analysis of the year's results in the context of each Fund's
investment objectives and policies. Since Vanguard has long been recognized for
the quality and content of these Fund Reports, our overriding objective was to
maintain the character of the previous Reports, while adding information to
assist shareholders in understanding the investment characteristics of their
Fund.
THE NEW FUND REPORTS INCLUDE A MESSAGE TO SHAREHOLDERS from Chairman John C.
Bogle and President John J. Brennan. This Message continues to provide a candid
assessment of the Fund's performance relative to an appropriate unmanaged
market benchmark and a peer group of mutual funds with similar investment
policies. It also reviews the principal factors contributing to--and detracting
from--the returns earned by the Fund. To help you evaluate your Fund's
current-year performance, the Message includes a discussion of the Fund's
long-term investment results, as well as a look ahead to the prospects for the
coming year. A recap of the financial markets, which had been included as part
of the Chairman's letter, now appears in The Markets In Perspective. This
overview covers the world's financial markets, putting the results of the
Fund's strategy in a global perspective.
THE PORTFOLIO PROFILE REPRESENTS AN ADDITION TO OUR FUND REPORTS. In this day
and age, many investors use detailed statistical information to evaluate their
mutual fund holdings, and our new Portfolio Profile furnishes shareholders with
comprehensive data on key characteristics--sector diversification, volatility,
top-ten holdings, among others--that ultimately define how a Fund is likely to
perform in various market environments. For this information to be used
effectively, we include a brief description of the profiled characteristics.
The Report From The Adviser (for our traditionally managed Funds) now covers
specific topics that we have defined as being the important ones for the
adviser to address--and we do our best to ensure that this Report is written in
the same simple and candid manner that characterizes all Vanguard
communications. Finally, each Adviser's Report will include an inset reminder
of the adviser's basic investment philosophy.
WE TRUST THAT THIS REDESIGNED FUND REPORT will continue to meet your need for a
fair, candid, and clear presentation of your Fund's investment results and a
thorough portfolio review. We welcome any comments that you might have at any
time regarding these Reports.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
3
Report From
The Adviser
5
Performance
Summary
7
Portfolio
Profile
8
Financial
Statements
10
Report Of
Independent
Accountants
18
Directors And
Officers
INSIDE BACK COVER
<PAGE> 3
[PHOTO]
John C. Bogle
[PHOTO]
John J. Brennan
FELLOW SHAREHOLDER,
The twelve months ended October 31--the 1996 fiscal year for Vanguard
Explorer Fund--were marked by mixed signals in the financial markets, with the
economy continuing to grow even as inflation remained in check. In this
environment, Explorer Fund produced a generous total return of +18.0%, a result
that was roughly in line with our performance measurement benchmarks.
The table below compares the Fund's twelve-month total return (capital
change plus reinvested dividends) with those of the unmanaged Russell 2000
Index (a broad measure of the performance of small-capitalization stocks) and
the average small-company growth mutual fund. By way of reference, the return
for the unmanaged Standard & Poor's 500 Composite Stock Price Index, which is
dominated by large-capitalization stocks, was +24.1%.
Our return is based on an increase in net asset value from $51.05 per
share on October 31, 1995, to $55.44 per share on October 31, 1996, adjusted
for the reinvestment of an annual dividend payment of $.24 per share from net
investment income and a distribution of $4.00 per share from net realized
capital gains. This year, the Fund realized additional capital gains of
approximately $2.80 per share, which will be distributed with the December
dividend payment.
<TABLE>
<CAPTION>
- ----------------------------------------------------
TOTAL RETURN
FISCAL YEAR ENDED
OCTOBER 31, 1996
- ----------------------------------------------------
<S> <C>
Vanguard Explorer Fund +18.0%
- ----------------------------------------------------
Average Small-Company
Growth Fund +20.4%
- ----------------------------------------------------
Russell 2000 Index +16.6%
- ----------------------------------------------------
</TABLE>
FISCAL 1996 PERFORMANCE OVERVIEW
During the twelve months ended October 31, the stock market flourished in an
ideal environment of moderate economic growth, rising corporate profits, and
low inflation. While all of the major stock market indicators achieved
double-digit returns for the year, large-cap blue-chip stocks held sway over
their smaller-cap cousins.
In this environment, the return of the Russell 2000 Index (+16.6%)--our
traditional benchmark--lagged that of the S&P 500 Index (+24.1%). The Russell
2000 Index is a tough standard for all professional fund managers, because it
is a theoretical construct that incurs none of the real-world operating costs
that are part and parcel of managing a mutual fund. However, with a return of
+18.0%, Explorer was able to eke out a slight advantage due largely to terrific
selections of individual stocks by our advisers, particularly in the
health-care and technology sectors. While our sector "bets" relative to the
Russell Index were not beneficial on balance, our stock selections more than
offset this shortfall.
Our performance in fiscal 1996 was not as good compared to the average
small-company growth fund, which earned a return of +20.4%. This modest
shortfall can be attributed largely to our holdings in cash reserves, which
averaged about 12% of our total net assets during the year (compared to 8% for
our typical competitor). Because returns on stocks far outpaced returns on cash
over the past twelve months, our modestly higher reserve position impeded our
performance. We also lost some ground because our portfolio's median market
capitalization is lower than that of our typical competitor. In general,
"larger was better" in fiscal 1996.
1
<PAGE> 4
LONG-TERM PERFORMANCE OVERVIEW
As shown in the table below, Explorer Fund's record over the past decade
bettered that of our Index standard but fell a bit behind that of our peer
group of small-company funds. That said, as we noted in last year's Annual
Report, we believe that our record since February 28, 1990--when we initiated
our multi-manager strategy--represents a more relevant period for evaluating
our performance. Our annual return of +16.5% over this abbreviated period
virtually equaled the +16.7% return of our peers and nicely exceeded the +14.2%
return of the Russell 2000 Index. A $10,000 investment in Explorer Fund on
February 28, 1990, would have grown to $27,655; the same $10,000 investment in
the Index would have grown to $24,184, and in the average small-company fund to
$27,961. The distribution of Explorer's assets between our two advisers at the
end of the fiscal year is presented in the following table.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
TOTAL RETURN
10 YEARS ENDED OCTOBER 31, 1996
---------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- ---------------------------------------------------------------
<S> <C> <C>
Vanguard Explorer Fund +12.4% $32,109
- ---------------------------------------------------------------
Average Small-Company
Growth Fund +14.0% $36,916
- ---------------------------------------------------------------
Russell 2000 Index +11.3% $29,171
- ---------------------------------------------------------------
</TABLE>
We should note that future returns for the Fund, our competitors, and
the Russell 2000 Index are by no means guaranteed to match the fine returns
achieved since 1990. However, with stock prices currently at lofty levels by
several measures, it seems at least possible that the decade ahead will provide
lower absolute returns. Whatever the future holds, our challenge, as always,
will be to provide relatively better performance than our competitive
benchmarks.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------
TOTAL ASSETS MANAGED
-----------------------------
$ MILLION PERCENT
- -------------------------------------------------------------------------
<S> <C> <C>
Granahan Investment Management, Inc. $1,157 53%
Wellington Management Company, LLP 930 43
Cash Reserve* 99 4
- -------------------------------------------------------------------------
Total $2,186 100%
- -------------------------------------------------------------------------
</TABLE>
*Each adviser also maintains a moderate cash reserve.
