<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 2-27203) UNDER
THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO.
POST-EFFECTIVE AMENDMENT NO. 58
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 59
VANGUARD EXPLORER FUND, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ARTICLES OF INCORPORATION)
P.O. BOX 1100, VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
SUZANNE F. BARTON
P.O. BOX 876
VALLEY FORGE, PA 19482
IT IS PROPOSED THAT THIS FILING BECOME EFFECTIVE:
on August 1, 1997, pursuant to paragraph (a) of Rule 485.
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
As soon as practicable after this Registration Statement becomes effective.
THE REGISTRANT HAS REGISTERED AN INDEFINITE NUMBER OF SECURITIES UNDER THE
SECURITIES ACT OF 1933 PURSUANT TO RULE 24f-2 OF THE INVESTMENT COMPANY ACT OF
1940. REGISTRANT FILED ITS RULE 24f-2 NOTICE FOR ITS FISCAL YEAR ENDED OCTOBER
31, 1996, WITH THE COMMISSION ON DECEMBER 30, 1996.
================================================================================
<PAGE> 2
VANGUARD EXPLORER FUND, INC.
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
<C> <S> <C>
Item 1. Cover Page.................................... Cover Page
Item 2. Synopsis...................................... Not Applicable
Item 3. Condensed Financial Information............... Financial Highlights; Yield and Total
Return Disclosure
Item 4. General Description of Registrant............. Investment Strategies; Investment
Policies; General Information; Who
Should Invest; Investment
Limitations; Implementation of
Policies; Investment Performance
Item 5. Management of the Fund........................ Management of the Fund; The Fund and
Vanguard; The Fund's Investment
Adviser
Item 6. Capital Stocks and Other Securities........... Investing with Vanguard; Buying
Shares; Redeeming Shares; The Share
Price; Dividends, Capital Gains and
Taxes; General Information
Item 7. Purchase of Securities Being Offered.......... Cover Page; Investing with Vanguard;
Buying Shares
Item 8. Redemption or Repurchase...................... Redeeming Your Shares
Item 9. Pending Legal Proceedings..................... Not Applicable
<CAPTION>
FORM N-1A LOCATION IN STATEMENT
ITEM NUMBER OF ADDITIONAL INFORMATION
<C> <S> <C>
Item 10. Cover Page.................................... Cover Page
Item 11. Table of Contents............................. Cover Page
Item 12. General Information and History............... Investment Objective and Policies
Item 13. Investment Objectives and Policies............ Investment Objective and Policies;
Investment Limitations
Item 14. Management of the Fund........................ Investment Advisory Services;
Directors and Officers
Item 15. Control Persons and Principal Holders of
Securities.................................... Not Applicable
Item 16. Investment Advisory and Other Services........ Investment Advisory Services
Item 17. Brokerage Allocation.......................... Portfolio Transactions
Item 18. Capital Stock and Other Securities............ Financial Statements
Item 19. Purchase, Redemption and Pricing of Securities
Being Offered................................. Purchase of Shares; Redemption of
Shares; Financial Statements
Item 20. Tax Status.................................... Not Applicable
Item 21. Underwriters.................................. Not Applicable
Item 22. Calculations of Yield Quotations of Money
Market Fund................................... Not Applicable
Item 23. Financial Statements.......................... Financial Statements
</TABLE>
<PAGE> 3
VANGUARD
EXPLORER FUND
Prospectus
August 1, 1997
This prospectus contains
financial data for the
Fund through the
fiscal year
ended October 31, 1996, and
the six months ended
April 30, 1997.
[GRAPHIC OF SHIP]
A member of
THE VANGUARD GROUP(R)
<PAGE> 4
VANGUARD EXPLORER FUND Type of Fund Here
CONTENTS
Fund Expenses 2
Financial Highlights 3
A Word About Risk 4
The Fund's Objective 4
Who Should Invest 4
Investment Strategies 5
Investment Policies 8
Investment Limitations 9
Investment
Performance 9
Share Price 10
Dividends, Capital
Gains, and Taxes 11
The Fund and
Vanguard 11
Investment Advisers 12
General Information 14
Investing
with Vanguard 15
Services and
Account Features 15
Types of Accounts 16
Distribution Options 17
Buying Shares 17
Redeeming Shares 19
Fund and Account
Updates 22
Prospectus Postscript 23
Risk Quiz 24
Glossary Inside Back Cover
INVESTMENT OBJECTIVE AND POLICIES
Vanguard Explorer Fund, Inc. (the "Fund") is an open-end, diversified investment
company, or mutual fund.
The Fund seeks to provide long-term capital growth by investing mainly in the
equity securities of small companies. (That is, the median market value of
companies' outstanding shares will be up to $1 billion. By comparison, the
median market value of the companies in the Russell 2000 Index is approximately
$550 million). These companies tend to be unseasoned but are considered by the
Fund's advisers to have superior growth potential.
IT IS IMPORTANT TO NOTE THAT THE FUND'S SHARES ARE NOT GUARANTEED OR INSURED
BY THE FDIC OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT. AS WITH ANY INVESTMENT
IN COMMON STOCKS, WHICH ARE SUBJECT TO WIDE FLUCTUATIONS IN MARKET VALUE, YOU
COULD LOSE MONEY BY INVESTING IN THE FUND.
FEES AND EXPENSES
Vanguard Explorer Fund is offered on a no-load basis, which means that you pay
no sales commissions or 12b-1 marketing fees. You will, however, incur expenses
for investment advisory, management, administrative, and distribution services,
which are included in the Fund's expense ratio.
ADDITIONAL INFORMATION ABOUT THE FUND
A Statement of Additional Information (dated August 1, 1997) containing more
information about the Fund is, by reference, part of this prospectus and may be
obtained without charge by writing to Vanguard or by calling our Investor
Information Department at 1-800-662-7447.
ADDITIONAL INFORMATION ABOUT THE FUND
A Statement of Additional Information (dated August 1, 1997) containing more
information about the Fund is, by reference, part of this prospectus and may be
obtained without charge by contacting Vanguard (see back cover).
WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objective, risks, and strategies of Vanguard
Explorer Fund. To highlight terms and concepts important to mutual fund
investors, we have provided "Plain Talk" explanations along the way. Reading the
prospectus will help you to decide whether the Fund is the right investment for
you. We suggest that you keep it for future reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
<PAGE> 5
FUND PROFILE Vanguard Explorer Fund
WHO SHOULD INVEST (page 4)
- - Investors seeking a small-company stock mutual fund as part of a balanced
and diversified investment program.
- - Investors seeking growth of their capital over the long term--at least five
years or longer.
WHO SHOULD NOT INVEST
- - Investors unwilling to accept significant, sometimes sharp, fluctuations in
share price.
- - Investors seeking dividend income.
RISKS OF THE FUND (pages 4-8)
The Fund's total return will fluctuate within a wide range, so an investor could
lose money over short or even extended periods. The Fund is also subject to
manager risk (the chance that poor security selection will cause it to lag the
stock market as a whole) and, as a small-company stock fund, objective risk (the
chance that returns from stocks of small or emerging companies will trail
returns from the overall stock market). The Fund can also invest a portion of
its assets in foreign securities; for more on the risks of international
investing, see page 8.
DIVIDENDS AND CAPITAL GAINS (page 11)
Paid annually in December.
INVESTMENT ADVISERS (page 12)
The Fund employs a multi-adviser approach:
- - Granahan Investment Management, Inc., Waltham, MA.
- - Wellington Management Company, LLP, Boston, MA.
- - Chartwell Investment Partners, Berwyn, PA.
- - Vanguard Core Management Group, Valley Forge, PA.
INCEPTION DATE: December 11, 1967
NET ASSETS AS OF 4/30/97: $2.0 billion
FUND'S ANNUALIZED EXPENSE RATIO FOR THE PERIOD ENDED 4/30/97: 0.63%
LOADS, 12b-1 MARKETING FEES: None
SUITABLE FOR IRAS: Yes
MINIMUM INITIAL INVESTMENT: $3,000; $1,000 for IRAs and custodial accounts for
minors
NEWSPAPER ABBREVIATION: Explr
VANGUARD FUND NUMBER: 024
ACCOUNT FEATURES (page 15)
- - Telephone Redemption
- - Vanguard Direct Deposit Service(SM)
- - Vanguard Automatic Exchange Service(SM)
- - Vanguard Fund Express(R)
- - Vanguard Dividend Express(SM)
AVERAGE ANNUAL TOTAL RETURNS--
PERIODS ENDED APRIL 30, 1997
<TABLE>
<CAPTION>
1 YEAR 5 YEARS 10 YEARS
- ----------------------------------------------------
<S> <C> <C> <C>
Explorer Fund -7.7% 12.2% 10.3%
Russell 2000 Index 0.1 13.7 9.8
</TABLE>
QUARTERLY RETURNS (%) 1987-1997 (intended to show volatility of returns)
[BAR GRAPH]
<TABLE>
<CAPTION>
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
EXPLORER 19.4 19.5 4.2 -3.8 27.3 2.2 -0.2 -3.1 5.5 6.1 -7.5
-0.1 4 5.2 10.4 -0.2 -7.6 1.3 -4.1 6.7 5.7
5.6 0.8 4.4 -23.9 10 3.6 9.4 9.3 10.1 1.2
-26.1 0.5 -4.4 10.4 11.6 15.5 4.3 -1.1 2.2 0.5
RUSSELL 2000 24.3 19.1 7.7 -2.2 29.7 7.5 4.3 -2.7 4.6 5.1 -5.2
-0.7 6.6 6.4 3.9 -1.6 -6.8 2.2 -3.9 9.4 5
4.2 -0.9 6.6 -24.5 8.2 2.9 8.7 7 9.9 0.3
-29.1 -0.7 -5 5 5.7 14.9 2.6 -1.9 2.2 5.2
</TABLE>
<TABLE>
<CAPTION>
10-Year Average
Annual Total
Return For
Period Ended
12/31/96
---------------
<S> <C>
EXPLORER 12.9
RUSSELL 2000 12.4
</TABLE>
In evaluating past performance, remember that it is not indicative of future
performance and that returns from stocks before adjusting for inflation were
relatively high during the periods shown. Performance figures include the
reinvestment of any dividends and capital gains distributions. The returns are
net of expenses, but they do not reflect income taxes an investor would have
incurred. Note, too, that both the return and principal value of an investment
will fluctuate so that investors' shares, when redeemed, may be worth more or
less than their original cost. And, finally, you should be aware that the Fund
made investment adviser changes in 1990 and 1997. See page 10 for details.
1
<PAGE> 6
PLAIN TALK ABOUT
THE COSTS OF INVESTING
Costs are an important consideration in choosing a mutual fund. That's because
you, as a shareholder, pay the costs of operating a fund, plus any transaction
costs associated with buying, selling, or exchanging shares. These costs can
erode a substantial portion of the gross income or capital appreciation a fund
achieves. Even seemingly small differences in fund expenses can, over time, have
a dramatic impact on a fund's performance.
PLAIN TALK ABOUT
FUND EXPENSES
All mutual funds have operating expenses. These expenses, which are deducted
from a fund's gross income, are expressed as a percentage of the net assets of
the fund. Vanguard Explorer Fund's expense ratio in fiscal year 1996 was 0.63%,
or $6.30 per $1,000 of average net assets. The average aggressive growth equity
mutual fund had expenses in 1996 of 1.48%, or $14.80 per $1,000 of average net
assets, according to Lipper Analytical Services, Inc., which reports on the
mutual fund industry.
FUND EXPENSES
The examples below are designed to help you understand the various costs you
would bear, directly or indirectly, as an investor in the Fund.
As noted in this table, you do not pay fees of any kind when you buy, sell,
or exchange shares of the Fund:
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Sales Load Imposed on Purchases: None
Sales Load Imposed on Reinvested Dividends: None
Redemption Fees: None
Exchange Fees: None
</TABLE>
The next table illustrates the operating expenses that you would incur as a
shareholder of the Fund. These expenses are deducted from the Fund's income
before it is paid to you. Expenses include investment advisory fees as well as
the costs of administering the Fund, maintaining accounts, providing shareholder
services, and other activities. The expenses shown in the table are for the
fiscal year ended October 31, 1996.
<TABLE>
<CAPTION>
ANNUAL FUND OPERATING EXPENSES
<S> <C> <C>
Management and Administrative Expenses: 0.35%
Investment Advisory Expenses: 0.25%
12b-1 Marketing Fees: None
Other Expenses
Marketing and Distribution Costs: 0.02%
Miscellaneous Expenses (e.g., Taxes, Auditing): 0.01%
----
Total Other Expenses: 0.03%
----
TOTAL OPERATING EXPENSES (EXPENSE RATIO): 0.63%
====
</TABLE>
The following example illustrates the hypothetical expenses that you would
incur on a $1,000 investment over various periods. The example assumes (1) that
the Fund provides a return of 5% a year and (2) that you redeem your investment
at the end of each period.
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------------------------------------------
<S> <C> <C> <C>
$6 $20 $35 $79
------------------------------------------
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE, WHICH MAY BE HIGHER OR LOWER THAN
THOSE SHOWN.
2
<PAGE> 7
FINANCIAL HIGHLIGHTS
The following financial highlights table shows the results for a share
outstanding for each of the last ten years ended October 31, 1996, and for the
six months ended April 30, 1997. The financial highlights, insofar as they
relate to each of the five years in the period ended October 31, 1996, were
audited by Price Waterhouse LLP, independent accountants, except for the
information for the six-month period ended April 30, 1997. You should read these
financial highlights in conjunction with the Fund's financial statements and
accompanying notes, which appear, along with the audit report from Price
Waterhouse, in the Fund's most recent Annual Report and Semiannual Report to
shareholders. The Annual Report and Semiannual Report are incorporated by
reference in the Statement of Additional Information and in this prospectus, and
contain a more complete discussion of the Fund's performance. You may have the
report sent to you without charge by writing to Vanguard or by calling our
Investor Information Department.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
YEAR ENDED OCTOBER 31,
SIX MONTHS ENDED -------------------------------------------------------------------------------
APRIL 30, 1997 1996 1995 1994 1993 1992 1991 1990 1989
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD $55.44 $51.05 $45.99 $49.37 $41.32 $36.75 $22.62 $ 30.76 $29.64
-------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income 0.13 0.26 0.24 0.16 0.14 0.15 0.26 0.31 0.39
Net Realized and
Unrealized Gain (Loss)
on Investments (3.22) 8.37 7.25 1.77 8.91 4.59 14.21 (7.07) 2.64
-------------------------------------------------------------------------------------------
TOTAL FROM INVESTMENT
OPERATIONS (3.09) 8.63 7.49 1.93 9.05 4.74 14.47 (6.76) 3.03
- -----------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income (0.27) (0.24) (0.17) (0.14) (0.13) (0.26) (0.34) (0.37) (0.32)
Distributions from
Realized Capital Gains (2.83) (4.00) (2.26) (5.17) (0.78) -- -- (1.01) (1.59)
-------------------------------------------------------------------------------------------
TOTAL DISTRIBUTIONS (3.10) (4.24) (2.43) (5.31) (0.91) (0.26) (0.34) (1.38) (1.91)
- -----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE,
END OF PERIOD $49.25 $55.44 $51.05 $45.99 $49.37 $41.23 $36.75 $ 22.62 $30.76
===================================================================================================================================
TOTAL RETURN -5.99% 17.97% 17.46% 4.49% 22.28% 12.95% 64.64% -22.92% 10.95%
===================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions) $1,999 $2,186 $1,476 $1,112 $ 802 $ 519 $ 381 $ 207 $ 270
Ratio of Total Expenses to
Average Net Assets 0.63%* 0.63% 0.68% 0.70% 0.73% 0.69% 0.56% 0.67% 0.58%
Ratio of Net Investment
Income to Average
Net Assets 0.45%* 0.51% 0.52% 0.39% 0.32% 0.38% 0.85% 1.11% 1.24%
Portfolio Turnover Rate 74% 51% 66% 82% 51% 43% 49% 46% 16%
Average Commission
Rate Paid $.0447 $.0424 N/A N/A N/A N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
---------------------
1988 1987
- -------------------------------------------------------------
<S> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD $25.06 $ 31.59
---------------------
INVESTMENT OPERATIONS
Net Investment Income 0.27 0.09
Net Realized and
Unrealized Gain (Loss)
on Investments 6.38 (3.33)
---------------------
TOTAL FROM INVESTMENT
OPERATIONS 6.65 (3.24)
- -------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income (0.11) (0.02)
Distributions from
Realized Capital Gains (1.96) (3.27)
---------------------
TOTAL DISTRIBUTIONS (2.07) (3.29)
- -------------------------------------------------------------
NET ASSET VALUE,
END OF PERIOD $29.64 $ 25.06
=============================================================
TOTAL RETURN 28.73% -11.42%
=============================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions) $ 266 $ 210
Ratio of Total Expenses to
Average Net Assets 0.65% 0.62%
Ratio of Net Investment
Income to Average
Net Assets 0.99% 0.28%
Portfolio Turnover Rate 28% 9%
Average Commission
Rate Paid N/A N/A
- -------------------------------------------------------------
*Annualized.
</TABLE>
From time to time, the Vanguard funds advertise yield and total return
figures. Yield is an historical measure of dividend income, and total return is
a measure of past dividend income (assuming that it has been reinvested) and
capital appreciation. Neither yield nor total return should be used to predict
the future performance of a fund.
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
The Fund began fiscal 1997 with a net asset value (price) of $55.44 per share.
During the six months ended April 30, 1997, the Fund earned $0.13 per share from
investment income (interest and dividends) and $3.22 per share from investments
that had appreciated in value or that were sold for higher prices than the Fund
paid for them. Of those total earnings of $3.09 per share, $3.10 was returned to
shareholders in the form of distributions ($0.27 in dividends, $2.83 in capital
gains). The earnings ($3.09 per share) less distributions ($3.10 per share)
resulted in a share price of $49.25 at April 30, 1997, a decrease of $6.19 per
share (from $55.44 at the beginning of the period to $49.25 at the end of the
period). Assuming that the shareholder had reinvested the distribution in the
purchase of more shares, the total return from the Fund was -5.99% for the six
months ended April 30, 1997.
As of and for the period ended April 30, 1997, the Fund had $2.0 billion in
net assets; an annualized expense ratio of 0.63% ($6.30 per $1,000 of net
assets); and net investment income amounting to 0.45% of its average net assets.
It sold and replaced securities valued at 74% of its average net assets.
3
<PAGE> 8
PLAIN TALK ABOUT
GROWTH FUNDS AND VALUE FUNDS
Growth investing and value investing are two styles employed by stock fund
managers. Growth funds generally focus on companies that, due to their strong
earnings and revenue potential, offer above-average prospects for capital
growth, with less emphasis on dividend income. Value funds generally emphasize
companies that, considering their assets and earnings history, are attractively
priced; these companies often pay regular dividend income to shareholders.
Growth and value stocks have, in the past, produced similar long-term returns,
though each has periods when it outperforms the other. In general, growth funds
appeal to investors who will accept more volatility in hope of a greater
increase in share price, while value funds are appropriate for investors who
want dividend income and the potential for capital gains but are less tolerant
of share-price fluctuations.
