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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. 66
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
AMENDMENT NO. 67
VANGUARD EXPLORER FUND
(EXACT NAME OF REGISTRANT AS SPECIFIED IN DECLARATION OF TRUST)
P.O. BOX 2600, VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
R. GREGORY BARTON, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
AS SOON AS PRACTICABLE AFTER THIS REGISTRATION STATEMENT BECOMES EFFECTIVE.
IT IS PROPOSED THAT THIS AMENDMENT BECOME EFFECTIVE:
ON FEBRUARY 27, 2001, PURSUANT TO PARAGRAPH (A) OF RULE 485.
<PAGE>
VANGUARD
EXPLORER (TM)
FUND
Prospectus
February 27, 2001
This prospectus contains
financial data for the
Fund through the
fiscal year ended
October 31, 2000.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
[A MEMBER OF
THE VANGUARD GROUP LOGO]
<PAGE>
VANGUARD EXPLORER FUND
Prospectus
FEBRUARY 27, 2001
A VALUE STOCK Mutual Fund
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CONTENTS
1 FUND PROFILE 13 FINANCIAL HIGHLIGHTS
3 ADDITIONAL INFORMATION 15 INVESTING WITH VANGUARD
3 MORE ON THE FUND 15 BUYING SHARES
8 THE FUND AND VANGUARD 16 REDEEMING SHARES
9 INVESTMENT ADVISER 17 OTHER RULES YOU SHOULD KNOW
11 DIVIDENDS, CAPITAL GAINS, AND TAXES 19 FUND AND ACCOUNT UPDATES
13 SHARE PRICE 20 CONTACTING VANGUARD
GLOSSARY (inside back cover)
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WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the investment objective, policies, strategies, and
risks associated with the Fund. To highlight terms and concepts important to
mutual fund investors, we have provided "Plain Talk/(R)/" explanations along the
way. Reading the prospectus will help you decide whether the Fund is the right
investment for you. We suggest that you keep this prospectus for future
reference.
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<PAGE>
1
FUND PROFILE
INVESTMENT OBJECTIVE
The Fund seeks to PROVIDE LONG-TERM CAPITAL GROWTH.
INVESTMENT STRATEGIES
The Fund invests mainly in the stocks of small companies (which, at the time of
purchase, typically have a market value of less than $1-2 billion). These
companies tend to be unseasoned but are considered by the Fund's advisers to
have superior growth potential. These companies often provide little or no
dividend income.
PRIMARY RISKS
An investment in the Fund could lose money over short or even long periods. You
should expect the Fund's share price and total return to fluctuate within a wide
range like the overall STOCK MARKET. The Fund's performance could be hurt by:
- Investment style risk, which is the chance that returns from
SMALL-CAPITALIZATION STOCKS--WHICH COMPRISE MOST OF THE FUND'S HOLDINGS--
will trail returns from the overall stock market. Historically, these
stocks have been more volatile in price than the large-cap stocks that
dominate the overall stock market, and they often perform quite
differently.
- Manager risk, which is the chance that poor security selection will cause
the Fund to underperform other funds with similar investment objectives.
PERFORMANCE/RISK INFORMATION
The following bar chart is intended to help you understand the risk of investing
in the Fund. It shows how the Fund's performance has varied from one calendar
year to another OVER THE PAST TEN YEARS. In addition, there is a table that
shows how the Fund's average annual total returns compare with those of A
RELEVANT MARKET INDEX over set periods of time. Keep in mind that the Fund's
past performance does not indicate how it will perform in the future.
----------------------------------------------------
ANNUAL TOTAL RETURNS
CHART GOES HERE
----------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was X.XX% (quarter ended MONTH, DD, YYYY), and the lowest return for a
quarter was X.XX% (quarter ended MONTH, DD, YYYY).
<PAGE>
2
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AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 2000
------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS
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Vanguard Explorer Fund XX.XX% XX.XX% XX.XX%
Russell 2000 Index XX.XX XX.XX XX.XX
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FEES AND EXPENSES
The following table describes the fees and expenses you may pay if you buy and
hold shares of the Fund. The expenses shown under Annual Fund Operating Expenses
are based on those incurred in the fiscal year ended October 31, 2000.
SHAREHOLDER FEES (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fee: None
Exchange Fee: None
ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's
assets)
Management Expenses: X.XX%
12b-1 Distribution Fee: None
Other Expenses: X.XX%
TOTAL ANNUAL FUND OPERATING EXPENSES: X.XX%
The following example is intended to help you compare the cost of investing
in the Fund with the cost of investing in other mutual funds. It illustrates the
hypothetical expenses that you would incur over various periods if you invest
$10,000 in the Fund's shares. This example assumes that the Fund provides a
return of 5% a year and that operating expenses remain the same. The results
apply whether or not you redeem your investment at the end of the given period.
--------------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
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$XX $XX $XX $XX
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THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE
HIGHER OR LOWER THAN THOSE SHOWN.
<PAGE>
3
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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 2000 was 0.XX%,
or $X.X0 per $1,000 of average net assets. The average small-cap growth mutual
fund had expenses in 2000 of 0.XX%, or $$X.X0 per $1,000 of average net assets
(derived from data provided by Lipper Inc., which reports on the mutual fund
industry). Management expenses, which are one part of operating expenses,
include investment advisory fees as well as other costs of managing a fund--such
as account maintenance, reporting, accounting, legal, and other administrative
expenses.
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PLAIN TALK ABOUT
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 the fund's buying and selling of securities. These costs
can erode a substantial portion of the gross income or capital appreciation a
fund achieves. Even seemingly small differences in expenses can, over time, have
a dramatic effect on a fund's performance.
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ADDITIONAL INFORMATION
DIVIDENDS AND CAPITAL GAINS NET ASSETS AS OF OCTOBER 31, 2000
Distributed annually in December $.
INVESTMENT ADVISERS SUITABLE FOR IRAS
-Granahan Investment Management, Yes
Inc., Waltham, Mass., since 1990
-Wellington Management Company, MINIMUM INITIAL INVESTMENT
LLP, Boston, Mass.,since $3,000; $1,000 for IRAs and custodial
inception accounts for minors
-Chartwell Investment Partners,
Berwyn, Pa., since 1997 NEWSPAPER ABBREVIATION
-The Vanguard Group, Valley Forge,Pa., Explr
since 1997
-Grantham, Mayo, Van Otterloo & VANGUARD FUND NUMBER
Co., LLC, Boston, Mass., since 024
2000
CUSIP NUMBER
INCEPTION DATE 921926101
December 11, 1967
TICKER SYMBOL
VEXPX
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MORE ON THE FUND
This prospectus describes risks you would face as a Fund shareholder. 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. As you
consider an investment in any mutual fund, you should take into account your
personal tolerance for daily fluctuations in the securities markets.
<PAGE>
4
Look for this [FLAG] symbol throughout the prospectus. It is used to mark
detailed information about each type of risk that you would confront as a Fund
shareholder.
The following sections explain the primary investment strategies and
policies that the Fund uses in pursuit of its objective. The Fund's board of
trustees, which oversees the Fund's management, may change investment strategies
or policies in the interest of shareholders without a shareholder vote unless
those strategies or policies are designated as fundamental.
Finally, you'll find information on other important features of the Fund.
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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 believed to have
above-average potential for growth in revenue and earnings. Reflecting the
market's high expectations for superior growth, such stocks typically have low
dividend yields and above-average prices in relation to such measures as
revenue, earnings, and book value. Value funds generally emphasize stocks of
companies from which the market does not expect strong growth. The prices of
value stocks typically are below-average in comparison to such factors as
earnings and book value, and these stocks typically pay above-average dividend
yields. Growth and value stocks have, in the past, produced similar long-term
returns, though each category has periods when it outperforms the other. In
general, growth funds appeal to investors who will accept more volatility in
hopes of a greater increase in share price. Growth funds also may appeal to
investors with taxable accounts who want a higher proportion of returns to come
as capital gains (which may be taxed at lower rates than dividend income). Value
funds, by contrast, are appropriate for investors who want some dividend income
and the potential for capital gains, but are less tolerant of share-price
fluctuations.
