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[PHOTO]
VANGUARD
EXPLORER FUND
ANNUAL REPORT
OCTOBER 31, 1998
[THE VANGUARD GROUP LOGO]
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AT VANGUARD, WE BELIEVE
THAT TRADITION MATTERS
Our 8,000 crew members embrace the traditional values on which our success is
built, including integrity, hard work, thrift, teamwork, and fair dealing on
behalf of our clients.
This year, our report cover pays homage to three anniversaries, each of great
significance to The Vanguard Group:
- - The 200th anniversary of the Battle of the Nile, which commenced on August 1,
1798. HMS Vanguard, the victorious British flagship at the Nile, is our
namesake. And its motto-- "Leading the way"--serves as a guiding principle for
our company.
- - The 100th birthday, on July 23, of Walter L. Morgan, founder of Wellington
Fund, the oldest member of what became The Vanguard Group. Mr. Morgan was
friend and mentor to Vanguard founder John C. Bogle, and helped to shape the
standards and business principles that Mr. Bogle laid down for Vanguard at its
beginning nearly 25 years ago: a stress on balanced, diversified investments;
insistence on fair dealing and candor with clients; and a focus on long-term
investing. To our great regret, Mr. Morgan died on September 2.
- - The 70th anniversary, on December 28, of the incorporation of Vanguard
Wellington Fund. It was the nation's first balanced mutual fund, and is one of
only a handful of funds created in the 1920s that are still in operation.
Although Vanguard constantly tackles new challenges, adopts new technology, and
develops new services, we treasure the traditions and values that set us apart
in a crowded, competitive industry. And we salute our shareholders, whose
support and trust we strive to earn each and every day.
[PHOTO]
CONTENTS
A Message to
Our Shareholders
1
The Markets in
Perspective
5
Report From
the Advisers
7
Performance Summary
9
Fund Profile
10
Financial Statements
12
Report of
Independent Accountants
23
All comparative mutual fund data are
from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER,
[PHOTO] [PHOTO]
John J. Brennan John C. Bogle
Chairman & CEO Senior Chairman
With small-capitalization stocks the market's outcasts, Vanguard Explorer Fund
declined -11.2% during the fiscal year ended October 31, 1998. Explorer actually
performed better than its average small-cap growth fund peers (-14.0%) and both
relevant market indexes, although the result was a far cry from the remarkable
+22.0% return on large-cap stocks.
The adjacent table compares the fiscal-year total returns (capital change
plus reinvested dividends) of Explorer Fund, the average competitor, the Russell
2000 Index, and the Small Company Growth Fund Stock Index, which is based on the
stocks held by the nation's largest small-cap mutual funds.
<TABLE>
<CAPTION>
- ------------------------------------------------------------
TOTAL RETURNS
FISCAL YEAR ENDED
OCTOBER 31, 1998
- ------------------------------------------------------------
<S> <C>
Vanguard Explorer Fund -11.2%
- ------------------------------------------------------------
Average Small-Cap Growth Fund -14.0%
- ------------------------------------------------------------
Russell 2000 Index -11.8%
- ------------------------------------------------------------
Small Company Growth Fund Stock Index -14.1%
- ------------------------------------------------------------
</TABLE>
The fund's return is based on adecrease in net asset value from $62.31 per
share on October 31, 1997, to $49.60 per share on October 31, 1998, with the
ending net asset value adjusted for a dividend of $0.25 per share paid from net
investment income and distributions totaling $5.85 per share paid from net
realized capital gains. Both payments were made in December 1997.
FINANCIAL MARKETS IN REVIEW
During the twelve months that ended October 31, the U.S. stock market was really
two markets. Large-cap stocks, as represented by the Standard & Poor's 500
Composite Stock Price Index, enjoyed a banner year, despite being buffeted by a
severe -19.2% downdraft from mid-July through August. However, conditions were
far different for mid- and small-cap stocks, which did not rise as far as large
stocks during the first part of the year and were hit even harder during the
market's six-week plunge. The Russell 2000 Index, for example, plummeted about
- -37% from its fiscal-year high.
After rising +31.2% from the start of the fiscal year through mid-July, the
S&P 500 Index gave back most of its gains during the summer slide. However,
stock prices rebounded again late in the year, leaving the index up by
+22.0%--twice the long-term average return of +11.0% a year for stocks. But the
large-cap-dominated S&P 500 was not at all representative of the rest of the
market.
The Wilshire 4500 Equity Index, consisting of stocks outside of the S&P 500,
actually fell -3.4% for the fiscal year. And small-cap stocks alone, as measured
by the Russell 2000 Index, lost -11.8%.
Interest rates declined significantly during the year, providing a
significant boost to stock prices and elevating prices for bonds. The yield on
the benchmark 30-year U.S. Treasury bond began the year at 6.15%, dwindled to a
low of 4.72% on October 5 amid concerns about a slowing economy, then rebounded
to end the fiscal year at 5.16%. For bonds, of course, lower yields translate
into higher prices. The Lehman Brothers Aggregate Bond Index, a benchmark for
taxable bonds of all maturities, returned +9.3% during the fiscal year, as a
price rise of about 2.5% augmented income of about 6.8%.
1
<PAGE> 4
The wide and abrupt shifts in investor sentiment that swept financial
markets during the year belied the generally positive economic environment.
Inflation stayed in check: Consumer prices rose just 1.5% during the twelve
months ended October 31. The U.S. economy grew by more than 3%, although the
pace of growth appeared to slow late in the period. The economy's expansion was
fueled by strong consumer spending encouraged by a strong job market (with
unemployment as low as 4.3%) and rising wages (up 4% during the year).
The slump in stock prices sent broad market indexes lower by approximately
- -20% or more, technically a "bear market," one of only four in the past 20
years. As noted earlier, small-cap stocks fared considerably worse. Analysts
cited a number of reasons for investors' skittishness, including Asia's
continuing economic distress. Whatever the causes, investors grew more
risk-averse and favored blue chip stocks over the small-cap sector of the
market--which, historically, has been more volatile. There was also a decided
movement toward the "safe haven" of U.S. Treasury securities, and away from
corporate bonds and U.S. and international stocks. By October, however, many
investors appeared to regain their appetite for risk, and prices of stocks--both
large and small--shot up, with the S&P 500 gaining +8.1% for the month and the
Russell 2000 up +4.1%.
FISCAL 1998 PERFORMANCE OVERVIEW
Explorer Fund's fortunes are tied to those of the small-cap market, which
suffered a particularly dismal fate this fiscal year. The fund's -11.2% return
certainly cannot be characterized as a triumph. However, it was a smaller
decline than those of our comparative benchmarks: the average small-cap growth
fund (-14.0%), the Small Company Growth Fund Stock Index (-14.1%), and the
Russell 2000 Index (-11.8%). The growth stocks within the Russell 2000 stumbled
- -15.9%--an astonishing contrast to the +32.0% gain for large-cap growth stocks.
Obviously, it was a horrible year for small-caps in general, and Explorer
could not overcome the tide. The fund's margin over its benchmarks was due
primarily to the relative strength of financial-services and health-care stocks
selected by our advisers. The Report From the Advisers starting on page 7 has
more information about Explorer's holdings.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Total Assets Managed
--------------------
$ Million Percent
- --------------------------------------------------------------------------------
<S> <C> <C>
Granahan Investment Management, Inc. $1,032 47%
Wellington Management Company, LLP 611 28
Chartwell Investment Partners 222 10
Vanguard Core Management Group 220 10
Cash Reserve* 111 5
- --------------------------------------------------------------------------------
Total $2,196 100%
- --------------------------------------------------------------------------------
</TABLE>
* This cash reserve is invested in equity index futures to simulate investment
in stocks; each adviser also maintains a modest cash reserve.
As you know, Explorer Fund uses four advisers to select stocks. The
adjacent table shows the share of assets managed by each as of October 31.
LONG-TERM PERFORMANCE OVERVIEW
As shown in the table at the top of the following page, Vanguard Explorer Fund's
+11.5% average annual return over the past decade has been almost identical to
that of its unmanaged index benchmark (+11.4%), but trails the +13.6% return of
the average small-cap growth fund by a little more than two percentage points.
The table also shows the results of hypothetical $10,000 investments in the fund
and its comparative benchmarks over the past ten years.
The primary reason for our shortfall versus the average fund is that many of
our competitors stray a considerable distance from the small-cap universe when
selecting stocks.
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<PAGE> 5
Sprinkling in some large-cap stocks was a big benefit for most of the past
decade, when the S&P/BARRA Growth Index--comprising the large growth stocks
within the S&P 500 Index--earned an average annual return of 19.7%. As noted,
this was far ahead of returns for the rest of the stock market, including
small-cap growth stocks.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED OCTOBER 31, 1998
-------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- --------------------------------------------------------------------------------
<S> <C> <C>
Vanguard Explorer Fund +11.5% $29,732
- --------------------------------------------------------------------------------
Average Small-Cap Growth Fund +13.6% $35,919
- --------------------------------------------------------------------------------
Russell 2000 Index +11.7% $30,298
- --------------------------------------------------------------------------------
Small Company Growth Fund
Stock Index* +11.4% $29,512
- --------------------------------------------------------------------------------
</TABLE>
* Russell 2000 Index through July 1997; Small Company Growth Fund Stock Index
thereafter.
We feel it is more telling to examine Explorer's record since the fund
changed to a multiadviser strategy on February 28, 1990. From that date through
October 31, 1998, the fund's average annual return of +13.2% has lagged slightly
the return of the average small-cap growth fund (+13.8%), but has surpassed the
returns of the Small Company Growth Fund Stock Index (+12.1%) and the Russell
2000 Index (12.4%).
We note that while the divergence in performance between small- and
large-cap stocks was unusually wide in fiscal 1998, it was not
unprecedented--and such disparities can cut in both directions. For example, as
recently as the early 1990s, smaller stocks significantly outpaced the S&P 500
Index--the Russell 2000's average annual return from calendar years 1990-1993
was +13.4%, versus +10.6% for the S&P 500. There have always been wide swings in
relative returns, at times lasting a decade or more, but they have typically
evened out over the very long run. Needless to say, we hope to significantly
improve our relative returns in the future and to surpass the results of our
comparative benchmarks.