PLAIN TALK ABOUT
INVESTING FOR THE LONG TERM
Vanguard Explorer Fund is intended to be a long-term investment vehicle and is
not designed to provide investors with a means of speculating on short-term
fluctuations in the stock market.
A WORD ABOUT RISK
This prospectus describes the risks you will face as an investor in Vanguard
Explorer Fund. It is important to keep in mind one of the main axioms of
investing: the higher the risk of losing money, the higher the potential reward.
The reverse, also, is generally true: the lower the risk, the lower the
potential reward. However, as you consider an investment in Vanguard Explorer
Fund, you should take into account your personal tolerance for the daily
fluctuations of the stock market.
Look for this "warning flag" symbol [FLAG] throughout the prospectus. It is
used to mark detailed information about each type of risk that you, as a
shareholder of the Fund, will confront.
THE FUND'S OBJECTIVE
Vanguard Explorer Fund seeks to provide long-term growth of capital. This
objective is fundamental, which means that it cannot be changed unless a
majority of shareholders vote to do so.
[FLAG] BECAUSE OF THE SEVERAL TYPES OF RISK DESCRIBED ON THE FOLLOWING PAGES,
YOUR INVESTMENT IN THE FUND, AS WITH ANY INVESTMENT IN COMMON STOCKS,
COULD LOSE MONEY.
WHO SHOULD INVEST
The Fund may be a suitable investment for you if:
- - You wish to add a small-company stock fund to your existing holdings, which
could include other stock--as well as bond, money market, and
tax-exempt--investments.
- - You are seeking maximum growth of capital over the long term--five years or
longer.
- - You are looking for a fund that focuses on small and/or emerging companies.
- - You are not looking for dividend income.
- - You characterize yourself as "aggressive."
This Fund is not an appropriate investment if you are a market-timer.
Investors who engage in excessive in-and-out trading activity generate
additional costs that are borne by all of the Fund's shareholders. To minimize
such costs, which reduce the ultimate returns achieved by you and other
shareholders, the Fund has adopted the following policies:
- - The Fund reserves the right to reject any purchase request--including
exchanges from other Vanguard funds--that it regards as disruptive to the
efficient management of the Fund. This could
4
<PAGE> 9
- - be because of the timing of the investment or because of a history of
excessive trading by the investor.
- - There is a limit on the number of times you can exchange into or out of the
Fund (see "Redeeming Shares" in the INVESTING WITH VANGUARD SECTION).
- - The Fund reserves the right to stop offering shares at any time.
INVESTMENT STRATEGIES
This section explains how Vanguard Explorer Fund's investment advisers pursue
the objective of long-term capital growth. It also explains several important
risks faced by investors in the Fund. Unlike the Fund's investment objective,
these investment strategies are not fundamental and can be changed by the Fund's
board of directors without shareholder approval. However, before making any
important change in its strategies, the Fund will give shareholders 30-days
notice in writing.
MARKET EXPOSURE
The Fund invests chiefly in the common stock of small-capitalization companies
that offer strong growth potential with little or no dividend income. At times,
the Fund may also invest in securities that are convertible into common stock.
[FLAG] THE FUND IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT STOCK
PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN EXTENDED PERIODS. STOCK
MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING STOCK PRICES AND
PERIODS OF FALLING STOCK PRICES.
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns (dividend income plus change in market
value) for the U.S. stock market over various periods as measured by the
Standard & Poor's 500 Composite Stock Price Index, a widely used barometer of
stock market activity. Note that the returns shown do not include the costs of
buying and selling stocks or any other expenses that a real-world investment
portfolio would incur. Note, also, how the gap between the best and worst
returns tends to narrow over the long term.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
U.S. STOCK MARKET RETURNS (1926 -1996)
- ---------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
- ---------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 53.9% 23.9% 20.1% 16.9%
Worst -43.3 -12.5 -0.9 3.1
Average 12.7 10.4 10.8 10.8
- ---------------------------------------------------------------
</TABLE>
PLAIN TALK ABOUT
COSTS AND MARKET TIMING
Some investors try to profit from "market timing"--switching money into
investments when they expect prices to rise, and taking money out when they
expect the market to fall. As money is shifted in and out, a fund incurs
expenses for buying and selling securities. These costs are borne by all fund
shareholders, including the long-term investors who did not generate the costs.
Therefore, the Fund discourages short-term trading by, among other things,
limiting the number of exchanges it permits.
PLAIN TALK ABOUT
LARGE-CAP, MID-CAP, AND SMALL-CAP STOCKS
Stocks of publicly traded companies--and mutual funds that hold these
stocks--can be classified by the companies' market value, or capitalization.
Vanguard defines large-capitalization, or large-cap, funds as those holding
stocks of companies with an average total market value of their outstanding
shares exceeding $5 billion. Mid-cap funds hold stocks of companies with an
average market value between $1 billion and $5 billion. Small-cap funds hold
stocks of companies with an average market value of less than $1 billion.
Historically, large-cap funds have exhibited lower volatility than mid-cap and
small-cap funds.
5
<PAGE> 10
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1996. For example, while the average return on stocks for all of the
5-year periods was 10.4%, returns for these 5-year periods ranged from a -12.5%
average (from 1928 through 1932), to 23.9% (from 1951 through 1955). These
average returns reflect past performance on common stocks and should not be
regarded as an indication of future returns from either the stock market as a
whole or this Fund in particular.
Keep in mind that Vanguard Explorer Fund focuses on the stocks of smaller
companies. Small-cap stocks have historically been more volatile than--and at
times have performed quite differently from--the large-cap stocks found in the
S&P 500 Index. This is due to several factors, including less-certain growth and
dividend prospects for smaller companies. For these reasons and because Vanguard
Explorer Fund does not hold the same securities held in the S&P 500 Index or any
other market index, the performance of the Fund will not mirror the returns of
any particular index.
[FLAG] THE FUND IS SUBJECT TO OBJECTIVE RISK, WHICH IS THE POSSIBILITY THAT THE
RETURNS FROM STOCKS OF SMALL COMPANIES WILL TRAIL RETURNS FROM THE
OVERALL STOCK MARKET. AS A GROUP, THESE STOCKS TEND TO GO THROUGH CYCLES
OF OUTPERFORMANCE AND UNDERPERFORMANCE IN COMPARISON TO COMMON STOCKS IN
GENERAL. THESE CYCLES HAVE, IN THE PAST, LASTED FOR AS LONG AS SEVERAL
YEARS.
SECURITY SELECTION
Explorer Fund uses four investment advisers, each of whom independently chooses
and maintains a portfolio of common stocks for the Fund. Each adviser is
responsible for investing a specific percentage of the Fund's assets. Before the
Fund makes a significant change in an adviser's percentage, shareholders will
receive 30-days notice, in writing.
The four advisers employ active investment management methods, which means
securities are bought and sold according to the advisers' judgments about
companies and their financial prospects, and about the stock market and the
economy in general.
Each uses somewhat different processes to select securities for its portion
of the Fund; however, each is committed to buying stocks of small companies
that, in the adviser's opinion, have strong growth potential.
Granahan Investment Management, Inc. (Granahan), which is expected to be
responsible for roughly 42% of the Fund's assets, groups its securities into
three categories as part of its selection process. The first category, Core
Growth (which makes up 50% to 75% of Granahan's portion of the Fund's assets),
emphasizes companies that produce a well-known or established product and, as a
result, have a proven record of growth and a strong market position. The second
category, Pioneers (10% to 25%), is comprised of companies that offer unique
products or technologies that may lead to new products or expansion into new
markets; these stocks are chosen
6
<PAGE> 11
based on Granahan's estimate of the company's growth potential compared to its
market value. Finally, companies in the Special Value category (10% to 25%) do
not have exceptional records of past growth, but are undervalued in the general
marketplace; Granahan emphasizes those companies with expectations of future
growth over a period of several years.
Wellington Management Company, LLP (WMC), which is expected to be
responsible for approximately 33% of the Fund's assets, uses traditional
methods--research and analysis--to select stocks that it feels have exceptional
growth potential. Often, however, WMC's portfolio of stocks will include value
stocks as well as growth stocks.
WMC constructs its portfolio on a stock-by-stock basis and continually
monitors the portfolio so that a potential problem with a stock can be
recognized before any harm is done to the Fund. To help protect against risk,
the Fund holds a number of stocks within industries that the adviser finds
attractive.
Chartwell Investment Partners (Chartwell), which is expected to be
responsible for approximately 10% of the Fund's assets, uses a research-driven
and valuation-sensitive process to select stocks that it feels have
exceptional growth potential.
Chartwell constructs its portfolio on a stock-by-stock basis and employs
quantitative monitoring techniques to constantly evaluate the portfolio's
holdings.
The remaining adviser, Vanguard Core Management Group, employs a
"quantitative" investment approach. In other words, they use computer techniques
to select a sampling of stocks that, as a group, are expected to have returns
and investment characteristics similar to a specific market standard. For
Explorer Fund, this market standard is the Small Company Growth Fund Stock
Index, which is made up of stocks held by the nation's 25 largest small-company
mutual funds. Core Management Group is expected to be responsible for about 10%
of the Fund's assets.
The balance of Vanguard Explorer Fund's assets (about 5%) is held in cash
reserves, also managed by Vanguard. Vanguard may invest the Fund's cash reserves
in stock futures. This strategy is intended to keep the Fund more fully invested
in common stocks while retaining cash in hand to meet liquidity needs. See pages
8 and 9 for more details on the Fund's policy on futures.
The top ten holdings (which amounted to 11% of the Fund's total net assets)
as of April 30, 1997, follow.
1. Air Express International Corp.
2. Interra Financial, Inc.
3. Sofamor/Danek Group, Inc.
4. Valmont Industries, Inc.
5. Vencor, Inc.
6. Magellan Health Services Corp.
7. Dionex Corp.
8. Sybron Corp.
9. Expeditors International of Washington, Inc.
10. Haemonetics Corp.
PLAIN TALK ABOUT
PORTFOLIO DIVERSIFICATION
In general, the more diversified a fund's portfolio of stocks, the less likely
that a specific stock's poor performance will hurt the fund. One measure of a
fund's level of diversification is the percentage of total net assets
represented by its ten largest holdings. The average U.S. equity mutual fund has
about 25% of its assets invested in its ten largest holdings, while some less
diversified mutual funds have more than 50% of their assets invested in the
stocks of just ten companies.
7
<PAGE> 12
PLAIN TALK ABOUT
PORTFOLIO TURNOVER
Before investing in a mutual fund, you should review its portfolio turnover rate
for an indication of the potential effect of transaction costs on the fund's
future returns. In general, the greater the volume of buying and selling by the
fund, the greater the impact that brokerage commissions and other transaction
costs will have on its return. Also, funds with high portfolio turnover rates
may be more likely than low-turnover funds to generate capital gains that must
be distributed to shareholders as taxable income. The average turnover rate for
actively managed funds investing in common stocks is about 79%.
PLAIN TALK ABOUT
THE RISKS OF INTERNATIONAL INVESTING
Because foreign stock markets operate differently from the U.S. market,
Americans investing abroad will encounter risks not typically associated with
U.S. companies. For instance, foreign companies are not subject to the same
accounting, auditing, and financial reporting standards and practices as U.S.
companies; and their stock may not be as liquid as the stock of similar U.S.
companies. In addition, foreign stock exchanges, brokers, and companies
generally have less government supervision and regulation than in the U.S. These
factors, among others, could negatively impact the returns Americans receive
from a foreign investment. For more information about foreign investment risk,
see the Statement of Additional Information.
Keep in mind that, because the makeup of the Fund changes daily, this
listing is only a "snapshot" at one point in time.
[FLAG] THE FUND IS SUBJECT TO MANAGER RISK, WHICH IS THE POSSIBILITY THAT
THE ADVISERS MAY DO A POOR JOB OF SELECTING STOCKS.
PORTFOLIO TURNOVER
Although the Fund generally seeks to invest for the long term, it retains the
right to sell securities regardless of how long they have been held. The Fund's
average turnover rate for the past ten years has been about 44%. (A turnover
rate of 100% would occur, for example, if the Fund sold and replaced securities
valued at 100% of its total net assets within a one-year period.)
INVESTMENT POLICIES
Besides investing in stocks of small or emerging companies, Vanguard Explorer
Fund may follow a number of investment policies to achieve its objective.
The Fund may invest as much as 20% of its assets in foreign securities.
These securities can be traded in either U.S. or foreign markets.
[FLAG] BECAUSE OF ITS FOREIGN INVESTMENTS, THE FUND IS SUBJECT TO COUNTRY RISK
AND CURRENCY RISK. COUNTRY RISK IS THE POSSIBILITY THAT POLITICAL
EVENTS (SUCH AS A WAR), FINANCIAL PROBLEMS (SUCH AS GOVERNMENT DEFAULT),
OR NATURAL DISASTERS (SUCH AS AN EARTHQUAKE) WILL WEAKEN A COUNTRY'S
ECONOMY AND CAUSE INVESTMENTS IN THAT COUNTRY TO LOSE MONEY. CURRENCY
RISK IS THE POSSIBILITY THAT A "STRONGER" U.S. DOLLAR WILL REDUCE
RETURNS FOR AMERICANS INVESTING OVERSEAS. GENERALLY, WHEN THE DOLLAR
RISES IN VALUE AGAINST A FOREIGN CURRENCY, YOUR INVESTMENT IN THAT
COUNTRY LOSES VALUE BECAUSE ITS CURRENCY IS WORTH FEWER U.S. DOLLARS.
The Fund may invest up to 15% of its assets in restricted securities with
limited marketability or other illiquid securities.
The Fund may also invest in derivatives.
[FLAG] THE FUND RESERVES THE RIGHT TO INVEST, TO A LIMITED EXTENT, IN STOCK
FUTURES AND OPTIONS CONTRACTS, WHICH ARE TRADITIONAL TYPES OF
DERIVATIVES.
Losses (or gains) involving futures can sometimes be substantial--in part
because a relatively small price movement in a futures contract may result in an
immediate and substantial loss (or gain) for a portfolio. The Fund will not use
futures and options for speculative purposes or as leveraged investments that
magnify the gains or losses of an investment. Rather, the Fund will keep
separate cash reserves or
8
<PAGE> 13
short-term cash-equivalent securities in the amount of the obligation underlying
the futures or options contract. Only a limited percentage of the Fund's total
assets--5%--may be applied to futures contract deposits and no more than 20% may
be committed to such contracts.
The reasons for which the Fund will invest in futures and options are:
- - To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in stocks.
- - To make it easier to trade.
- - To reduce costs by buying futures instead of actual stocks when futures are
cheaper.
The Fund will usually hold only a small percentage of its assets in cash
reserves, although if an investment adviser believes that market conditions
warrant a temporary defensive measure, the Fund may hold cash reserves without
limit.
INVESTMENT LIMITATIONS
To reduce risk and maintain diversification, the Fund has adopted limits on some
of its investment policies. Specifically, the Fund will not:
- - Invest more than 25% of its assets in any one industry.
- - Borrow money, except for temporary or emergency purposes in an amount not
exceeding 15% of its assets. Whenever the Fund's outstanding borrowing is
more than 5% of its assets, it will stop making investments. With respect
to 75% of its assets, the Fund will not:
- - Invest more than 5% in the securities of any one company.
- - Buy more than 10% of the outstanding voting shares of any company.
The limitations listed in this prospectus and in the Statement of
Additional Information are fundamental and may be changed only by approval of a
majority of the Fund's shareholders.
INVESTMENT PERFORMANCE
Vanguard Explorer Fund invests primarily in common stocks, so its performance is
closely correlated to the overall stock market. Historically, performance of the
stock markets, both foreign and domestic, has been characterized by sharp
up-and-down swings in the short term and by more stable growth over the long
term.
PLAIN TALK ABOUT
DERIVATIVES
A derivative is a financial contract whose value is based on (or "derived" from)
a traditional security (such as a stock or a bond), an asset (such as a
commodity like gold), or a market index (such as the S&P 500 Index). Futures and
options are derivatives that have been trading on regulated exchanges for more
than two decades. These "traditional" derivatives are standardized contracts
that can easily be bought and sold, and whose market values are determined and
published daily. It is these characteristics that differentiate futures and
options from the relatively new, exotic types of derivatives--some of which can
carry considerable risks.
PLAIN TALK ABOUT
CASH RESERVES
With mutual funds, holding cash reserves--or "cash"--does not mean literally
that the fund holds a stack of currency. Rather, cash reserves also refer to
short-term, interest-bearing securities that can easily and quickly be converted
to cash, as described in the prospectus glossary. (Most mutual funds hold at
least a small percentage of assets in cash to accommodate shareholder
redemptions.) While some equity funds strive to keep cash levels at a minimum
and to always remain fully invested in stocks, other equity funds allow
investment advisers to hold up to 20% or more of a fund's assets in cash
reserves.
9
<PAGE> 14
PLAIN TALK ABOUT
PAST PERFORMANCE
Whenever you see information on a fund's performance, do not consider the
figures to be an indication of the performance you could expect by making an
investment in the fund today. The past is an imperfect guide to the future;
history does not repeat itself in neat, predictable patterns.
[BAR GRAPH]
<TABLE>
<CAPTION>
--------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
FOR PERIODS ENDED APRIL 30, 1997
--------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
EXPLORER FUND -7.7% 10.8% 12.2% 10.3%
RUSSELL 2000 INDEX .01% 12.6% 13.7% 9.8%
--------------------------------------
</TABLE>
The results shown above represent the Fund's "average annual total return"
performance, which assumes that any distributions of capital gains and dividends
were reinvested for the indicated periods. Also included is comparative
information on the unmanaged Russell 2000 Index, a benchmark of
small-capitalization stocks. The chart does not make any allowances for federal,
state, or local income taxes that shareholders must pay on a current basis.
In weighing these performance figures, note that the Fund has been in
operation since December 11, 1967, and that Wellington Management Company, LLP
was the sole investment adviser for the Fund until February 28, 1990, when the
Fund and Vanguard Explorer II (a Granahan-managed fund with the same objective)
merged. Chartwell Investment Partners and Vanguard Core Management Group were
added as advisers on August 1, 1997.
SHARE PRICE
The Fund's share price, called its net asset value, is calculated each business
day after the close of regular trading (generally 4 p.m. Eastern time) on the
New York Stock Exchange. Net asset value per share is calculated by adding up
the total assets of the Fund, subtracting all of its liabilities, or debts, and
then dividing by the number of Fund shares outstanding:
TOTAL ASSETS - LIABILITIES
NET ASSET VALUE = ----------------------------
NUMBER OF SHARES OUTSTANDING
The daily net asset value, or NAV, is useful to you as a shareholder
because the NAV, multiplied by the number of Fund shares you own, gives you the
dollar amount you would have received had you sold all of your shares back to
the Fund that day.
To help determine its daily share price, the Fund calculates the value of
its foreign securities, if any, in U.S. dollars. The Fund uses
10
<PAGE> 15
the daily exchange rate employed by Morgan Stanley Capital International in the
calculation of its own indexes. If Morgan Stanley's exchange rate is not
available, the Fund uses a rate according to policies set by its board of
directors.