IN SUMMARY
In last year's Annual Report, we cautioned that, given the relatively high
returns of stocks during the past decade, the risks of investing have evidently
increased. One year later, with the U.S. stock market continuing to climb,
these risks do not appear to have abated.
Most investors understand that volatility risk is a two-way
street--that is, stock prices fluctuate up and down--but many today have
experienced only "upside volatility." Although no one can accurately predict
what will happen next, it seems unlikely that stocks will repeat the
exceptional returns of the past 15 years. Indeed, there are sure to be some
rough seas ahead. Nonetheless, we believe that investors who maintain a
balanced portfolio of stock funds, bond funds, and money market funds will be
rewarded. "Stay the course" has proved wise counsel in the past, as it should
continue to be in the future.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
Chairman of the Board President
December 2, 1996
2
<PAGE> 5
THE MARKETS IN PERSPECTIVE: FISCAL YEAR ENDED OCTOBER 31, 1996
U.S. EQUITY MARKETS
The past twelve months were truly rewarding for common-stock investors in the
United States, particularly those who emphasized larger companies. As noted in
the table, the Standard & Poor's 500 Composite Stock Price Index gained 24.1%
for the fiscal year, while the Russell 2000 Small Stock Index posted a 16.6%
advance. The strong absolute returns can be attributed primarily to solid
earnings growth, continued low inflation, and the expectation on the part of
investors that this environment will prevail over the near term.
Among larger-capitalization issues, the best performing sector was
financial, with a 39.0% advance. Leading this group were banks and brokerage
firms. Banks benefited from the relative stability of economic growth--which
could be expected to result in both growing demand for loans and low default
rates; brokerage firms continued to reap the benefits of positive equity
markets. Energy issues also posted very strong results (33.1%), reflecting the
pronounced increase in oil prices from $17.98 per barrel to $23.35 during the
past twelve months.
Technology issues probably exhibited the greatest disparity of any sector.
The best performers were generally larger companies with dominant positions in
their industries; many of these firms rose 30% or more compared to 16.9%, in
aggregate, for the technology holdings in the S&P 500 Index. By contrast,
technology was the worst-performing sector within the Russell 2000 Index, with
a scant 2.9% return over the fiscal year.
In sum, investors displayed a strong preference for companies with
"predictable" earnings streams. One unusual note: the price/earnings ratio of
the S&P 500 Index rose 17% (from 15.8 to 18.5) during the last twelve months,
despite a rise in interest rates. In general, the P/E ratio moves inversely
with interest rates.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED OCTOBER 31, 1996
-------------------------------
1 YEAR 3 YEARS 5 YEARS
- ---------------------------------------------------------------------
<S> <C> <C> <C>
Equity
S&P 500 Index 24.1% 17.7% 15.5%
Russell 2000 Index 16.6 11.2 14.8
MSCI-EAFE Index 10.8 6.9 8.0
- ---------------------------------------------------------------------
Fixed-Income
Lehman Aggregate Bond Index 5.9% 5.6% 7.7%
Lehman 10-Year Municipal
Bond Index 5.0 5.2 7.7
Salomon 90-Day U.S. Treasury Bills 5.3 5.0 4.4
- ---------------------------------------------------------------------
Other
Consumer Price Index 3.0% 2.8% 2.9%
- ---------------------------------------------------------------------
</TABLE>
U.S. FIXED-INCOME MARKETS
While U.S. stock investors relished their solid gains, bond investors were not
so fortunate. Interest rates, as reflected in the 30-year U.S. Treasury yield,
fell from 6.33% on October 31, 1995, to 5.95% two months later. At that time,
analysts anticipated an environment of slow economic growth and harbored almost
no concern about potential increases in inflation. Underscoring that view, the
Federal Reserve Board's Open Market Committee cut both the discount rate and
the Federal funds rate by 0.25% in late January.
3
<PAGE> 6
Economic data soon suggested a different scenario--one characterized
by accelerating economic activity. A range of indicators pointed toward more
rapid growth than anticipated, but none concerned the bond market as much as
the ongoing increases in employment. In many analysts' view, continued job
growth would probably lead to higher wage rates, which might not be offset by
improvements in productivity. The net result would be higher inflation, the
bane of bond investors. Such concerns caused the 30-year U.S. Treasury yield to
climb to 7.19% in early July. From that point forward, interest rates declined,
although in an erratic pattern, leaving the long-term Treasury yield at 6.64%
by the end of October.
Three categories of bonds did benefit their investors, at least on a
relative basis, over the past year: short-maturity portfolios, low-quality
issues, and municipals. Short-maturity investors saw a small increase in rates
(0.18% for the 3-year U.S. Treasury bond). Owners of junk bonds earned
positive returns as lower-quality, higher-yielding issues generally fare well
during periods of steady growth; a modest increase in inflation can be
beneficial to junk-bond issuers (the Lehman High Yield Bond Index gained
11.1%). Municipal bonds, freed from investor worries over the proposed "flat
tax," performed exceptionally well and, to some extent, seemed immune to the
inflation concerns of the taxable market. In fact, the yield on the benchmark
30-year municipal fell -0.05% during the twelve months, while the yield on the
comparable-maturity U.S. Treasury issue rose 0.31%.
INTERNATIONAL EQUITY MARKETS
Investments in non-U.S. equity markets fared quite well over the fiscal year,
with one major exception: Japan. For the past twelve months, the Morgan Stanley
Capital International--Europe, Australasia, Far East Index (which covers all
major markets outside North America) posted a total return of 10.8% in dollars,
after a 5.1% increase in the value of the U.S. dollar over foreign currencies.
Nearly all of this return was generated in the European markets, where the
dollar return was 17.9% compared to 3.5% for the Pacific Basin. Aside from
Japan (-0.7% in dollars) and Singapore (-3.1%), markets in the Pacific Basin
provided very strong returns, as evidenced by Hong Kong (28.0%) and Australia
(18.3%).
The variation in returns across and within regions can be attributed
to differing environments and expectations for growth and inflation. In Europe,
many governments focused on the deficit-spending guidelines mandated by the
Maastricht Treaty for the conversion to a common European currency unit (the
ECU). The Treaty stipulated that deficit spending not exceed defined
levels--with the idea that restraint would keep inflation to reasonable levels.
Over the past year, many governments reaffirmed their commitments to the ECU
and cut spending accordingly. Investors took this as an indication that
inflation would remain modest and economic growth tepid. The result was a
strong boost to high-quality growth stocks across Europe.
The Japanese market continues to suffer because the long-anticipated
economic recovery has yet to materialize in a meaningful way. Despite some
positive signs, such as improving corporate profits, the Japanese economy
continues to perform in a lack-luster fashion.