IN SUMMARY
It is a truism that to profit from the long-term rewards of the stock market,
investors must be willing and able to endure discomforting declines along the
way. Both the risks and rewards of stocks were on display during the past fiscal
year. However, the mettle of an investment strategy is proven not in a year or
two, but over the long term.
We urge our fellow shareholders in Explorer Fund to maintain a long-term
focus and to recognize that the fund's concentration on small, up-and-coming
companies means that it will often march to a different drummer than the blue
chip stocks that have led the market in recent years. Indeed, it is for exactly
this reason that we believe Explorer Fund is a sound means to diversify a
balanced portfolio of other stock funds, bond funds, and reserves. We suggest
that investors construct such balanced investment programs appropriate to their
personal goals, time horizon, and tolerance for the ups and downs of the
financial markets, and be resolute in sticking with their plans.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
Chief Executive Officer
November 18, 1998
3
<PAGE> 6
NOTICE TO SHAREHOLDERS
At a special meeting on June 30, 1998, shareholders of Vanguard Explorer Fund
overwhelmingly approved three proposals. The proposals and voting results were:
1. REORGANIZATION INTO A DELAWARE BUSINESS TRUST. Based on the fund's assets at
the time of the vote, this change will reduce the amount of state taxes the fund
pays annually by an estimated $172,000. Approved by 95.78% of the shares voted,
as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------
FOR AGAINST ABSTAIN
- ------------------------------------------------------------
<S> <C> <C> <C>
25,525,339 282,097 842,654
- ------------------------------------------------------------
</TABLE>
2a. INVESTMENT LIMITATION CHANGES--INTERFUND LENDING PROGRAM. This change
permits Explorer Fund to participate in Vanguard's interfund lending program,
which allows funds to loan money to each other if--and only if--it makes good
financial sense to do so on both sides of the transaction. The interfund lending
program won't be an integral part of your fund's investment program; it is a
contingency arrangement for managing unusual cash flows. Approved by 93.79% of
shares voted, as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------
FOR AGAINST ABSTAIN
- ------------------------------------------------------------
<S> <C> <C> <C>
24,996,354 739,075 914,662
- ------------------------------------------------------------
</TABLE>
2b. INVESTMENT LIMITATION CHANGES--BORROWING MONEY AND PLEDGING ASSETS. This
change sets standard limits of 15% of net assets on the amount of money Vanguard
funds can borrow from all sources and on the amount of assets that can be
pledged to secure any loans. Approved by 92.84% of the shares voted, as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------
FOR AGAINST ABSTAIN
- ------------------------------------------------------------
<S> <C> <C> <C>
24,743,107 912,136 994,849
- ------------------------------------------------------------
</TABLE>
4
<PAGE> 7
THE MARKETS IN PERSPECTIVE
YEAR ENDED OCTOBER 31, 1998
U.S. financial markets encountered strong turbulence yet produced solid overall
gains during the fiscal year ended October 31. The S&P 500 Index gained 22.0%,
overcoming a sharp six-week setback in July and August. Bond prices rose as
interest rates declined over the course of the year. Overseas, returns varied
widely, with big gains on European bourses and sharp losses in Pacific and most
emerging stock markets.
U.S. STOCK MARKETS
Large-capitalization stocks--especially large growth stocks--overwhelmingly led
the market during the year. While the S&P 500 Index, which is dominated by
large-cap stocks, was rising 22.0%, the rest of the market was down 3.4%, more
than 25 percentage points behind the S&P. Results were even worse--a negative
return of 11.8%--for small-cap stocks, as represented by the Russell 2000 Index.
The Wilshire 5000 Equity Index, a measure of the entire U.S. market, gained
14.9%.
Even large-cap investors endured sharp fluctuations during the year. After
vaulting to a record high on July 17, the S&P 500 fell by 19.2% during the
following six weeks, just shy of the 20% mark generally considered the
"boundary" between a bear market and a mere "correction." However, declines were
certifiably bearish for most smaller stocks. The Russell 2000 Index fell more
than 30% from its peak in April before recovering somewhat during the final two
months of the fiscal year.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED OCTOBER 31, 1998
------------------------------
1 YEAR 3 YEARS 5 YEARS
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
STOCKS
S&P 500 Index 22.0% 26.0% 21.3%
Russell 2000 Index -11.8 10.0 9.4
MSCI EAFE Index 10.0 8.5 7.1
- --------------------------------------------------------------------------------
BONDS
Lehman Aggregate Bond Index 9.3% 8.0% 7.0%
Lehman 10-Year Municipal Bond Index 8.3 7.3 6.5
Salomon Smith Barney 3-Month
U.S. Treasury Bill Index 5.2 5.2 5.1
- --------------------------------------------------------------------------------
OTHER
Consumer Price Index 1.5% 2.2% 2.4%
- --------------------------------------------------------------------------------
</TABLE>
The July-August tumble in stock prices reflected a number of factors that
collectively raised the anxiety level for many investors. Among these factors
were deteriorating corporate earnings reports and forecasts, Russia's default on
its debts, and a murkier global economic picture. Asia's economic
troubles--which surfaced in mid-1997--persisted and began to look like a
significant threat to continued expansions in the U.S. and European economies.
But after steadying during September, stock prices bounced back strongly in
October. Although many of the risk factors remained--for example, securities
analysts continued to trim their estimates of corporate earnings--stock prices
got a lift from falling interest rates, which dropped to levels last seen in the
1960s. (Low inflation and low interest rates help stock prices by raising the
estimated value of future dividends and earnings.)
Three forces clearly shaped the performance of industry sectors within the
overall market. They could be summarized as faith (the buoyant confidence of
consumers), fear (related to the effects of financial troubles abroad), and
fortresses (companies somewhat protected from competition). U.S. consumers
played the role of Atlas during fiscal 1998,
5
<PAGE> 8
propping up the economic world with their strong spending. Feeling flush because
of plentiful jobs (the nation's unemployment rate was as low as 4.3%) and rising
wages, consumers spent a record proportion of their income. Not surprisingly,
then, two big gainers among sectors of the S&P 500 Index were consumer staples
(+26%) and consumer discretionary firms, such as retailers (+23%).
Fear was a factor in the lagging returns from industry groups that were
perceived by investors to be vulnerable to slowing global growth, falling
commodity prices, and heightened price competition from foreign suppliers. Among
these were exploration and services firms in the "other energy" category (-34%);
chemical, metals, and other materials & processing firms (-3%); and makers of
producer durables such as airplanes and machinery (-0.3%). Conversely, the
utilities sector was the year's top performer (+45%) in part because utilities
are seen as relatively insulated from foreign competition or economic troubles.
Fortresses are companies perceived as relatively safe from competitors because
of patented products, brands, or services. Such companies dominated the
health-care (+41%) and technology (+37%) groups.
U.S. BOND MARKETS
Interest rates declined during the fiscal year, especially for U.S. Treasury
securities, which benefited from greater aversion to risk among investors and
from a slight decrease in supply, thanks to a $70 billion federal budget
surplus. The Federal Reserve Board twice trimmed short-term rates by 0.25
percentage point, first on September 29 and then on October 15. Inflation, the
bane of bond investors, was remarkably tame--consumer prices were up just 1.5%
for the 12 months ended October 31. In this friendly environment, yields on
long-term Treasury bonds fell by roughly 1 to 1.25 percentage points, with the
30-year Treasury bond ending the fiscal year at 5.16%. Lower rates mean higher
prices for bonds, and the Lehman Brothers Long U.S. Treasury Bond Index earned a
return of 16.3%, an astounding margin of nearly 15 percentage points over the
inflation rate.
High-quality corporate bonds and mortgage-backed securities did not rise in
price as far as Treasury securities. Mortgage bonds tend to lag Treasuries
during periods of falling rates because increased refinancing activity by
homeowners results in prepayments of principal to holders of mortgage-backed
securities. The Lehman Aggregate Bond Index, which comprises high-quality
corporate and mortgage-backed bonds, as well as Treasuries, and has an
intermediate-term average maturity, earned 9.3%. Yields on long-term municipal
bonds declined only modestly during the fiscal year, and by October 31 were only
slightly lower than yields on comparable Treasury securities, even though
interest on municipals is exempt from federal income tax.
INTERNATIONAL STOCK MARKETS
Europe's stock markets outshone even the S&P 500 Index, but big declines swept
the markets of Asia and Latin America. As a group, European stocks earned 23.4%
for U.S. investors, reflecting local returns of about 21% and a gain of about 2%
from a slight strengthening of several currencies against the dollar. Reasons
for Europe's bull market included continuing economic growth; increased
corporate restructuring and merger activity; and optimism about the long-term
impact of the euro, a common currency due to be adopted in 1999 by 11 nations.
In Japan, the stock market declined 14.3% in U.S.-dollar terms, reflecting a
severe recession and a shaky banking system. Declines elsewhere in the Pacific
region ranged from about 1% in Hong Kong to more than 60% in Indonesia and
Malaysia. Losses were steep in non-Asian emerging markets, too. Notable declines
in our own hemisphere occurred in Mexico (-20%), Venezuela (-64%), Brazil
(-30%), and Chile (-38%).
6
<PAGE> 9
REPORT FROM THE ADVISERS
[PHOTO]
Small-capitalization stocks suffered through a steep decline during the second
half of Vanguard Explorer Fund's fiscal year ended October 31, 1998. Your fund
saw its 8.5% first-half return erased en route to a decline of 11.2% for the
full fiscal year. It is, perhaps, only cold comfort to note that our full-year
return was better than the 14.0% decline of the average small-cap growth fund
and the 11.8% decline of the Russell 2000 Index.