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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.
Market capitalization changes over time, and there is no "official" definition
of the boundaries of large-, mid-, and small-cap stocks. Vanguard generally
defines large-capitalization (large-cap) funds as those holding stocks of
companies whose outstanding shares have, on average, a market value exceeding
$13 billion; mid-cap funds as those holding stocks of companies with a market
value between $1.5 billion and $13 billion; and small-cap funds as those
typically holding stocks of companies with a market value of less than $1.5
billion. Vanguard periodically reassesses these classifications.
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MARKET EXPOSURE
The Fund invests mainly in common stocks of small-capitalization companies that
offer strong growth potential. These companies typically provide little or no
dividend income.
Because it invests mainly in stocks, the Fund is subject to certain risks.
<PAGE>
5
[FLAG]THE FUND IS SUBJECT TO STOCK MARKET RISK, WHICH IS THE CHANCE THAT STOCK
PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN LONG PERIODS. STOCK MARKETS
TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS OF
FALLING PRICES.
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns for the U.S. stock market over various
periods as measured by the S&P 500 Index, a widely used barometer of market
activity. (Total returns consist of dividend income plus change in market
price.) Note that the returns shown do not include the costs of buying and
selling stocks or other expenses that a real-world investment portfolio would
incur. Note, also, that the gap between best and worst tends to narrow over the
long term.
----------------------------------------------------------
U.S. STOCK MARKET RETURNS (1926-2000)
----------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
----------------------------------------------------------
Best 54.2% 28.6% 19.9% 17.9%
Worst -43.1 -12.4 -0.9 3.1
Average 13.2 11.0 11.1 11.1
----------------------------------------------------------
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 2000. You can see, for example, that while the average return on common
stocks for all of the 5-year periods was 11.0%, returns for individual 5-year
periods ranged from a -12.4% average (from 1928 through 1932) to XXX% (from 1995
through 2000). These average returns reflect past performance on common stocks;
you should not regard them 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. Historically, small-cap stocks have 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.
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PLAIN TALK ABOUT
FUND DIVERSIFICATION
In general, the more diversified a fund's stock or bond holdings, the less
likely that a specific security's poor performance will hurt the fund. One
measure of a fund's diversification is the percentage of its assets represented
by its ten largest holdings. The average U.S. equity mutual fund has about 35%
of its assets invested in its ten largest holdings, while some less-diversified
mutual funds have more than 50% of assets invested in their top ten.
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[FLAG] THE FUND IS SUBJECT TO INVESTMENT STYLE RISK, WHICH IS THE CHANCE THAT
RETURNS FROM THE MARKET SECTOR IN WHICH IT INVESTS WILL TRAIL RETURNS FROM
OTHER MARKET SECTORS. AS A GROUP, SMALL-CAPITALIZATION STOCKS TEND TO GO
THROUGH CYCLES OF DOING BETTER--OR WORSE--THAN COMMON STOCKS IN GENERAL.
THESE PERIODS HAVE, IN THE PAST, LASTED FOR AS LONG AS SEVERAL YEARS.
<PAGE>
6
SECURITY SELECTION
Vanguard Explorer Fund employs five investment advisers, each of whom
independently chooses and maintains a portfolio of common stocks for the Fund.
The Fund's Board of Trustees decides the relative amount of Fund assets to be
managed by each adviser and may change these proportions at any time.
The five advisers use active investment management methods, which means
they buy and sell securities based on their judgments about companies and their
financial prospects, the prices of the securities, and the stock market and
economy in general.
Each adviser uses different processes to select securities for its portion
of the Fund's assets; 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 managed about XX% of
the Fund's assets as of October 31, 2000, groups securities into three
categories as part of its selection process. The first category, "core growth,"
emphasizes companies that have 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," comprises companies that offer unique products or
technologies that may lead to new products or expansion into new markets.
Granahan judges "pioneer" stocks based on the estimated growth potential
compared with market value. The third category, "special value," includes
companies that lack a record of strong growth but that, in the adviser's view,
are both undervalued in the market and likely to grow in the next few years.
"Core growth" stocks generally make up 30% to 60% of the adviser's share of Fund
assets, with the other two categories generally at 20% to 35% each.
Wellington Management Company, LLP (Wellington Management), which managed
about XX% of the Fund's assets as of October 31, 2000, uses research and
analysis of individual companies to select stocks that the adviser feels have
exceptional growth potential relative to their valuation in the marketplace.
Wellington Management considers each stock individually before purchase,
and continually monitors developments at these companies for comparison with the
adviser's expectations for growth. To help limit risk, the portfolio is broadly
diversified both by number of stocks and by exposure to a range of industries.
Chartwell Investment Partners (Chartwell), which managed about XX% of the
Fund's assets as of October 31, 2000, uses a research-driven process to choose
stocks judged to have exceptional growth potential and reasonable prices.
After considering each stock individually before purchase, Chartwell
constantly monitors characteristics of its Fund holdings as a group by using
computerized techniques.
The Vanguard Group (Vanguard), employs a "quantitative" investment approach
for approximately XX% of the Fund's assets. In other words, it uses computerized
mathematical models to select a sampling of stocks that, as a group, are
expected to have returns and investment characteristics similar to the Russell
2000 Index, which is made up of stocks held by the nation's 25 largest
small-company mutual funds.
The fifth adviser, Grantham, Mayo, Van Otterloo & Company, LLC (GMO) began
managing new cash invested in the Fund on April 3, 2000. As of October 31, 2000,
GMO managed about XX% of the Fund's assets. GMO uses computerized models to
select the most attractive small-capitalization growth stocks according to
several criteria, including changes in projected earnings, earnings growth, and
recent price trends. This quantitative investment method is expected to result
in a portfolio that is broadly diversified among small-cap stocks. GMO seeks to
maintain reasonable liquidity by limiting positions in individual issues.
<PAGE>
7
Vanguard also managed approximately XX% of the Fund's assets as cash
reserves as of October 31, 2000. The Fund's cash reserves are generally invested
in stock futures to achieve performance similar to that of common stocks. This
strategy is intended to keep the Fund more fully invested in common stocks while
retaining cash on hand to meet liquidity needs. See "Other Investment Policies
and Risks" for more details on the Fund's policy on futures.
The Fund is generally managed without regard to tax ramifications.
[FLAG]THE FUND IS SUBJECT TO MANAGER RISK, WHICH IS THE CHANCE THAT THE ADVISER
WILL DO A POOR JOB OF SELECTING STOCKS.
TURNOVER RATE
Although the Fund normally seeks to invest for the long term, it may sell
securities regardless of how long they have been held. The FINANCIAL HIGHLIGHTS
section of this prospectus shows historic turnover rates for the Fund. A
turnover rate of 100%, for example, would mean that the Fund had sold and
replaced securities valued at 100% of its net assets within a one-year period.
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PLAIN TALK ABOUT
TURNOVER RATE
Before investing in a mutual fund, you should review its turnover rate. This
gives an indication of how transaction costs could affect 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 turnover rates may be more likely
to generate capital gains that must be distributed to shareholders as taxable
income. As of October 31, 2000, the average turnover rate for all domestic stock
funds was approximately XX%, according to Morningstar, Inc.
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OTHER INVESTMENT POLICIES AND RISKS
Besides investing in common stocks of growth companies, the Fund may make
certain other kinds of investments to achieve its objective.
Although the Fund typically does not make significant investments in
foreign securities, it reserves the right to invest up to 20% of its assets this
way. Foreign securities may be traded in U.S. or foreign markets. To the extent
that it owns foreign securities, the Fund is subject to (1) country risk, which
is the chance that domestic events--such as political upheaval, financial
troubles, or a natural disaster--will weaken a country's securities markets; and
(2) currency risk, which is the chance that a foreign investment will decrease
in value because of unfavorable changes in currency exchange rates.