4
<PAGE> 7
REPORT FROM THE ADVISERS
[PHOTO]
The fiscal year ended October 31, 1996, was a good period for stocks,
although large-capitalization stocks as a group outperformed
small-capitalization stocks, which are Vanguard Explorer Fund's bread and
butter. Even so, Explorer's total return of 18.0% exceeded the 16.6% return of
the Russell 2000 Index, the Fund's unmanaged benchmark. Explorer trailed,
however, the 20.4% return of the average small-company growth mutual fund.
The positive results during the year mask some significant volatility in
the small-capitalization sector. The good news for small-cap stocks was
front-loaded into the first half of the fiscal year. These stocks rebounded
only modestly from a summertime slump, while large-cap stocks in general
bounced back strongly. In the second half of the fiscal year, returns were
negative for Explorer (-1.8%), the Russell 2000 Index (-1.5%), and the
average small-company growth fund (-0.1%).
The stock market during Explorer's fiscal year was helped by strong cash
flow into stocks, including record flows into equity mutual funds. Economic
growth was only moderate, but it provided sufficient momentum to allow most
companies to increase their revenues. This revenue growth, combined with very
weak inflationary pressures and a continuing focus by corporate managers on
cost reductions, resulted in solid earnings growth for many of the companies in
the Fund.
Among Explorer's top performers for fiscal 1996 were Encad (wide-format
printers), whose new product line was successful; Compuware Corp., which was
sold during the year; Natural Microsystems Corp., a pioneer in digital
processing chips; Videoserver, which sells technology that allows multi-point
videoconferencing; Anchor Gaming, which benefited from a new proprietary game;
and Catalina Marketing Corp., a rapidly growing supplier of in-store electronic
marketing services for consumer-goods makers and retailers.
Explorer also benefited significantly from takeovers of several of the
companies it holds, including FHP International, American Travelers, Red Lion
Hotels, Athena Neurosciences, Ventritex Inc., and CyCare Systems. There seems
to be no lessening of interest among larger companies in buying the kind of
smaller companies emphasized in Explorer.
Among the Fund's big disappointments during the year were Micrografx Inc.,
which supplies graphics software to businesses and consumers, and MobileMedia
Corp., a paging company. Also detracting from Explorer's returns were Diamond
Multimedia, which makes graphics accelerators and modems for personal
computers, and the computer software makers Broderbund, Red Brick, and Expert
Software. In cases where companies' earnings expectations remain on track, the
Fund has maintained or even augmented its positions, as with Micrografx and Red
Brick. Where earnings growth is not expected to materialize, holdings have been
sold, as with MobileMedia and Diamond Multimedia.
Stocks are added to the portfolio after "one company at a time" research
and analysis; however, given the
INVESTMENT PHILOSOPHY
The Fund reflects a belief that superior long-term investment results can be
achieved by selecting a very diversified group of small-company stocks with
prospects for above-average growth.
5
<PAGE> 8
differing investment strategies of our two advisers, there are several themes
at work in the Fund. For example, Explorer holds a number of companies that
should benefit from a trend toward outsourcing business functions as a way of
reducing costs. Such holdings include air freight and freight-forwarding
companies, such as Expeditors International, Air Express, Harper Group, and
Mark VII. The Fund also has invested in companies that provide
personnel-placement services (On Assignment) and outplacement (Right
Management). Other areas of emphasis in the Fund include some rapidly growing
rent-to-own retail chains (Renters Choice, Alrenco, and Rent-Way), and
companies providing better access to or security for public and private
computer networks (Shiva, Ascend, Teltrend, Amati, Aware, and Security
Dynamics).
The Fund remains focused on its goal of selecting small companies with
prospects for above-average earnings growth. Companies in the Fund are, on the
whole, increasing their earnings at a 30% rate in 1996, down from a 35% growth
rate in 1995. While further deceleration in earnings growth in 1997 may occur,
gains should still be quite healthy, averaging roughly 25%. The price/earnings
ratio of companies in the Fund, based on earnings over the latest twelve
months, is about 25, a bit higher than the midpoint of Explorer's historical
range.
There are signs of overheating in the market for initial public offerings
(IPOs) of stocks, yet one can feel optimistic about the continuing global
competitiveness of American companies. The depths of entrepreneurial spirit and
the rapid pace of innovation in this economy are impressive. There appears to
be no shortage of promising ventures; as always, the challenge is to correctly
find and evaluate these enterprises.
Granahan Investment Management, Inc.
Wellington Management Company, LLP
November 7, 1996
6
<PAGE> 9
PERFORMANCE SUMMARY: EXPLORER 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 that an investment in the
Fund could lose money.
TOTAL INVESTMENT RETURNS: 10/31/76--10/31/96
<TABLE>
<CAPTION>
- --------------------------------------------------------------
EXPLORER FUND RUSSELL 2000*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- --------------------------------------------------------------
<S> <C> <C> <C> <C>
1977 17.0% 0.8% 17.8% -6.1%
1978 26.0 0.1 26.1 6.3
1979 30.6 1.9 32.5 15.3
1980 60.7 2.3 63.0 55.3
1981 8.5 1.1 9.6 4.1
1982 20.5 2.2 22.7 14.8
1983 35.2 1.0 36.2 38.3
1984 -15.3 1.4 -13.9 -3.2
1985 5.4 1.4 6.8 15.8
1986 1.0 1.0 2.0 22.2
<CAPTION>
- --------------------------------------------------------------
EXPLORER FUND RUSSELL 2000*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- --------------------------------------------------------------
<S> <C> <C> <C> <C>
1987 -11.5% 0.1% -11.4% -13.6%
1988 28.2 0.5 28.7 27.1
1989 9.8 1.2 11.0 15.6
1990 -23.9 1.0 -22.9 -27.3
1991 62.5 2.1 64.6 58.6
1992 12.2 0.8 13.0 9.5
1993 21.9 0.4 22.3 32.4
1994 4.2 0.3 4.5 -0.3
1995 17.0 0.5 17.5 18.3
1996 17.4 0.6 18.0 16.6
- --------------------------------------------------------------
</TABLE>
* S&P 500 Index through 1979; Russell 2000 Index thereafter.