The Fund's share price can be found in the mutual fund listings of most
major newspapers under the heading Vanguard Group. Different newspapers use
different abbreviations of the Fund's name, but the most common is EXPLR.
DIVIDENDS, CAPITAL GAINS, AND TAXES
Each December, the Fund distributes to shareholders virtually all of its income
from interest and dividends, as well as any capital gains realized from the sale
of securities. Your distributions of income and capital gains will be
automatically invested in more shares of the Fund, unless you elect to receive
these distributions in cash. In either case, distributions of dividends and
capital gains are taxable to you in the year reinvested or paid. As an exception
to this rule, distributions that are declared in December and paid to you in
January are taxed as if they had been paid to you in December. Vanguard will
process your dividend distribution and will send you a statement each year
showing the tax status of all your distributions.
- - The dividends and short-term capital gains that you receive are taxable to
you as ordinary dividend income. Any distributions of net long-term capital
gains by the Fund are taxable to you as long-term capital gains, no matter
how long you've owned shares in the Fund. Both dividends and capital gains
distributions are taxable to you whether received in cash or reinvested in
additional shares. Although the Fund does not seek to realize any
particular amount of capital gains during a year, such gains are realized
from time to time as byproducts of the ordinary investment activities of
the Fund. Consequently, distributions may vary considerably from year to
year.
- - If you sell or exchange shares of the Fund, any gain or loss you have is a
taxable event, which means that you may have a capital gain to report as
income, or a capital loss as a deduction, when you complete your federal
income tax return.
- - Distributions of dividends or capital gains, and capital gains or losses
from your sale or exchange of Fund shares, may be subject to state and
local taxes as well.
The tax information in this prospectus is provided as general information
and will not apply to you if you are investing in a tax-deferred account such as
an IRA. You should consult your own tax adviser about the tax consequences of an
investment in the Fund.
PLAIN TALK ABOUT
DISTRIBUTIONS
As a shareholder, you are entitled to your share of a fund's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or capital gains distribution. Income
dividends come from the dividends that a fund earns from its holdings as well as
interest it receives from money market and bond investments. Capital gains are
realized whenever the fund sells securities for higher prices than it paid for
them. The capital gains are either short-term or long-term depending on whether
the fund held the securities for less than or more than one year.
PLAIN TALK ABOUT
"BUYING A DIVIDEND"
Unless you are investing in a tax-deferred retirement account (such as an IRA),
it is not to your advantage to buy shares of a fund shortly before it makes a
distribution, because part of your investment will come back to you as a taxable
distribution. This is known as "buying a dividend." For example: on December 15,
you invest $5,000, buying 250 shares for $20 each. If the fund pays a
distribution of $1 per share on December 16, its share price would drop to $19
(not counting market change). You would still have only $5,000 (250 shares x $19
= $4,750 in share value, plus 250 shares x $1 = $250 in distributions), but you
would owe tax on the $250 distribution you received, even if you had reinvested
the dividends in more shares. To avoid "buying a dividend," check a fund's
distribution schedule before you invest.
THE FUND AND VANGUARD
Vanguard Explorer Fund is a member of The Vanguard Group, a family of more than
30 investment companies with more than 90
11
<PAGE> 16
distinct investment portfolios and total net assets of more than $290 billion.
All of the Vanguard funds share in the expenses associated with business
operations, such as personnel, office space, equipment, and advertising.
Vanguard also provides marketing services to the funds. Although
shareholders do not pay sales commissions or 12b-1 marketing fees, each fund
pays its allocated share of The Vanguard Group's costs.
A list of the Fund's directors and officers, and their present positions
and principal occupations during the past five years, can be found in the
Statement of Additional Information.
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group, Inc. is the only MUTUAL mutual fund company. It is owned
jointly by the funds it oversees and by the shareholders in those funds. Other
mutual funds are operated by for-profit management companies that may be owned
by one person, by a group of individuals, or by investors who bought the
management company's publicly traded stock. Because of its structure, Vanguard
operates its funds at cost. Instead of distributing profits from operations to a
separate managing company, Vanguard returns profits to fund shareholders in the
form of lower operating expenses.
PLAIN TALK ABOUT
THE FUND'S ADVISERS
The individuals primarily responsible for Vanguard Explorer Fund are:
JOHN J. GRANAHAN, CFA, Founder and President of Granahan Investment
Management, Inc.; 34 years investment experience (17 years with Granahan and 17
years with WMC); B.S. from St. Joseph's University, Graduate Fellow of Catholic
University of America.
KENNETH L. ABRAMS, Senior Vice President of Wellington Management Company,
LLP; 11 years investment experience (all with WMC); B.A. and M.B.A. from
Stanford University.
EDWARD N. ANTOIAN, CFA, Partner and one of the original founders of
Chartwell Investment Partners; 18 years investment experience; B.S. from State
University of New York, M.B.A. from the University of Pennsylvania.
GEORGE U. SAUTER, Principal of Vanguard; 12 years investment experience, 10
years primary responsibility for Vanguard Core Management Group; A.B. from
Dartmouth College, M.B.A. from the University of Chicago.
INVESTMENT ADVISERS
The Fund uses four investment advisers who independently manage a percentage of
the Fund's assets subject to the control of the officers and directors of the
Fund. Note that two of the Fund's advisers (Chartwell and Vanguard Core
Management Group) are new as of August 1, 1997. Following a transition period,
the percentage of the Fund's assets managed by each of the four advisers should
match the percentages stated on pages 6 and 7.
Granahan Investment Management, Inc., 275 Wyman Street, Waltham, MA 02154,
is an investment advisory firm specializing in small-company stock investments.
Founded in 1985, Granahan currently manages about $1.3 billion in assets. As of
June 30, 1997, Granahan managed approximately 56% of Vanguard Explorer Fund.
Granahan is paid an advisory fee each quarter that is based on its
portion's average month-end assets for the quarter.
<TABLE>
<CAPTION>
-----------------------------------
NET ASSETS BASIC FEE
-----------------------------------
<S> <C>
First $500 million 0.30%
Next $250 million 0.20
Next $250 million 0.15
Assets over $1 billion 0.10
-----------------------------------
</TABLE>
Granahan's quarterly advisory fee may be increased or decreased based upon
the total return performance of its portion of Explorer Fund compared to that of
the Small Company Growth Fund Stock Index. This incentive/penalty fee will not
be fully operable until August 1, 2000. Until that date, the incentive/penalty
will be calculated using certain transition rules that are explained in the
Statement of Additional Information.
Wellington Management Company, LLP (WMC), 75 State Street, Boston, MA
02109, was founded in 1933. The investment advisory firm currently manages more
than $155 billion in stock and bond portfolios, including 13 Vanguard funds. As
of June 30, 1997, WMC managed approximately 44% of the Fund's assets.
WMC is paid an advisory fee each quarter that is based on its portion's
average month-end assets for the quarter.
12
<PAGE> 17
PLAIN TALK ABOUT
THE SMALL COMPANY GROWTH FUND STOCK INDEX
The Small Company Growth Fund Stock Index is the benchmark that Vanguard
Explorer Fund uses to evaluate the performance of its investment advisers. The
compensation of the Fund's external advisers -- Granahan, WMC, and Chartwell --
can be either increased or decreased, depending on the results they have
achieved compared with the Index. The Index is made up of the common stocks
held by the 25 largest small-company stock mutual funds (at the end of 1996,
this amounted to approximately 1,800 stocks). Morningstar, Inc. maintains the
Index especially for Explorer Fund.
<TABLE>
<CAPTION>
-----------------------------------
NET ASSETS BASIC FEE
-----------------------------------
<S> <C>
First $500 million 0.25%
Next $250 million 0.20
Next $250 million 0.15
Assets over $1 billion 0.10
-----------------------------------
</TABLE>
WMC's quarterly advisory fee may be increased or decreased by as much as
50% based upon the total return performance of its portion of Explorer Fund
compared to that of the Small Company Growth Fund Stock Index. This
incentive/penalty fee will not be fully operable until August 1, 2000. Until
that date, the incentive/penalty will be calculated using certain transition
rules that are explained in the Statement of Additional Information.
Chartwell Investment Partners, 1235 Westlakes Drive, Suite 330, Berwyn, PA
19312, was founded in 1997. The investment advisory firm currently manages about
$350 million in assets. Chartwell first began managing a portion of the Fund's
assets on August 1, 1997.
Chartwell is paid an advisory fee each quarter that is based on its
portion's average month-end assets for the quarter.
<TABLE>
<CAPTION>
---------------------------------
NET ASSETS RATE
---------------------------------
<S> <C>
First $250 million 0.40%
Next $250 million 0.30
Over $500 million 0.20
---------------------------------
</TABLE>
Chartwell's quarterly advisory fee may be increased or decreased by as much
as 20% based upon the total return performance of its portion of Explorer Fund
compared to that of the Small Company Growth Fund Stock Index. This
incentive/penalty fee will not be fully operable until August 1, 2000. Until
that date, the incentive/penalty will be calculated using certain transition
rules that are explained in the Statement of Additional Information.
The Vanguard Group, Inc., P.O. Box 2600, Valley Forge, PA 19482, first
began managing a portion of the Fund's assets on August 1, 1997. Vanguard
provides investment advisory services to the Fund on an at-cost basis. Vanguard
Core Management Group serves as investment adviser to several Vanguard funds and
as of June 30, 1997, managed more than $79 billion in total assets.
For the fiscal year ended October 31, 1996, the total fee paid by Vanguard
Explorer Fund to its advisers (at that time, Granahan and WMC only) was
approximately $4.70 million, which included a base fee of $4.31 million and an
incentive of $393,000. Note, however, that the fee schedules used to calculate
these amounts were different than those described in the preceding paragraphs.
The previous fee schedules used the Russell 2000 Index, rather than the Small
Company Growth Fund Stock Index, as a performance benchmark.
13
<PAGE> 18
The advisers are authorized to choose brokers or dealers to handle the
purchase and sale of the Fund's securities, and are directed to get the best
available price and most favorable execution from these brokers with respect to
all transactions. The advisers consider the full range and quality of brokerage
services available when making these determinations. At times, the advisers may
choose brokers who charge higher commissions in the interest of obtaining better
execution of a transaction. If more than one broker can obtain the best
available price and favorable execution of a transaction, then the advisers are
authorized to choose a broker who, in addition to executing the transaction,
will provide research services to the advisers or the Fund. However, the
advisers will not pay higher commissions specifically for the purpose of
obtaining research services. The Fund may direct the advisers to use a
particular broker for certain transactions in exchange for commission rebates or
research services provided to the Fund.
The board of directors may, without prior approval from shareholders,
change the terms of the advisory agreements or hire a new investment adviser as
either a replacement adviser or as an additional adviser. However, no such
change would be made before giving shareholders 30-days notice, in writing.
GENERAL INFORMATION
Vanguard Explorer Fund, Inc. is a corporation organized under the laws of the
state of Maryland. Shareholders of the Fund have rights and privileges similar
to those enjoyed by other corporate shareholders. For example, shareholders will
not be responsible for any liabilities of the corporation. If any matters are to
be voted on by shareholders (such as a change in a fundamental investment
objective or the election of directors), each share outstanding at that point
would be entitled to one vote. Annual meetings will not be held by the Fund
except as required by the Investment Company Act of 1940. A meeting will be
scheduled (for example, to vote on the removal of a director) if the holders of
at least 10% of the Fund's shares request a meeting in writing.
14
<PAGE> 19
INVESTING WITH VANGUARD
Are you looking for the most convenient way to open or add money to a Vanguard
account? Obtain instant access to fund information? Establish an account for a
minor child or for your retirement savings?
Vanguard can help. Our goal is to make it easy and pleasant for you to do
business with us.
The following sections of the prospectus briefly explain the many services we
offer you as a Vanguard Explorer Fund shareholder. Booklets providing detailed
information are available on the services marked with a [BOOK ARTWORK]. Please
call us to request copies.
SERVICES AND ACCOUNT FEATURES
Vanguard offers many services that make it convenient to buy, sell, or exchange
shares.
TELEPHONE REDEMPTIONS Automatically set up for this Fund
(SALES AND EXCHANGES) unless you notify us otherwise.
VANGUARD DIRECT DEPOSIT Automatic method for depositing your
SERVICE paycheck or U.S. government payment
[BOOK ARTWORK] (including Social Security and
government pension checks) into your
account.
VANGUARD AUTOMATIC EXCHANGE SERVICE Automatic method for moving a fixed
[BOOK ARTWORK] amount of money from one Vanguard fund
account to another.*
VANGUARD FUND EXPRESS Electronic method for buying or selling
[BOOK ARTWORK] shares. You can transfer money between
your Vanguard fund account and an
account at your bank, savings and loan,
or credit union on a systematic schedule
or whenever you wish.*
VANGUARD DIVIDEND EXPRESS Electronic method for transferring
[BOOK ARTWORK] dividends and/or capital gains
distributions directly from your
Vanguard fund account to your bank,
savings and loan, or credit union
account or to another Vanguard fund
account.
VANGUARD BROKERAGE SERVICES A cost-effective way to trade stocks,
(VBS) bonds, and options on major exchanges,
[BOOK ARTWORK] the Nasdaq Stock Market, and other
domestic over-the-counter markets at
reduced rates, and to buy and sell
shares of non-Vanguard mutual funds.
Call VBS (1-800-992-8327) for additional
information and the appropriate forms.
*Can be used to "dollar-cost average" [BOOK ARTWORK] or to contribute to an IRA
or other retirement plan.
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739 -
TELE-ACCOUNT 1-800-662-6273
15
<PAGE> 20
TYPES OF ACCOUNTS
INDIVIDUAL OR OTHER ENTITY
Vanguard's account registration form can be used to establish a variety of
nonretirement accounts.
FOR ONE OR MORE PEOPLE To open an account in the name of one
(individual) or more (joint tenants)
people. $3,000 minimum initial
investment.
FOR A MINOR CHILD To open an account as an UGMA/UTMA
[BOOK ARTWORK] (Uniform Gifts/Transfers to Minors Act).
Age of majority and other requirements
are set by state law. $1,000 minimum
initial investment.
FOR HOLDING TRUST ASSETS To invest assets held in an existing
[BOOK ARTWORK] trust. $3,000 minimum initial
investment.
FOR THIRD-PARTY TRUSTEE To open an account as a retirement trust
RETIREMENT INVESTMENTS or plan based on an existing corporate
(Vanguard is not the custodian or institutional plan. These accounts
or trustee.) are established by the custodian or
trustee of the existing plan.
FOR AN ORGANIZATION To open an account as a corporation,
partnership, or other entity. These
accounts may require a corporate
resolution or other documents to name
the individuals authorized to act.
$3,000 minimum initial investment.
RETIREMENT
You establish these accounts with a Vanguard adoption agreement -- not a
Vanguard account registration form. To request the appropriate adoption
agreement and forms, or to ask questions about investing for retirement, call
Investor Information.
FOR AN INDIVIDUAL RETIREMENT To open a retirement account in the name
ACCOUNT (IRA) of an individual. IRAs can be
(Vanguard Fiduciary Trust established with a contribution, a
Company is the custodian.) direct rollover from an employer's plan,
such as a 401(k), or an asset transfer
or rollover from another financial
institution, such as a bank or mutual
fund company. $1,000 minimum initial
investment.
FOR A SIMPLIFIED EMPLOYEE To open a retirement account in the name
PENSION PLAN ACCOUNT (SEP-IRA) of an employee. SEPs allow employers to
(Vanguard Fiduciary Trust make deductible contributions directly
Company is the custodian.) to IRAs established by their employees.
A SEP can be established by people who
are self-employed, small-business
owners, partnerships, or corporations.
FOR A SAVINGS INCENTIVE MATCH To open a retirement account in the name
PLAN FOR EMPLOYEES ACCOUNT of an employee. Created as part of the
(SIMPLE IRA) Small Business Job Protection Act of
(Vanguard Fiduciary Trust 1996, SIMPLEs replace SAR-SEPs.
Company is the custodian.) SIMPLEs are exclusively for employers
that had 100 or fewer employees in the
most recent calendar year and that do
not maintain another employer-sponsored
retirement plan. A SIMPLE can be
established by people who are
self-employed, small business owners,
partnerships, or corporations. Salary
reduction contributions may be made by
the employee, with matching or
nonmatching contributions from the
employer.
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739 -
TELE-ACCOUNT 1-800-662-6273
16
<PAGE> 21
TYPES OF ACCOUNTS (continued)
FOR A QUALIFIED RETIREMENT To open a retirement account that allows
PROGRAM ACCOUNT small-business owners or people who are
(Vanguard Fiduciary Trust self-employed to make tax-deductible
Company can be the custodian.) retirement contributions for themselves
and their employees into Profit-Sharing
and Money Purchase Pension (Keogh)
plans.
FOR A 403(b)(7) CUSTODIAL ACCOUNT To open a retirement account that allows
(Vanguard Fiduciary Trust employees of tax-exempt institutions
Company is the custodian.) (for example, schools or hospitals) to
make pretax retirement contributions.
DISTRIBUTION OPTIONS
You can receive distributions of dividends and/or capital gains in a number of
ways:
REINVESTMENT Dividends and capital gains are
automatically reinvested in additional
shares of the Fund unless you request a
different distribution method.
DIVIDENDS IN CASH Dividends are paid by check and mailed
to your account's address of record, and
capital gains are reinvested in
additional shares of the Fund.
DIVIDENDS AND CAPITAL GAINS Both dividends and capital gains are
IN CASH paid by check and mailed to your
account's address of record.
To electronically transfer cash dividends and/or capital gains to your bank,
savings and loan, or credit union account, or to another Vanguard fund account,
see Vanguard Dividend Express under "Services and Account Features."
BUYING SHARES
You buy your shares at the Fund's next-determined net asset value after Vanguard
receives your request, provided we receive your request before 4 p.m. Eastern
time (the close of trading on the New York Stock Exchange). The Fund is offered
on a no-load basis, meaning that you do not pay sales commissions or 12b-1
marketing fees.
<TABLE>
<CAPTION>
OPEN A NEW ACCOUNT ADD TO AN EXISTING ACCOUNT
<S> <C> <C>
MINIMUM INVESTMENT $3,000 (regular account); $1,000 $100 by mail or exchange; $1,000
(IRAs and custodial accounts for by wire.
minors).
BY MAIL Complete and sign the application Mail your check with an Invest-
[ENVELOPE] form. By-Mail form detached from
your confirmation statement to
FIRST-CLASS mail to: the address listed on the form.
The Vanguard Group
P.O. Box 2600 Make your check payable to: Make your check payable to:
Valley Forge, PA 19482 The Vanguard Group - 24 The Vanguard Group - 24
EXPRESS or REGISTERED mail to: All purchases must be made in All purchases must be made in
The Vanguard Group U.S. dollars, and checks must be U.S. dollars, and checks must be
455 Devon Park Drive drawn on U.S. banks. drawn on U.S. banks.
Wayne, PA 19087
</TABLE>
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739 -
TELE-ACCOUNT 1-800-662-6273
17
<PAGE> 22
BUYING SHARES (continued)
IMPORTANT NOTE: To prevent check fraud, Vanguard will not accept checks made
payable to third parties.