The Fund may also invest 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
fund. The Fund will not use futures for speculative purposes or as leveraged
investments that magnify gains or losses. The Fund's obligation under futures
contracts will not exceed 20% of its total assets.
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.
<PAGE>
8
- To reduce the Fund's transaction costs or add value when these instruments
are favorably priced.
The Fund may invest up to 15% of its assets in restricted securities with
limited marketability or other illiquid securities.
The Fund may temporarily depart from its normal investment policies--for
instance, by investing substantially in cash reserves--in response to
extraordinary market, economic, political, or other conditions. In doing so, the
Fund may succeed in avoiding losses but otherwise fail to achieve its investment
objective.
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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). Some forms
of derivatives, such as exchange-traded futures and options on securities,
commodities, or indexes, have been trading on regulated exchanges for more than
two decades. These types of derivatives are standardized contracts that can
easily be bought and sold, and whose market values are determined and published
daily. Non-standardized derivatives, on the other hand, tend to be more
specialized or complex, and may be harder to value. If used for speculation or
as leveraged investments, derivatives can carry considerable risks.
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COSTS AND MARKET-TIMING
Some investors try to profit from a strategy called market-timing--switching
money into mutual funds when they expect prices to rise and taking money out
when they expect prices 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 do not generate the costs.
This is why all Vanguard funds have adopted special policies to discourage
short-term trading. Specifically:
- Each Vanguard fund reserves the right to reject any purchase
request--including exchanges from other Vanguard funds--that it regards as
disruptive to efficient portfolio management. A purchase request could be
rejected because of the timing of the investment or because of a history of
excessive trading by the investor.
- Each Vanguard fund (except the money market funds) limits the number of
times that an investor can exchange into and out of the fund.
- Each Vanguard fund reserves the right to stop offering shares at any time.
- Vanguard U.S. Stock Index Funds, International Stock Index Funds, REIT
Index Fund, Balanced Index Fund, and Growth and Income Fund generally do
NOT accept exchanges by telephone or fax, or online. (IRAs and other
retirement accounts are not subject to this rule.)
- Certain Vanguard funds charge transaction fees on purchase and/or
redemptions of their shares.
See the INVESTING WITH VANGUARD section of this prospectus for further details
on Vanguard's transaction policies.
THE VANGUARD FUNDS DO NOT PERMIT MARKET-TIMING. DO NOT INVEST WITH VANGUARD
IF YOU ARE A MARKET-TIMER.
<PAGE>
9
THE FUND AND VANGUARD
The Fund is a member of The Vanguard Group, a family of more than 35 investment
companies with more than 100 funds holding assets worth more than $5x0 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 distribution fees, each fund
pays its allocated share of The Vanguard Group's marketing costs.
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PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by
the funds it oversees and thus indirectly by the shareholders in those funds.
Most 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 own the
management company's stock. By contrast, Vanguard provides its services on an
"at-cost" basis, and the funds' expense ratios reflect only these costs. No
separate management company reaps profits or absorbs losses from operating the
funds.
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INVESTMENT ADVISERS
The Fund uses a multimanager approach. It employs five investment advisers, each
of which independently manages a separate portion of the Fund's assets, subject
to the control of the Trustees and officers of the Fund.
- Granahan Investment Management, Inc. (Granahan), 275 Wyman Street, Waltham,
MA 02154, is an investment advisory firm founded in 1985. As of October 31,
2000, Granahan managed about $2.1 billion in assets.
- Wellington Management Company, LLP (Wellington Management), 75 State
Street, Boston, MA 02109, is an investment advisory firm founded in 1928.
As of October 31, 2000, Wellington Management managed about $269 billion in
assets.
- Chartwell Investment Partners (Chartwell), 1235 Westlake Drive, Suite 330,
Berwyn, PA 19312, is an investment advisory firm founded in 1997. As of
October 31, 2000, Chartwell managed about $5.03 billion in assets.
- The Vanguard Group (Vanguard), P.O. Box 2600, Valley Forge, PA 19482,
founded in 1975, is a wholly owned subsidiary of the Vanguard funds. As of
October 31, 2000, Vanguard served as adviser for about $XX in assets.
- Grantham, Mayo, Van Otterloo & Co. LLC (GMO), 40 Rowes Wharf, Boston, MA
02110, is an investment advisory firm founded in 1977. As of October 31,
2000, GMO managed about $22.3 in assets. The firm specializes in
small-company stock investments.
The Fund pays four of its investment advisers--Granahan, Wellington
Management, Chartwell and GMO--on a quarterly basis. For each adviser, the
quarterly fee is based on certain annual percentage rates applied to average net
assets managed by the adviser over the quarterly period. In addition, the
quarterly fees paid to each adviser are increased or decreased based upon the
adviser's performance in comparison to a benchmark index. For these purposes,
the cumulative total return of each adviser's portion of the Fund over a
trailing 36-month period is compared to the cumulative total return of the
Russell 2000 Growth Index over the same period.
<PAGE>
10
Please consult the Fund's Statement of Additional Information for a
complete explanation of how advisory fees are calculated. The Fund pays no
advisory fees to Vanguard, since it provides services to the Fund on an at-cost
basis.
The advisers are authorized to choose broker-dealers to handle the purchase
and sale of the Fund's securities, and to obtain the best available price and
most favorable execution for all transactions. Also, 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.
In the interest of obtaining better execution of a transaction, the
advisers may at times choose brokers who charge higher commissions. If more than
one broker can obtain the best available price and most favorable execution,
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.
The board of trustees may, without prior approval from shareholders, change
the terms of an advisory agreement or hire a new investment adviser--either as a
replacement for an existing adviser or as an additional adviser. Any significant
change in the Fund's advisory arrangements will be communicated to shareholders
in writing. In addition, as the Fund's sponsor and overall manager, The Vanguard
Group may provide investment advisory services to the Fund, on an at-cost basis,
at any time.
For the fiscal year ended October 31, 2000, the advisory fees and expenses
represented an effective annual rate of 0.XX% of the Fund's average net assets
PERFORMANCE INCREASE/DECREASE.
<PAGE>
11
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PLAIN TALK ABOUT
THE FUND'S ADVISERS
The managers primarily responsible for overseeing the Fund's investments are:
JOHN J. GRANAHAN. CFA, Founder and President of Granahan Investment Management,
Inc. He has worked in investment management since 1960; has been with Granahan
since 1985; and has managed the Fund since 1990. Education: B.A., St. Joseph's
University; Graduate Fellow of Catholic University of America.
KENNETH L. ABRAMS, Senior Vice President of Wellington Management Company, LLP.
He has worked in investment management since 1982; has been with Wellington
Management since 1986; and has managed the Fund since 1994. Education: B.A. and
M.B.A., Stanford University.
EDWARD N. ANTOIAN, CFA, Partner and one of the founders of Chartwell Investment
Partners in 1997. He has managed equity funds since 1984 ; and has managed the
Fund since 1997. Education: B.S., State University of New York; M.B.A.,
University of Pennsylvania.
CHRISTOPHER M. DARNELL, Chief Investment Officer of Quantitative Investment
Products and Chairman of the U.S. Equity Investment Policy Group at Grantham,
Mayo, Van Otterloo & Co. LLC. He has managed investments for GMO since 1979; and
has managed the Fund since 2000. Education: B.A., Yale University; M.B.A.,
Harvard University.
ROBERT M. SOUCY, Managing Director of U.S. Quantitative Equity at Grantham,
Mayo, Van Otterloo & Co. LLC. He has managed investments for GMO since 1987; and
has managed the Fund since 2000. Education: B.S., University of Massachusetts.
GEORGE U. SAUTER, Managing Director of Vanguard and head of Vanguard's
Quantitative Equity Group. He has worked in investment management since 1985;
and has had primary responsibility for Vanguard's stock indexing investments and
strategy since joining the company in 1987. Education: A.B., Dartmouth College;
M.B.A., University of Chicago.