See Financial Highlights table on page 16 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE: 10/31/86--10/31/96
<TABLE>
<CAPTION>
Vanguard Explorer Fund Lipper Small Company Growth Russell 2000 Stock Index
- -----------------------------------------------------------------------------------------
<S> <C> <C> <C>
1986 10000 10000 10000
10813 10924 10805
11354 11750 11686
11828 12339 12318
1987 8858 9180 8636
9479 9727 9213
11095 11048 10752
11461 11387 11099
1988 11403 11233 10977
11801 12026 11519
12450 12990 12395
12915 13894 13124
1989 12652 13851 12687
11572 12867 11699
12016 13560 12125
12969 14402 12448
1990 9752 11124 9224
12238 13759 11248
14335 15804 13352
14899 16548 13640
1991 16057 17875 14630
18568 19983 16292
16997 18712 15631
16856 18517 15619
1992 18136 19200 16017
20012 21846 18447
18911 21084 18095
20097 22492 19275
1993 22177 24627 21208
23268 25548 21882
22174 24155 20777
21348 23146 20177
1994 23172 25058 21142
22777 24358 20568
24296 26370 22276
26999 30519 25207
1995 27218 30696 25017
28738 32129 26727
32694 36968 29624
29862 33870 26949
1996 32109 36916 29171
</TABLE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED OCTOBER 31, 1996
------------------------------ FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
EXPLORER FUND 17.97% 14.87% 12.37% $32,109
AVERAGE SMALL-COMPANY
GROWTH FUND 20.44 15.75 13.95 36,916
RUSSELL 2000 INDEX 16.60 14.80 11.30 29,171
- -------------------------------------------------------------------------------------
</TABLE>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED 9/30/96*
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
10 Years
Inception ---------------------------
Date 1 Year 5 Years Capital Income Total
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Explorer 12/11/67 15.89% 16.02% 12.36% 0.71% 13.07%*
- ----------------------------------------------------------------------------------------
</TABLE>
* SEC rules require that we provide this average annual total return information
through the latest calendar quarter as well as for the Fund s fiscal year end.
7
<PAGE> 10
PORTFOLIO PROFILE: EXPLORER FUND
OCTOBER 31, 1996
This Profile provides a snapshot of the Fund's characteristics, where
appropriate, compared to an unmanaged index. Key elements of this Profile are
defined on page 9.
PORTFOLIO CHARACTERISTICS
<TABLE>
<CAPTION>
- ------------------------------------------
EXPLORER RUSSELL 2000
- ------------------------------------------
<S> <C> <C>
Number of Stocks 292 2,000
Median Market Cap $0.5B $0.5B
Price/Earnings Ratio 21.4x 18.0x
Price/Book Ratio 3.1x 2.4x
Yield 0.6% 1.6%
Return on Equity 16.3% 12.0%
Earnings Growth Rate 17.7% 11.3%
Foreign Holdings 1.0% 0.0%
Turnover Rate 51% --
Expense Ratio 0.63% --
Cash Reserves 10.8% --
</TABLE>
VOLATILITY MEASURES
- -----------------------------------------
EXPLORER S&P 500
- -----------------------------------------
R-Squared 0.46 1.00
Beta 0.94 1.00
INVESTMENT FOCUS
- -----------------------------------------
[CHART]
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- --------------------------------------------
<S> <C>
Air Express International Corp. 1.4%
Dionex Corp. 1.1
Haemonetics Corp. 1.0
Newpark Resources, Inc. 0.9
Valmont Industries, Inc. 0.9
Encad, Inc. 0.9
Coachmen Industries, Inc. 0.8
Catalina Marketing Corp. 0.8
Acxiom Corp. 0.8
Smith International, Inc. 0.8
- --------------------------------------------
Top Ten 9.4%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- ------------------------------------------------------------------------------------------------
OCTOBER 31, 1995 OCTOBER 31, 1996
------------------------------------------------------
EXPLORER EXPLORER RUSSELL 2000
------------------------------------------------------
<S> <C> <C> <C>
Basic Materials . . . . . . . . . . . 1.9% 1.0% 6.0%
Capital Goods & Construction . . . . . 6.0 6.8 8.4
Consumer Cyclical . . . . . . . . . . 22.0 18.8 16.8
Consumer Staples . . . . . . . . . . . 1.9 1.9 4.1
Energy . . . . . . . . . . . . . . . . 1.8 2.7 4.6
Financial . . . . . . . . . . . . . . 7.4 11.5 22.3
Health Care . . . . . . . . . . . . . 20.1 18.5 9.1
Technology . . . . . . . . . . . . . . 31.3 30.1 17.4
Transport & Services . . . . . . . . . 5.6 6.0 1.8
Utilities . . . . . . . . . . . . . . 0.0 0.3 4.9
Miscellaneous . . . . . . . . . . . . 2.0 2.4 4.6
- ------------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
[PHOTO]
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the fluctuations in the overall market (or appropriate market
index). The market, or index, has a beta of 1.00, so a portfolio with a beta of
1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
EARNINGS GROWTH RATE. The annual average rate of growth in earnings over the
past five years for the stocks now in a portfolio.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors. The average expense ratio for a stock mutual fund was
1.34% in 1995.
FOREIGN HOLDINGS. The percentage of a portfolio's investments
represented by stocks or American Depository Receipts (ADRs) of companies based
outside the United States.
INVESTMENT FOCUS. This grid indicates a portfolio's characteristics in terms
of market capitalization and relative valuation (growth, value, or a blend).
For instance, if the upper right box of the grid is shaded, it indicates that
a portfolio emphasizes large capitalization growth stocks.
MEDIAN MARKET CAP. The midpoint of market capitalization (market price
x shares outstanding) of stocks in the portfolio. Half the stocks in the
portfolio have higher market capitalizations and half lower.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified, and the more likely it is to perform in line with
the overall stock market.
PRICE/BOOK RATIO. The share price of a stock, divided by its net worth, or book
value, per share. For a portfolio, the weighted average price/book ratio of
the stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. P/E is an indicator of market expectations about
corporate prospects; the higher the P/E, the greater the expectations for a
company's future growth. For a portfolio, the weighted average P/E of the
stocks it holds.
RETURN ON EQUITY. The rate of return generated by a company during the past
year for each dollar of shareholder's equity (net income for the year
/ shareholder's equity). For a portfolio, the weighted average return on
equity for the companies represented in the portfolio.
R-SQUARED. A measure of how much of a portfolio's past returns can be
explained by the returns from the overall market (or its benchmark index).
If a portfolio's total return were precisely synchronized with the overall
market's return, its R-squared would be 1.00. If a portfolio's returns bore
no relationship to the market's returns, its R-squared would be 0.
SECTOR DIVERSIFICATION. The percentage of a portfolio's common stocks invested
in each of the major industry classifications that compose the stock market.
TEN LARGEST HOLDINGS. Indicates the percentage of a portfolio's total net
assets in its ten largest stocks (the average for stock mutual funds is about
25%). As this percentage rises, a portfolio's returns are likely to be more
volatile, since its return is more dependent on a few companies.
TURNOVER RATE. Indicates trading activity during the past year. Portfolios with
high turnover rates incur higher transaction costs and are more likely to
realize and distribute capital gains (which are taxable to investors). The
average turnover rate for stock mutual funds is about 80%.
YIELD. A snapshot of a portfolio's income from interest and dividends. The
yield, expressed as a percentage of a portfolio's net asset value, is based on
income earned by the portfolio over the past 30 days and is annualized, or
projected forward for the coming year.