THE ENVIRONMENT FOR SMALL-CAP STOCKS
Economic instability in Asia, Russia, and Latin America during fiscal 1998
raised doubts about the continuance of economic expansions in the United States
and Europe. This uncertainty, which reached a zenith in midsummer, was
accompanied by a dramatic increase in risk premiums--the difference between the
values assigned by investors to relatively "safe" or liquid assets, such as U.S.
Treasury securities and large-capitalization U.S. stocks, and the values
assigned to riskier assets. In this environment, stock investors strongly
favored large-cap stocks, especially those of companies perceived to be
predictable sources of higher earnings, while shunning small-cap issues. From a
record high reached in April, small-cap stocks (as measured by the Russell 2000
Index) fell nearly 37% before bottoming out on October 8. This was nearly twice
the decline of 19.2% in the large-cap-dominated S&P 500 Index from its high in
mid-July to its low point on August 31. In the final few weeks of the fiscal
year, small-cap stocks rebounded more sharply than large-cap stocks. Even so,
the small-caps suffered serious declines for the full fiscal year, while the S&P
500 registered a 22.0% advance.
The best-performing small-cap groups were utility stocks, followed by
health-care and consumer-discretionary companies. The worst performers were
industry groups hit hard by declining commodity prices, including oil and
oil-related companies and such materials & processing companies as chemical,
paper, and metals producers.
For Explorer Fund, the top gains were from financial-services stocks, which
provided returns of about 10% for the fiscal year. Our health-care holdings,
which were down about 1%, were our second-best group. These sectors accounted
for about one-third of our equity holdings during the year. Fortunately, our
worst-performing industry groups were relatively minor holdings. The "other
energy" category, which was down about 60% for the year, made up less than 3% of
assets on average, and the consumer-staples group, down about 30%, represented
only about 1% of our assets during fiscal 1998.
CHANGES IN THE FUND'S HOLDINGS
Explorer's industry-group weightings at year-end were only modestly different
from those at the beginning of the year. The biggest increase was a shift of
about 5% of assets to the consumer-discretionary group, a broad category that
includes retailing, entertainment, and publishing companies. Among the additions
in this sector were AMC Entertainment and Loews Cineplex, the two largest U.S.
movie-theater chains, and Action Performance, which sells NASCAR-related
merchandise. Our holdings of health-care stocks rose from a
7
<PAGE> 10
little under 16% of assets to 18%. Among biotechnology stocks, we have focused
on companies that have products in the latter stages of development and have
profits or significant cash hoards, including Genzyme, Biogen, and Agouron
Pharmaceuticals. At the same time, we have sold holdings in development-stage
biotech stocks, including Alliance Pharmaceutical and Amylin Pharmaceuticals. We
increased exposure to the utilities sector from 2.5% of assets to 4.6%, adding a
mixture of cable, electric-power, and telecommunications companies.
The biggest decrease in sector weightings was in technology, where our stake
fell from 17.7% of assets to 12.2%. Our underweighting versus the market indexes
in this area is due largely to the great uncertainty about earnings estimates
for many technology companies. The only other sector in which we have trimmed
holdings by 2% or more of assets is the "other energy" group, where the
reduction reflects both selective sales of stocks and the general price declines
for the group. However, the price declines have been steep enough to prompt a
little additional buying by the fund during the second half of the fiscal year.
LOOKING FORWARD
There are some signs that the market is beginning to recognize the compelling
values in many small-cap stocks. The fund's holdings in the aggregate continue
to show solid growth in earnings, and we believe that they will grow faster than
the earnings of the companies that make up the S&P 500 Index. Explorer Fund's
stocks have, as a group, an average price/earnings ratio of about 19, which is
significantly lower than that of the S&P 500. In short, the backdrop appears
relatively positive for small-cap stocks, although we note that the performance
of individual stocks--and ultimately of the market--will most likely be driven
by earnings surprises and changes in market perception toward specific stocks.
Granahan Investment Management, Inc.
Wellington Management Company, LLP
Chartwell Investment Partners
Vanguard Core Management Group
November 13, 1998
INVESTMENT PHILOSOPHY
The fund reflects a belief that superior long-term investment results can be
achieved by selecting a diversified group of small-company stocks with
prospects for above-average growth.
8
<PAGE> 11
PERFORMANCE SUMMARY
EXPLORER FUND
All of the data on this page represent past performance, which cannot be used to
predict future returns that may be achieved by the fund. Note, too, that both
share price and return can fluctuate widely, so an investment in the fund could
lose money.
Total Investment Returns: October 31, 1978-October 31, 1998
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
EXPLORER FUND RUSSELL
2000*
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ---------------------------------------------------------------------
<S> <C> <C> <C> <C>
1979 30.6% 1.9% 32.5% 15.3%
1980 60.7 2.3 63.0 55.3
1981 8.5 1.1 9.6 4.1
1982 20.5 2.2 22.7 14.8
1983 35.2 1.0 36.2 38.3
1984 -15.3 1.4 -13.9 -3.2
1985 5.4 1.4 6.8 15.8
1986 1.0 1.0 2.0 22.2
1987 -11.5 0.1 -11.4 -13.6
1988 28.2 0.5 28.7 27.1
1989 9.8 1.2 11.0 15.6
1990 -23.9 1.0 -22.9 -27.3
1991 62.5 2.1 64.6 58.6
1992 12.2 0.8 13.0 9.5
1993 21.9 0.4 22.3 32.4
1994 4.2 0.3 4.5 -0.3
1995 17.0 0.5 17.5 18.3
1996 17.4 0.6 18.0 16.6
1997 18.4 0.5 18.9 29.3
1998 -11.6 0.4 -11.2 -11.8
- ---------------------------------------------------------------------
</TABLE>
*S&P 500 Index through 1979; Russell 2000 Index thereafter.
See Financial Highlights table on page 20 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE: OCTOBER 31, 1988-OCTOBER 31, 1998
<TABLE>
<CAPTION>
Average Small-Cap Russell
Explorer Fund Growth Fund 2000 Index
<S> <C> <C> <C>
198810 10000 10000 10000
198901 10349 10706 10493
198904 10919 11564 11291
198907 11326 12368 11956
198910 11095 12330 11557
199001 10148 11455 10657
199004 10537 12071 11046
199007 11373 12820 11339
199010 8552 9903 8403
199101 10732 12248 10246
199104 12571 14069 12163
199107 13066 14731 12425
199110 14081 15913 13327
199201 16283 17789 14841
199204 14906 16657 14239
199207 14782 16484 14229
199210 15905 17092 14591
199301 17550 19448 16805
199304 16584 18769 16484
199307 17624 20023 17559
199310 19448 21923 19319
199401 20405 22743 19934
199404 19446 21503 18927
199407 18721 20605 18380
199410 20321 22306 19260
199501 19974 21684 18737
199504 21307 23475 20292
199507 23677 27168 22963
199510 23869 27325 22790
199601 25202 28602 24347
199604 28671 32909 26987
199607 26188 30151 24549
199610 28158 32937 26574
199701 29238 35282 28961
199704 26470 31825 27000
199707 32108 40000 32746
199710 33490 42052 34360
199801 32261 41001 33498
199804 36326 46671 38492
199807 31740 41253 33107
199810 29732 35919 29512
</TABLE>
*Russell 2000 Index through July 1997; Small Company Growth Fund Stock Index
thereafter.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED OCTOBER 31, 1998
------------------------------ FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Explorer Fund -11.22% 8.86% 11.51% $29,732
Average Small-Cap Growth Fund -13.97 10.47 13.64 35,919
Russell 2000 Index -11.84 9.42 11.72 30,298
- -----------------------------------------------------------------------------------------------------
</TABLE>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED SEPTEMBER 30, 1998*
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION --------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Explorer Fund 12/11/1967 -20.75% 7.81% 10.04% 0.74% 10.78%
- -----------------------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
9
<PAGE> 12
FUND PROFILE
EXPLORER FUND
This Profile provides a snapshot of the fund's characteristics as of October 31,
1998, compared where appropriate to an unmanaged index. Key elements of this
Profile are defined on page 11.
PORTFOLIO CHARACTERISTICS
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
EXPLORER RUSSELL 2000
- ---------------------------------------------------------------------
<S> <C> <C>
Number of Stocks 516 1,949
Median Market Cap $0.8B $0.7B
Price/Earnings Ratio 19.2x 16.8x
Price/Book Ratio 3.1x 2.3x
Yield 0.5% 1.5%
Return on Equity 16.5% 14.2%
Earnings Growth Rate 20.3% 16.0%
Foreign Holdings 0.0% 0.0%
Turnover Rate 72% --
Expense Ratio 0.62% --
Cash Reserves 5.3% --
</TABLE>
INVESTMENT FOCUS
- --------------------------
[GRAPH]
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- ----------------------------------------------------------
EXPLORER S&P 500
- ----------------------------------------------------------
<S> <C> <C>
R-Squared 0.64 1.00
Beta 1.03 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- --------------------------------------------------------------------
<S> <C>
Genzyme Corp. 2.1%
Biogen, Inc. 1.7
Concord EFS, Inc. 1.6
Boole & Babbage Inc. 1.2
Investment Technology Group, Inc. 1.2
Plantronics, Inc. 1.2
Montana Power Co. 1.1
BISYS Group, Inc. 1.0
Ballard Medical Products 1.0
BJ's Wholesale Club, Inc. 1.0
- --------------------------------------------------------------------
Top Ten 13.1%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCKS)
- ----------------------------------------------------------------------------------
OCTOBER 31, 1997 OCTOBER 31, 1998
------------------------------------------------
EXPLORER EXPLORER RUSSELL 2000
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Auto & Transportation 7.4% 5.9% 4.2%
Consumer Discretionary 17.9 23.2 17.2
Consumer Staples 1.6 0.3 3.0
Financial Services 14.9 17.0 24.7
Health Care 17.6 20.0 9.7
Integrated Oils 0.0 0.1 0.5
Other Energy 4.9 1.9 2.8
Materials & Processing 4.5 4.4 9.8
Producer Durables 7.4 7.5 6.9
Technology 19.8 13.6 12.6
Utilities 2.8 5.1 7.8
Other 1.2 1.0 0.8
- ----------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 13
BETA. A measure of the magnitude of a fund's past share-price fluctuations in
relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a fund with a beta
of 1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
CASH RESERVES. The percentage of a fund's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing securities. This
figure does not include cash invested in futures contracts to simulate stock
investment.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a fund.