<TABLE>
<CAPTION>
OPEN A NEW ACCOUNT ADD TO AN EXISTING ACCOUNT
<S> <C> <C>
BY TELEPHONE Call Vanguard Tele-Account* 24 Call Vanguard Tele-Account* 24
[TELEPHONE] hours a day -- or Client Services hours a day -- or Client Services
during business hours -- to ex- during business hours -- to ex-
1-800-662-6273 change from another Vanguard change from another Vanguard
Vanguard Tele-Account(R) fund account with the same reg- fund account with the same reg-
istration (name, address, taxpayer istration (name, address, taxpayer
1-800-662-2739 I.D., and account type). I.D., and account type).
Client Services
Use Vanguard Fund Express (see
"Services and Account Features")
to transfer assets from your bank
account. Call Client Services be-
fore your first use to verify that
this option is in place.
*You must obtain a Personal Identification Number through Tele-Account at
least seven days before you request your first exchange.
</TABLE>
IMPORTANT NOTE: Once a telephone transaction has been approved by you and a
confirmation number assigned, it cannot be revoked. We reserve the right to
refuse any purchase.
<TABLE>
<S> <C> <C>
BY WIRE Call Client Services to arrange Call Client Services to arrange
[WIRE] your wire transaction. your wire transaction.
Wire to:
CoreStates Bank, N.A. Wire transactions are not available Wire transactions are not available
ABA 031000011 for retirement accounts. for retirement accounts.
CoreStates No 01019897
[Temporary Account Number]
Vanguard Explorer Fund
[Account Registration]
Attention: Vanguard
AUTOMATICALLY -- Vanguard offers a variety of ways
[ARROWS IN A CIRCLE] that you can add to your account
automatically. See "Services and
Account Features."
</TABLE>
You can redeem (that is, sell or exchange) shares purchased by check or Vanguard
Fund Express at any time. However, while your redemption request will be
processed at the next-determined net asset value after it is received, your
redemption proceeds will not be available until payment for your purchase is
collected, which may take up to ten days.
NOTE: If you buy Fund shares through a registered broker-dealer or investment
adviser, the broker-dealer or adviser may charge you a service fee.
It is important that you call Vanguard before you invest a large dollar
amount by wire or check. We must consider the interests of all Fund shareholders
and so reserve the right to delay or refuse any purchase that will disrupt the
Fund's operation or performance.
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739 -
TELE-ACCOUNT 1-800-662-6273
18
<PAGE> 23
REDEEMING SHARES
IMPORTANT TAX NOTE: Any sale or exchange of shares in a nonretirement account
could result in a taxable gain or a loss.
The ability to redeem (that is, sell or exchange) Fund shares by telephone is
automatically established for your account unless you tell us in writing that
you do not want this option.
To protect your account from unauthorized or fraudulent telephone
instructions, Vanguard follows specific security procedures. When we receive a
call requesting an account transaction, we require the caller to provide:
X Fund name.
X 10-digit account number.
X Name and address exactly as registered on that account.
X Social Security or Employer Identification number as registered on that
account.
If you call to sell shares, the sale proceeds will be made payable to you, as
the registered shareholder, and mailed to your account's address of record.
If we follow reasonable security procedures, neither the Fund nor Vanguard
will be responsible for the authenticity of transaction instructions received by
telephone. We believe that these procedures are reasonable and that, if we
follow them, you bear the risk of any losses resulting from unauthorized or
fraudulent telephone transactions on your account.
HOW TO SELL SHARES
You may withdraw any part of your account, at any time, by selling shares. Sale
proceeds are normally mailed within two business days after Vanguard receives
your request. The sale price of your shares will be the Fund's next-determined
net asset value after Vanguard receives all required documents in good order.
Good order means that the request includes:
X Fund name and account number.
X Amount of the transaction (in dollars or shares).
X Signatures of all owners exactly as registered on the account.
X Signature guarantees (if required).
X Any supporting legal documentation that may be required.
X Any certificates you are holding for the account.
Sales or exchange requests received after the close of trading on the New
York Stock Exchange (generally 4 p.m. Eastern time) are processed at the next
business day's net asset value.
The Fund reserves the right to close any nonretirement or UGMA/UTMA account
whose balance falls below the minimum initial investment. The Fund will deduct a
$10 annual fee if your nonretirement account balance falls below $2,500 or if
your UGMA/UTMA account balance falls below $500. The fee is waived if your total
Vanguard account assets are $50,000 or more.
Some written requests require a signature guarantee from a bank, broker, or
other acceptable financial institution. A notary public cannot provide a
signature guarantee.
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739 -
TELE-ACCOUNT 1-800-662-6273
19
<PAGE> 24
REDEEMING SHARES (continued)
HOW TO EXCHANGE SHARES
An exchange is the selling of shares of one Vanguard fund to purchase shares of
another.
Although we make every effort to maintain the exchange privilege, Vanguard
reserves the right to revise or terminate the exchange privilege, limit the
amount of an exchange, or reject any exchange, at any time, without notice.
Because excessive exchanges can potentially disrupt the management of the
Fund and increase transaction costs, Vanguard limits exchange activity to TWO
SUBSTANTIVE EXCHANGE REDEMPTIONS (at least 30 days apart) from the Fund during
any 12-month period. "Substantive" means either a dollar amount large enough to
have a negative impact on the Fund or a series of movements between Vanguard
funds.
Before you exchange into a new Vanguard fund, be sure to read its prospectus.
For a copy and for answers to questions you might have, call Investor
Information.
SELLING OR EXCHANGING SHARES ACCOUNT TYPE
BY TELEPHONE ALL TYPES EXCEPT RETIREMENT:
[TELEPHONE] Call Vanguard Tele-Account* 24 hours a
day -- or Client Services during
1-800-662-6273 business hours -- to sell or exchange
Vanguard Tele-Account shares. You can exchange shares from
this Fund to open an account in another
1-800-662-2739 Vanguard fund or to add to an existing
Client Services Vanguard fund account with an identical
registration.
RETIREMENT:
You can exchange -- but not sell --
shares by calling Tele-Account or Client
Services.
*You must obtain a Personal
Identification Number through
Tele-Account at least seven days before
you request your first redemption.
BY MAIL ALL TYPES EXCEPT RETIREMENT:
[ENVELOPE] Send a letter of instruction signed by
all registered account holders. Include
FIRST-CLASS mail to: the fund name and account number and (if
The Vanguard Group you are selling) a dollar amount or
Vanguard Explorer Fund number of shares OR (if you are
P.O. Box 1120 exchanging) the name of the fund you
Valley Forge, PA 19482 want to exchange into and a dollar
amount or number of shares.
EXPRESS or REGISTERED mail to: RETIREMENT:
The Vanguard Group For information on how to request
Vanguard Explorer Fund distributions from . . .
455 Devon Park Drive - IRAs, call Client Services.
Wayne, PA 19087 - SEP - IRAs, SIMPLE IRAs, 403(b)(7)
custodial accounts, and Profit-Sharing
and Money Purchase Pension (Keogh)
Plans, call Individual Retirement
Plans at 1-800-662-2003.
Depending on your account registration
type, additional documentation may be
required.
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739 -
TELE-ACCOUNT 1-800-662-6273
20
<PAGE> 25
REDEEMING SHARES (continued)
SELLING OR EXCHANGING SHARES ACCOUNT TYPE
EXCHANGING SHARES ON-LINE You may use your personal computer to
[COMPUTER ARTWORK] exchange shares of most Vanguard funds by
accessing Vanguard's website
(http://www.vanguard.com). To establish this
service for your account, you must first
register through our website. We will then
send to you, by mail, an account access
password that will enable you to make on-line
exchanges.
The Vanguard funds that you cannot purchase
or sell through on-line exchange are VANGUARD
INDEX TRUST, VANGUARD BALANCED INDEX FUND,
VANGUARD INTERNATIONAL EQUITY INDEX FUND,
VANGUARD REIT INDEX PORTFOLIO, VANGUARD TOTAL
INTERNATIONAL PORTFOLIO, AND VANGUARD GROWTH
AND INCOME PORTFOLIO (formerly known as
Vanguard Quantitative Portfolios). These
funds do permit on-line exchanges within IRAs
and other retirement accounts.
AUTOMATICALLY ALL TYPES EXCEPT RETIREMENT:
[3 CIRCULAR ARROWS ARTWORK] Vanguard offers several ways to sell or
exchange shares automatically (see "Services
and Account Features"). Call Investor
Information for the appropriate booklet and
application if you did not elect this feature
when you opened your account.
It is important that you call Vanguard before you redeem a large dollar amount.
We must consider the interests of all Fund shareholders and so reserve the right
to delay your redemption proceeds -- up to seven days -- if the amount will
disrupt the Fund's operation or performance.
A NOTE ON UNUSUAL CIRCUMSTANCES
Vanguard reserves the right to revise or terminate the telephone redemption
privilege at any time, without notice. In addition, Vanguard can stop selling
shares or postpone payment at times when the New York Stock Exchange is closed
or under any emergency circumstances as determined by the United States
Securities and Exchange Commission. If you experience difficulty making a
telephone redemption during periods of drastic economic or market change, you
can send us your request by regular or express mail. Follow the instructions on
selling or exchanging shares by mail in the "Redeeming Shares" section.
Investor Information 1-800-662-7447 - Client Services 1-800-662-2739 -
Tele-Account 1-800-662-6273
21
<PAGE> 26
FUND AND ACCOUNT UPDATES
STATEMENTS AND REPORTS
We will send you clear, concise account and tax statements to help you keep
track of your Vanguard Explorer Fund account throughout the year as well as when
you are preparing your income tax returns.
In addition, you will receive financial reports about the Fund twice a year.
These comprehensive reports include an assessment of the Fund's performance (and
a comparison to its industry benchmark), an overview of the markets, a report
from the adviser, as well as a listing of its holdings and other financial
statements.
CONFIRMATION STATEMENT Sent each time you buy, sell, or exchange
shares; confirms the date and the amount of
your transaction.
PORTFOLIO SUMMARY Mailed quarterly; shows the market value of
your account at the close of the statement
period, as well as distributions, purchases,
sales, and exchanges for the current calendar
year.
FUND FINANCIAL REPORTS Mailed in June and December for this Fund.
TAX STATEMENTS Generally mailed in January; report previous
year's dividend distributions, proceeds from
the sale of shares, and distributions from
IRAs or other retirement accounts.
AVERAGE COST STATEMENT Issued quarterly for taxable accounts
[BOOK ARTWORK] (accompanies your Portfolio Summary); shows
the average cost of shares that you redeemed
during the previous quarter, using the
average cost single category method.
AUTOMATED TELEPHONE ACCESS
VANGUARD TELE-ACCOUNT Toll-free access to Vanguard fund and account
1-800-662-6273 information -- as well as some transactions
Any time, seven days a week, -- through any Touch-Tone(TM) telephone.
from anywhere in the continental Tele-Account provides total return, share
United States and Canada. price, price change, and yield quotations for
[BOOK ARTWORK] all Vanguard funds; gives your account
balances and history (e.g., last transaction,
latest dividend distribution); and allows you
to sell or exchange fund shares.
COMPUTER ACCESS
VANGUARD ON THE Use your personal computer to visit
WORLD WIDE WEB Vanguard's education-oriented website, which
http://www.vanguard.com provides timely news and information about
Vanguard funds and services; an on-line
"university" that offers a variety of mutual
fund classes; and easy-to-use, interactive
tools to help you create your own investment
and retirement strategies.
INVESTOR INFORMATION 1-800-662-7447 - CLIENT SERVICES 1-800-662-2739 -
TELE-ACCOUNT 1-800-662-6273
22
<PAGE> 27
PLAIN TALK ABOUT
KEEPING YOUR PROSPECTUS
Reading this prospectus will help you to decide whether Vanguard Explorer Fund
is suitable for your investment goals. If you decide to invest, don't throw the
prospectus out; you will no doubt need it for future reference.
PROSPECTUS POSTSCRIPT
This prospectus is designed to provide you with pertinent information about
Vanguard Explorer Fund, including its investment objective, risks, strategies,
and expenses, as well as services available to you as a shareholder.
It is important that you understand these facts so that you can decide
whether an investment in this Fund is right for you. The following questions
offer a quick review of some of the subjects covered by this prospectus.
IN READING THE PROSPECTUS, DID YOU LEARN . . .
- The Fund's objective? (page 4)
- The Fund's investment strategies? (page 5)
- Who should invest in the Fund? (page 4)
- The risks associated with the Fund? (pages 4 - 8)
- Whether the Fund is federally insured?
(inside front cover)
- The Fund's expenses? (page 2)
- The background of the Fund's investment managers?
(page 12)
- How to open an account? (page 17)
- How to sell or exchange shares? (page 19)
- How often you'll receive statements and financial reports?
(page 22)
23
<PAGE> 28
ABOUT THE QUIZ
Knowing your risk tolerance is important when you are making an investment
decision. To give you a general idea of your comfort level with investing,
circle the response that most closely matches your personal situation. Keep in
mind, though, that there is no "foolproof" way to accurately gauge your risk
tolerance. Scoring for the quiz is below.
HOW TO SCORE THE QUIZ
Use the number of your answer as the number of points scored. For instance, if
you chose answer #3 to a question, that's worth three points. Add up your points
and check below for the type of investor you are. (Note: If you chose answer #1
or #2 to Question C, subtract five points from your total score.)
- - If you scored between 0 and 25 points, you are considered a conservative
investor.
- - If you scored between 26 and 32 points, you are considered a moderate
investor.
- - If you scored between 33 and 35 points, you are considered an aggressive
investor.
A SIMPLE RISK QUIZ
A. I HAVE BEEN INVESTING IN STOCK AND BOND MUTUAL FUNDS (OR IN INDIVIDUAL STOCKS
OR BONDS) FOR . . .
1. Less than a year
2. 1 - 2 years
3. 3 - 4 years
4. 5 - 9 years
5. 10 years or more
B. WHEN IT COMES TO INVESTING IN STOCK OR BOND MUTUAL FUNDS (OR INDIVIDUAL
STOCKS OR BONDS), I WOULD SAY I'M . . .
1. A very inexperienced investor
2. A somewhat inexperienced investor
3. A somewhat experienced investor
4. An experienced investor
5. A very experienced investor
C. I AM COMFORTABLE WITH INVESTMENTS THAT MAY LOSE MONEY FROM TIME TO TIME IF
THEY OFFER THE POTENTIAL FOR HIGHER RETURNS.
1. I strongly disagree
2. I disagree
3. I somewhat agree
4. I agree
5. I strongly agree
D. I WILL KEEP AN INVESTMENT EVEN IF IT LOSES 10% OF ITS VALUE OVER THE COURSE
OF A YEAR.
1. I strongly disagree
2. I disagree
3. I somewhat agree
4. I agree
5. I strongly agree
E. IN ADDITION TO MY LONG-TERM INVESTMENTS, I HAVE EMERGENCY SAVINGS EQUAL TO
____ MONTHS OF MY TAKE-HOME PAY.
1. Zero
2. One
3. Two
4. Three
5. Four or more
F. I FIND IT EASY TO PAY MY MONTHLY BILLS FROM MY CURRENT PAY.
1. I strongly disagree
2. I disagree
3. I somewhat agree
4. I agree
5. I strongly agree
G. OVERALL, MY PERSONAL FINANCIAL SITUATION IS SECURE.
1. I strongly disagree
2. I disagree
3. I somewhat agree
4. I agree
5. I strongly agree
24
<PAGE> 29
GLOSSARY OF INVESTMENT TERMS
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized during the year on
securities that the fund has sold at a profit, minus any realized losses.
CASH RESERVES
Cash deposits as well as short-term bank deposits, money market instruments,
U.S. Treasury bills, commercial paper, and bankers acceptances.
COMMON STOCK
A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which may be paid out as
dividends.
COUNTRY RISK
The possibility that events such as changes in regulation, political or
financial troubles, or natural disasters will weaken a country's economy and
cause investments in that country to lose money.
CURRENCY RISK
The possibility that an American's foreign investment will lose money because of
unfavorable exchange rate movements.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by a
fund's investments.
DOLLAR-COST AVERAGING
Investing equal amounts of money at regular intervals on an ongoing basis. This
technique ensures that an investor buys fewer shares when prices are high and
more shares when prices are low.
EXPENSE RATIO
The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
marketing fees.
INVESTMENT ADVISER
An organization that makes the day-to-day decisions regarding a portfolio's
investments.
MUTUAL FUND
An investment company that pools the money of many people and invests it in a
variety of securities in an attempt to achieve a specific objective over time.
NET ASSET VALUE (NAV)
The market value of a mutual fund's total assets, minus liabilities, divided by
the number of shares outstanding. The value of a single share is called its
share value or share price.
PORTFOLIO DIVERSIFICATION
Holding a variety of securities so that a portfolio's return is not hurt by the
poor performance of a single security or industry.
PRINCIPAL
The amount of your own money you put into an investment.
SECURITIES
Stocks, bonds, and other investment vehicles.
TOTAL RETURN
A percentage change, over a specified time period, in a mutual fund's net asset
value, with the ending net asset value adjusted to account for the reinvestment
of all distributions of dividends and capital gains.
VOLATILITY
The fluctuations in value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
YIELD
Current income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE> 30
<TABLE>
<S> <C> <C>
[GRAPHIC OF SHIP]
THE VANGUARD GROUP(R)
Post Office Box 2600
Valley Forge, PA 19482
INVESTOR INFORMATION VANGUARD BROKERAGE ELECTRONIC ACCESS TO THE
DEPARTMENT SERVICES VANGUARD MUTUAL FUND
1-800-662-7447 (SHIP) 1-800-992-8327 EDUCATION AND INFORMATION
TEXT TELEPHONE: CENTER
1-800-952-3335 For information on trading
stocks, bonds, and options World Wide Web
For information on our funds, at reduced commissions http://www.vanguard.com
fund services, and retirement
accounts; requests for VANGUARD TELE-ACCOUNT(R) E-mail
literature 1-800-662-6273 (ON-BOARD) [email protected]
CLIENT SERVICES DEPARTMENT For 24-hour automated access
1-800-662-2739 (CREW) to price and yield, information
TEXT TELEPHONE: on your account, certain
1-800-662-2738 transactions
For information on your
account, account transactions,
account statements
(C) 1997 Vanguard Marketing
Corporation, Distributor
P024N
</TABLE>
<PAGE> 31
VANGUARD
EXPLORER FUND
Institutional Prospectus
August 1, 1997
This prospectus contains financial data for the Fund through the fiscal year
ended October 31, 1996, and the six months ended April 30, 1997.
[GRAPHIC OF A SHIP]
[A member of THE VANGUARD GROUP LOGO]
<PAGE> 32
VANGUARD EXPLORER FUND
A Small-Company Stock Mutual Fund
<TABLE>
<CAPTION>
CONTENTS
<S> <C>
Fund Expenses 2
Financial Highlights 3
A Word About Risk 4
The Fund's Objective 4
Who Should Invest 4
Investment Strategies 5
Investment Policies 8
Investment Limitations 9
Investment
Performance 9
Share Price 10
Dividends, Capital
Gains, and Taxes 11
The Fund and
Vanguard 11
Investment Advisers 12
General Information 13
Investing
with Vanguard
- - For Plan Participants 15
- - For Other
Institutional Investors 15
Accessing Fund
Information
by Computer 16
Glossary Inside Back Cover
</TABLE>
INVESTMENT OBJECTIVE AND POLICIES
Vanguard Explorer Fund, Inc. (the "Fund") is an open-end, diversified investment
company, or mutual fund.