9
<PAGE> 12
[PHOTO]
FINANCIAL STATEMENTS
OCTOBER 31, 1996
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, preferred stocks, bonds,
etc.) and by industry sector. 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. 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
EXPLORER FUND SHARES (000)
- ------------------------------------------------------------------------------
COMMON STOCKS (88.4%)
- ------------------------------------------------------------------------------
BASIC MATERIALS (0.9%)
<S> <C> <C>
# Liposome Co., Inc. 300,000 $ 5,100
# Lydall, Inc. 521,800 11,545
# Scios, Inc. 400,000 2,300
--------
18,945
--------
CAPITAL GOODS & CONSTRUCTION (6.0%)
# American Buildings Co. 215,000 4,488
# American Homestar Corp. 325,825 6,517
# Brooks Automation, Inc. 371,000 3,710
# Catalytica, Inc. 600,000 2,325
# The Cherry Corp. Class A 454,500 4,886
# Cuno Inc. 134,500 2,118
# (1)Hirsch International Corp. Class A 297,500 5,206
NN Ball and Roller 278,000 3,684
# Newpark Resources, Inc. 541,850 20,319
Oakwood Homes Corp. 461,800 12,238
# Palm Harbor Homes, Inc. 391,750 10,871
# Prime Service, Inc. 19,600 461
# Rohr, Inc. 55,600 1,029
# Security Dynamics
Technologies, Inc. 168,500 13,522
# Southern Energy Homes, Inc. 692,750 10,045
# Tetra Technologies, Inc. 300,000 6,263
# UCAR International, Inc. 100,000 3,913
Valmont Industries, Inc. 572,000 19,448
--------
131,043
--------
CONSUMER CYCLICAL (16.6%)
# Action Performance Cos., Inc. 435,000 6,525
# Alrenco, Inc. 220,000 4,180
# Anchor Gaming 100,000 4,950
# Au Bon Pain Co., Inc. 477,900 2,987
# Bed Bath & Beyond, Inc. 250,000 6,281
# Best Buy, Co., Inc. 400,000 6,550
# (1)Borg-Warner Security Corp. 1,200,000 12,450
# Brightpoint, Inc. 392,000 9,800
# Broderbund Software, Inc. 233,000 6,495
Callaway Golf Co. 150,000 4,594
# Carmike Cinemas, Inc. Class A 270,000 6,413
# Catalina Marketing Corp. 356,900 18,157
# Champion Enterprises, Inc. 372,000 7,347
# Chicago Miniature Lamp, Inc. 200,000 5,950
Coachmen Industries, Inc. 656,400 18,379
# Discount Auto Parts Inc. 250,000 5,438
# Egghead, Inc. 820,000 4,151
Ethan Allen Interiors Inc. 375,000 13,406
First Brands Corp. 168,700 4,787
# The Good Guys, Inc. 701,500 4,735
# The Gymboree Corp. 400,000 12,500
Harman International
Industries, Inc. 100,000 5,138
Heilig-Meyers Co. 200,000 2,600
# Ingram Micro, Inc. 46,000 828
Intelligent Electronics Inc. 1,300,000 11,213
# (1)Iwerks Entertainment, Inc. 800,000 4,000
# JPE, Inc. 179,000 1,477
# LodgeNet Entertainment Corp. 585,500 9,075
Marcus Corp. 535,000 11,904
(1)McGrathRent Corp. 394,900 9,379
Mercantile Stores Co., Inc. 150,000 7,444
# Metro Networks, Inc. 262,300 5,213
# National Auto Credit Inc. 282,000 3,032
# People s Choice TV Corp. 350,000 3,850
# Planet Hollywood International,
Inc. Class A 200,000 4,150
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- -----------------------------------------------------------------------------
<S> <C> <C>
# (1)Platinum Entertainment, Inc. 365,000 3,741
# Playboy Enterprises Inc. Class B 720,500 8,646
# (1)Play By Play Toys &
Novelties, Inc. 277,600 2,256
# Prime Hospitality Corp. 500,000 7,625
# Quality Dining, Inc. 348,000 7,395
# Red Lion Hotels, Inc. 193,200 5,796
# Renters Choice, Inc. 726,000 13,431
# (1)REX Stores Corp. 464,000 4,408
Richfood Holdings, Inc. 180,000 4,343
The Rival Co. 184,200 4,283
# Spectrum Holobyte 887,100 4,879
# Sports & Recreation 778,900 6,718
# Stage Stores, Inc. 21,000 383
Sturm, Ruger & Co., Inc. 246,000 4,613
# Tuesday Morning, Inc. 240,000 4,560
# Tyco Toys, Inc. 319,900 2,039
# Ultimate Electronics, Inc. 258,000 903
# United Auto Group, Inc. 8,600 296
# Urban Outfitters, Inc. 600,000 9,150
# VWR Scientific Products Corp. 598,000 7,625
# Valuevision International, Inc.
Class A 700,000 3,763
# Vans, Inc. 237,100 3,912
Warnaco Group 300,000 7,463
--------
363,606
--------
CONSUMER STAPLES (1.7%)
# Boston Beer Co., Inc. Class A 250,000 3,094
Bridgford Foods Corp. 169,600 1,230
# Celestial Seasonings, Inc. 200,000 4,100
Chiquita Brands International, Inc. 85,500 1,069
# Hain Food Group, Inc. 334,500 1,150
# Robert Mondavi Corp. 277,600 7,773
# National Dentex Corp. 90,000 1,643
# Sylvan, Inc. 275,000 3,541
# Whole Foods Market, Inc. 544,500 13,953
--------
37,553
--------
ENERGY (2.3%)
# Falcon Drilling Co., Inc. 250,000 8,844
# Noble Drilling Corp. 776,700 14,466
Production Operators Corp. 17,000 667
# Smith International, Inc. 452,400 17,191
# 3-D Geophysical, Inc. 211,000 1,688
Tidewater, Inc. 200,000 8,750
--------
51,606
--------
FINANCIAL (10.2%)
Bancorp Hawaii, Inc. 200,000 7,925
# Castle & Cooke, Inc. 400,000 6,150
Cenfed Financial Corp. 148,930 3,835
Charter One Financial 136,500 5,921
Chateau Properties, Inc. REIT 200,000 4,875
# Dime Bancorp, Inc. 356,500 5,303
Fidelity National Financial, Inc. 518,646 8,234
Finova Group, Inc. 15,200 939
# First Federal Financial Corp. 470,000 10,340
Frontier Insurance Group, Inc. 81,700 3,248
Green Point Financial Corp. 200,000 9,300
# HF Bancorp, Inc. 200,000 2,125
# Imperial Credit 362,000 6,426
Inter-Regional Financial
Group, Inc. 487,400 15,780
Legg Mason Inc. 205,300 6,621
Long Island Bancorp, Inc. 167,900 4,995
MMI Cos., Inc. 254,900 7,328
Manufactured Home
Communities, Inc. REIT 555,150 10,825
Mercury Finance Co. 918,716 10,565
NAC Re Corp. 290,000 10,186
North American Mortgage Co. 500,000 10,438
Peoples Bank of Bridgeport 250,000 6,375
# Physicians Health Services, Inc. 245,000 3,981
Quick & Reilly Group, Inc. 550,297 14,514
Redwood Trust, Inc. REIT 74,487 2,439
Resource Bancshares Mortgage
Group, Inc. 267,500 3,979
Sun Communities, Inc. REIT 495,000 14,169
Thornburg Mortgage Asset
Corp. REIT 320,300 5,645
Walden Residential Properties,
Inc. REIT 458,500 10,717
Westcorp, Inc. 380,800 9,044
--------
222,222
--------
HEALTH CARE (16.3%)