EXPENSE RATIO. The percentage of a fund's average net assets used to pay its
annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FOREIGN HOLDINGS. The percentage of a fund's equity assets represented by stocks
or American Depositary Receipts of companies based outside the United States.
INVESTMENT FOCUS. This grid indicates the focus of a fund in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. An indicator of the size of companies in which a fund
invests; the midpoint of market capitalization (market price x shares
outstanding) of a fund's stocks, weighted by the proportion of the fund's assets
invested in each stock. Stocks representing half of the fund's assets have
market capitalizations above the median, and the rest are below it.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a fund holds,
the more diversified it is and the more likely to perform in line with the
overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a fund, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a fund, the weighted average P/E of the stocks
it holds. P/E is an indicator of market expectations about corporate prospects;
the higher the P/E, the greater the expectations for a company's future growth.
R-SQUARED. A measure of how much of a fund's past returns can be explained by
the returns from the overall market (or its benchmark index). If a fund's total
return were precisely synchronized with the overall market's return, its
R-squared would be 1.00. If a fund's returns bore no relationship to the
market's returns, its R-squared would be 0.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a fund, the weighted average return on
equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a fund's common stocks that come from
each of the major industry groups that compose the stock market.
TEN LARGEST HOLDINGS. The percentage of net assets that a fund has invested in
its ten largest holdings. (The average for stock mutual funds is about 30%.) As
this percentage rises, a fund's returns are likely to be more volatile because
they are more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the past year. Funds
with high turnover rates incur higher transaction costs and are more likely to
distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a fund's income from interest and dividends. The yield,
expressed as a percentage of the fund's net asset value, is based on income
earned over the past 30 days and is annualized, or projected forward for the
coming year. The index yield is based on the current annualized rate of
dividends paid on stocks in the index.
11
<PAGE> 14
FINANCIAL STATEMENTS
OCTOBER 31, 1998
STATEMENT OF NET ASSETS [PHOTO]
This Statement provides a detailed list of the fund's holdings, including each
security's market value on the last day of the reporting period. Securities are
grouped and subtotaled by asset type (common stocks, bonds, etc.) and by
industry sector. Other assets are added to, and liabilities are subtracted from,
the value of Total Investments to calculate the fund's Net Assets. Finally, Net
Assets are divided by the outstanding shares of the fund to arrive at its share
price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table displaying
the composition of the fund's net assets on both a dollar and per-share basis.
Because all income and any realized gains must be distributed to shareholders
each year, the bulk of net assets consists of Paid in Capital (money invested by
shareholders). The amounts shown for Undistributed Net Investment Income and
Accumulated Net Realized Gains usually approximate the sums the fund had
available to distribute to shareholders as income dividends or capital gains as
of the statement date. Any Accumulated Net Realized Losses, and any cumulative
excess of distributions over net income or net realized gains, will appear as
negative balances. Unrealized Appreciation (Depreciation) is the difference
between the market value of the fund's investments and their cost, and reflects
the gains (losses) that would be realized if the fund were to sell all of its
investments at their statement-date values.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
MARKET
VALUE*
EXPLORER FUND SHARES SHARES (000)
- ---------------------------------------------------------------------------------------
COMMON STOCKS (89.7%)(3)
- ---------------------------------------------------------------------------------------
<S> <C> <C>
AUTO & TRANSPORTATION (5.3%)
AAR Corp. 176,350 $ 4,078
Air Express International Corp. 740,600 15,553
Airborne Freight Corp. 33,300 780
- - Atlantic Coast Airlines Holdings 26,200 629
Borg-Warner Automotive, Inc. 17,000 797
C.H. Robinson Worldwide, Inc. 382,000 8,476
- - Coach USA, Inc. 87,600 2,349
ComAir Holdings, Inc. 29,400 966
- - Covenant Transport, Inc. 280,500 4,242
- - Halter Marine Group, Inc. 102,800 887
- - Heartland Express, Inc. 744,233 13,396
- - Landstar System 28,400 1,008
- - M.S. Carriers, Inc. 530,000 11,395
- - Mark VII, Inc. 48,200 795
Meritor Automotive, Inc. 7,600 142
- - Mesaba Holdings, Inc. 425,800 7,771
- - Midwest Express Holdings, Inc. 179,650 5,681
- - National R. V. Holdings, Inc. 16,500 373
- - Old Dominion Freight Line, Inc. 19,200 240
Petroleum Helicopters, Inc. 29,200 474
Pittston BAX Group 33,600 195
- - Swift Transportation Co., Inc. 454,400 10,039
Tidewater Inc. 565,000 15,996
- - Tower Automotive, Inc. 54,300 1,208
Wabash National Corp. 21,900 389
Werner Enterprises, Inc. 428,750 7,717
Wynn's International Inc. 23,400 440
------------
116,016
------------
CONSUMER DISCRETIONARY (20.8%)
- - AMC Entertainment, Inc. 459,300 6,660
- - APAC Teleservices, Inc. 103,500 647
- - Action Performance Cos., Inc. 595,000 17,776
- - Activision, Inc. 646,300 6,826
- - ADVO, Inc. 36,600 931
- - Allied Waste Industries, Inc. 516,565 11,171
- - Ambassadors International, Inc. 99,200 1,451
- - American Eagle Outfitters, Inc. 44,000 1,782
- - American Skiing Co. 648,000 5,791
- - Ames Department Stores, Inc. 249,750 4,589
- - BJ's Wholesale Club, Inc. 605,000 21,742
- - Bally Total Fitness Holding Corp. 55,600 1,049
BeautiControl Cosmetics 91,700 567
Blair Corp. 24,900 577
- - Blyth Industries, Inc. 43,900 1,213
- - Boron, LePore & Associates, Inc. 69,200 1,868
- - Brinker International, Inc. 50,300 1,217
- - Budget Group, Inc. 57,100 1,024
- - CDW Computer Centers, Inc. 16,300 1,221
- - CEC Entertainment Inc. 525,700 14,851
CKE Restaurants Inc. 36,490 960
- - Catalina Marketing Corp. 18,300 873
- - Central Garden and Pet Co. 219,200 4,329
- - The Cheesecake Factory 30,200 577
- - Circuit City Stores, Inc.-
CarMax Group 47,000 285
- - Clear Channel
Communications, Inc. 26 1
- - Kenneth Cole Productions, Inc. 43,600 736
- - Computer Learning Centers, Inc. 51,920 464
- - Consolidated Graphics, Inc. 20,500 972
</TABLE>
<PAGE> 15
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ---------------------------------------------------------------------------------------
<S> <C> <C>
- - Copart, Inc. 39,800 876
Crown Crafts, Inc. 50,100 282
- - Daisytek International Corp. 45,500 685
- - Discount Auto Parts Inc. 23,600 569
Dover Downs Entertainment, Inc. 760,000 $ 10,355
- - The Dress Barn, Inc. 901,600 12,735
- - Eagle Hardware & Garden, Inc. 87,100 2,025
- - Education Management Corp. 33,300 1,224
Ethan Allen Interiors, Inc. 22,200 763
- - Extended Stay America, Inc. 15,300 147
- - Footstar Inc. 26,500 692
Fred's, Inc. 41,125 537
- - French Fragrances, Inc. 600,000 4,200
- - Fruit of the Loom, Inc. 36,100 550
- - GT Interactive Software Corp. 612,100 4,170
Gaylord Entertainment Co.
Class A 7,066 187
- - General Nutrition Cos., Inc. 180,700 2,631
- - Genesco, Inc. 168,800 1,013
- - Getty Images, Inc. 300,000 3,694
Hancock Fabrics, Inc. 45,300 393
Harman International
Industries, Inc. 27,600 1,116
- - Hearst-Argyle Television Inc. 17,104 474
- - ITI Technologies, Inc. 359,000 10,366
- - Interim Services, Inc. 114,300 2,429
International Speedway Corp. 27,500 849
- - Iron Mountain, Inc. 44,200 1,351
- - King World Productions, Inc. 232,700 6,108
- - Labor Ready, Inc. 37,000 666
- - Lamar Advertising Co. Class A11 6,900 3,649
- - Landry's Seafood
Restaurants, Inc. 812,300 6,803
- - Linens 'n Things, Inc. 207,300 6,413
- - LoJack Corp. 294,500 3,239
- -(1)LodgeNet Entertainment Corp. 627,000 3,292
- - Loews Cineplex
Entertainment Corp. 300,000 3,150
- - Lone Star Steakhouse &
Saloon, Inc. 91,900 735
- - MGM Grand, Inc. 76,900 2,009
- - MSC Industrial Direct Co., Inc.