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DIVIDENDS, CAPITAL GAINS, AND TAXES
FUND DISTRIBUTIONS
The Fund distributes to shareholders virtually all of its net income (interest
and dividends less expenses), as well as any capital gains realized from the
sale of its holdings. Distributions generally occur in December. You can receive
distributions of income dividends or capital gains in cash, or you can have them
automatically reinvested in more shares of the Fund.
<PAGE>
12
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
DISTRIBUTIONS
As a shareholder, you are entitled to your portion of the fund's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or a capital gains distribution. Income
dividends come from both the dividends that the fund earns from any stock
holdings and the interest it receives from any money market and bond
investments. Capital gains are realized whenever the fund sells securities for
higher prices than it paid for them. These capital gains are either short-term
or long-term depending on whether the fund held the securities for one year or
less, or more than one year.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
"BUYING A DIVIDEND"
Unless you are investing through a tax-deferred retirement account (such as an
IRA), you should avoid buying shares of a fund shortly before it makes a
distribution, because doing so can cost you money in taxes. 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 still
have only $5,000 (250 shares x $19 = $4,750 in share value, plus 250 shares x $1
= $250 in distributions), but you owe tax on the $250 distribution you
received--even if you reinvest it in more shares. To avoid "buying a dividend,"
check a fund's distribution schedule before you invest.
--------------------------------------------------------------------------------
BASIC TAX POINTS
Vanguard will send you a statement each year showing the tax status of all your
distributions. In addition, taxable investors should be aware of the following
basic tax points:
- Distributions are taxable to you for federal income tax purposes whether or
not you reinvest these amounts in additional Fund shares.
- Distributions declared in December--if paid to you by the end of
January--are taxable for federal income tax purposes as if received in
December.
- Any dividends and short-term capital gains that you receive are taxable to
you as ordinary income for federal income tax purposes.
- Any distributions of net long-term capital gains are taxable to you as
long-term capital gains for federal income tax purposes, no matter how long
you've owned shares in the Fund.
- Capital gains distributions may vary considerably from year to year as a
result of the Fund's normal investment activities and cash flows.
- A sale or exchange of Fund shares is a taxable event. This means that you
may have a capital gain to report as income, or a capital loss to report as
a deduction, when you complete your federal income tax return.
- Dividend and capital gains distributions that you receive, as well as your
gains or losses from any sale or exchange of Fund shares, may be subject to
state and local income taxes.
GENERAL INFORMATION
BACKUP WITHHOLDING. By law, Vanguard must withhold 31% of any taxable
distributions or redemptions from your account if you do not:
<PAGE>
13
- provide us with your correct taxpayer identification number;
- certify that the taxpayer identification number is correct; and
- confirm that you are not subject to backup withholding.
Similarly, Vanguard must withhold from your account if the IRS instructs us to
do so.
FOREIGN INVESTORS. The Vanguard funds generally do not offer their shares for
sale outside of the United States. Foreign investors should be aware that U.S.
withholding and estate taxes may apply to any investments in Vanguard funds.
INVALID ADDRESSES. If a dividend or capital gains distribution check mailed to
your address of record is returned as undeliverable, Vanguard will automatically
reinvest all future distributions until you provide us with a valid mailing
address.
TAX CONSEQUENCES. This prospectus provides general tax information only. If you
are investing through a tax-deferred retirement account, such as an IRA, special
tax rules apply. Please consult your tax adviser for detailed information about
a fund's tax consequences for you.
SHARE PRICE
The Fund's share price, called its net asset value, or NAV, is calculated each
business day after the close of regular trading on the New York Stock Exchange
(the NAV is not calculated on holidays or other days when the Exchange is
closed). Net asset value per share is computed by dividing the net assets of the
Fund by the number of Fund shares outstanding.
Knowing the daily net asset value is useful to you as a shareholder because
it indicates the current value of your investment. The Fund's NAV, multiplied by
the number of 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.
A NOTE ON PRICING: The Fund's investments will be priced at their market
value when market quotations are readily available. When these quotations are
not readily available, investments will be priced at their fair value,
calculated according to procedures adopted by the Fund's board of trustees.
The Fund's share price can be found daily in the mutual fund listings of
most major newspapers under the heading "Vanguard Funds."
FINANCIAL HIGHLIGHTS
The following financial highlights table is intended to help you understand the
Fund's financial performance for the past five years, and certain information
reflects financial results for a single Fund share. The total returns in the
table represent the rate that an investor would have earned or lost each year on
an investment in the Fund (assuming reinvestment of all dividend and capital
gains distributions). This information has been derived from the financial
statements audited by PricewaterhouseCoopers LLP, independent accountants, whose
report--along with the Fund's financial statements--is included in the Fund's
most recent annual report to shareholders. You may have the annual report sent
to you without charge by contacting Vanguard.
<PAGE>
14
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
VANGUARD EXPLORER FUND
YEAR ENDED OCTOBER 31,
-------------------------------------------------------------------------
2000 1999 1998 1997 1996
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $61.49 $49.60 $62.31 $55.44 $51.05
--------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .21 .21 .26 .26
Net Realized and Unrealized Gain (Loss)
on Investments 12.18 (6.82) 9.71 8.37
-------------------------------------------------------------------------
Total from Investment Operations 12.39 (6.61) 9.97 8.63
-------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.20) (.25) (.27) (.24)
Distributions from Realized Capital Gains (.30) (5.85) (2.83) (4.00)
-------------------------------------------------------------------------
Total Distributions (.50) (6.10) (3.10) (4.24)
--------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $61.49 $49.60 $62.31 $55.44
====================================================================================================================
TOTAL RETURN 25.14% -11.22% 18.93% 17.97%
--------------------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $2,484 $2,196 $2,550 $2,186
Ratio of Total Expenses to Average Net Assets 0.74% 0.62% 0.62% 0.63%
Ratio of Net Investment Income to Average Net Assets 0.36% 0.37% 0.45% 0.51%
Turnover Rate 79% 72% 84% 51%
====================================================================================================================
</TABLE>
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
The Fund began fiscal 2000 with a net asset value (price) of $61.49 per share.
During the year, the Fund earned $0.XX per share from investment income
(interest and dividends) and $0.XX per share from investments that had
appreciated in value or that were sold for higher prices than the Fund paid for
them.
Shareholders received $0.XX per share in the form of dividend and capital gains
distributions. A portion of each year's distributions may come from the prior
year's income or capital gains.
The earnings ($X.XX per share) minus the distributions ($0.XX per share)
resulted in a share price of $XX.XX at the end of the year. This was an increase
of $0.XX per share (from $61.49 at the beginning of the year to $XX.XX at the
end of the year). For a shareholder who reinvested the distributions in the
purchase of more shares, the total return from the Fund was XX.XX%% for the
year.
As of October 31, 2000, the Fund had $XX billion in net assets. For the year,
its expense ratio was 0.XX% ($X.X0 per $1,000 of net assets); and its net
investment income amounted to 0.XX% of its average net assets. It sold and
replaced securities valued at XX% of its net assets.
--------------------------------------------------------------------------------
<PAGE>
15
--------------------------------------------------------------------------------
INVESTING WITH VANGUARD
This section of the prospectus explains the basics of doing business with
Vanguard. A special booklet, The Vanguard Service Directory, provides details of
our many shareholder services for individual investors. A separate booklet, The
Compass, does the same for institutional investors. You can request either
booklet by calling or writing Vanguard, using the Contacting Vanguard
instructions found at the end of this section.
BUYING SHARES
REDEEMING SHARES
OTHER RULES YOU SHOULD KNOW
FUND AND ACCOUNT UPDATES
CONTACTING VANGUARD
--------------------------------------------------------------------------------
BUYING SHARES
ACCOUNT MINIMUMS
TO OPEN AND MAINTAIN AN ACCOUNT: $3,000 for regular accounts; $1,000 for IRA
ADDON custodial accounts for minors.
TO ADD TO AN EXISTING ACCOUNT: $100 by mail or exchange; $1,000 by wire.
HOW TO BUY SHARES
BY CHECK: Mail your check and a completed account registration to Vanguard. When
adding to an existing account, send your check with an Invest-By-Mail form
detached from your last account statement. For addresses, see Contacting
Vanguard.