The Fund seeks to provide long-term capital growth by investing mainly in
the equity securities of small companies. (That is, the median market value of
companies' outstanding shares will be up to $1 billion. By comparison, the
median market value of the companies in the Russell 2000 Index is approximately
$550 million). These companies tend to be unseasoned but are considered by the
Fund's advisers to have superior growth potential.
IT IS IMPORTANT TO NOTE THAT THE FUND'S SHARES ARE NOT GUARANTEED OR INSURED
BY THE FDIC OR ANY OTHER AGENCY OF THE U.S. GOVERNMENT. AS WITH ANY INVESTMENT
IN COMMON STOCKS, WHICH ARE SUBJECT TO WIDE FLUCTUATIONS IN MARKET VALUE, YOU
COULD LOSE MONEY BY INVESTING IN THE FUND.
FEES AND EXPENSES
Vanguard Explorer Fund is offered on a no-load basis, which means that you pay
no sales commissions or 12b-1 marketing fees. You will, however, incur expenses
for investment advisory, management, administrative, and distribution services,
which are included in the Fund's expense ratio.
IMPORTANT NOTE
This prospectus is intended for institutional clients and for participants in
employer-sponsored retirement or savings plans. Another version -- for investors
who would like to open a personal investment account -- can be obtained by
calling Vanguard at 1-800-662-7447.
ADDITIONAL INFORMATION ABOUT THE FUND
A Statement of Additional Information (dated August 1, 1997) containing more
information about the Fund is, by reference, part of this prospectus and may be
obtained without charge by contacting Vanguard (see back cover).
WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objective, risks, and strategies of
Vanguard Explorer Fund. To highlight terms and concepts important to mutual fund
investors, we have provided "Plain Talk" explanations along the way. Reading the
prospectus will help you to decide whether the Fund is the right investment for
you. We suggest that you keep it for future reference.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
<PAGE> 33
FUND PROFILE Vanguard Explorer Fund
WHO SHOULD INVEST (page 4)
- - Investors seeking a small-company stock mutual fund as part of a balanced
and diversified investment program.
- - Investors seeking growth of their capital over the long term--at least five
years or longer.
WHO SHOULD NOT INVEST
- - Investors unwilling to accept significant, sometimes sharp, fluctuations in
share price.
- - Investors seeking dividend income.
RISKS OF THE FUND (pages 4-8)
The Fund's total return will fluctuate within a wide range, so an investor could
lose money over short or even extended periods. The Fund is also subject to
manager risk (the chance that poor security selection will cause it to lag the
stock market as a whole) and, as a small-company stock fund, objective risk (the
chance that returns from stocks of small or emerging companies will trail
returns from the overall stock market). The Fund can also invest a portion of
its assets in foreign securities; for more on the risks of international
investing, see page 8.
DIVIDENDS AND CAPITAL GAINS (page 11)
Paid annually in December. In participant accounts, all distributions are
automatically reinvested.
INVESTMENT ADVISERS (page 12)
The Fund employs a multi-adviser approach:
- - Granahan Investment Management, Inc., Waltham, MA.
- - Wellington Management Company, LLP, Boston, MA.
- - Chartwell Investment Partners, Berwyn, PA.
- - Vanguard Core Management Group, Valley Forge, PA.
INCEPTION DATE: December 11, 1967
NET ASSETS AS OF APRIL 30, 1997: $2.0 billion
FUND'S ANNUALIZED EXPENSE RATIO FOR THE
PERIOD ENDED 4/30/97: 0.63%
NEWSPAPER ABBREVIATION: Explr
VANGUARD FUND NUMBER: 024
AVERAGE ANNUAL TOTAL RETURNS--
PERIODS ENDED APRIL 30, 1997
<TABLE>
<CAPTION>
1 Year 5 Years 10 Years
--------------------------
<S> <C> <C> <C>
Explorer Fund -7.7% 12.2% 10.3%
Russell 2000 Index 0.1 13.7 9.8
</TABLE>
QUARTERLY RETURNS (%) 1987-1997 (intended to show volatility of returns)
<TABLE>
<CAPTION>
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Explorer 19.4 19.5 4.2 -3.8 27.3 2.2 -0.2 -3.1 5.5 6.1 -7.5
-0.1 4.0 5.2 10.4 -0.2 -7.6 1.3 -4.1 6.7 5.7
5.6 0.8 4.4 -23.9 10.0 3.6 9.4 9.3 10.1 1.2
-26.1 0.5 -4.4 10.4 11.6 15.5 4.3 -1.1 2.2 0.5
Russell 24.3 19.1 7.7 -2.2 29.7 7.5 4.3 -2.7 4.6 5.1 -5.2
-0.7 6.6 6.4 3.9 -1.6 -6.8 2.2 -3.9 9.4 5.0
4.2 -0.9 6.6 -24.5 8.2 2.9 8.7 7.0 9.9 0.3
-29.1 -0.7 -5.0 5.0 5.7 14.9 2.6 -1.9 2.2 5.2
</TABLE>
In evaluating past performance, remember that it is not indicative of future
performance and that returns from stocks before adjusting for inflation were
relatively high during the periods shown. Performance figures include the
reinvestment of any dividends and capital gains distributions. The returns are
net of expenses, but they do not reflect income taxes an investor would have
incurred. Note, too, that both the return and principal value of an investment
will fluctuate so that investors' shares, when redeemed, may be worth more or
less than their original cost. And, finally, you should be aware that the Fund
made investment adviser changes in 1990 and 1997. See page 10 for details.
1
<PAGE> 34
PLAIN TALK ABOUT
THE COSTS OF INVESTING
Costs are an important consideration in choosing a mutual fund. That's because
you, as a shareholder, pay the costs of operating a fund, plus any transaction
costs associated with buying, selling, or exchanging shares. These costs can
erode a substantial portion of the gross income or capital appreciation a fund
achieves. Even seemingly small differences in fund expenses can, over time, have
a dramatic impact on a fund's performance.
PLAIN TALK ABOUT
FUND EXPENSES
All mutual funds have operating expenses. These expenses, which are deducted
from a fund's gross income, are expressed as a percentage of the net assets of
the fund. Vanguard Explorer Fund's expense ratio in fiscal year 1996 was 0.63%,
or $6.30 per $1,000 of average net assets. The average aggressive growth equity
mutual fund had expenses in 1996 of 1.48%, or $14.80 per $1,000 of average net
assets, according to Lipper Analytical Services, Inc., which reports on the
mutual fund industry.
FUND EXPENSES
The examples below are designed to help you understand the various costs you
would bear, directly or indirectly, as an investor in the Fund.
As noted in this table, you do not pay fees of any kind when you buy, sell,
or exchange shares of the Fund:
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES
<S> <C>
Sales Load Imposed on Purchases: None
Sales Load Imposed on Reinvested Dividends: None
Redemption Fees: None
Exchange Fees: None
</TABLE>
The next table illustrates the operating expenses that you would incur as a
shareholder of the Fund. These expenses are deducted from the Fund's income
before it is paid to you. Expenses include investment advisory fees as well as
the costs of administering the Fund, maintaining accounts, providing shareholder
services, and other activities. The expenses shown in the table are for the
fiscal year ended October 31, 1996.
<TABLE>
<CAPTION>
ANNUAL FUND OPERATING EXPENSES
<S> <C> <C>
Management and Administrative Expenses: 0.35%
Investment Advisory Expenses: 0.25%
12b-1 Marketing Fees: None
Other Expenses
Marketing and Distribution Costs: 0.02%
Miscellaneous Expenses (e.g., Taxes, Auditing): 0.01%
----
Total Other Expenses: 0.03%
----
TOTAL OPERATING EXPENSES (EXPENSE RATIO): 0.63%
====
</TABLE>
The following example illustrates the hypothetical expenses that you would
incur on a $1,000 investment over various periods. The example assumes (1) that
the Fund provides a return of 5% a year and (2) that you redeem your investment
at the end of each period.
<TABLE>
<CAPTION>
------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------------------------------------------
<S> <C> <C> <C>
$6 $20 $35 $79
------------------------------------------
</TABLE>
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE, WHICH MAY BE HIGHER OR LOWER THAN
THOSE SHOWN.
2
<PAGE> 35
FINANCIAL HIGHLIGHTS
The following financial highlights table shows the results for a share
outstanding for each of the last ten years ended October 31, 1996, and for the
six months ended April 30, 1997. The financial highlights, insofar as they
relate to each of the five years in the period ended October 31, 1996 were
audited by Price Waterhouse LLP, independent accountants, except for the
information for the six-month period ended April 30, 1997. You should read these
financial highlights in conjunction with the Fund's financial statements and
accompanying notes, which appear, along with the audit report from Price
Waterhouse, in the Fund's most recent Annual Report and Semiannual Report to
shareholders. The Annual Report and Semiannual Report are incorporated by
reference in the Statement of Additional Information and in this prospectus, and
contains a more complete discussion of the Fund's performance. You may have the
report sent to you without charge by contacting Vanguard.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Six Months Year Ended October 31,
Ended -----------------------------------------------------------------------------------------------------
April 30, 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE,
BEGINNING OF PERIOD $55.44 $ 51.05 $45.99 $49.37 $41.32 $36.75 $22.62 $30.76 $29.64 $25.06 $31.59
------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income 0.13 0.26 0.24 0.16 0.14 0.15 0.26 0.31 0.39 0.27 0.09
Net Realized and
Unrealized Gain (Loss)
on Investments (3.22) 8.37 7.25 1.77 8.91 4.59 14.21 (7.07) 2.64 6.38 (3.33)
------------------------------------------------------------------------------------------------------
TOTAL FROM INVESTMENT
OPERATIONS (3.09) 8.63 7.49 1.93 9.05 4.74 14.47 (6.76) 3.03 6.65 (3.24)
- --------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net
Investment Income (0.27) (0.24) (0.17) (0.14) (0.13) (0.26) (0.34) (0.37) (0.32) (0.11) (0.02)
Distributions from
Realized Capital Gains (2.83) (4.00) (2.26) (5.17) (0.78) -- -- (1.01) (1.59) (1.96) (3.27)
------------------------------------------------------------------------------------------------------
TOTAL DISTRIBUTIONS (3.10) (4.24) (2.43) (5.31) (0.91) (0.26) (0.34) (1.38) (1.91) (2.07) (3.29)
- --------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE,
END OF PERIOD $49.25 $ 55.44 $51.05 $45.99 $49.37 $41.23 $36.75 $22.62 $30.76 $29.64 $25.06
================================================================================================================================
TOTAL RETURN -5.99% 17.97% 17.46% 4.49% 22.28% 12.95% 64.64% - 22.92% 10.95% 28.73% -11.42%
================================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of
Period (Millions) $1,999 $ 2,186 $1,476 $1,112 $802 $519 $ 381 $207 $270 $ 266 $ 210
Ratio of Total Expenses
to Average Net Assets 0.63%* 0.63% 0.68% 0.70% 0.73% 0.69% 0.56% 0.67% 0.58% 0.65% 0.62%
Ratio of Net Investment
Income to Average
Net Assets 0.45% 0.51% 0.52% 0.39% 0.32% 0.38% 0.85% 1.11% 1.24% 0.99% 0.28%
Portfolio Turnover Rate 74%* 51% 66% 82% 51% 43% 49% 46% 16% 28% 9%
Average Commission
Rate Paid .0447 $.0424 N/A N/A N/A N/A N/A N/A N/A N/A N/A
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* Annualized.
From time to time, the Vanguard funds advertise yield and total return
figures. Yield is an historical measure of dividend income, and total return is
a measure of past dividend income (assuming that it has been reinvested) and
capital appreciation. Neither yield nor total return should be used to predict
the future performance of a fund.
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
The Fund began fiscal 1997 with a net asset value (price) of $55.44 per share.
During the six months ended April 30, 1997, the Fund earned $0.13 per share from
investment income (interest and dividends) and $3.22 per share from investments
that had appreciated in value or that were sold for higher prices than the Fund
paid for them. Of those total earnings of $3.09 per share, $3.10 was returned to
shareholders in the form of distributions ($0.27 in dividends, $2.83 in capital
gains). The earnings ($3.09 per share) less distributions ($3.10 per share)
resulted in a share price of $49.25 at April 30, 1997, an increase of $6.19 per
share (from $55.44 at the beginning of the period to $49.25 at the end of the
period). Assuming that the shareholder had reinvested the distribution in the
purchase of more shares, the total return from the Fund was -5.99% for the six
months ended April 30, 1997. As of and for the period ended April 30, 1997 the
Fund had $2.0 billion in net assets; an annualized expense ratio of 0.63% ($6.30
per $1,000 of net assets); and net investment income amounting to 0.45% of its
average net assets. It sold and replaced securities valued at 74% of its average
net assets.
3
<PAGE> 36
PLAIN TALK ABOUT
GROWTH FUNDS AND
VALUE FUNDS
Growth investing and value investing are two styles employed by stock fund
managers. Growth funds generally focus on companies that, due to their strong
earnings and revenue potential, offer above-average prospects for capital
growth, with less emphasis on dividend income. Value funds generally emphasize
companies that, considering their assets and earnings history, are attractively
priced; these companies often pay regular dividend income to shareholders.
Growth and value stocks have, in the past, produced similar long-term returns,
though each has periods when it outperforms the other. In general, growth funds
appeal to investors who will accept more volatility in hope of a greater
increase in share price, while value funds are appropriate for investors who
want dividend income and the potential for capital gains but are less tolerant
of share-price fluctuations.
PLAIN TALK ABOUT
INVESTING FOR THE LONG TERM
Vanguard Explorer Fund is intended to be a long-term investment vehicle and is
not designed to provide investors with a means of speculating on short-term
fluctuations in the stock market.
A WORD ABOUT RISK
This prospectus describes the risks you will face as an investor in Vanguard
Explorer Fund. It is important to keep in mind one of the main axioms of
investing: the higher the risk of losing money, the higher the potential reward.
The reverse, also, is generally true: the lower the risk, the lower the
potential reward. However, as you consider an investment in Vanguard Explorer
Fund, you should take into account your personal tolerance for the daily
fluctuations of the stock market.
Look for this "warning flag" symbol [FLAG] throughout the prospectus. It is
used to mark detailed information about each type of risk that you, as a
shareholder of the Fund, will confront.
THE FUND'S OBJECTIVE
Vanguard Explorer Fund seeks to provide long-term growth of capital. This
objective is fundamental, which means that it cannot be changed unless a
majority of shareholders vote to do so.
[FLAG] BECAUSE OF THE SEVERAL TYPES OF RISK DESCRIBED ON THE FOLLOWING PAGES,
YOUR INVESTMENT IN THE FUND, AS WITH ANY INVESTMENT IN COMMON STOCKS,
COULD LOSE MONEY.
WHO SHOULD INVEST
The Fund may be a suitable investment for you if:
- - You wish to add a small-company stock fund to your existing holdings, which
could include other stock--as well as bond, money market, and tax-exempt
--investments.
- - You are seeking maximum growth of capital over the long term--five years or
longer.
- - You are looking for a fund that focuses on small and/or emerging companies.
- - You characterize yourself as "aggressive."
This Fund is not an appropriate investment if you are a market-timer.
Investors who engage in excessive in-and-out trading activity generate
additional costs that are borne by all of the Fund's shareholders. To minimize
such costs, which reduce the ultimate returns achieved by you and other
shareholders, the Fund has adopted the following policies:
- - The Fund reserves the right to reject any purchase request--including
exchanges from other Vanguard funds--that it regards as disruptive to the
efficient management of the Fund. This could be because of the timing of the
investment or because of a history of excessive trading by the investor.
4
<PAGE> 37
- - There is a limit on the number of times you can exchange into or out of the
Fund. If you own Fund shares as an investment option in an
employer-sponsored retirement or savings plan, your plan dictates the rules
governing exchanges. Contact your plan administrator for details.
- - The Fund reserves the right to stop offering shares at any time.
INVESTMENT STRATEGIES
This section explains how Vanguard Explorer Fund's investment advisers pursue
the objective of long-term capital growth. It also explains several important
risks faced by investors in the Fund. Unlike the Fund's investment objective,
these investment strategies are not fundamental and can be changed by the Fund's
board of directors without shareholder approval. However, before making any
important change in its strategies, the Fund will give shareholders 30-days
notice in writing.
MARKET EXPOSURE
The Fund invests chiefly in the common stock of small-capitalization companies
that offer strong growth potential with little or no dividend income. At times,
the Fund may also invest in securities that are convertible into common stock.
[FLAG] THE FUND IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY THAT STOCK
PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN EXTENDED PERIODS. STOCK
MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING STOCK PRICES AND
PERIODS OF FALLING STOCK PRICES.
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns (dividend income plus change in market
value) for the U.S. stock market over various periods as measured by the
Standard & Poor's 500 Composite Stock Price Index, a widely used barometer of
stock market activity. Note that the returns shown do not include the costs of
buying and selling stocks or any other expenses that a real-world investment
portfolio would incur. Note, also, how the gap between the best and worst
returns tends to narrow over the long term.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
U.S. STOCK MARKET RETURNS (1926-1996)
- -----------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
- -----------------------------------------------------------------
<S> <C> <C> <C> <C>
Best 53.9% 23.9% 20.1% 16.9%
Worst - 43.3 - 12.5 - 0.9 3.1
Average 12.7 10.4 10.8 10.8
- -----------------------------------------------------------------
</TABLE>
PLAIN TALK ABOUT
COSTS AND MARKET TIMING
Some investors try to profit from "market timing"--switching money into
investments when they expect prices to rise, and taking money out when they
expect the market to fall. As money is shifted in and out, a fund incurs
expenses for buying and selling securities. These costs are borne by all fund
shareholders, including the long-term investors who did not generate the costs.
Therefore, the Fund discourages short-term trading by, among other things,
closely monitoring daily transactions.
PLAIN TALK ABOUT
LARGE-CAP, MID-CAP, AND SMALL-CAP STOCKS
Stocks of publicly traded companies--and mutual funds that hold these stocks
- --can be classified by the companies' market value, or capitalization. Vanguard
defines large-capitalization, or large-cap, funds as those holding stocks of
companies with an average total market value of their outstanding shares
exceeding $5 billion. Mid-cap funds hold stocks of companies with an average
market value between $1 billion and $5 billion. Small-cap funds hold stocks of
companies with an average market value of less than $1 billion. Historically,
large-cap funds have exhibited lower volatility than mid-cap and small-cap
funds.
5
<PAGE> 38
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1996. For example, while the average return on stocks for all of the
5-year periods was 10.4%, returns for these 5-year periods ranged from a -12.5%
average (from 1928 through 1932), to 23.9% (from 1951 through 1955). These
average returns reflect past performance on common stocks and should not be
regarded as an indication of future returns from either the stock market as a
whole or this Fund in particular.