Class A 520,000 11,050
- - Mail-Well, Inc. 91,600 1,196
(1)The Marcus Corp. 980,700 15,078
Meredith Corp. 28,300 1,047
- - MeriStar Hotels & Resorts, Inc. 54,600 130
- - Metro Networks, Inc. 26,900 985
- - Metro One
Telecommunications, Inc. 32,800 295
- - Micro Warehouse Inc. 61,100 1,333
- - Midway Games Inc. 32,562 319
- - Modis Professional Services Inc. 59,200 1,043
- - Mortons Restaurant Group 150,300 2,931
Movado Group, Inc. 267,000 5,040
- - Musicland Stores Corp. 39,500 521
- - NCO Group, Inc. 35,400 1,115
- - NPC International Class A 27,400 327
- - Nautica Enterprises, Inc. 453,700 9,386
- - 99 Cents Only Stores 3,800 176
Norrell Corp. 59,500 807
- - The North Face, Inc. 330,500 3,945
- - Object Design, Inc. 659,000 2,924
Oneida Ltd. 669,600 9,584
- - O'Reilly Automotive, Inc. 22,200 868
- - Outback Steakhouse 145,200 5,027
- - Pacific Sunwear of California 200,000 4,325
- - PalEx, Inc. 18,100 127
- - Papa John's International, Inc. 57,700 2,191
- - Pegasus Communications Corp.
Class A 385,300 6,646
- - Penske Motorsports, Inc. 7,000 154
Penton Media, Inc. Class A1 5,100 227
- - Personnel Group of America, Inc. 395,500 6,130
Pier 1 Imports Inc. 73,050 676
- - Piercing Pagoda, Inc. 48,150 716
Pittston Brink's Group 22,000 654
- - Plantronics, Inc. 456,900 26,015
- - Playboy Enterprises Inc. Class B 650,000 9,344
- - Premier Parks Inc. 183,300 4,067
- - QRS Corp. 191,200 7,266
- - Rainforest Cafe, Inc. 33,150 220
- - Renters Choice, Inc. 181,600 4,506
- - Republic Industries, Inc. 230,500 3,702
- - Revlon, Inc. Class A 9,600 182
- - REX Stores Corp. 221,400 2,435
- - Romac International, Inc. 62,100 1,087
Ross Stores, Inc. 28,500 926
Russ Berrie & Co., Inc. 478,000 9,441
- - SPR Inc. 17,075 307
St. John Knits, Inc. 280,700 5,667
- - Samsonite Corp. 11,386 58
Sbarro, Inc. 37,400 879
E.W. Scripps Co. Class A1 70,000 7,523
- - Snyder Communications, Inc. 26,500 946
Sodexho Marriott Services, Inc. 231,400 7,463
- - Sonic Corp. 28,100 534
Strayer Education, Inc. 47,900 1,629
The Stride Rite Corp. 951,100 8,679
- - Sun International Hotels Ltd. 168,000 6,720
- - TETRA Technologies, Inc. 494,600 5,966
Tiffany & Co. 27,400 885
- - Trans World Entertainment Corp. 384,550 7,931
- - USA Networks, Inc. 216,400 4,869
- - Urban Outfitters, Inc. 650,000 8,531
- - Vail Resorts Inc. 60,800 1,626
- - Vistana, Inc. 584,000 6,497
- - Wackenhut Corrections Corp. 39,800 978
- - Waste Industries, Inc. 17,300 404
- - Westpoint Stevens, Inc. 35,700 1,015
-------------
457,798
-------------
CONSUMER STAPLES (0.3%)
- - American Italian Pasta Co. 105,500 2,427
Casey's General Stores 16,700 234
- - Consolidated Cigar Holdings Inc. 33,100 381
- - General Cigar Holdings, Inc. 30,800 273
Nash-Finch Co. 19,100 289
- - Ralcorp Holdings, Inc. 65,200 1,149
Richfood Holdings, Inc. 29,000 515
- - Suiza Foods Corp. 23,000 750
Universal Corp. 5,800 215
-------------
6,233
-------------
</TABLE>
13
<PAGE> 16
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
MARKET
VALUE*
EXPLORER FUND SHARES (000)
- ---------------------------------------------------------------------------------------
<S> <C> <C>
FINANCIAL SERVICES (15.3%)
- - Advent Software, Inc. 151,500 $ 5,265
Advest Group, Inc. 18,000 374
- - Affiliated Computer Services, Inc.
Class A 316,500 11,711
Allmerica Financial Corp. 10,200 510
AmerUs Life Holdings, Inc. 35,890 866
Annuity and Life Re
(Holdings), Ltd. 489,900 11,451
Astoria Financial Corp. 22,600 972
- - BISYS Group, Inc. 524,900 22,964
- - Banctec, Inc. 41,600 515
- - Billing Concepts Corp. 83,100 1,174
- - CheckFree Holdings Corp. 315,000 4,951
City National Corp. 280,600 9,593
Colonial BancGroup, Inc. 47,100 615
- - Columbia Banking System, Inc. 28,750 579
Comdisco, Inc. 500,000 7,719
- - Concord EFS, Inc. 1,201,900 34,254
- - ContiFinancial Corp. 18,500 138
Corus Bankshares Inc. 23,500 912
Cullen/Frost Bankers, Inc. 137,300 7,311
- - Data Transmission Network Corp. 27,800 827
- - Farm Family Holdings, Inc. 14,800 496
Federal Realty Investment
Trust REIT 300,000 6,788
Fidelity National Financial, Inc. 324,200 9,969
FINOVA Group, Inc. 15,900 775
First Mutual Bancorp, Inc. 27,600 469
First Union Corp. 6,962 404
First Washington Realty Trust,
Inc. REIT 270,000 6,109
- - FIRSTPLUS Financial Group, Inc. 126,500 561
Franklin Bank N.A. 23,020 245
- - Golden State Bancorp Inc. 17,200 330
HUBCO, Inc. 31,763 858
Hartford Life, Inc. 66,700 3,085
Heller Financial, Inc. 431,600 10,358
Jack Henry & Associates 19,000 867
- - ITLA Capital Corp. 41,400 631
- - Investment Technology
Group, Inc. 811,500 26,577
Investors Financial Services Corp. 22,600 1,218
Jefferies Group, Inc. 77,800 2,334
LandAmerica Financial
Group, Inc. 16,600 862
Legg Mason Inc. 385,466 10,239
MMI Cos., Inc. 39,300 631
Manufactured Home
Communities, Inc. REIT 699,250 17,438
McGrath RentCorp 405,200 8,459
MeriStar Hospitality Corp. 239,400 4,429
NAC Re Corp. 16,700 809
Nationwide Financial
Services, Inc. 9,400 390
Ohio Casualty Corp. 23,300 880
Omega Healthcare Investors,
Inc. REIT 10,400 322
The PMI Group Inc. 15,800 797
Peoples Bank Bridgeport 375,000 9,586
- - Philadelphia Consolidated
Holding Corp. 42,300 989
Phoenix Investment Partners Ltd. 81,100 654
- - Policy Management
Systems Corp. 400,000 18,175
Protective Life Corp. 19,800 734
Raymond James Financial, Inc. 348,600 7,996
Regency Realty Corp. REIT 490,000 11,301
Reinsurance Group of
America, Inc. 83,300 4,592
- - Rental Service Corp. 144,300 3,211
Resource Bancshares
Mortgage Group, Inc. 450,000 6,638
Saul Centers, Inc. REIT 231,200 3,670
- - Silicon Valley Bancshares 36,100 740
- - Southwest Bancorporation of
Texas, Inc. 18,200 279
Stifel Financial Corp. 44,570 448
Student Loan Corp. 17,800 834
Sun Communities, Inc. REIT 605,000 20,230
Trenwick Group Inc. 8,000 266
- - UICI 36,000 531
- - United Rentals, Inc. 40,906 1,099
WestAmerica Bancorporation 99,700 3,315
-------------
335,319
-------------
HEALTH CARE (18.0%)
- - Agouron Pharmaceuticals, Inc. 378,600 14,671
Alpharma, Inc. Class A 22,700 629
- - American HomePatient, Inc. 17,900 46
- - American Retirement Corp. 252,800 3,855
Arrow International, Inc. 619,800 17,199
- - Arterial Vascular
Engineering, Inc. 84,900 2,611
- - Assisted Living Concepts Inc. 250,000 3,375
Ballard Medical Products 1,051,100 22,336
- - Biogen, Inc. 540,000 37,530
Cardinal Health, Inc. 13,015 1,231
- - Cell Genesys, Inc. 545,000 1,873
- - Centocor, Inc. 265,000 11,793
- - Concentra Managed Care 39,200 402
- - Cooper Cos., Inc. 45,600 1,083
- - Coulter Pharmaceutical, Inc. 153,600 4,339
DENTSPLY International Inc. 530,000 13,648
- - Eclipsys Corp. 94,800 2,139
- - Envoy Corp. 27,400 808
- - FPA Medical Management, Inc. 127,500 13
- - Forest Laboratories, Inc. 255,000 10,662
- - Genesis Health Ventures Inc. 58,200 786
- - Genzyme Corp. 1,100,000 46,269
- - Gilead Sciences, Inc. 204,200 5,794
- - Guilford Pharmaceuticals, Inc. 38,600 632
- - Health Management Associates
Class A 170,700 3,041
- - Hologic, Inc. 40,000 548
- - IDX Systems Corp. 172,200 7,297
- - Inhale Therapeutic Systems 39,400 1,034
Integrated Health Services, Inc. 39,200 635
Jones Pharma, Inc. 40,800 1,318
- - MIM Corp. 123,100 462
- - Magellan Health Services, Inc. 662,800 6,007
- - Marquette Medical Systems Inc. 20,600 918
</TABLE>
14
<PAGE> 17
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ---------------------------------------------------------------------------------------
<S> <C> <C>
- - Matria Healthcare, Inc. 1,300,000 $ 2,478
McKesson Corp. 270,000 20,790
- - Medicis Pharmaceutical Corp. 28,900 1,449
- - MedPartners, Inc. 2,250,000 8,016
- - Mid Atlantic Medical
Services, Inc. 127,600 997
Minntech Corp. 84,100 904
- - PSS World Medical, Inc. 500,000 11,063
- - PathoGenesis Corp. 403,000 16,120
- - Patterson Dental Co. 386,375 15,938
- - Pediatrix Medical Group, Inc. 27,300 1,273
- - Pharmaceutical Product
Development, Inc. 7,870 212
- - PharMerica, Inc. 191,600 647
- - PhyCor, Inc. 35,900 260
- - Province Healthcare Co. 204,700 5,348
- - Quorum Health Group, Inc. 300,000 4,350
- - Renal Care Group, Inc. 38,700 1,127
- - Res-Care, Inc. 42,300 936
- - Safeskin Corp. 25,300 560
- - Sangstat Medical Corp. 35,200 730
- - Henry Schein, Inc. 40,700 1,575
- - Schick Technologies, Inc. 192,595 3,659
- - Sierra Health Services 36,750 857
- - Sofamor Danek Group, Inc. 144,300 14,664
- - STERIS Corp. 48,700 1,120
- - Sunrise Assisted Living, Inc. 215,100 9,263
- - Sybron International Corp. 450,000 11,138
- - TheraTech, Inc. 429,000 6,086
- - Transition Systems, Inc. 34,400 359
- - Trex Medical Corp. 75,400 924
- - United Payors & United
Providers, Inc. 391,000 8,993
- - Universal Health Services
Class B 34,200 1,755
- - ViroPharma Inc. 188,100 3,409
- - Wellpoint Health Networks Inc.