# Advanced Magnetics, Inc. 197,300 3,033
# Alliance Pharmaceutical Corp. 600,000 8,250
# Alpha Beta Tech 225,000 2,306
Alpharma Inc. Class A 169,500 2,119
# Amylin Pharmaceuticals, Inc. 818,000 8,998
# Anesta Corp. 300,000 4,050
# Angeion Corp. 200,000 825
# Apria Healthcare 300,000 5,738
Arrow International, Inc. 171,000 4,745
# Atria Communities, Inc. 400,000 4,950
Ballard Medical Products 192,000 3,384
Bergen Brunswig Corp. Class A 324,700 10,187
# Beverly Enterprises Inc. 700,000 8,662
# Bio-Rad Laboratories, Inc.
Class A 387,450 9,396
# Biotechnology General 600,000 4,875
# Bio-Vascular, Inc. 370,000 2,313
# (1)Caretenders Healthcorp 178,600 1,049
# Cell Genesys, Inc. 620,000 3,875
# Centocor, Inc. 280,000 8,190
# Cohr, Inc. 174,500 4,275
# Creative Biomolecules, Inc. 120,000 1,020
# CytoTherapeutics, Inc. 213,000 1,864
# FHP International Corp. 350,000 11,944
# Gelman Sciences, Inc. 97,925 3,011
# Genetics Institute Inc.
Depository Shares 136,142 8,883
Genesis Health Ventures Inc. 300,000 6,863
# Genome Therapeutics Corp. 306,000 2,525
# Grancare Inc. 603,400 10,861
# Haemonetics Corp. 1258,700 22,499
# Heartstream, Inc. 350,000 3,981
# (1)Healthdyne Information
Enterprises, Inc. 900,000 3,712
# Healthdyne Technologies, Inc. 569,880 5,058
# Integra Lifesciences 320,000 1,440
# Isomedix, Inc. 278,300 3,827
Kinetic Concepts, Inc. 752,000 9,776
Life Technologies, Inc. 372,900 8,297
</TABLE>
11
<PAGE> 14
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
MARKET
VALUE*
EXPLORER FUND SHARES (000)
- -----------------------------------------------------------------------------
<S> <C> <C>
# Ligand Pharmaceuticals Class B 300,000 $ 3,713
# Magainin Pharmaceuticals 400,000 4,350
# Magellan Health Services Corp. 750,000 13,781
# Medpartners Inc. 400,000 8,450
# Multicare Cos., Inc. 430,500 7,749
# NABI 946,225 8,634
# Pathogenesis Corp. 458,000 9,504
# Patterson Dental Co. 240,000 6,720
# Physician Corp. of America 700,200 7,702
# Sangstat Medical Corp. 119,000 3,064
# SIBIA Neurosciences, Inc. 200,000 1,325
# Sofamor Danek Group Inc. 381,300 10,486
Sullivan Dental Products, Inc. 325,000 3,819
# Sybron International Corp. 416,000 12,116
# Target Therapeutics, Inc. 350,000 12,906
# TheraTech, Inc. 467,500 5,084
# United Payors & United
Providers, Inc. 220,000 2,750
# Vencor, Inc. 500,000 14,813
# Ventritex Inc. 576,800 13,122
--------
356,869
--------
TECHNOLOGY (26.6%)
COMMUNICATION EQUIPMENT (1.3%)
# Amati Communications Corp. 200,000 3,450
# Aspect Telecommunications Corp. 247,700 14,614
# Davox Corp. 200,000 7,200
# Executone Information Systems 1155,000 2,960
COMPUTER RELATED (0.6%)
# Auspex Systems, Inc. 583,300 5,906
# CompuCom Systems, Inc. 524,000 5,109
# IDX Systems Corp. 116,900 3,390
COMPUTER SERVICES (0.3%)
# LanVision Systems, Inc. 160,000 1,320
# MDL Information Systems, Inc. 313,000 4,695
COMPUTER SOFTWARE (12.8%)
# Acxiom Corp. 454,500 17,725
# Advent Software, Inc. 317,000 10,065
# Affiliated Computer Services, Inc. 125,000 6,687
# Applied Voice Technology, Inc. 216,900 2,630
# Arbor Software Corp. 160,000 5,720
# Aware, Inc. 96,000 1,152
BGS Systems, Inc. 155,000 6,665
# BISYS Group, Inc. 277,700 10,310
# Boole & Babbage Inc. 484,500 14,535
# Caere Corp. 250,000 2,000
# (1)Cayenne Software Inc. 1,000,000 5,375
# Cognos Inc. 262,500 8,170
# Concord EFS, Inc. 440,500 12,664
# DH Technology, Inc. 392,150 8,921
# DST Systems, Inc. 280,000 8,610
# Data Translation, Inc. 157,300 1,632
# Dialogic Corp. 100,000 3,350
# Documentum, Inc. 103,000 3,759
# E*TRADE Group, Inc. 223,000 2,453
# (1)Expert Software Inc. 445,500 2,339
# GT Interactive Software Corp. 366,500 6,872
# Ikos Systems, Inc. 300,000 5,362
# MapInfo Corp. 200,000 2,175
# Mechanical Dynamics, Inc. 261,500 3,661
# Mercury Interactive Corp. 350,000 4,375
# (1)Micrografx, Inc. 500,000 2,812
# OrCAD, Inc. 312,000 3,198
# PRI Automation, Inc. 360,000 12,510
# Pinnacle Systems, Inc. 290,500 3,087
# Policy Management
Systems Corp. 200,000 7,200
# Pure Atria Software Corp. 297,167 8,061
# Red Brick Systems, Inc. 333,500 7,837
# Remedy Corp. 214,000 10,325
# Sterling Software, Inc. 340,000 11,050
# SunGard Data Systems, Inc. 380,000 16,007
# Synopsys, Inc. 205,500 9,247
# Truevision Inc. 417,200 1,304
# Verilink Corp. 157,500 5,512
# Videoserver, Inc. 250,000 11,687
# Visio Corp. 251,000 11,545
# Xionics Document
Technologies, Inc. 123,000 1,568
ELECTRONIC COMPONENTS (6.7%)
# Acres Gaming, Inc. 236,000 4,454
# Actel Corp. 200,000 3,500
# Advanced Lighting
Technologies, Inc. 282,000 5,287
BMC Industries, Inc. 199,500 5,910
# Centigram Communications 330,000 4,331
# Computer Products, Inc. 225,000 4,416
# (1)Conductus, Inc. 400,000 3,600
Dallas Semiconductor Corp. 550,000 11,000
# (1)Dionex Corp. 643,000 24,595
# IFR Systems, Inc. 137,225 2,196
# ITI Technologies, Inc. 343,000 9,690
# Input/Output, Inc. 473,500 14,087
# Macromedia 365,000 6,022
Memtec Ltd. ADR 150,000 5,119
# Oak Industries, Inc. 200,000 5,075
# Recoton Corp. 143,150 1,950
# Shiva Corp. 260,000 10,660
# Sterling Electronics Corp. 245,580 3,500
# Symbol Technologies, Inc. 100,000 4,487
TSI, Inc. 97,500 841
Teleflex Inc. 197,000 9,481
# Trident International, Inc. 332,000 5,395
OFFICE EQUIPMENT (1.2%)
# Encad, Inc. 464,000 18,908
# International Imaging
Materials, Inc. 342,000 7,951
SEMICONDUCTORS (0.1%)
# Tegal Corp. 285,000 1,603
TELECOMMUNICATIONS (3.6%)
# American Telecasting, Inc. 500,000 4,812
# Arch Communications Group, Inc. 547,000 6,290
# Ascend Communications, Inc. 81,858 5,341
# Gilat Satellite Networks Ltd. 400,000 7,750
# Harmonic Lightwaves, Inc. 300,000 5,025
</TABLE>
12
<PAGE> 15
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- -----------------------------------------------------------------------------
<S> <C>
## Highwaymaster
Communications, Inc. 300,000 $ 5,250
## International Cabletel, Inc. 256,666 6,032
##(1)Natural Microsystems Corp. 260,000 13,520
##(1)Peoples Telephone Co., Inc. 1,225,000 4,058
## Teltrend, Inc. 229,300 7,510
## Trescom International, Inc. 449,800 5,510
## Western Wireless Corp. 438,400 7,234
---------
581,191
---------
TRANSPORT & SERVICES (5.3%)
Air Express International Corp. 1,017,150 30,514
## Boyd Brothers
Transportation, Inc. 186,000 1,441
Expeditors International of
Washington, Inc. 401,300 16,754
Frozen Food Express
Industries, Inc. 312,282 2,654
Harper Group, Inc. 400,000 9,500
## Heartland Express, Inc. 556,033 12,094
## Kirby Corp. 451,500 8,804
## M.S. Carriers Inc. 355,000 6,656
## Mark VII, Inc. 15,000 388
## Midwest Express Holdings, Inc. 294,000 9,996
## RailTex, Inc. 387,000 8,853
## Swift Transportation Co., Inc. 400,000 9,000
---------
116,654
---------
UTILITIES (0.3%)
## Tucson Electric Power Co. 310,500 6,132
---------
MISCELLANEOUS (2.2%)
American List Corp. 168,100 4,623
## Asyst Technologies, Inc. 220,000 3,520
## Correctional Services Inc. 141,000 1,674
McKesson Corp. 73,000 3,632
##(1)NFO Research Inc. 522,750 11,631
## On Assignment, Inc. 172,000 5,160
## Prepaid Legal Services, Inc. 465,000 5,464
## Rent-Way, Inc. 321,000 3,611
## Right Management Consultants 250,000 5,313
## Service Experts Inc. 107,500 2,741
## XLConnect Solutions Inc. 18,000 526
---------
47,895
---------
- -----------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $1,566,170) 1,933,716
- -----------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCK (0.4%)