Keep in mind that Vanguard Explorer Fund focuses on the stocks of smaller
companies. Small-cap stocks have historically been more volatile than--and at
times have performed quite differently from--the large-cap stocks found in the
S&P 500 Index. This is due to several factors, including less-certain growth and
dividend prospects for smaller companies. For these reasons and because Vanguard
Explorer Fund does not hold the same securities held in the S&P 500 Index or any
other market index, the performance of the Fund will not mirror the returns of
any particular index.
[FLAG] THE FUND IS SUBJECT TO OBJECTIVE RISK, WHICH IS THE POSSIBILITY THAT
THE RETURNS FROM STOCKS OF SMALL COMPANIES WILL TRAIL RETURNS FROM THE
OVERALL STOCK MARKET. AS A GROUP, THESE STOCKS TEND TO GO THROUGH
CYCLES OF OUTPERFORMANCE AND UNDERPERFORMANCE IN COMPARISON TO COMMON
STOCKS IN GENERAL. THESE CYCLES HAVE, IN THE PAST, LASTED FOR AS LONG
AS SEVERAL YEARS.
SECURITY SELECTION
Explorer Fund uses four investment advisers, each of whom independently chooses
and maintains a portfolio of common stocks for the Fund. Each adviser is
responsible for investing a specific percentage of the Fund's assets. Before the
Fund makes a significant change in an adviser's percentage, shareholders will
receive 30-days notice, in writing.
The four advisers employ active investment management methods, which means
securities are bought and sold according to the advisers' judgments about
companies and their financial prospects, and about the stock market and the
economy in general.
Each uses somewhat different processes to select securities for its portion
of the Fund; however, each is committed to buying stocks of small companies
that, in the adviser's opinion, have strong growth potential.
Granahan Investment Management, Inc. (Granahan), which is expected to be
responsible for roughly 42% of the Fund's assets, groups its securities into
three categories as part of its selection process. The first category, Core
Growth (which makes up 50% to 75% of Granahan's portion of the Fund's assets),
emphasizes companies that produce a well-known or established product and, as a
result, have a proven record of growth and a strong market position. The second
category, Pioneers (10% to 25%), is comprised of companies that offer
6
<PAGE> 39
unique products or technologies that may lead to new products or expansion into
new markets; these stocks are chosen based on Granahan's estimate of the
company's growth potential compared to its market value. Finally, companies in
the Special Value category (10% to 25%) do not have exceptional records of past
growth, but are undervalued in the general marketplace; Granahan emphasizes
those companies with expectations of future growth over a period of several
years.
Wellington Management Company, LLP (WMC), which is expected to be
responsible for approximately 33% of the Fund's assets, uses traditional methods
- --research and analysis--to select stocks that it feels have exceptional growth
potential. Often, however, WMC's portfolio of stocks will include value stocks
as well as growth stocks.
WMC constructs its portfolio on a stock-by-stock basis and continually
monitors the portfolio so that a potential problem with a stock can be
recognized before any harm is done to the Fund. To help protect against risk,
the Fund holds a number of stocks within industries that the adviser finds
attractive.
Chartwell Investment Partners (Chartwell), which is expected to be
responsible for approximately 10% of the Fund's assets, uses a research-driven
and valuation-sensitive process to select stocks that it feels have exceptional
growth potential.
Chartwell constructs its portfolio on a stock-by-stock basis and employs
quantitative monitoring techniques to constantly evaluate the portfolio's
holdings.
The remaining adviser, Vanguard Core Management Group, employs a
"quantitative" investment approach. In other words, they use computer techniques
to select a sampling of stocks that, as a group, are expected to have returns
and investment characteristics similar to a specific market standard. For
Explorer Fund, this market standard is the Small Company Growth Fund Stock
Index, which is made up of stocks held by the nation's 25 largest small-company
mutual funds. Core Management Group is expected to be responsible for about 10%
of the Fund's assets.
The balance of Vanguard Explorer Fund's assets (about 5%) is held in cash
reserves, also managed by Vanguard. Vanguard may invest the Fund's cash reserves
in stock futures. This strategy is intended to keep the Fund more fully invested
in common stocks while retaining cash on hand to meet liquidity needs. See pages
8 and 9 for more details on the Fund's policy on futures.
The top ten holdings (which amounted to 11% of the Fund's total net assets)
as of April 30, 1997, follow.
1. Air Express International Corp.
2. Interra Financial, Inc.
3. Sofamor/Danek Group, Inc.
4. Valmont Industries, Inc.
5. Vencor, Inc.
6. Magellan Health Services Corp.
7. Dionex Corp.
8. Sybron Corp.
9. Expeditors International of Washington, Inc.
10. Haemonetics Corp.
PLAIN TALK ABOUT
PORTFOLIO DIVERSIFICATION
In general, the more diversified a fund's portfolio of stocks, the less likely
that a specific stock's poor performance will hurt the fund. One measure of a
fund's level of diversification is the percentage of total net assets
represented by its ten largest holdings. The average U.S. equity mutual fund has
about 25% of its assets invested in its ten largest holdings, while some less
diversified mutual funds have more than 50% of their assets invested in the
stocks of just ten companies.
7
<PAGE> 40
PLAIN TALK ABOUT
PORTFOLIO TURNOVER
Before investing in a mutual fund, you should review its portfolio turnover rate
for an indication of the potential effect of transaction costs on the fund's
future returns. In general, the greater the volume of buying and selling by the
fund, the greater the impact that brokerage commissions and other transaction
costs will have on its return. The average turnover rate for actively managed
funds investing in common stocks is about 79%.
PLAIN TALK ABOUT
THE RISKS OF
INTERNATIONAL INVESTING
Because foreign stock markets operate differently from the U.S. market,
Americans investing abroad will encounter risks not typically associated with
U.S. companies. For instance, foreign companies are not subject to the same
accounting, auditing, and financial reporting standards and practices as U.S.
companies; and their stock may not be as liquid as the stock of similar U.S.
companies. In addition, foreign stock exchanges, brokers, and companies
generally have less government supervision and regulation than in the U.S. These
factors, among others, could negatively impact the returns Americans receive
from a foreign investment. For more information about foreign investment risk,
see the Statement of Additional Information.
Keep in mind that, because the makeup of the Fund changes daily, this
listing is only a "snapshot" at one point in time.
[FLAG] THE FUND IS SUBJECT TO MANAGER RISK, WHICH IS THE POSSIBILITY THAT
EITHER THE ADVISORS MAY DO A POOR JOB OF SELECTING STOCKS.
PORTFOLIO TURNOVER
Although the Fund generally seeks to invest for the long term, it retains the
right to sell securities regardless of how long they have been held. The Fund's
average turnover rate for the past ten years has been about 44%. (A turnover
rate of 100% would occur, for example, if the Fund sold and replaced securities
valued at 100% of its total net assets within a one-year period.)
INVESTMENT POLICIES
Besides investing in stocks of small or emerging companies, Van-guard Explorer
Fund may follow a number of investment policies to achieve its objective.
The Fund may invest as much as 20% of its assets in foreign securities.
These securities can be traded in either U.S. or foreign markets.
[FLAG] BECAUSE OF ITS FOREIGN INVESTMENTS, THE FUND IS SUBJECT TO COUNTRY RISK
AND CURRENCY RISK. COUNTRY RISK IS THE POSSIBILITY THAT POLITICAL
EVENTS (SUCH AS A WAR), FINANCIAL PROBLEMS (SUCH AS GOVERNMENT
DEFAULT), OR NATURAL DISASTERS (SUCH AS AN EARTHQUAKE) WILL WEAKEN A
COUNTRY'S ECONOMY AND CAUSE INVESTMENTS IN THAT COUNTRY TO LOSE MONEY.
CURRENCY RISK IS THE POSSIBILITY THAT A "STRONGER" U.S. DOLLAR WILL
REDUCE RETURNS FOR AMERICANS INVESTING OVERSEAS. GENERALLY, WHEN THE
DOLLAR RISES IN VALUE AGAINST A FOREIGN CURRENCY, YOUR INVESTMENT IN
THAT COUNTRY LOSES VALUE BECAUSE ITS CURRENCY IS WORTH FEWER U.S.
DOLLARS.
The Fund may invest up to 15% of its assets in restricted securities with
limited marketability or other illiquid securities. The Fund may also invest in
derivatives.
[FLAG] THE FUND RESERVES THE RIGHT TO INVEST, TO A LIMITED EXTENT, IN STOCK
FUTURES AND OPTIONS CONTRACTS, WHICH ARE TRADITIONAL TYPES OF
DERIVATIVES.
Losses (or gains) involving futures can sometimes be substantial--in part
because a relatively small price movement in a futures contract may result in an
immediate and substantial loss (or gain) for a portfolio. The Fund will not use
futures and options for speculative
8
<PAGE> 41
purposes or as leveraged investments that magnify the gains or losses of an
investment. Rather, the Fund will keep separate cash reserves or short-term
cash-equivalent securities in the amount of the obligation underlying the
futures or options contract. Only a limited percentage of the Fund's total
assets--5%--may be applied to future contract deposits and no more than 20%
may be committed to such contracts.
The reasons for which the Fund will invest in futures and options are:
- - To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in stocks.
- - To make it easier to trade.
- - To reduce costs by buying futures instead of actual stocks when futures
are cheaper.
The Fund will usually hold only a small percentage of its assets in
cash reserves, although if an investment adviser believes that market conditions
warrant a temporary defensive measure, the Fund may hold cash reserves without
limit.
INVESTMENT LIMITATIONS
To reduce risk and maintain diversification, the Fund has adopted limits on some
of its investment policies. Specifically, the Fund will not:
- - Invest more than 25% of its assets in any one industry.
- - Borrow money, except for temporary or emergency purposes in an amount not
exceeding 15% of its assets. Whenever the Fund's outstanding borrowing is
more than 5% of its assets, it will stop making investments. With respect
to 75% of its assets, this Fund will not:
- - Invest more than 5% in the securities of any one company.
- - Buy more than 10% of the outstanding voting shares of any company.
The limitations listed in this prospectus and in the Statement of
Additional Information are fundamental and may be changed only by approval of a
majority of the Fund's shareholders.
Investment Performance
Vanguard Explorer Fund invests primarily in common stocks, so its performance is
closely correlated to the overall stock market. Historically, performance of the
stock markets, both foreign and domestic, has been characterized by sharp
up-and-down swings in the short term and by more stable growth over the long
term.
PLAIN TALK ABOUT
DERIVATIVES
A derivative is a financial contract whose value is based on (or "derived" from)
a traditional security (such as a stock or a bond), an asset (such as a
commodity like gold), or a market index (such as the S&P 500 Index). Futures and
options are derivatives that have been trading on regulated exchanges for more
than two decades. These "traditional" derivatives are standardized contracts
that can easily be bought and sold, and whose market values are determined and
published daily. It is these characteristics that differentiate futures and
options from the relatively new, exotic types of derivatives--some of which
can carry considerable risks.
PLAIN TALK ABOUT
CASH RESERVES
With mutual funds, holding cash reserves--or "cash"--does not mean literally
that the fund holds a stack of currency. Rather, cash reserves also refer to
short-term, interest-bearing securities that can easily and quickly be converted
to cash, as described in the prospectus glossary. (Most mutual funds keep at
least a small percent of assets in cash to accommodate shareholder redemptions.)
While some funds strive to keep cash levels at a minimum and to always remain
fully invested in stocks, other equity funds allow investment advisers to hold
up to 20% of a fund's assets in cash reserves.
9
<PAGE> 42
PLAIN TALK ABOUT
PAST PERFORMANCE
Whenever you see information on a fund's performance, do not consider the
figures to be an indication of the performance you could expect by making an
investment in the fund today. The past is an imperfect guide to the future;
history does not repeat itself in neat, predictable patterns.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
FOR PERIODS ENDED APRIL 30, 1997
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
EXPLORER FUND -7.7% 10.8% 12.2% 10.3%
RUSSELL 2000 INDEX 0.1% 12.6% 13.7% 9.8%
</TABLE>
The results shown above represent the Fund's "average annual total
return" performance, which assumes that any distributions of capital gains and
dividends were reinvested for the indicated periods. Also included is
comparative information on the unmanaged Russell 2000 Index, a benchmark of
small-capitalization stocks. The chart does not make any allowances for federal,
state, or local income taxes that shareholders must pay on a current basis.
In weighing these performance figures, note that the Fund has been in
operation since December 11, 1967, and that Wellington Management Company, LLP
was the sole investment adviser for the Fund until February 28, 1990, when the
Fund and Vanguard Explorer II (a Granahan-managed fund with the same objective)
merged. Chartwell Investment Partners and Vanguard Core Management Group were
added as advisers on August 1, 1997.
SHARE PRICE
The Fund's share price, called its net asset value, is calculated each business
day after the close of regular trading (generally 4 p.m. Eastern time) on the
New York Stock Exchange. Net asset value per share is calculated by adding up
the total assets of the Fund, subtracting all of its liabilities, or debts, and
then dividing by the number of Fund shares outstanding:
TOTAL ASSETS - LIABILITIES
NET ASSET VALUE = -----------------------------
NUMBER OF SHARES OUTSTANDING
The daily net asset value, or NAV, is useful to you as a shareholder
because the NAV, multiplied by the number of Fund shares you own, gives you the
dollar amount you would have received had you sold all of your shares back to
the Fund that day.
To help determine its daily share price, the Fund calculates the value
of its foreign securities, if any, in U.S. dollars. The Fund uses
10
<PAGE> 43
the daily exchange rate employed by Morgan Stanley Capital International in the
calculation of its own indexes. If Morgan Stanley's exchange rate is not
available, the Fund uses a rate according to policies set by its board of
directors.
The Fund's share price can be found in the mutual fund listings of most
major newspapers under the heading Vanguard Group. Different newspapers use
different abbreviations of the Fund's name, but the most common is EXPLR.
DIVIDENDS, CAPITAL GAINS, AND TAXES
Each December, the Fund distributes to shareholders virtually all of its income
from interest and dividends, as well as any capital gains realized from the sale
of securities.
If you own shares of the Fund as an investment option in an
employer-sponsored retirement or savings plan, these dividend and capital gains
distributions will be reinvested in additional Fund shares and accumulate on a
tax-deferred basis. You will not owe taxes on these distributions until you
begin withdrawals. You should consult your plan administrator, your plan's
Summary Plan Document, or your own tax adviser about the tax consequences of an
investment in the Fund and of any plan withdrawals.
If your Vanguard Explorer Fund investment is not part of an
employer-sponsored plan, you can receive distributions of income or capital
gains in cash, or you may have them automatically reinvested in more shares of
the Fund. Both dividend and capital gains distributions--whether received in
cash or reinvested in additional shares--are subject to federal (and possibly
state and local) income taxes, no matter how long you have held the shares in
the Fund. You should consult your own tax adviser about other tax consequences
of an investment in the Fund.
THE FUND AND VANGUARD
Vanguard Explorer Fund is a member of The Vanguard Group, a family of more than
30 investment companies with more than 90 distinct investment portfolios and
total net assets of more than $290 billion. All of the Vanguard funds share in
the expenses associated with business operations, such as personnel, office
space, equipment, and advertising.
Vanguard also provides marketing services to the funds. Although
shareholders do not pay sales commissions or 12b-1 marketing fees, each fund
pays its allocated share of The Vanguard Group's costs.
A list of the Fund's directors and officers, and their present
positions and principal occupations during the past five years, can be found in
the Statement of Additional Information.
PLAIN TALK ABOUT
DISTRIBUTIONS
As a shareholder, you are entitled to your share of a fund's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or capital gains distribution. Income
dividends come from the dividends that a fund earns from its holdings as well as
interest it receives from money market and bond investments. Capital gains are
realized whenever the fund sells securities for higher prices than it paid for
them. The capital gains are either short-term or long-term depending on whether
the fund held the securities for less than or more than one year.
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group, Inc. is the only MUTUAL mutual fund company. It is owned
jointly by the funds it oversees and by the shareholders in those funds. Other
mutual funds are operated by for-profit management companies that may be owned
by one person, by a group of individuals, or by investors who bought the
management company's publicly traded stock. Because of its structure, Vanguard
operates its funds at cost. Instead of distributing profits from operations to a
separate managing company, Vanguard returns profits to fund shareholders in the
form of lower operating expenses.
11
<PAGE> 44
PLAIN TALK ABOUT
THE FUND'S ADVISERS
The individuals primarily responsible for Vanguard Explorer Fund are:
JOHN J. GRANAHAN, CFA, Founder and President of Granahan Investment
Management, Inc.; 34 years investment experience (17 years with Granahan and 17
years with WMC); B.S. from St. Joseph's University, Graduate Fellow of Catholic
University of America.
KENNETH L. ABRAMS, Senior Vice President of Wellington Management
Company, LLP; 11 years investment experience (all with WMC); B.A. and M.B.A.
from Stanford University.
EDWARD N. ANTOIAN, CFA, Partner and one of the original founders of
Chartwell Investment Partners; 18 years investment experience; B.S. from State
University of New York, M.B.A. from the University of Pennsylvania.
GEORGE U. SAUTER, Principal of Vanguard; 12 years investment
experience, 10 years primary responsibility for Vanguard Core Management Group;
A.B. from Dartmouth College, M.B.A. from the University of Chicago.
INVESTMENT ADVISERS
The Fund uses four investment advisers who independently manage a percentage of
the Fund's assets subject to the control of the officers and directors of the
Fund. Note that two of the Fund's advisers (Chartwell and Vanguard Core
Management Group) are new as of August 1, 1997. Following a transition period,
the percentage of the Fund's assets managed by each of the four advisers should
match the percentages stated on pages 6 and 7.
Granahan Investment Management, Inc., 275 Wyman Street, Waltham, MA
02154, is an investment advisory firm specializing in small-company stock
investments. Founded in 1985, Granahan currently manages about $1.3 billion in
assets. As of June 30, 1997, Granahan managed approximately 56% of Vanguard
Explorer Fund.
Granahan is paid an advisory fee each quarter that is based on its
portion's average month-end assets for the quarter.
<TABLE>
<CAPTION>
-------------------------------------------------------
NET ASSETS BASIC FEE
-------------------------------------------------------
<S> <C>
First $500 million 0.30%
Next $250 million 0.20
Next $250 million 0.15
Assets over $1 billion 0.10
-------------------------------------------------------
</TABLE>
Granahan's quarterly advisory fee may be increased or decreased based
upon the total return performance of its portion of Explorer Fund compared to
that of the Small Company Growth Fund Stock Index. This incentive/penalty fee
will not be fully operable until August 1, 2000. Until that date, the
incentive/penalty will be calculated using certain transition rules that are
explained in the Statement of Additional Information.
Wellington Management Company, LLP (WMC), 75 State Street, Boston, MA
02109, was founded in 1933. The investment advisory firm currently manages more
than $155 billion in stock and bond portfolios, including 13 Vanguard funds. As
of June 30, 1997, WMC managed approximately 44% of the Fund's assets.
WMC is paid an advisory fee each quarter that is based on its portion's
average month-end assets for the quarter.