Class A 170,000 12,516
---------------
394,500
---------------
INTEGRATED OILS
Giant Industries, Inc. 43,000 503
- - Tesoro Petroleum Corp. 47,700 707
---------------
1,210
---------------
OTHER ENERGY (1.7%)
- - Chieftain International, Inc. 296,800 5,825
- - Cliffs Drilling Co. 11,900 272
- - Core Laboratories NV 166,500 3,757
- - Evergreen Resources, Inc. 39,400 891
- - Global Industries Ltd. 116,300 1,119
ICO, Inc. 12,000 30
- - Marine Drilling Co., Inc. 86,200 964
- - Newpark Resources, Inc. 79,300 748
- - Noble Drilling Corp. 600,000 10,313
- - Patterson Energy, Inc. 32,700 202
- - Pride International Inc. 71,300 829
- - R & B Falcon Corp. 338,700 4,594
St. Mary Land & Exploration Co. 219,500 4,610
- - Seitel, Inc. 58,000 769
- - Stolt Comex Seaway SA 13,600 173
- - Stolt Comex Seaway SA Class A 6,800 70
- - Trico Marine Services, Inc. 67,500 481
- - Varco International, Inc. 61,900 669
- - Veritas DGC Inc. 47,500 885
---------------
37,201
---------------
MATERIALS & PROCESSING (4.0%)
- - ABT Building Products Corp. 52,600 460
- - American Buildings Co. 32,500 780
- - American Pad & Paper Co. 107,600 202
- - Armco, Inc. 149,400 710
- - Avatar Holding, Inc. 8,100 147
BMC Industries, Inc. 69,700 501
Belden, Inc. 1,800 26
- - Buckeye Technology, Inc. 5,400 108
Cambrex Corp. 250,000 6,391
- - The Carbide/Graphite Group, Inc. 39,300 491
- - Catellus Development Corp. 36,400 501
Chesapeake Corp. of Virginia 10,700 375
Commonwealth Industries Inc. 66,300 501
Culp, Inc. 51,100 370
Elcor Corp. 566,800 16,437
- - Fairfield Communities, Inc. 563,200 5,526
General Cable Corp. 781,400 15,433
Lilly Industries Inc. Class A 45,500 873
Lindberg Corp. 35,700 455
- - Mohawk Industries, Inc. 29,200 881
N L Industries, Inc. 35,400 502
National Steel Corp. Class B 33,400 215
- - Nortek, Inc. 800 22
Northland Cranberries, Inc. 70,400 766
OM Group, Inc. 36,600 1,194
Schnitzer Steel Industries, Inc.
Class A 8,600 133
- - Service Experts, Inc. 621,800 18,771
Spartech Corp. 26,000 468
- - Steel Dynamics, Inc. 55,700 759
- - Sunterra Corp. 103,800 986
Unifi, Inc. 9,000 152
- - United States Can Co. 45,000 726
Valmont Industries, Inc. 611,000 9,623
Wausau-Mosinee Paper Corp. 50,720 884
- - Zoltek Cos., Inc. 30,900 464
---------------
86,833
---------------
PRODUCER DURABLES (6.7%)
- - AFC Cable Systems, Inc. 3,400 84
Aeroquip-Vickers Inc. 11,400 359
- - American Homestar Corp. 850,150 13,921
- - American Power
Conversion Corp. 477,400 20,260
Ametek Aerospace Products Inc. 43,200 915
- - Antec Corp. 44,500 740
- - CUNO Inc. 300,800 4,587
Centex Corp. 12,200 409
Cordant Technologies, Inc. 7,500 305
- - Cymer, Inc. 67,200 823
Donaldson Co., Inc. 230,000 4,183
- - Dynatech Corp. 12,650 32
- - Electro Scientific Industries, Inc. 25,500 641
- - Esterline Technologies Corp. 47,000 940
- - GTS Duratek, Inc. 33,900 229
</TABLE>
15
<PAGE> 18
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
MARKET
VALUE*
EXPLORER FUND SHARES (000)
- ---------------------------------------------------------------------------------------
<S> <C> <C>
- - Gardner Denver Inc. 47,200 $ 679
- - Gemstar International Group Ltd. 34,700 1,895
Graco, Inc. 29,600 781
Inter-Tel, Inc. 54,100 977
- - Interdigital Communications Corp. 194,000 958
- - inTEST Corp. 52,500 256
- - Kellstrom Industries, Inc. 242,927 5,466
- - Knoll, Inc. 32,300 872
- - Kulicke & Soffa Industries, Inc. 55,000 897
Lindsay Manufacturing Co. 201,050 3,267
Mark IV Industries, Inc. 13,000 200
- - Mettler-Toledo International Inc. 957,810 20,952
Herman Miller, Inc. 44,000 971
- - Oak Industries, Inc. 250,000 6,766
Oakwood Homes Corp. 25,500 402
- - Orbital Sciences Corp. 29,300 967
- - ORBIT/FR, Inc. 14,600 64
- - Osmonics, Inc. 32,600 291
- - PRI Automation, Inc. 635,800 11,007
- - Palm Harbor Homes, Inc. 793,108 20,026
Pentair, Inc. 8,000 301
Pittway Corp. Class A 30,200 693
Pulte Corp. 24,400 628
- - RF Micro Devices, Inc. 167,200 3,971
Scotsman Industries, Inc. 47,700 975
Standard Pacific Corp. 52,700 511
Superior Telecom Inc. 10,300 443
Technitrol, Inc. 286,000 7,794
- - Thermo Instrument Systems, Inc. 3,000 37
- - Transcrypt International, Inc. 8,400 27
- - Trident International, Inc. 221,500 1,772
- - U.S. Filter Corp. 35,675 756
- - Veeco Instruments, Inc. 13,100 389
- - Vivid Technologies, Inc. 459,500 2,700
-------------
147,119
-------------
TECHNOLOGY (12.2%)
- - Acxiom Corp. 648,840 16,302
- - Adtran, Inc. 35,900 910
- - Alliant Techsystems, Inc. 15,000 1,050
- - American Precision
Industries Inc. 40,700 504
- - American Tower Corp. Class A 450,000 9,844
- - Anixter International Inc. 59,500 919
- - Ascend Communications, Inc. 19,275 930
- - Aspect Development, Inc. 299,200 9,453
- - Aspen Technologies, Inc. 9,700 136
- - Avant! Corp. 250,000 4,266
- - Best Software, Inc. 54,900 1,345
- - Black Box Corp. 34,700 1,158
- - Boole & Babbage Inc. 1,014,275 27,005
- - Burr-Brown Corp. 21,700 403
- - CHS Electronics, Inc. 60,400 589
- - CSG Systems International, Inc. 120,900 6,589
- - Cadence Design Systems, Inc. 13,200 282
- - Caere Corp. 457,500 4,432
- - The Cherry Corp. Class A 322,500 4,313
- - Ciber, Inc. 48,500 952
- - Cognos Inc. 425,800 8,543
- - Complete Business Solutions, Inc. 26,367 626
Computer Task Group, Inc. 16,200 496
- - Comverse Technology, Inc. 21,600 994
- - Cyberoptics Corp. 30,900 460
- - DII Group, Inc. 73,800 1,084
- - Discreet Logic, Inc. 23,200 287
EG&G, Inc. 32,500 817
- - ENCAD, Inc. 138,300 605
- - ESS Technology, Inc. 78,860 350
- - Glenayre Technologies, Inc. 21,400 128
- - Hadco Corp. 27,700 873
- - Harbinger Corp. 8,050 53
- - IKOS Systems, Inc. 156,400 332
- - Ingram Micro, Inc. 358,300 16,303
- - Intuit, Inc. 100,300 5,065
- - JDA Software Group, Inc. 21,450 204
- - Legato Systems, Inc. 22,800 892
- - MTI Technology Corp. 390,000 1,268
- - Macrovision Corp. 120,000 3,713
- - Melita International Corp. 528,700 6,344
- - Mercury Interactive Corp. 26,900 1,116
- - MetaCreations Corp. 22,200 75
- - Metro Information Services, Inc. 20,300 482
- - Micrel, Inc. 29,500 970
- - National Instruments Corp. 37,850 1,036
- - Natural Microsystems Corp. 218,000 1,955
- - Network Computing Devices, Inc. 62,000 403
Newport News Shipbuilding Inc. 14,400 379
- - Oak Technology, Inc. 895,000 3,188
- - PMC Sierra Inc. 153,000 6,866
- - PairGain Technologies, Inc. 80,200 659
- - Pinnacle Systems, Inc. 164,000 5,576
- - Planar Systems, Inc. 43,300 390
- - Rational Software Corp. 600,000 13,425
- - RealNetworks, Inc. 150,650 5,075
- - Remedy Corp. 255,700 2,237
- - SCI Systems, Inc. 23,900 944
- - SPSS, Inc. 11,300 216
- - STB Systems, Inc. 248,375 1,288
- - Safeguard Scientifics, Inc. 33,300 893
- - Sanmina Corp. 29,000 1,189
- - Sapient Corp. 47,000 2,118
- - Semtech Corp. 303,500 7,227
- - Siebel Systems, Inc. 22,352 457
- - SMART Modular
Technologies, Inc. 28,400 596
- - Sterling Software, Inc. 793,200 20,772
- - Summit Design, Inc. 200,600 1,680
- - Symantec Corp. 19,300 309
Symbol Technologies, Inc. 25,900 1,159
- - Synopsys, Inc. 284,500 12,874
- - Tech-Sym Corp. 39,000 887
- - Technology Solutions Co. 58,950 707
- - Transaction Network
Services, Inc. 125,000 3,422
- - Transaction Systems
Architects, Inc. 72,900 2,631
- - TranSwitch Corp. 54,400 1,326
- - TriQuint Semiconductor, Inc. 5,000 96
- - VLSI Technology, Inc. 39,000 375
- - Veritas Software Corp. 30,175 1,513
- - Viasoft, Inc. 361,500 2,214
(1)VideoServer, Inc. 903,000 11,231
</TABLE>
16
<PAGE> 19
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ---------------------------------------------------------------------------------------
<S> <C> <C>
- - Vitesse Semiconductor Corp. 500 $ 16
- - Xilinx, Inc. 160,100 7,149
------------
267,940
------------
UTILITIES (4.6%)
- - Cable Michigan, Inc. 6,100 228
- - Commonwealth Telephone
Enterprises, Inc. 3,440 84
- - Davel Communications Group, Inc. 16,300 216
- - EchoStar Communications Corp. 412,190 11,129
- - El Paso Electric Co. 93,400 817
- - Gilat Satellite Networks Ltd. 330,400 15,364
- - IXC Communications, Inc. 22,900 887
KN Energy, Inc. 17,900 889
Madison Gas & Electric Co. 1,500 35
- - McLeodUSA, Inc. Class A 179,500 6,563
- - Metrocall, Inc. 960,000 3,840
Montana Power Co. 550,000 23,822
- - NTL Inc. 178,000 8,533
Nevada Power Co. 24,900 629
New Jersey Resources Corp. 18,800 723
Rochester Gas & Electric Corp. 25,800 751
TCA Cable TV, Inc. 354,000 9,801
- - UniSource Energy Corp. 954,200 14,790
- - U.S. Cellular Corp. 26,300 963
Washington Water Power Co. 37,800 711
------------