BY EXCHANGE PURCHASE: You can purchase shares with the proceeds of a redemption
from another Vanguard fund. All open Vanguard funds permit exchange purchases
requested in writing. MOST VANGUARD FUNDS--OTHER THAN THE STOCK AND BALANCED
INDEX-ORIENTED FUNDS--ALSO ACCEPT EXCHANGE PURCHASES REQUESTED ONLINE OR BY
TELEPHONE. See Other Rules You Should Know for specifics.
BY WIRE: Call Vanguard to purchase shares by wire. See Contacting Vanguard.
YOUR PURCHASE CHECK
When investing by check, make the check payable to: The Vanguard Group-24.
YOUR PURCHASE PRICE
You buy shares at a fund's next-determined NAV after Vanguard accepts your
purchase request. As long as your request is accepted before the close of
regular trading on the New York Stock Exchange (generally 4 p.m., Eastern time),
you will buy your shares at that day's NAV. This is known as your TRADE DATE.
PURCHASE RULES YOU SHOULD KNOW
-THIRD PARTY CHECKS. To protect the funds from check fraud, Vanguard will not
accept checks made payable to third parties.
<PAGE>
16
-U.S. CHECKS ONLY. All purchase checks must be written in U.S. dollars and drawn
on a U.S. bank.
-LARGE PURCHASES. Vanguard reserves the right to reject any purchase request
that may disrupt a fund's operation or performance. Please call us before
attempting to invest a large dollar amount.
-NO CANCELLATIONS. Place your transaction requests carefully. Vanguard will NOT
cancel any transaction once it has been initiated and a confirmation number has
been assigned (if applicable).
-FUTURE PURCHASES. All Vanguard funds reserve the right to stop selling shares
at any time, or to reject specific purchase requests, including purchases by
exchange from another Vanguard fund.
REDEEMING SHARES
HOW TO REDEEM SHARES
Be sure to check Other Rules You Should Know before initiating your request.
ONLINE: Request a redemption through our website at Vanguard.com. BY TELEPHONE:
Contact Vanguard by telephone to request a redemption. For telephone numbers,
see Contacting Vanguard.
BY MAIL: Send your written redemption instructions to Vanguard. For addresses,
see Contacting Vanguard.
BY WRITING A CHECK: If you've established the checkwriting service on your
account, you can redeem shares by writing a check for $250 or more.
YOUR REDEMPTION PRICE
You redeem shares at a fund's next-determined NAV after Vanguard accepts your
redemption request, including any special documentation required under the
circumstances. As long as your request is accepted before the close of regular
trading on the New York Stock Exchange (generally 4 p.m., Eastern time), your
shares are redeemed at that day's NAV. This is known as your TRADE DATE.
TYPES OF REDEMPTIONS
-CHECK REDEMPTIONS: Unless instructed otherwise, Vanguard will mail you a check,
normally within two business days of your trade date.
-EXCHANGE REDEMPTIONS: You may instruct Vanguard to apply the proceeds of your
redemption to purchase shares of another Vanguard fund. All open Vanguard funds
accept exchange redemptions requested in writing. Most Vanguard funds--other
than the stock and balanced index-oriented funds--also accept exchange
redemptions requested online or by telephone. See Other Rules You Should Know
for specifics.
-WIRE REDEMPTIONS: When redeeming from a money market fund, bond fund, or the
Preferred Stock Fund, you may instruct Vanguard to wire your redemption proceeds
to a previously designated bank account. Wire redemptions are not available for
Vanguard's other funds, except by exchanging into a bond or money market fund
first. The wire redemption option is not automatic; you must establish it by
completing a special form or the appropriate section of your account
registration. Also, wire redemp-
<PAGE>
17
tions must be requested in writing or by telephone, not online. A $5 fee applies
to wire redemptions under $5,000.
Money Market Funds: For telephone requests accepted at Vanguard by 10:45 a.m.,
Eastern time, the redemption proceeds will arrive at your bank by the close of
business that same day. For other requests accepted before 4 p.m., the
redemption proceeds will arrive at your bank by the close of business on the
following business day.
Bond Funds: For requests accepted at Vanguard by 4 p.m., Eastern time, the
redemption proceeds will arrive at your bank by the close of business on the
following business day.
REDEMPTION RULES YOU SHOULD KNOW
-SPECIAL ACCOUNTS. Special documentation may be required to redeem from certain
types of accounts, such as trust, corporate, non-profit, or retirement accounts.
Please call us before attempting to redeem from these types of accounts.
-POTENTIALLY DISRUPTIVE REDEMPTIONS. Vanguard reserves the right to pay all or
part of your redemption in-kind--that is, in the form of securities--if we
believe that a cash redemption would disrupt the fund's operation or
performance. Under these circumstances, Vanguard also reserves the right to
delay payment of your redemption proceeds for up to seven days. By calling us
before you attempt to redeem a large dollar amount, you are more likely to avoid
in-kind or delayed payment of your redemption.
-RECENTLY PURCHASED SHARES. While you can redeem shares at any time, proceeds
will not be made available to you until the Fund collects payment for your
purchase. This may take up to ten calendar days for shares purchased by check or
Vanguard Fund Express(R).
-SHARE CERTIFICATES. If share certificates have been issued for your account,
those shares cannot be redeemed until you return the certificates (unsigned) to
Vanguard by registered mail. For the correct address, see Contacting Vanguard.
-PAYMENT TO A DIFFERENT PERSON OR ADDRESS. We can make your redemption check
payable to a different person or send it to a different address. However, this
requires the written consent of all registered account owners, which must be
provided under signature guarantees. You can obtain a signature guarantee from
most commercial and savings banks, credit unions, trust companies, or member
firms of a U.S. stock exchange.
-NO CANCELLATIONS. Place your transaction requests carefully. Vanguard will NOT
cancel any transaction once it has been initiated and a confirmation number has
been assigned (if applicable).
-EMERGENCY CIRCUMSTANCES. Vanguard funds can postpone payment of redemption
proceeds for up to seven calendar days at any time. In addition, Vanguard funds
can suspend redemptions and/or postpone payments of redemption proceeds at times
when the New York Stock Exchange is closed or during emergency circumstances, as
determined by the U.S. Securities and Exchange Commission.
OTHER RULES YOU SHOULD KNOW
TELEPHONE TRANSACTIONS
-AUTOMATIC. In setting up your account, we'll automatically enable you to do
business with us by regular telephone, unless you instruct us otherwise in
writing.
<PAGE>
18
-TELE-ACCOUNT(TM). To conduct account transactions through Vanguard's automated
telephone service, you must first obtain a personal identification number (PIN).
Call Tele-Account to obtain a PIN, and allow seven days before using this
service.
-PROOF OF A CALLER'S AUTHORITY. We reserve the right to refuse a telephone
request if the caller is unable to provide the following information exactly as
registered on the account:
- Ten-digit account number.
- Complete owner name and address.
- Primary Social Security or employer identification number.
- Personal Identification Number (PIN), if applicable.
-SUBJECT TO REVISION. We reserve the right to revise or terminate Vanguard's
telephone transaction service at any time, without notice.
-SOME VANGUARD FUNDS DO NOT PERMIT TELEPHONE EXCHANGES. To discourage
market-timing, Vanguard's Stock Index Funds, Growth and Income Fund, and
Balanced Index Fund generally do not permit telephone exchanges (in or out),
except for IRAs and certain other retirement accounts.
VANGUARD.COM
-REGISTRATION. You can use your personal computer to review your account
holdings, to sell or exchange shares of most Vanguard funds, and to perform
other transactions. To establish this service, you can register online.
-SOME VANGUARD FUNDS DO NOT PERMIT ONLINE EXCHANGES. To discourage
market-timing, Vanguard's Stock Index Funds, Growth and Income Fund, and
Balanced Index Fund do not permit online exchanges (in or out), except for IRAs
and certain other retirement accounts.