<TABLE>
<CAPTION>
-------------------------------------------------------
NET ASSETS BASIC FEE
-------------------------------------------------------
<S> <C>
First $500 million 0.25%
Next $250 million 0.20
Next $250 million 0.15
Assets over $1 billion 0.10
-------------------------------------------------------
</TABLE>
WMC's quarterly advisory fee may be increased or decreased by as much
as 50% based upon the total return performance of its portion of Explorer Fund
compared to that of the Small Company Growth Fund Stock Index. This incentive/
penalty fee will not be fully operable until August 1, 2000. Until that date,
the incentive/penalty will be
12
<PAGE> 45
calculated using certain transition rules that are explained in the Statement of
Additional Information.
PLAIN TALK ABOUT
THE SMALL COMPANY GROWTH FUND STOCK INDEX
The Small Company Growth Fund Stock Index is the benchmark that Vanguard
Explorer Fund uses to evaluate the performance of its investment advisers. The
compensation of the Fund's external advisors - Granahan, WMC, and Chartwell -
can be either increased or decreased, depending on the results they have
achieved compared with the Index. The Index is made up of the common stocks held
by the 25 largest small-company stock mutual funds (at the end of 1996, this
amounted to approximately 1,800 stocks). Morningstar, Inc., maintains the Index
especially for Explorer Fund.
Chartwell Investment Partners, 1235 Westlakes Drive, Suite 330, Berwyn,
PA 19312, was founded in 1997. The investment advisory firm currently manages
about $350 million in assets. Chartwell first began managing a portion of the
Fund's assets on August 1, 1997.
Chartwell is paid an advisory fee each quarter that is based on its
portion's average month-end assets for the quarter.
<TABLE>
<CAPTION>
-------------------------------------------------------
NET ASSETS RATE
-------------------------------------------------------
<S> <C>
First $250 million 0.40%
Next $250 million 0.30
Over $500 million 0.20
-------------------------------------------------------
</TABLE>
Chartwell's quarterly advisory fee may be increased or decreased by as
much as 20% based upon the total return performance of its portion of Explorer
Fund compared to that of the Small Company Growth Fund Stock Index. This
incentive/penalty fee will not be fully operable until August 1, 2000. Until
that date, the incentive/penalty will be calculated using certain transition
rules that are explained in the Statement of Additional Information.
The Vanguard Group, Inc., P.O. Box 2600, Valley Forge, PA 19482, first
began managing a portion of the Fund's assets on August 1, 1997. Vanguard
provides investment advisory services to the Fund on an at-cost basis. Vanguard
Core Management Group serves as investment adviser to several Vanguard funds
and as of June 30, 1997 managed more than $79 billion in total assets.
For the fiscal year ended October 31, 1996, the total fee paid by
Vanguard Explorer Fund to its advisers (at that time, Granahan and WMC only) was
approximately $4.70 million, which included a base fee of $4.31 million and an
incentive of $393,000. Note, however, that the fee schedules used to calculate
these amounts were different than those described in the preceding paragraphs.
The previous fee schedules used the Russell 2000 Index, rather than the Small
Company Growth Fund Stock Index, as a performance benchmark.
The advisers are authorized to choose brokers or dealers to handle the
purchase and sale of the Fund's securities, and are directed to get the best
available price and most favorable execution from these brokers with respect to
all transactions. The advisers consider the full range and quality of brokerage
services available when making these determinations. At times, the advisers may
choose brokers who charge higher commissions in the interest of obtaining better
execution of a transaction. If more than one broker can obtain the best
available price and favorable execution of a transaction, then the advisers are
authorized to choose a broker who, in addition to executing the transaction,
will provide research services to the advisers or
13
<PAGE> 46
the Fund. However, the advisers will not pay higher commissions specifically for
the purpose of obtaining research services. The Fund may direct the advisers to
use a particular broker for certain transactions in exchange for commission
rebates or research services provided to the Fund.
The board of directors may, without prior approval from shareholders,
change the terms of the advisory agreements or hire a new investment adviser as
either a replacement adviser or as an additional adviser. However, no such
change would be made before giving shareholders 30-days notice, in writing.
GENERAL INFORMATION
Vanguard Explorer Fund, Inc. is a corporation organized under the laws of the
state of Maryland. Shareholders of the Fund have rights and privileges similar
to those enjoyed by other corporate shareholders. For example, shareholders will
not be responsible for any liabilities of the corporation. If any matters are to
be voted on by shareholders (such as a change in a fundamental investment
objective or the election of directors), each share outstanding at that point
would be entitled to one vote. Annual meetings will not be held by the Fund
except as required by the Investment Company Act of 1940. A meeting will be
scheduled (for example, to vote on the removal of a director) if the holders of
at least 10% of the Fund's shares request a meeting in writing.
14
<PAGE> 47
INVESTING WITH VANGUARD
FOR PLAN PARTICIPANTS
Vanguard Explorer Fund is an investment option in your retirement or savings
plan. Your plan administrator or your employee benefits office can provide you
with detailed information on how to participate in your plan and how to elect
the Fund as an investment option.
- - If you have any questions about the Fund or Vanguard, including the
Fund's investment objective, strategies, or risks, contact Vanguard's
Participant Services Department, toll-free, at 1-800-523-1188.
- - If you have questions about your account, contact your plan
administrator or the organization that provides recordkeeping
services for your plan.
INVESTMENT OPTIONS AND ALLOCATIONS
Your plan's specific provisions may allow you to change your investment
selections, the amount of your contributions, or how your contributions are
allocated among the investment choices available to you. Contact your plan
administrator or employee benefits office for more details.
TRANSACTIONS
Contributions, exchanges, or redemptions of the Fund's shares are processed as
soon as they have been received by Vanguard in good order. Good order means that
your request includes complete information on your contribution, exchange, or
redemption, and that Vanguard has received the appropriate assets.
EXCHANGES
The exchange privilege (your ability to redeem shares from one fund to purchase
shares of another fund) may be available to you through your plan. However,
because excessive exchanges can potentially disrupt the management of the Fund
and increase its transaction costs, Vanguard reserves the right to refuse any
exchange request. In addition, certain investment options, particularly funds
made up of company stock or investment contracts, may be subject to unique
restrictions. Contact your plan administrator for details on the exchange
policies that apply to your plan.
Before making an exchange, you should consider the following:
- - Before you exchange to another Vanguard fund available in your plan,
you should read that fund's prospectus. Contact Participant Services,
toll-free, at 1-800-523-1188 for a copy.
- - Vanguard can accept exchanges only as permitted by your plan. Your plan
administrator can explain how frequently exchanges are allowed.
FOR OTHER INSTITUTIONAL INVESTORS
If you have questions about Vanguard Explorer Fund, including how to
establish an account, call Vanguard, toll-free, at 1-800-523-1036.
If you have questions about an existing account, contact your Vanguard
account administrator.
TRANSACTIONS
Purchases, exchanges, or redemptions of the Fund's shares are processed as soon
as they have been received by Vanguard in good order. Good order means that your
request
15
<PAGE> 48
INVESTING WITH VANGUARD (continued)
includes complete information on your purchase, exchange, or redemption, and
that Vanguard has received the appropriate assets. The price of shares bought,
exchanged, or sold will be the Fund's next-determined net asset value after
Vanguard has processed your request, provided your request has been received
before 4 p.m. Eastern time.
Vanguard must consider the interests of all Fund shareholders and so
reserves the right to . . .
- - Delay or reject any purchase or exchange request that may disrupt the
Fund's operation or performance.
- - Delay or reject any purchase or exchange request that may disrupt the
Fund's operation or performance.
- - Revise or terminate the exchange privilege or limit the amount of an
exchange, at any time, without notice.
- - Take up to seven days to deliver your redemption proceeds.
- - Pay redemption proceeds -- in whole or in part -- through a
distribution in kind of readily marketable securities.
ACCESSING FUND INFORMATION BY COMPUTER
VANGUARD ON THE
WORLD WIDE WEB
http://www.vanguard.com
Use your personal computer to visit Vanguard's education-oriented website, which
provides timely news and information about Vanguard funds and services; an
on-line "university" that offers a variety of mutual fund classes; and
easy-to-use, interactive tools to help you create your own investment and
retirement strategies.
16
<PAGE> 49
GLOSSARY OF INVESTMENT TERMS
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized during the year on
securities that the fund has sold at a profit, minus any realized losses.
CASH RESERVES
Cash deposits as well as short-term bank deposits, money market instruments,
U.S. Treasury bills, commercial paper, and bankers acceptances.
COMMON STOCK
A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which may be paid out as
dividends.
COUNTRY RISK
The possibility that events such as changes in regulation, political or
financial troubles, or natural disasters will weaken a country's economy and
cause investments in that country to lose money.
CURRENCY RISK
The possibility that an American's foreign investment will lose money because of
unfavorable exchange rate movements.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by a
fund's investments.
DOLLAR-COST AVERAGING
Investing equal amounts of money at regular intervals on an ongoing basis. This
technique ensures that an investor buys fewer shares when prices are high and
more shares when prices are low.
EXPENSE RATIO
The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
marketing fees.
INVESTMENT ADVISER
An organization that makes the day-to-day decisions regarding a portfolio's
investments.
MUTUAL FUND
An investment company that pools the money of many people and invests it in a
variety of securities in an attempt to achieve a specific objective over time.
NET ASSET VALUE (NAV)
The market value of a mutual fund's total assets, minus liabilities, divided by
the number of shares outstanding. The value of a single share is called its
share value or share price.
PORTFOLIO DIVERSIFICATION
Holding a variety of securities so that a portfolio's return is not hurt by the
poor performance of a single security or industry.
PRINCIPAL
The amount of your own money you put into an investment.
SECURITIES
Stocks, bonds, and other investment vehicles.
TOTAL RETURN
A percentage change, over a specified time period, in a mutual fund's net asset
value, with the ending net asset value adjusted to account for the reinvestment
of all distributions of dividends and capital gains.
VOLATILITY
The fluctuations in value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
YIELD
Current income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE> 50
[GRAPHIC OF SHIP]
Institutional Division
Post Office Box 2900
Valley Forge, PA 19482
FOR PARTICIPANTS IN
EMPLOYER-SPONSORED PLANS
PARTICIPANT SERVICES
DEPARTMENT
1-800-523-1188
TEXT TELEPHONE:
1-800-523-8004
For information on the
Vanguard funds in your plan,
Monday through Friday
8:30 a.m. to 7 p.m.,
Eastern time
FOR OTHER INSTITUTIONAL
INVESTORS
1-800-523-1036
For information on Vanguard
funds and services
ELECTRONIC ACCESS TO THE
VANGUARD MUTUAL FUND
EDUCATION AND INFORMATION
CENTER
World Wide Web
http://www.vanguard.com
E-mail
[email protected]
(C) 1997 Vanguard Marketing
Corporation, Distributor
1024N
<PAGE> 51
PART B
VANGUARD EXPLORER FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
AUGUST 1, 1997
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectus (dated August 1, 1997). To obtain the Prospectus
please call the Investor Information Department:
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objective and Policies......................................................... B-1
Purchase of Shares........................................................................ B-5
Redemption of Shares...................................................................... B-6
Dividends and Capital Gains Distributions................................................. B-6
Yield and Total Return.................................................................... B-6
Investment Limitations.................................................................... B-6
Management of the Fund.................................................................... B-7
Investment Advisory Services.............................................................. B-10
Portfolio Transactions.................................................................... B-17
General Information About the Fund........................................................ B-18
Performance Measures...................................................................... B-19
Financial Statements...................................................................... B-21
</TABLE>
INVESTMENT OBJECTIVE AND POLICIES
The objective of the Fund is to provide long-term capital growth. The Fund
invests primarily in the equity securities of small companies. Dividend income
is expected to be incidental to this objective. There is no assurance that the
Fund will achieve its stated objective. The objective of the Fund is
fundamental. The following policies supplement the Fund's investment 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 a 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. See "Restricted or Illiquid Securities"
on page 5.
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
B-1
<PAGE> 52
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 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 three 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 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. Assets committed to futures contracts will be segregated at
the Fund's custodian bank to the extent required by law.
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
B-2
<PAGE> 53
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, 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 to 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
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<PAGE> 54
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.
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.
FOREIGN INVESTMENTS. As indicated in the Prospectus, the Fund may invest
up to 20% of its assets in foreign securities and may engage in currency
transactions with respect to such investments. Investors should recognize that
investing in foreign companies involves certain special considerations which are
not typically associated with investing in U.S. companies.
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Country Risk. As foreign companies are not generally subject to uniform
accounting, auditing and financial reporting standards and practices comparable
to those applicable to domestic companies, there may be less publicly available
information about certain foreign companies than about domestic companies.
Securities of some foreign companies are generally less liquid and more volatile
than securities of comparable domestic companies. There is generally less
government supervision and regulation of stock exchanges, brokers and listed
companies than in the U.S. In addition, with respect to certain foreign
countries, there is the possibility of expropriation or confiscatory taxation,
political or social instability, or diplomatic developments which could affect
U.S. investments in those countries.
Although the Fund will endeavor to achieve most favorable execution costs
in its portfolio transactions in foreign securities, fixed commissions on many
foreign stock exchanges are generally higher than negotiated commissions on U.S.
exchanges. In addition, it is expected that the expenses for custodial
arrangements of the portfolio's foreign securities will be somewhat greater than
the expenses for the custodial arrangements for handling U.S. securities of
equal value.
Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes is
recoverable, the non-recovered portion of foreign withholding taxes will reduce
the income the Fund receives from its foreign investments.
Currency Risk. Since the stocks of foreign companies are frequently
denominated in foreign currencies, and since the Fund may temporarily hold
uninvested reserves in bank deposits in foreign currencies, the Fund will be
affected favorably or unfavorably by changes in currency rates and in exchange
control regulations, and may incur costs in connection with conversions between
various currencies. The investment policies of the Fund permit it to enter into
forward foreign currency exchange contracts in order to hedge holdings and
commitments against changes in the level of future currency rates. Such
contracts involve an obligation to purchase or sell a specific currency at a
future date at a price set at the time of the contract.
RESTRICTED OR ILLIQUID SECURITIES. The Fund is authorized to invest up to
15% of its net assets in restricted or illiquid securities. Illiquid Securities
are securities that may not be sold or disposed of in the ordinary course of
business within seven business days at approximately the value at which they are
being carried on the Fund's books. 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.
Securities that are unregistered that can be sold to "qualified
institutional buyers" in accordance with Rule 144A under the 1933 Act will not
be considered illiquid for the purpose of this limitation, as long as it is
determined by the Fund's adviser that an adequate trading market exists for the
security.
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 investment for, or any other restrictions on,
initial and subsequent
B-5
<PAGE> 56
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.
YIELD AND TOTAL RETURN
The yield of the Fund for the thirty-day period ended April 30, 1997 was
0.51%.
The average annual total returns for the Fund for the one-, five- and
ten-year periods ending October 31, 1996 and April 30, 1997, were +17.97%,
+14.87% and +12.37%, and -7.68%, +12.17% and +10.27%, 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 period 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
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<PAGE> 57
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; and
11) 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 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.
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 set broad policies
for the Fund and choose its Officers. A list of the Directors and
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<PAGE> 58
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 and Director*
Chairman and Director of The Vanguard Group, Inc. and of each of the
investment companies in The Vanguard Group; Director of The Mead
Corporation, General Accident Insurance, and Chris-Craft Industries, Inc.
JOHN J. BRENNAN, President, Chief Executive Officer and Director*
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, Director
Chairman Emeritus and Director of Rhone-Poulenc Rorer, Inc.; Director of
Sun Company, Inc., Westinghouse Electric Corporation and Global Health Care
Partners/DLJ Merchant Banking Partners.
BARBARA BARNES HAUPTFUHRER, Director
Director of The Great Atlantic and Pacific Tea Company, Ikon Business
Solutions, Inc., Raytheon Company, Knight-Ridder, Inc., and Massachusetts
Mutual Life Insurance Co. and Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY, Director
President Emeritus of The Brookings Institution; Director of American
Express Bank, Ltd., The St. Paul Companies, Inc., and National Steel
Corporation.
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, and The Standard Products 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, Procter & Gamble
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. and of Kmart
Corporation.
J. LAWRENCE WILSON, Director
Chairman and Chief Executive Officer of Rohm & Haas Company; Director of
Cummins Engine Company; and Trustee of Vanderbilt University.
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*
Principal of The Vanguard Group, Inc.; Controller of each of the investment
companies in The Vanguard Group.
- ---------------
*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
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
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<PAGE> 59
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
Funds' Service Agreement provides for the following arrangement: (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 has 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, 1996 and April 30, 1997, Vanguard Explorer Fund had
contributed capital of $214,000 and $169,000 to Vanguard, representing 1.1% and
0.8% 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, 1996 and the six months ended April 30, 1997, the
Fund's share of Vanguard's actual net costs of operation relating to management
and administrative services (including transfer agency) totaled approximately
$6,647,000 and $4,061,000.
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 of 1% of
its average month-end net assets. During the fiscal year ended October 31, 1996
and the six months ended April 30, 1997, the Fund paid approximately $369,000
and $276,000 of the Group's distribution and marketing expenses, which
represented an effective annual rate of .02 of 1% and .03 of 1% of the Fund's
average net assets.
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 Index
Trust; Vanguard International Equity
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<PAGE> 60
Index Fund; Vanguard Balanced Index Fund; Vanguard Explorer Fund; Vanguard
Institutional Index Fund; several Portfolios of Vanguard Variable Insurance
Fund, Vanguard Admiral Funds, Vanguard Tax-Managed Fund, Aggressive Growth
Portfolio of Vanguard Horizon Fund, the Total International Portfolio of
Vanguard STAR Fund; the REIT Index Portfolio of Vanguard Specialized Portfolios;
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.
During the fiscal year ended October 31, 1996, the Fund paid approximately
$7,000 in Directors' fees and expenses to its "non-interested" Directors. The
Fund's proportionate share of remuneration paid by Vanguard (and reimbursed by
the Fund) during the fiscal year to all Officers of the Fund, as a group, was
approxi-mately $57,594.
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 Fund's proportionate share of retirement benefits paid by Vanguard on behalf
of all eligible Officers of the Fund, as a group, during the fiscal year ended
October 31, 1996 was approximately $1,650.
The following table provides detailed information with respect to the
amounts paid or accrued for the Directors for the fiscal year ended October 31,
1996.
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 $806 $ 125 $15,000 $65,000
Robert E. Cawthorn $806 $ 104 $13,000 $65,000
Bruce K. MacLaury $873 $ 122 $12,000 $60,000
Burton G. Malkiel $806 $ 83 $15,000 $65,000
Alfred M. Rankin, Jr. $806 $ 66 $15,000 $65,000
John C. Sawhill $806 $ 78 $15,000 $65,000
James O. Welch, Jr. $806 $ 96 $15,000 $65,000
J. Lawrence Wilson $806 $ 69 $15,000 $65,000
</TABLE>
(1) As "Interested Directors," Messrs. Bogle and Brennan receive no compensation
for their service as directors.
(2)The amounts reported in this column reflect the total compensation paid to
each Director for their service as Director or Trustee of 34 Vanguard Funds
(33 in the case of Mr. Malkiel; 27 in the case of Mr. MacLaury).
INVESTMENT ADVISORY SERVICES
The Fund currently use four separate investment advisers, each of whom
manages the investment and reinvestment of a portion of the Fund's assets. 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),
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<PAGE> 61
and Granahan served as sole investment adviser to Explorer II, the acquired
fund. Chartwell Investment Partners and The Vanguard Group Inc. were added as
advisers August 1, 1997.