- -----------------------------------------------------------------------------
AMC Entertainment $1.75
(COST $8,816) 280,000 8,680
- -----------------------------------------------------------------------------
<CAPTION>
FACE MARKET
AMOUNT VALUE*
(000) (000)
- -----------------------------------------------------------------------------
<S> <C>
CONVERTIBLE BONDS (0.3%)
- -----------------------------------------------------------------------------
ARV Assisted Living
6.75%, 4/1/06 $ 4,300 $ 3,913
Inacom Corp.
6.00%, 6/15/06 2,000 2,965
- -----------------------------------------------------------------------------
TOTAL CONVERTIBLE BONDS
(COST $6,765) 6,878
- -----------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (11.6%)
- -----------------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account 5.58%, 11/1/96
(COST $253,107) 253,107 253,107
- -----------------------------------------------------------------------------
TOTAL INVESTMENTS (100.7%)
(COST $1,834,858) 2,202,381
- -----------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.7%)
- -----------------------------------------------------------------------------
Other Assets--Note C 19,291
Liabilities (35,594)
-------
(16,303)
- -----------------------------------------------------------------------------
NET ASSETS (100%)
- -----------------------------------------------------------------------------
Applicable to 39,430,148 outstanding
$.001 par value shares
(authorized 100,000,000 shares) $2,186,078
=============================================================================
NET ASSET VALUE PER SHARE $55.44
=============================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
## Non-Income Producing Security.
(1)Considered an affiliated company as the Fund owns
more than 5% of the outstanding voting securities of
such company.
ADR--American Depository Receipt.
<TABLE>
- -----------------------------------------------------------------------------
AT OCTOBER 31, 1996, NET ASSETS CONSISTED OF:
- -----------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- -----------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $1,699,573 $43.11
Undistributed Net
Investment Income 8,018 .20
Accumulated Net Realized Gains 110,964 2.81
Unrealized Appreciation--Note E 367,523 9.32
- -----------------------------------------------------------------------------
NET ASSETS $2,186,078 $55.44
=============================================================================
</TABLE>
13
<PAGE> 16
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.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
EXPLORER FUND
YEAR ENDED OCTOBER 31, 1996
(000)
- -------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 7,380
Interest 14,544
---------
Total Income 21,924
---------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 4,312
Performance Adjustment 393
The Vanguard Group--Note C
Management and Administrative 6,647
Marketing and Distribution 369
Taxes (other than income taxes) 128
Custodian Fees 34
Auditing Fees 10
Shareholders Reports 137
Annual Meeting and Proxy Costs 50
Directors Fees and Expenses 7
---------
Total Expenses 12,087
- -------------------------------------------------------------------------------------
NET INVESTMENT INCOME 9,837
- -------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 111,853
- -------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 157,545
- -------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $279,235
=====================================================================================
</TABLE>
14
<PAGE> 17
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
that is 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>
- ----------------------------------------------------------------------------------------
EXPLORER FUND
YEAR ENDED OCTOBER 31,
--------------------------
1996 1995
(000) (000)
- ----------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 9,837 $ 6,622
Realized Net Gain 111,853 117,328
Change in Unrealized Appreciation (Depreciation) 157,545 85,259
------------------------
Net Increase in Net Assets Resulting from Operations 279,235 209,209
------------------------
DISTRIBUTIONS
Net Investment Income (7,088) (4,173)
Realized Capital Gain (118,130) (55,488)
------------------------
Total Distributions (125,218) (59,661)
------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 916,013 411,707
Issued in Lieu of Cash Distributions 122,486 58,533
Redeemed (482,398) (256,155)
------------------------
Net Increase from Capital Share Transactions 556,101 214,085
- -------------------------------------------------------------------------------------
Total Increase 710,118 363,633
- -------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 1,475,960 1,112,327
------------------------
End of Year $2,186,078 $1,475,960
=====================================================================================
(1)Shares Issued (Redeemed)
Issued 17,091 8,774
Issued in Lieu of Cash Distributions 2,493 1,402
Redeemed (9,063) (5,452)
------------------------
Net Increase in Shares Outstanding 10,521 4,724
=====================================================================================
</TABLE>
15
<PAGE> 18
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. Finally, the table lists the Fund's Average Commission
Rate Paid, a disclosure required by the SEC beginning in 1996. This rate is
calculated by dividing total commissions paid on portfolio securities by the
total number of shares purchased and sold on which commissions were charged.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------
EXPLORER FUND
YEAR ENDED OCTOBER 31,
-----------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1996 1995 1994 1993 1992
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $51.05 $45.99 $49.37 $41.23 $36.75
- --------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .26 .24 .16 .14 .15
Net Realized and Unrealized Gain on Investments 8.37 7.25 1.77 8.91 4.59
------------------------------------------------
Total from Investment Operations 8.63 7.49 1.93 9.05 4.74
------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.24) (.17) (.14) (.13) (.26)
Distributions from Realized Capital Gains (4.00) (2.26) (5.17) (.78) --
------------------------------------------------
Total Distributions (4.24) (2.43) (5.31) (.91) (.26)
- ---------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $55.44 $51.05 $45.99 $49.37 $41.23
===============================================================================================================
TOTAL RETURN 17.97% 17.46% 4.49% 22.28% 12.95%
===============================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $2,186 $1,476 $1,112 $802 $519
Ratio of Total Expenses to Average Net Assets 0.63% 0.68% 0.70% 0.73% 0.69%
Ratio of Net Investment Income to Average Net Assets 0.51% 0.52% 0.39% 0.32% 0.38%
Portfolio Turnover Rate 51% 66% 82% 51% 43%
Average Commission Rate Paid $.0424 N/A N/A N/A N/A
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE> 19
NOTES TO FINANCIAL STATEMENTS
Vanguard Explorer Fund is registered under the Investment Company Act of 1940
as a diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform with generally
accepted accounting principles for mutual funds. The Fund consistently follows
such policies in preparing its financial statements.