100,775
------------
OTHER (0.8%)
GenCorp, Inc. 7,100 157
Kaman Corp. Class A 42,600 692
- - PEC Israel Economic Corp. 25,000 620
Teleflex Inc. 445,800 17,247
------------
18,716
------------
- --------------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $1,745,496) 1,969,660
- --------------------------------------------------------------------------------------
CONVERTIBLE PREFERRED STOCK (0.1%)
- --------------------------------------------------------------------------------------
(4)SGW Holding Corp.
0.00% Cvt. Pfd. 483,840 2,218
- --------------------------------------------------------------------------------------
TOTAL CONVERTIBLE PREFERRED STOCKS
(Cost $5,000) 2,218
- --------------------------------------------------------------------------------------
<CAPTION>
- --------------------------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (11.5%)
- --------------------------------------------------------------------------------------
<S> <C> <C>
U.S. Treasury Bills
(2)3.885%, 1/14/1999 $ 3,800 3,768
(2)3.735%, 1/7/1999 2,000 1,985
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.41%, 11/2/1998 218,941 218,941
5.41%, 11/2/1998--Note F 27,353 27,353
- --------------------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(Cost $252,048) 252,047
- --------------------------------------------------------------------------------------
TOTAL INVESTMENTS (101.3%)
(Cost $2,002,544) 2,223,925
- --------------------------------------------------------------------------------------
<CAPTION>
- --------------------------------------------------------------------------------------
MARKET
VALUE*
(000)
- --------------------------------------------------------------------------------------
<S> <C>
OTHER ASSETS AND LIABILITIES (-1.3%)
Other Assets--Note C $ 17,973
Liabilities--Note F (45,981)
- --------------------------------------------------------------------------------------
(28,008)
- --------------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------------
Applicable to 44,268,929 outstanding
$.001 par value shares of
beneficial interest
(unlimited authorization) $ 2,195,917
======================================================================================
NET ASSET VALUE PER SHARE $ 49.60
======================================================================================
</TABLE>
*See Note A in NOTES TO FINANCIAL STATEMENTS.
-Non-Income-Producing Security.
(1) Considered an affiliated company as the fund owns more than 5% of the
outstanding voting securities of such company. The total market value of
investments in affiliated companies was $29,601,000.
(2) Security with a value of $5,753,000 has been segregated as initial margin
for open futures contracts.
(3) The combined market value of common stocks and index futures contracts
represents 94.6% of net assets. See Note E in Notes to Financial Statements.
(4) Restricted Security represents 0.1% of net assets. REIT--Real Estate
Investment Trust.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
AT OCTOBER 31, 1998, NET ASSETS CONSISTED OF:
- -------------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- -------------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $ 1,955,858 $ 44.18
Undistributed Net
Investment Income 6,448 .15
Accumulated Net Realized Gains 4,645 .10
Unrealized Appreciation--Note E
Investment Securities 221,381 5.00
Futures Contracts 7,585 .17
- -------------------------------------------------------------------------------------
NET ASSETS $ 2,195,917 $ 49.60
=====================================================================================
</TABLE>
17
<PAGE> 20
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the fund during the
reporting period, and details the operating expenses charged to the fund. These
expenses directly reduce the amount of investment income available to pay to
shareholders as dividends. This Statement also shows any Net Gain (Loss)
realized on the sale of investments, and the increase or decrease in the
Unrealized Appreciation (Depreciation) on investments during the period. If the
fund invested in futures contracts during the period, the results of these
investments are shown separately.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------
EXPLORER FUND
YEAR ENDED OCTOBER 31, 1998
(000)
- --------------------------------------------------------------------------
INVESTMENT INCOME
INCOME
<S> <C>
Dividends* $ 9,840
Interest 13,667
Security Lending 663
--------------
Total Income 24,170
--------------
Expenses
Investment Advisory Fees--Note B
Basic Fee 5,147
Performance Adjustment (838)
The Vanguard Group--Note C
Management and Administrative 9,723
Marketing and Distribution 637
Taxes (other than income taxes) 129
Custodian Fees 86
Auditing Fees 11
Shareholders' Reports 110
Annual Meeting and Proxy Costs 61
Trustees' Fees and Expenses 6
--------------
Total Expenses 15,072
- --------------------------------------------------------------------------
NET INVESTMENT INCOME 9,098
- --------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold* 23,351
Futures Contracts (20,907)
- --------------------------------------------------------------------------
REALIZED NET GAIN 2,444
- --------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities (293,182)
Futures Contracts 11,078
- --------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) (282,104)
- --------------------------------------------------------------------------
NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $(270,562)
==========================================================================
</TABLE>
*Dividend income and realized net loss from affiliated companies were $426,000
and $4,197,000, respectively.
18
<PAGE> 21
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the fund's total net assets changed during the two most
recent reporting periods. The Operations section summarizes information detailed
in the Statement of Operations. The amounts shown as Distributions to
shareholders from the fund's net income and capital gains may not match the
amounts shown in the Operations section, because distributions are determined on
a tax basis and may be made in a period different from the one in which the
income was earned or the gains were realized on the financial statements. The
Capital Share Transactions section shows the amount shareholders invested in the
fund, either by purchasing shares or by reinvesting distributions, as well as
the amounts redeemed. The corresponding numbers of Shares Issued and Redeemed
are shown at the end of the Statement.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------
EXPLORER FUND
YEAR ENDED OCTOBER 31,
------------------------------
1998 1997
(000) (000)
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
OPERATIONS
Net Investment Income $ 9,098 $ 10,301
Realized Net Gain 2,444 244,061
Change in Unrealized Appreciation (Depreciation) (282,104) 143,547
------------------------------
Net Increase (Decrease) in Net Assets Resulting from Operations (270,562) 397,909
------------------------------
DISTRIBUTIONS
Net Investment Income (10,298) (10,671)
Realized Capital Gain (240,982) (111,842)
------------------------------
Total Distributions (251,280) (122,513)
------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 763,144 746,689
Issued in Lieu of Cash Distributions 247,188 120,564
Redeemed (842,473) (778,827)
------------------------------
Net Increase from Capital Share Transactions 167,859 88,426
- ---------------------------------------------------------------------------------------------------------
Total Increase (Decrease) (353,983) 363,822
- ---------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 2,549,900 2,186,078
------------------------------
End of Year $ 2,195,917 $ 2,549,900
=========================================================================================================
(1)Shares Issued (Redeemed)
Issued 13,941 13,183
Issued in Lieu of Cash Distributions 4,672 2,263
Redeemed (15,267) (13,954)
------------------------------
Net Increase in Shares Outstanding 3,346 1,492
=========================================================================================================
</TABLE>
19
<PAGE> 22
FINANCIAL HIGHLIGHTS
This table summarizes the fund's investment results and distributions to
shareholders on a per-share basis. It also presents the fund's Total Return and
shows net investment income and expenses as percentages of average net assets.