The proportion of the net assets of the Fund managed by each adviser was
established by the Board of Directors 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
uses four 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, LLP
The Fund has entered into an advisory agreement with WMC dated August 1,
1997 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
June 30, 1997, WMC managed approximately 44% 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 globally provides
investment services to investment companies, other institutions and individuals.
WMC is a Massachusetts limited liability partnership of which the following
persons are managing partners: Robert W. Doran, Duncan M. McFarland and John R.
Ryan.
WMC and its predecessor organizations have provided investment advisory
services to investment companies since 1933 and to investment counseling clients
since 1960.
Kenneth L. Abrams, Senior Vice President of WMC, serves as portfolio
manager of the assets of the Fund assigned to WMC. Mr. Abrams has been employed
by WMC for eleven years and has served as portfolio manager of the Fund since
1994.
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 $500 million .250%
Next $250 million .200%
Next $250 million .150%
Assets in excess of $1
billion .100%
</TABLE>
The Basic Fee, as provided above, shall be increased or decreased by
applying an incentive/penalty fee adjustment based on the investment performance
of the WMC Portfolio relative to the investment performance of the Small Company
Growth Fund Stock Index (the "Index").(1)
- ---------------
1Prior to July 31, 1997, WMC's fees were calculated by using the Russell 2000
Index as a performance benchmark. Beginning with the quarter-ending October 31,
1997, the "new" benchmark (Small Company Growth Fund Stock Index) will be phased
in over a 36-month period by calculating WMC's incentive/penalty fee based on
the linked performance of new and old benchmarks.
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<PAGE> 62
The following table sets forth the adjustment factors to the base advisory
fee payable by the Fund to WMC under this investment advisory agreement:
<TABLE>
<CAPTION>
CUMULATIVE 36-MONTH
PERFORMANCE VERSUS THE INDEX
- ------------------------------------------ PERFORMANCE FEE
ADJUSTMENT(1)
------------------
<S> <C>
Trails by -12% or more -0.50 X Basic Fee
Trails by more than -6% up to -12% -0.25 X Basic Fee
Trails/exceeds from -6% through 6% 0.00 X Basic Fee
Exceeds by more than 6% but less than 12% +0.25 X Basic Fee
Exceeds by 12% or more +0.50 X Basic Fee
</TABLE>
- ---------------
(1) For purposes of this calculation, the basic fee is calculated by applying
the quarterly rate against the Fund's average net assets over the same time
period that performance is measured.
For the purpose of determining the fee adjustment for investment
performance, as described above, the net assets of the WMC Portfolio shall be
averaged over the same period as the investment performance of the WMC Portfolio
and the investment record of the Index are computed.
Under the rules of the Securities and Exchange Commission, and as a result
of a prior advisory agreement dated August 1, 1996, the current
incentive/penalty fee will not be fully operable until the quarter ending July
31, 1999. Until that date, a "blended" fee rate consisting of varying
percentages of (i) the performance adjustment based on the schedule set forth
above (the "current rate"), and (ii) the performance adjustment based on the
schedule set forth in the Fund's previous investment advisory agreement with
WMC(2) (the "previous rate") shall be used as follows:
1. QUARTER ENDING APRIL 30, 1997. The incentive/penalty fee shall be
calculated as the sum of 25% of the fee payable under current new rate plus 75%
of the fee payable under the previous rate.
2. QUARTER ENDING JULY 31, 1997. The incentive/penalty fee shall be
calculated as the sum of 33% of the fee payable under the current rate plus 67%
of the fee payable under the previous rate.
3. QUARTER ENDING OCTOBER 31, 1997. The incentive/penalty fee shall be
calculated as the sum of 41.6% of the fee payable under the current rate plus
58.4% of the fee payable under the previous rate.
4. QUARTER ENDING JANUARY 31, 1998. The incentive/penalty fee shall be
calculated as the sum of 50% of the fee payable under the current rate plus 50%
of the fee payable under the previous rate.
5. QUARTER ENDING APRIL 30, 1998. The incentive/penalty fee shall be
calculated as the sum of 58.4% of the fee payable under the current rate plus
41.6% of the fee payable under the previous rate.
6. QUARTER ENDING JULY 31, 1998. The incentive/penalty fee shall be
calculated as the sum of 67% of the fee payable under the current rate plus 33%
of the fee payable under the previous rate.
7. QUARTER ENDING OCTOBER 31, 1998. The incentive/penalty fee shall be
calculated as the sum of 75% of the fee payable under the current rate plus 25%
of the fee payable under the previous rate.
8. QUARTER ENDING JANUARY 31, 1999. The incentive/penalty fee shall be
calculated as the sum of 83.3% of the fee payable under the current rate plus
16.7% of the fee payable under the previous rate.
9. QUARTER ENDING APRIL 30, 1999. The incentive/penalty fee shall be
calculated as the sum of 91.7% of the fee payable under the current rate plus
8.3% of the fee payable under the previous rate.
- ---------------
(2) The previous incentive/penalty fee structure provided that the Basic Fee be
increased or decreased by an amount equal to .0375% per annum (.009375 of 1% per
quarter) of the average month-end assets if the Fund's investment performance
for the 36 months preceding the end of the quarter was between 6 and 12
percentage points above or below, respectively, the investment record of the
Russell 2000 Small Company Stock Index and .075% per annum (.01875 of 1% per
quarter) of the average month-end assets of the Fund if the Fund's investment
performance for the 36 months preceding the end of the quarter was twelve
percentage points or more above or below, respectively, the investment record of
the Russell 2000 Small Stock Index.
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<PAGE> 63
10. QUARTER ENDING JULY 31, 1999. Current rate fully operable.
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.
The "WMC Portfolio unit value" is determined by dividing the total net
assets of the WMC Portfolio by a given number of units. Pursuant to the Fund's
investment advisory agreement with WMC dated February 28, 1990, the number of
units in the WMC Portfolio originally equaled the total shares outstanding of
the Fund on that date. Subsequently, as assets have been added to or withhdrawn
from the WMC Portfolio, the number of units of the WMC Portfolio has been and
shall continue to be adjusted based on the unit value of the WMC Portfolio on
the day such changes are executed.
The investment record of the Index or Russell 2000 for any period,
expressed as a percentage of the Index or Russell 2000 at the beginning of such
period, is the sum of (i) the change in the level of the Index or Russell 2000
during such period and (ii) the value, computed consistently with the Index or
Russell 2000, of cash distributions having an ex-dividend date occurring within
such period made by companies whose securities comprise the Index or Russell
2000. For this purpose, cash distributions on the securities which comprise the
Small Company Growth Stock Index shall be treated as reinvested in the Index or
Russell 2000 as applicable 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 linked return of the Russell 2000 and the Index is computed.
Any computation of the investment performance of the WMC Portfolio and the
investment record of the Russell 2000 and Indexes 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, 1994, 1995, and 1996, the Fund
paid WMC approximately the following advisory fees:
<TABLE>
<CAPTION>
1994 1995 1996
---------- ---------- ----------
<S> <C> <C> <C>
Basic Fee........................... $1,362,455 $1,698,254 $1,922,594
Increase (Decrease) for Performance
Adjustment........................ (61,905) (44,661) 6,708
---------- ---------- ----------
Total.......................... $1,300,550 $1,653,593 $1,929,302
========== ========== ==========
</TABLE>
These fees were paid under a previous fee schedule that provided for a
higher rate of fees.
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
June 30, 1997, Granahan managed approximately 44% of the Fund's net assets.
Granahan discharges its responsibilities subject to the control of the Officers
and Directors of the Fund.
Granahan Investment Management, Inc., is an investment advisory firm
specializing in small company stock investments. Mr. John Granahan is the
President and major stockholder of Granahan Investment Management, Inc.
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<PAGE> 64
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 $500 million .300%
Next $250 million .200%
Next $250 million .150%
Assets in excess of $1
billion .100%
</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 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 Index 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 Index for the same period.(1) 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 Index
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. Pursuant to the
Fund's investment advisory agreement with Granahan dated February 28, 1990, the
number of units in the Granahan Portfolio originally equalled the total shares
outstanding of the Fund on that date. Subsequently, as assets have been added to
or withdrawn from the Granahan Portfolio, the number of units of the Granahan
Portfolio has been, and shall continue to be, adjusted based on the unit value
of the Granahan Portfolio on the day such changes are executed.
The investment record of the Index or Russell 2000 for any period,
expressed as a percentage of the Index or Russell 2000 at the beginning of such
period, is the sum of (i) the change in the level of the Index or Russell 2000
during such period and (ii) the value, computed consistently with the Index or
Russell 2000, of cash distributions having an ex-dividend date occurring within
such period made by companies whose securities comprise the Index or Russell
2000. For this purpose cash distributions on the securities which comprise the
Index or Russell 2000 shall be treated as reinvested in the Index or Russell
2000, as applicable, 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 linked return of the Russell 2000 and Index is
computed.
- ---------------
(1) Prior to July 31, 1997, Granahan's fees were calculated by using the Russell
2000 Index as a performance benchmark. Beginning with the quarter-ending October
31, 1997, the "new" benchmark (Small Company Growth Fund Stock Index) will be
phased in over a 36-month period by calculating Granahan's incentive/penalty fee
based on the linked performance of the new and old benchmarks.
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<PAGE> 65
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.
During the fiscal years ended October 31, 1994, 1995 and 1996, the Fund
paid Granahan approximately the following advisory fees:
<TABLE>
<CAPTION>
1994 1995 1996
---------- ---------- ----------
<S> <C> <C> <C>
Basic Fee....................... $1,397,812 $1,799,069 $2,389,787
Increase (Decrease) for
Performance Adjustment........ 40,525 69,595 386,752
---------- ---------- ----------
Total...................... $1,438,337 $1,868,664 $2,776,539
========== ========== ==========
</TABLE>
These fees were paid under a previous fee schedule that provided for a
higher rate of fees.
CHARTWELL INVESTMENT PARTNERS
The Fund also employs Chartwell Investment Partners ("Chartwell") under an
investment advisory agreement dated as of August 1, 1997 to manage the
investment and reinvestment of approximately 10% of the Fund's assets. Chartwell
discharges its responsibilities subject to the control of the Officers and
Directors of the Fund.
For the services provided by Chartwell under the advisory agreement the
Fund will pay Chartwell 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 Chartwell Portfolio
for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
----------------------------- -----
<S> <C>
First $250 million 0.40%
Next $250 million 0.30%
Over $500 million 0.20%
</TABLE>
Effective with the quarter ending July 31, 1998 the Basic Fee, as provided
above, shall be increased or decreased by applying an incentive/penalty fee
adjustment based on the investment performance of the Chartwell Portfolio
relative to the investment performance of the Small Company Growth Fund Stock
Index. The following table sets forth the fee payable by the Fund to Chartwell
based upon the incentive/penalty adjustment:
<TABLE>
<CAPTION>
THREE-YEAR CUMULATIVE
PERFORMANCE DIFFERENTIAL PERFORMANCE FEE
VERSUS SCGFSI ADJUSTMENT*
-------------------------------------------------- ------------------
<S> <C>
Trails by -12% or more -0.20 x Basic Fee
Trails by more than -6% up to -12% -0.10 x Basic Fee
Trails/exceeds from -6 through +6 0.00 x Basic Fee
Exceeds by more than 6% but less than 12% +0.10 x Basic Fee
Exceeds by 12% of more +0.20 x Basic Fee
------------------
</TABLE>
- ---------------
* For purposes of this calculation, the Basic Fee is calculated by applying the
quarterly rate against the Fund's average net assets over the same time period
which the performance is measured.
Through the quarter ending July 31, 2000, the incentive/penalty fee for
Chartwell will be calculated according to the following transition rules:
(A) AUGUST 1, 1997 THROUGH APRIL 30, 1998. Beginning with the quarter
ending October 31, 1997 and through the quarter ending April 30, 1998,
there will be no Performance Fee Adjustment.
(B) MAY 1, 1998 THROUGH JULY 31, 2000. Beginning with the quarter ending
July 31, 1998 and through the quarter ending July 31, 2000, the
Performance Fee Adjustment will be computed based upon a
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<PAGE> 66
comparison of the investment performance of the Chartwell Portfolio and that of
the Index over the number of quarters that have elapsed between August 1, 1997
and the end of the quarter for which the fee is computed. During this period,
the number of percentage points by which the investment performance of
the Chartwell Portfolio must exceed or trail the investment performance
of the Index at each Performance Fee Adjustment level shall be determined
on the basis of a fraction applied to the performance differentials shown
in the above table. For each quarter, this fraction shall equal the
number of quarters elapsed since August 1, 1997 divided by twelve.
(C) ON AND AFTER JULY 31, 2000. For the quarter ending July 31, 2000 and
thereafter, the period used to calculate the Performance Fee Adjustment
shall be the 36 months through the end of the quarter for which the fee
is being computed and the number of percentage points used shall be as
stated in the table above.
The investment performance of the Portfolio, for any period, expressed as a
percentage of the "Portfolio Unit Value" at the beginning of such period, will
be the sum of: (i) the change in the Portfolio Unit Value during such period;
(ii) the unit value of the Fund's cash distributions from the Portfolio's 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 taxes paid including withholding taxes and capital gains taxes
paid or accrued during such period by the Fund for undistributed realized
long-term capital gains realized from the Portfolio.
The "Portfolio Unit Value" will be determined by dividing the total net
assets of the Portfolio by a given number of units. On the initial date of the
agreement, the number of units in the Portfolio will equal the total shares
outstanding of the Fund. After such initial date, as assets are added to or
withdrawn from the Portfolio, the number of units of the Portfolio will be
adjusted based on the unit value of the Portfolio on the day such changes are
executed.
For the purposes of determining the incentive/penalty fee adjustment, the
Portfolio's net assets will be averaged over the same time period as the
investment performance of those assets and the investment record of the Small
Company Growth Fund Stock Index are computed.
DURATION AND TERMINATION OF INVESTMENT ADVISORY AGREEMENTS
The Fund's current agreements with WMC, Granahan and Chartwell continue in
effect until July 31, 1999. The agreements 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 an investment advisory 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. An 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 the adviser, or (2)
by the adviser upon 90 days' written notice to the Fund.
MORE INFORMATION ON ADVISERS' INCENTIVE PENALTY FEES
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 P10 percentage points" annually
before the maximum performance adjustment may be made. However, the Release also
states that "because of the preliminary nature of these
B-16
<PAGE> 67
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 P10 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 P12 percentage
points from the performance of the index over a thirty-six month period, which
would effectively be the equivalent of approximately P4 percentage points
difference per year.
THE VANGUARD GROUP, INC.
Vanguard's Core Management Group provides investment advisory services on
an at-cost basis with respect to 10% of Vanguard Explorer Fund's assets. The
Core Management Group employs a quantitative investment approach that uses
computer techniques to track -- and, if possible, outperform -- a specific
market standard. For Explorer Fund, this market standard is the Small Company
Growth Fund Stock Index, which is made up of stocks held by the nation's 25
largest small company funds.
The Core Management Group also provides investment advisory services to
several Vanguard Funds, including Vanguard Index Trust, Vanguard Balanced Index
Fund, the Aggressive Growth Portfolio of Vanguard Horizon Fund, the REIT Index
Portfolio of Vanguard Specialized Portfolios, Vanguard International Equity
Index Fund, Vanguard Institutional Index Fund, the Total International Portfolio
of Vanguard STAR Fund, the Equity Index Portfolio of Vanguard Variable Insurance
Fund, the Growth and Income and Capital Appreciation Portfolios and the equity
portion of the Balanced Portfolio of Vanguard Tax-Managed Fund, a portion of
Vanguard/Windsor II Fund's assets, a portion of Vanguard/Morgan Growth Fund's
assets, as well as several indexed separate accounts. The Core Management Group
is supervised by the Officers of the Fund.
Vanguard also manages the Fund's cash reserves. Vanguard is supervised by
the Officers of the Fund.
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.
PORTFOLIO TRANSACTIONS
The Advisers are authorized (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. The Advisers 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, the Advisers 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
B-17
<PAGE> 68
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 the Advisers. The Advisers consider such information useful in the
performance of their obligations under the agreements but are unable to
determine the amount by which such services may reduce their expenses.
The investment advisory agreements also incorporate 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, the Advisers 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 the Advisers to the Fund and the other Funds in the Group.
Currently, it is the Fund's policy that the Advisers 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 the Advisers and/or the Fund. However, the
Advisers have informed the Fund that they will not pay higher commission rates
specifically for the purpose of obtaining research services.
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, 1994, 1995 and 1996, the Fund
paid $1,627,910, $1,889,236 and $1,804,896 in brokerage commissions,
respectively.
Some securities considered for investment by the Fund may also be
appropriate for other Funds and/or clients served by the Advisers. 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
the Advisers.
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
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
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<PAGE> 69
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
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member funds of The Vanguard Group of Investment Companies.
The Fund may use one or more, either singularly or in a composite, of the
following unmanaged indexes for comparative performance purposes:
SMALL COMPANY GROWTH FUND STOCK INDEX -- is composed of the various common
stocks that are held in the 25 largest small company stock mutual funds, using
year-end net assets, monitored by Morningstar, Inc. Under an agreement with the
Fund, Morningstar, Inc. maintains the composition of the Index and its total
return each quarter. Neither The Vanguard Group, Inc., WMC, Granahan nor
Chartwell are affiliated with Morningstar in any way.
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 7,000 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, Australasia and the Far East.
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX -- currently includes 71 bonds and 29
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 INDEX -- 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 INDEX -- 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.
LEHMAN BROTHERS LONG-TERM CORPORATE BOND INDEX -- is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed-rate,
nonconvertible U.S. debt issues rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
BOND BUYER MUNICIPAL BOND INDEX -- 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.
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<PAGE> 70
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 -- 65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index.
COMPOSITE INDEX -- 65% Lehman Long-Term Corporate AA or Better Bond Index and a
35% weighting in a blended equity composite (75% Standard & Poor's/BARRA Value
Index and 25% Standard & Poor's Utilities Index).
LEHMAN LONG-TERM CORPORATE AA OR BETTER BOND INDEX -- consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar-denominated,
SEC-registered corporate debt rated AA or AAA.
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 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.
LIPPER GENERAL EQUITY FUND AVERAGE -- an industry benchmark of average general
equity funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
LIPPER FIXED INCOME FUND AVERAGE -- an industry benchmark of average fixed
income funds with similar investment objectives and policies, as measured by
Lipper Analytical Services, Inc.
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<PAGE> 71
FINANCIAL STATEMENTS
The Fund's audited Financial Statements for the year ended October 31,
1996, including the financial highlights for each of the five fiscal years in
the period ended October 31, 1996, appearing in the Vanguard Explorer Fund 1996
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 unaudited financial statements
and financial highlights of the Fund for the six months ended April 30, 1997, as
set forth in the Vanguard Explorer Fund Semi-Annual Report to Shareholders, are
incorporated herein by reference. The Fund's 1996 Annual Report and Semi-Annual
Report to Shareholders is enclosed with this Statement of Additional
Information.
B-21