WRITTEN INSTRUCTIONS
-"GOOD ORDER" REQUIRED. We reserve the right to reject any written transaction
instructions that are not in "good order." This means that your instructions
must include:
- The fund name and account number.
- The amount of the transaction (in dollars or shares).
- Signatures of all owners exactly as registered on the account.
- Signature guarantees, if required for the type of transaction.*
*For instance, signature guarantees must be provided by all registered account
shareholders when redemption proceeds are to be sent to a different person or
address.
RESPONSIBILITY FOR FRAUD
Vanguard will not be responsible for any account losses due to fraud, so long as
we reasonably believe that the person transacting on an account is authorized to
do so. Please take precautions to protect yourself from fraud. Keep your account
information private and immediately review any account statements that we send
to you. Contact Vanguard immediately about any transactions you believe to be
unauthorized.
UNCASHED CHECKS
Please cash your distribution or redemption checks promptly.
Vanguard will not pay interest on uncashed checks.
<PAGE>
19
LIMITS ON ACCOUNT ACTIVITY
Because excessive account transactions can disrupt management of a fund and
increase the fund's costs for all shareholders, Vanguard limits account activity
as follows:
- You may make no more than TWO SUBSTANTIVE "ROUND TRIPS" THROUGH A NON-MONEY
MARKET FUND during any 12-month period.
- Your round trips through a non-money market fund must be at least 30 days
apart.
- All funds may refuse share purchases at any time, for any reason.
- Vanguard reserves the right to revise or terminate the exchange privilege,
limit the amount of an exchange, or reject an exchange, at any time, for any
reason.
A "round trip" is a redemption from a fund followed by a purchase back into the
same fund. Also, a "round trip" covers transactions accomplished by any
combination of methods, including transactions conducted by check, wire, or
exchange to/from another Vanguard fund. "Substantive" means a dollar amount that
Vanguard determines, in its sole discretion, could adversely affect the
management of the fund.
UNUSUAL CIRCUMSTANCES
If you experience difficulty contacting Vanguard online, by telephone, or by
Tele-Account, you can send us your transaction request by regular or express
mail. See Contacting Vanguard for addresses.
INVESTING WITH VANGUARD THROUGH OTHER FIRMS
You may purchase or sell shares of most Vanguard funds through a financial
intermediary, such as a bank, broker, or investment adviser. If you invest with
Vanguard through an intermediary, please read that firm's program materials
carefully to learn of any special rules that may apply. For example, special
terms may apply to additional service features, fees, or other policies. Consult
your intermediary to determine when your order will be priced.
LOW BALANCE ACCOUNTS
All Vanguard funds reserve the right to close any investment-only
retirement-plan account or any nonretirement account whose balance falls below
the minimum initial investment.
Vanguard deducts a $10 fee in June from each nonretirement account whose
balance at that time is below $2,500 ($500 for Vanguard STAR(TM) Fund). The fee
is waived if your total Vanguard account assets are $50,000 or more.
FUND AND ACCOUNT UPDATES
PORTFOLIO SUMMARIES
We will send you quarterly portfolio summaries to help you keep track of your
accounts throughout the year. Each summary shows the market value of your
account at the close of the statement period, as well as all distributions,
purchases, sales, and exchanges for the current calendar year.
AVERAGE COST REVIEW STATEMENTS
For most taxable accounts, average cost review statements will accompany the
quarterly portfolio summaries. These statements show the average cost of shares
that you
<PAGE>
20
redeemed during the current calendar year, using the average cost single
category method.
CONFIRMATION STATEMENTS
Each time you buy, sell, or exchange shares, we will send you a statement
confirming the trade date and amount of your transaction.
TAX STATEMENTS
We will send you annual tax statements to assist in preparing your income tax
returns. These statements, which are generally mailed in January, will report
the previous year's dividend and capital gains distributions, proceeds from the
sale of shares, and distributions from IRAs or other retirement plans.
REPORTS
You will receive financial reports about your funds twice a year--in June and
December. These comprehensive reports include an assessment of the fund's
performance (and a comparison to its industry benchmark), an overview of the
financial markets, a report from the advisers, and the fund's financial
statements, which include a listing of the fund's holdings.
To keep the funds' costs as low as possible (so that you and other
shareholders can keep more of the funds' investment earnings), Vanguard attempts
to eliminate duplicate mailings to the same address. When we find that two or
more shareholders have the same last name and address, we send just one fund
report to that address--instead of mailing separate reports to each shareholder.
If you want us to send separate reports, however, you may notify our Client
Services Department.
CONTACTING VANGUARD
ONLINE
VANGUARD.COM
- Your best source of Vanguard news
- For fund, account, and service information
- For most account transactions
- For literature requests
- 24 hours per day, 7 days per week
VANGUARD TELE-ACCOUNT(R) 1-800-662-6273 (ON-BOARD)
- For automated fund and account information
- For redemptions by check, exchange, or wire
- Toll-free, 24 hours per day, 7 days per week
INVESTOR INFORMATION
1-800-662-7447 (SHIP)
(Text telephone at
1-800-952-3335)
<PAGE>
21
- For fund and service information
- For literature requests
- Business hours only
CLIENT SERVICES
1-800-662-2739 (CREW)
(Text telephone at 1-800-749-7273)
- For account information
- For most account transactions
- Business hours only
INSTITUTIONAL DIVISION
1-888-809-8102
- For information and services for large institutional investors
- Business hours only
VANGUARD ADDRESSES
REGULAR MAIL (INDIVIDUALS--CURRENT CLIENTS):
The Vanguard Group
P.O. Box 1110
Valley Forge, PA 19482-1110
REGULAR MAIL (INSTITUTIONS):
The Vanguard Group
P.O. Box 2900
Valley Forge, PA 19482-2900
REGULAR MAIL (GENERAL INQUIRIES):
The Vanguard Group
P.O. Box 2600
Valley Forge, PA 19482-2600
REGISTERED OR EXPRESS MAIL:
The Vanguard Group
455 Devon Park Drive
Wayne, PA 19087-1815
FUND NUMBER
Always use this fund number when contacting Vanguard about the Fund:
Explorer-24.
<PAGE>
GLOSSARY OF INVESTMENT TERMS
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized on securities that a fund
has sold at a profit, minus any realized losses.
CASH RESERVES
Cash deposits, short-term bank deposits, and money market instruments that
include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase
agreements, commercial paper, and banker's 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 chance that domestic events--such as political upheaval, financial troubles,
or a natural disaster--will weaken a country's securities markets.
CURRENCY RISK
The chance that a foreign investment will decrease in value because of
unfavorable changes in currency exchange rates.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by a
fund's investments.
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
distribution fees.
FUND DIVERSIFICATION
Holding a variety of securities so that a fund's return is not badly hurt by the
poor performance of a single security, industry, or country.
INVESTMENT ADVISER
An organization that makes the day-to-day decisions regarding a fund's
investments.
MUTUAL FUND
An investment company that pools the money of many people and invests it in a
variety of securities in an effort 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.
PRICE/EARNINGS (P/E) RATIO
The current share price of a stock, divided by its per-share earnings (profits).
A stock selling for $20, with earnings of $2 per share, has a price/earnings
ratio of 10.
PRINCIPAL
The amount of money you put into an investment.
SECURITIES
Stocks, bonds, money market instruments, and other investment vehicles.
TOTAL RETURN
A percentage change, over a specified time period, in a mutual fund's net asset
value, assuming 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
Income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE>
[SHIP]
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, PA 19482-2600
FOR MORE INFORMATION
If you'd like more information about
Vanguard Explorer Fund, the
following documents are available
free upon request:
ANNUAL/SEMIANNUAL REPORTS
TO SHAREHOLDERS
Additional information about the
Fund's investments is available in
the Fund's annual and semiannual
reports to shareholders.
STATEMENT OF ADDITIONAL
INFORMATION (SAI)
The SAI provides more detailed
information about the Fund.
The current annual and semiannual
reports and the SAI are incorporated
by reference into (and are thus
legally a part of) this prospectus.