1. SECURITY VALUATION: Securities listed on an exchange 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. Securities not listed on an exchange are
valued at the latest quoted bid prices. Temporary cash investments are valued
at cost, which approximates market value.
2. 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.
3. 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.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Under the terms of advisory contracts, the Fund pays Granahan Investment
Management, Inc. and Wellington Management Company, LLP advisory fees
calculated at an annual percentage rate of average net assets. The basic fees
thus computed are subject to quarterly adjustments based on performance
relative to the Russell 2000 Small Stock Index. For the year ended October 31,
1996, the aggregate investment advisory fee represented an effective annual
basic rate of 0.23% of average net assets before an increase of $393,000
(0.02%) based on performance. The basic fee reflects a fee waiver of $541,000
(0.03%) during the period November 1, 1995, to July 31, 1996.
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 Directors. At October 31,
1996, the Fund had contributed capital of $214,000 to Vanguard (included in
Other Assets), representing 1.1% of Vanguard's capitalization. The Fund's
directors and officers are also directors and officers of Vanguard.
D. During the year ended October 31, 1996, the Fund purchased $1,234,509,000
of investment securities and sold $844,478,000 of investment securities, not
counting U.S. Government securities and temporary cash investments.
E. At October 31, 1996, net unrealized appreciation of investment securities
for financial reporting and Federal income tax purposes was $367,523,000,
consisting of unrealized gains of $491,458,000 on securities that had risen in
value since their purchase and $123,935,000 in unrealized losses on securities
that had fallen in value since their purchase.
17
<PAGE> 20
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors of
Vanguard Explorer 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 Explorer Fund (the "Fund") at October 31, 1996, and the results of its
operations, the changes in its net assets and the financial highlights for each
of the periods indicated, in conformity with generally accepted accounting
principles. These financial statements and financial highlights (hereafter
referred to as "financial statements") are the responsibility of the 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 October 31, 1996 by correspondence with the
custodian and brokers and the application of alternative auditing procedures
where confirmations from brokers were not received, provide a reasonable basis
for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
December 2, 1996
18
<PAGE> 21
SPECIAL 1996 TAX INFORMATION (UNAUDITED)
FOR VANGUARD EXPLORER FUND
This information for the fiscal year ended October 31, 1996, is included
pursuant to provisions of the Internal Revenue Code.
The Fund designates $97,522,000 as capital gain dividends (from net long-term
capital gains), which will be distributed in December 1996.
For corporate shareholders, 29.3% of investment income (dividend income plus
short-term gains, if any) qualifies for the dividends-received deduction.
All comparative mutual fund data are from Lipper Analytical Services, Inc. or
Morningstar unless otherwise noted.
19
<PAGE> 22
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director of The Vanguard Group,
Inc. and of each of the investment companies in The Vanguard Group;
Director of Chris-Craft Industries, Inc.
JOHN J. BRENNAN, President, Chief Executive Officer, and Director of The
Vanguard Group, Inc. and of each of the investment companies in The
Vanguard Group.
ROBERT E. CAWTHORN, Chairman Emeritus and Director of Rhone-Poulenc Rorer
Inc.; Director of Sun Company, Inc. and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea
Co., Alco Standard Corp., Raytheon Co., Knight-Ridder, Inc., and
Massa-chusetts Mutual Life Insurance Co.
BRUCE K. MACLAURY, President Emeritus of The Brookings Institution; Director
of American Express Bank Ltd., The St. Paul Companies, Inc., and
National Steel Corp.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl
Corp., Baker Fentress & Co., The Jeffrey Co., and Southern New England
Communications Co.
ALFRED M. RANKIN, JR., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich
Co., and The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co.
and President of New York University; Director of Pacific Gas and
Electric Co., Procter & Gamble Co., and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc.
and Kmart Corp.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas
Co.; Director of Cummins Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies in
The Vanguard Group.
RICHARD F. HYLAND, Treasurer; Principal of The Vanguard Group, Inc.; Treasurer
of each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller; Principal of The Vanguard Group, Inc.; Controller
of each of the investment companies in The Vanguard Group. Directors
And Officers
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President, Information Technology.
JAMES H. GATELY, Senior Vice President,
Individual Investor Group.
IAN A. MACKINNON, Senior Vice President,
Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President, Institutional.
RALPH K. PACKARD, Senior Vice President and
Chief Financial Officer.
[THE VANGUARD GROUP LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
[email protected] http://www.vanguard.com
All Vanguard Funds are offered by prospectus only. Prospectuses contain more
complete information in advisory fees, destribution charges, and other expenses
and should be read carefully before investing or sending money. Prospectuses
may be obtained directly from the Vanguard Group.
(c) 1996 Vanguard Marketing Corporation, Distributor
<PAGE> 23
THE VANGUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard Selected Value Portfolio
Vanguard/Trustees' Equity-U.S. Portfolio
Vanguard Convertible Securities Fund
BALANCED FUNDS
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LifeStrategy Portfolios
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity-International
Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Money Market Reserves
Vanguard Admiral Funds
INCOME FUNDS
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
Q240-10/96
[PHOTO]