These data will help you assess: the variability of the fund's net income and
total returns from year to year; the relative contributions of net income and
capital gains to the fund's total return; how much it costs to operate the fund;
and the extent to which the fund tends to distribute capital gains. The table
also shows the Portfolio Turnover Rate, a measure of trading activity. A
turnover rate of 100% means that the average security is held in the fund for
one year.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------
EXPLORER FUND
YEAR ENDED OCTOBER 31,
- -----------------------------------------------------------------------------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $ 62.31 $ 55.44 $ 51.05 $ 45.99 $ 49.37
- -----------------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .21 .26 .26 .24 .16
Net Realized and Unrealized Gain (Loss) on Investments (6.82) 9.71 8.37 7.25 1.77
-----------------------------------------------------------------
Total from Investment Operations (6.61) 9.97 8.63 7.49 1.93
-----------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.25) (.27) (.24) (.17) (.14)
Distributions from Realized Capital Gains (5.85) (2.83) (4.00) (2.26) (5.17)
-----------------------------------------------------------------
Total Distributions (6.10) (3.10) (4.24) (2.43) (5.31)
- -----------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $ 49.60 $ 62.31 $ 55.44 $ 51.05 $ 45.99
=============================================================================================================================
TOTAL RETURN -11.22% 18.93% 17.97% 17.46% 4.49%
=============================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $ 2,196 $ 2,550 $ 2,186 $ 1,476 $ 1,112
Ratio of Total Expenses to Average Net Assets 0.62% 0.62% 0.63% 0.68% 0.70%
Ratio of Net Investment Income to Average Net Assets 0.37% 0.45% 0.51% 0.52% 0.39%
Portfolio Turnover Rate 72% 84% 51% 66% 82%
=============================================================================================================================
</TABLE>
20
<PAGE> 23
NOTES TO FINANCIAL STATEMENTS
Vanguard Explorer Fund is registered under the Investment Company Act of 1940 as
a diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform to generally accepted
accounting principles for mutual funds. The fund consistently follows such
policies in preparing its financial statements.
1. SECURITY VALUATION: Equity securities are valued at the latest quoted
sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date; such securities not
traded on the valuation date are valued at the mean of the latest quoted bid and
asked prices. Prices are taken from the primary market in which each security
trades. Temporary cash investments acquired over 60 days to maturity are valued
using the latest bid prices or using valuations based on a matrix system (which
considers such factors as security prices, yields, maturities, and ratings),
both as furnished by independent pricing services. Other temporary cash
investments are valued at amortized cost, which approximates market value.
Securities for which market quotations are not readily available are valued by
methods deemed by the Board of Trustees to represent fair value.
2. FEDERAL INCOME TAXES: The fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for federal income taxes is required in the financial
statements.
3. REPURCHASE AGREEMENTS: The fund, along with other members of The Vanguard
Group, transfers uninvested cash balances to a Pooled Cash Account, which is
invested in repurchase agreements secured by U.S. government securities.
Securities pledged as collateral for repurchase agreements are held by a
custodian bank until the agreements mature. Each agreement requires that the
market value of the collateral be sufficient to cover payments of interest and
principal; however, in the event of default or bankruptcy by the other party to
the agreement, retention of the collateral may be subject to legal proceedings.
4. FUTURES: The fund uses S&P MidCap 400 and Russell 2000 Index futures
contracts to a limited extent, with the objectives of maintaining full exposure
to the stock market while maintaining liquidity. The fund may purchase or sell
futures contracts to achieve a desired level of investment, whether to
accommodate portfolio turnover or cash flows from capital shares transactions.
The primary risks associated with the use of futures contracts are imperfect
correlation between changes in market values of stocks held by the fund and the
prices of futures contracts, and the possibility of an illiquid market.
Futures contracts are valued at their quoted daily settlement prices. The
aggregate principal amounts of the contracts are not recorded in the financial
statements. Fluctuations in the value of the contracts are recorded in the
Statement of Net Assets as an asset (liability) and in the Statement of
Operations as unrealized appreciation (depreciation) until the contracts are
closed, when they are recorded as realized futures gains (losses).
5. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes.
6. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Granahan Investment Management, Inc., Wellington Management Company, LLP, and
Chartwell Investment Partners provide investment advisory services to the fund
for fees calculated at an annual percentage rate of average net assets. The
basic fees of Granahan and Wellington are subject to quarterly adjustments based
on performance for the preceding three years relative to the Russell 2000 Index
and an index of the stocks held by the largest small-capitalization stock mutual
funds. For the year ended October 31, 1998, the aggregate investment advisory
fee
21
<PAGE> 24
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
represented an effective annual basic rate of 0.21% of the fund's average net
assets before a decrease of $838,000 (0.03%) based on performance.
The Vanguard Group provides investment advisory services to a portion of the
fund on an at-cost basis; the fund paid Vanguard advisory fees of $39,000 for
the year ended October 31, 1998.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the fund under methods approved by the Board of Trustees. The fund has
committed to provide up to 0.40% of its net assets in capital contributions to
Vanguard. At October 31, 1998, the fund had contributed capital of $406,000 to
Vanguard (included in Other Assets), representing 0.02% of the fund's net
assests and 0.6% of Vanguard's capitalization. The fund's Trustees and officers
are also Directors and officers of Vanguard.
D. During the year ended October 31, 1998, the fund purchased $1,594,053,000 of
investment securities and sold $1,638,466,000 of investment securities, other
than temporary cash investments.
E. At October 31, 1998, net unrealized appreciation of investment securities for
financial reporting and federal income tax purposes was $221,381,000, consisting
of unrealized gains of $443,859,000 on securities that had risen in value since
their purchase and $222,478,000 in unrealized losses on securities that had
fallen in value since their purchase.
At October 31, 1998, the aggregate settlement value of open futures
contracts expiring in December 1998, and the related unrealized appreciation
were:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
(000)
-----------------------------------
AGGREGATE
NUMBER OF SETTLEMENT UNREALIZED
FUTURES CONTRACTS LONG CONTRACTS VALUE APPRECIATION
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
S&P MidCap 400 Index 171 $28,941 $2,836
Russell 2000 Index 411 78,296 4,749
- ------------------------------------------------------------------------------
</TABLE>
Unrealized appreciation on open futures contracts is required to be treated
as realized gain for tax purposes.
F. The market value of securities on loan to broker/dealers at October 31, 1998,
was $25,091,000, for which the fund held cash collateral of $27,353,000. Cash
collateral received is invested in repurchase agreements.
22
<PAGE> 25
REPORT OF INDEPENDENT
ACCOUNTANTS
[PHOTO]
To the Shareholders and
Board of Trustees of
Vanguard Explorer Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard Explorer Fund (the "Fund") at October 31, 1998, the results of its
operations for the year then ended, the changes in its net assets for each of
the two years in the period then ended and the financial highlights for each of
the five years in the period then ended, in conformity with generally accepted
accounting principles. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities at October 31, 1998 by correspondence with the
custodian, provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
November 30, 1998
23
<PAGE> 26
SPECIAL 1998 TAX INFORMATION (UNAUDITED) FOR EXPLORER FUND
This information for the fiscal year ended October 31, 1998, is included
pursuant to provisions of the Internal Revenue Code.
The fund distributed $235,421,000 as capital gains dividends (from net
long-term capital gains), to shareholders in December 1997. of the $235,421,000
capital gain dividends, the fund designates $179,414,000 as a 20% rate gain
distribution.
For corporate shareholders, 100.0% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received deduction.
24
<PAGE> 27
TRUSTEES AND OFFICERS
JOHN C. BOGLE
Founder, Senior Chairman of the Board, and Director/Trustee of The Vanguard
Group, Inc., and each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN
Chairman of the Board, Chief Executive Officer, and Director/Trustee of The
Vanguard Group, Inc., and each of the investment companies in The Vanguard
Group.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions, Inc.,
Raytheon Co., Knight-Ridder, Inc., Massachusetts Mutual Life Insurance Co., and
Ladies Professional Golf Association; Trustee Emerita of Wellesley College.
JOANN HEFFERNAN HEISEN
Vice President, Chief Information Officer, and a member of the Executive
Committee of Johnson & Johnson; Director of Johnson & JohnsonoMerck Consumer
Pharmaceuticals Co., Women First HealthCare, Inc., Recording for the Blind and
Dyslexic, The Medical Center at Princeton, and Women's Research and Education
Institute.
BRUCE K. MacLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
BURTON G. MALKIEL
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Banco Bilbao Gestinova, Baker Fentress &
Co., The Jeffrey Co., and Southern New England Telecommunications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co.,
NACCO Industries, and Newfield Exploration Co.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
THOMAS J. HIGGINS
Treasurer; Principal of The Vanguard Group, Inc.; Treasurer of each of the
investment companies in The Vanguard Group.
KAREN E. WEST
Controller; Principal of The Vanguard Group, Inc.; Controller of each of the
investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DiSTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MacKINNON
Managing Director, Fixed Income Group.
F. WILLIAM McNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
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<PAGE> 28
VANGUARD
MILESTONES
[PHOTO]
The Vanguard Group is
named for HMS Vanguard,
Admiral Horatio Nelson's flagship
at the Battle of the Nile on
August 1, 1798. Our founder,
John C. Bogle, chose the name
after reading Nelson's inspiring
tribute to his fleet: "Nothing could
withstand the squadron . . .
with the judgment of the captains,
together with their valour, and that
of the officers and men of every
description, it was absolutely irresistible."
[PHOTO]
Walter L. Morgan, founder of
Wellington Fund, the nation's
first balanced mutual fund
and forerunner of today's family
of some 100 Vanguard funds,
celebrated his 100th birthday on
July 23, 1998. Mr. Morgan,
a true investment pioneer, died
six weeks later on September 2.
[PHOTO]
Wellington Fund,
The Vanguard Group's oldest fund,
was incorporated by Mr. Morgan
70 years ago, on December 28, 1928.
The fund was named after
the Duke of Wellington,
whose forces defeated
Napoleon Bonaparte at the
Battle of Waterloo in 1815.
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All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other expenses
and should be read carefully before you invest or send money. Prospectuses can
be obtained directly from The Vanguard Group.
Q240-12/16/1998
(C) 1998 Vanguard Marketing
Corporation, Distributor.
All rights reserved.