All market indexes referenced in
this prospectus are the exclusive
property of their respective owners.
To receive a free copy of the latest
annual or semiannual report or the
SAI, or to request additional
information about the Fund or other
Vanguard funds, please contact us
as follows:
THE VANGUARD GROUP
INVESTOR INFORMATION
DEPARTMENT
P.O. BOX 2600
VALLEY FORGE,
PA 19482-2600
TELEPHONE:
1-800-662-7447 (SHIP)
TEXT TELEPHONE:
1-800-952-3335
WORLD WIDE WEB:
WWW.VANGUARD.COM
If you are a current Fund shareholder
and would like information about
your account, account transactions,
and/or account statements,
please call:
CLIENT SERVICES DEPARTMENT
TELEPHONE:
1-800-662-2739 (CREW)
TEXT TELEPHONE:
1-800-749-7273
INFORMATION PROVIDED BY THE
SECURITIES AND EXCHANGE
COMMISSION (SEC)
You can review and copy
information about the Fund
(including the SAI) at the SEC's
Public Reference Room in
Washington, DC. To find out more
about this public service, call the
SEC at 1-202-942-8090. Reports and
other information about the Fund are
also available on the SEC's Internet
site at http:\\www.sec.gov, or you
can receive copies of this
information, for a fee, by electronic
request at the following e-mail
address: [email protected], or by
writing the Public Reference
Section, Securities and Exchange
Commission, Washington, DC
20549-0102.
Fund's Investment Company Act file
number: 811-1530
(C) 2000 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing Corporation,
Distributor.
P024N 022001
[/R]
<PAGE>
VANGUARD
EXPLORER(TM) FUND
Participant Prospectus
February 27, 2001
This prospectus contains
financial data for the
Fund through the
fiscal year ended
October 31, 2000.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
[A MEMBER OF
THE VANGUARD GROUP LOGO]
<PAGE>
VANGUARD EXPLORER FUND
Participant Prospectus
February 27, 2001
A SMALL-COMPANY GROWTH STOCK Mutual Fund
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CONTENTS
1 FUND PROFILE 13 SHARE PRICE
3 ADDITIONAL INFORMATION 13 FINANCIAL HIGHLIGHTS
3 MORE ON THE FUND 15 INVESTING WITH VANGUARD
8 THE FUND AND VANGUARD 11 ACCESSING FUND INFORMATION BY
COMPUTER
9 INVESTMENT ADVISER
GLOSSARY
11 DIVIDENDS, CAPITAL GAINS, AND TAXES
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WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the investment objective, policies, strategies, and
risks associated with the Fund. To highlight terms and concepts important to
mutual fund investors, we have provided "Plain Talk/(R)/" explanations along the
way. Reading the prospectus will help you decide whether the Fund is the right
investment for you. We suggest that you keep this prospectus for future
reference.
This prospectus is intended 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.
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<PAGE>
1
FUND PROFILE
INVESTMENT OBJECTIVE
The Fund seeks to provide long-term capital growth.
INVESTMENT STRATEGIES
The Fund invests mainly in the stocks of small companies (which, at the time of
purchase, typically have a market value of less than $1-2 billion). These
companies tend to be unseasoned but are considered by the Fund's advisers to
have superior growth potential. These companies often provide little or no
dividend income.
PRIMARY RISKS
An investment in the Fund could lose money over short or even long periods. You
should expect the Fund's share price and total return to fluctuate within a wide
range like the overall stock market. The Fund's performance could be hurt by:
- Investment style risk, which is the chance that returns from
small-capitalization stocks--which comprise most of the fund's holdings--
will trail returns from the overall stock market. Historically, these
stocks have been more volatile in price than the large-cap stocks that
dominate the overall stock market, and they often perform quite
differently.
- Manager risk, which is the chance that poor security selection will cause
the Fund to underperform other funds with similar investment objectives.
PERFORMANCE/RISK INFORMATION
The following bar chart is intended to help you understand the risk of investing
in the Fund. It shows how the Fund's performance has varied from one calendar
year to another over the past ten years. In addition, there is a table that
shows how the Fund's average annual total returns compare with those of a
relevant market index over set periods of time. Keep in mind that the Fund's
past performance does not indicate how it will perform in the future.
----------------------------------------------------
ANNUAL TOTAL RETURNS
CHART GOES HERE
----------------------------------------------------
During the period shown in the bar chart, the highest return for a calendar
quarter was X.XX% (quarter ended MONTH, DD, YYYY), and the lowest return for a
quarter was X.XX% (quarter ended MONTH, DD, YYYY).
<PAGE>
2
------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS FOR YEARS ENDED DECEMBER 31, 2000
------------------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS
------------------------------------------------------------------
Vanguard Explorer Fund XX.XX% XX.XX% XX.XX%
Russell 2000 Index XX.XX XX.XX XX.XX
------------------------------------------------------------------
FEES AND EXPENSES
The following table describes the fees and expenses you may pay if you buy and
hold shares of the Fund. The expenses shown under Annual Fund Operating Expenses
are based on those incurred in the fiscal year ended October 31, 2000.
SHAREHOLDER FEES (fees paid directly from your investment)
Sales Charge (Load) Imposed on Purchases: None
Sales Charge (Load) Imposed on Reinvested Dividends: None
Redemption Fee: None
Exchange Fee: None
ANNUAL FUND OPERATING EXPENSES (expenses deducted from the Fund's
assets)
Management Expenses: X.XX%
12b-1 Distribution Fee: None
Other Expenses: X.XX%
TOTAL ANNUAL FUND OPERATING EXPENSES: X.XX%
The following example is intended to help you compare the cost of investing
in the Fund with the cost of investing in other mutual funds. It illustrates the
hypothetical expenses that you would incur over various periods if you invest
$10,000 in the Fund's shares. This example assumes that the Fund provides a
return of 5% a year and that operating expenses remain the same. The results
apply whether or not you redeem your investment at the end of the given period.
--------------------------------------------------
1 YEAR 3 YEARS 5 YEARS 10 YEARS
--------------------------------------------------
$XX $XX $XX $XX
--------------------------------------------------
THIS EXAMPLE SHOULD NOT BE CONSIDERED TO REPRESENT ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE. ACTUAL FUTURE EXPENSES MAY BE
HIGHER OR LOWER THAN THOSE SHOWN.
<PAGE>
3
--------------------------------------------------------------------------------
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 2000 was 0.XX%,
or $X.X0 per $1,000 of average net assets. The average small-cap growth mutual
fund had expenses in 2000 of 0.XX%, or $$X.X0 per $1,000 of average net assets
(derived from data provided by Lipper Inc., which reports on the mutual fund
industry). Management expenses, which are one part of operating expenses,
include investment advisory fees as well as other costs of managing a fund--such
as account maintenance, reporting, accounting, legal, and other administrative
expenses.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
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 the fund's buying and selling of securities. These costs
can erode a substantial portion of the gross income or capital appreciation a
fund achieves. Even seemingly small differences in expenses can, over time, have
a dramatic effect on a fund's performance.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
ADDITIONAL INFORMATION
DIVIDENDS AND CAPITAL GAINS NET ASSETS AS OF OCTOBER 31, 2000
Distributed annually in December $.
INVESTMENT ADVISERS NEWSPAPER ABBREVIATION
-Granahan Investment Management, Explr
Inc., Waltham, Mass., since 1990
-Wellington Management Company, VANGUARD FUND NUMBER
LLP, Boston, Mass.,since 024
inception
-Chartwell Investment Partners, CUSIP NUMBER
Berwyn, Pa., since 1997 921926101
-The Vanguard Group, Valley Forge,Pa.,
since 1997 TICKER SYMBOL
-Grantham, Mayo, Van Otterloo & VEXPX
Co., LLC, Boston, Mass., since
2000
INCEPTION DATE
December 11, 1967
--------------------------------------------------------------------------------
MORE ON THE FUND
This prospectus describes risks you would face as a Fund shareholder. 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. As you
consider an investment in any mutual fund, you should take into account your
personal tolerance for daily fluctuations in the securities markets. Look for
this [FLAG] symbol throughout the prospectus. It is used to mark detailed
information about each type of risk that you would confront as a Fund
shareholder.
The following sections explain the primary investment strategies and
policies that the Fund uses in pursuit of its objective. The Fund's board of
trustees, which oversees the
<PAGE>
4
Fund's management, may change investment strategies or policies in the interest
of shareholders without a shareholder vote unless those strategies or policies
are designated as fundamental.
Finally, you'll find information on other important features of the Fund.
--------------------------------------------------------------------------------
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 believed to have
above-average potential for growth in revenue and earnings. Reflecting the
market's high expectations for superior growth, such stocks typically have low
dividend yields and above-average prices in relation to such measures as
revenue, earnings, and book value. Value funds generally emphasize stocks of
companies from which the market does not expect strong growth. The prices of
value stocks typically are below-average in comparison to such factors as
earnings and book value, and these stocks typically pay above-average dividend
yields. Growth and value stocks have, in the past, produced similar long-term
returns, though each category has periods when it outperforms the other. In
general, growth funds appeal to investors who will accept more volatility in
hopes of a greater increase in share price. Growth funds also may appeal to
investors with taxable accounts who want a higher proportion of returns to come
as capital gains (which may be taxed at lower rates than dividend income). Value
funds, by contrast, are appropriate for investors who want some dividend income
and the potential for capital gains, but are less tolerant of share-price
fluctuations.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
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.
Market capitalization changes over time, and there is no "official" definition
of the boundaries of large-, mid-, and small-cap stocks. Vanguard generally
defines large-capitalization (large-cap) funds as those holding stocks of
companies whose outstanding shares have, on average, a market value exceeding
$13 billion; mid-cap funds as those holding stocks of companies with a market
value between $1.5 billion and $13 billion; and small-cap funds as those
typically holding stocks of companies with a market value of less than $1.5
billion. Vanguard periodically reassesses these classifications.
--------------------------------------------------------------------------------
MARKET EXPOSURE
The Fund invests mainly in common stocks of small-capitalization companies that
offer strong growth potential. These companies typically provide little or no
dividend income.
Because it invests mainly in stocks, the Fund is subject to certain risks.
[FLAG]THE FUND IS SUBJECT TO STOCK MARKET RISK, WHICH IS THE CHANCE THAT STOCK
PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN LONG PERIODS. STOCK MARKETS
TEND TO MOVE IN CYCLES, WITH PERIODS OF RISING PRICES AND PERIODS OF
FALLING PRICES.
<PAGE>
5
To illustrate the volatility of stock prices, the following table shows the
best, worst, and average total returns for the U.S. stock market over various
periods as measured by the S&P 500 Index, a widely used barometer of market
activity. (Total returns consist of dividend income plus change in market
price.) Note that the returns shown do not include the costs of buying and
selling stocks or other expenses that a real-world investment portfolio would
incur. Note, also, that the gap between best and worst tends to narrow over the
long term.
----------------------------------------------------------
U.S. STOCK MARKET RETURNS (1926-2000)
----------------------------------------------------------
1 YEAR 5 YEARS 10 YEARS 20 YEARS
----------------------------------------------------------
Best 54.2% 28.6% 19.9% 17.9%
Worst -43.1 -12.4 -0.9 3.1
Average 13.2 11.0 11.1 11.1
----------------------------------------------------------
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 2000. You can see, for example, that while the average return on common
stocks for all of the 5-year periods was 11.0%, returns for individual 5-year
periods ranged from a -12.4% average (from 1928 through 1932) to XXX% (from 1995
through 2000). These average returns reflect past performance on common stocks;
you should not regard them 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. Historically, small-cap stocks have 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.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
FUND DIVERSIFICATION
In general, the more diversified a fund's stock or bond holdings, the less
likely that a specific security's poor performance will hurt the fund. One
measure of a fund's diversification is the percentage of its assets represented
by its ten largest holdings. The average U.S. equity mutual fund has about 35%
of its assets invested in its ten largest holdings, while some less-diversified
mutual funds have more than 50% of assets invested in their top ten.
--------------------------------------------------------------------------------
[FLAG]THE FUND IS SUBJECT TO INVESTMENT STYLE RISK, WHICH IS THE CHANCE THAT
RETURNS FROM THE MARKET SECTOR IN WHICH IT INVESTS WILL TRAIL RETURNS FROM
OTHER MARKET SECTORS. AS A GROUP, SMALL-CAPITALIZATION STOCKS TEND TO GO
THROUGH CYCLES OF DOING BETTER--OR WORSE--THAN COMMON STOCKS IN GENERAL.
THESE PERIODS HAVE, IN THE PAST, LASTED FOR AS LONG AS SEVERAL YEARS.
SECURITY SELECTION
Vanguard Explorer Fund employs five investment advisers, each of whom
independently chooses and maintains a portfolio of common stocks for the Fund.
The Fund's Board of Trustees decides the relative amount of Fund assets to be
managed by each adviser and may change these proportions at any time.
<PAGE>
6
The five advisers use active investment management methods, which means
they buy and sell securities based on their judgments about companies and their
financial prospects, the prices of the securities, and the stock market and
economy in general.
Each adviser uses different processes to select securities for its portion
of the Fund's assets; 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 managed about XX% of
the Fund's assets as of October 31, 2000, groups securities into three
categories as part of its selection process. The first category, "core growth,"
emphasizes companies that have 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," comprises companies that offer unique products or
technologies that may lead to new products or expansion into new markets.
Granahan judges "pioneer" stocks based on the estimated growth potential
compared with market value. The third category, "special value," includes
companies that lack a record of strong growth but that, in the adviser's view,
are both undervalued in the market and likely to grow in the next few years.
"Core growth" stocks generally make up 30% to 60% of the adviser's share of Fund
assets, with the other two categories generally at 20% to 35% each.
Wellington Management Company, LLP (Wellington Management), which managed
about XX% of the Fund's assets as of October 31, 2000, uses research and
analysis of individual companies to select stocks that the adviser feels have
exceptional growth potential relative to their valuation in the marketplace.
Wellington Management considers each stock individually before purchase,
and continually monitors developments at these companies for comparison with the
adviser's expectations for growth. To help limit risk, the portfolio is broadly
diversified both by number of stocks and by exposure to a range of industries.
Chartwell Investment Partners (Chartwell), which managed about XX% of the
Fund's assets as of October 31, 2000, uses a research-driven process to choose
stocks judged to have exceptional growth potential and reasonable prices.
After considering each stock individually before purchase, Chartwell
constantly monitors characteristics of its Fund holdings as a group by using
computerized techniques.
The Vanguard Group (Vanguard), employs a "quantitative" investment approach
for approximately XX% of the Fund's assets. In other words, it uses computerized
mathematical models to select a sampling of stocks that, as a group, are
expected to have returns and investment characteristics similar to the Russell
2000 Index, which is made up of stocks held by the nation's 25 largest
small-company mutual funds.
The fifth adviser, Grantham, Mayo, Van Otterloo & Company, LLC (GMO) began
managing new cash invested in the Fund on April 3, 2000. As of October 31, 2000,
GMO managed about XX% of the Fund's assets. GMO uses computerized models to
select the most attractive small-capitalization growth stocks according to
several criteria, including changes in projected earnings, earnings growth, and
recent price trends. This quantitative investment method is expected to result
in a portfolio that is broadly diversified among small-cap stocks. GMO seeks to
maintain reasonable liquidity by limiting positions in individual issues.
Vanguard also managed approximately XX% of the Fund's assets as cash
reserves as of October 31, 2000. The Fund's cash reserves are generally invested
in stock futures to achieve performance similar to that of common stocks. This
strategy is intended to keep the Fund more fully invested in common stocks while
retaining cash on hand to meet
<PAGE>
7
liquidity needs. See "Other Investment Policies and Risks" for more details on
the Fund's policy on futures.
The Fund is generally managed without regard to tax ramifications.
[FLAG]THE FUND IS SUBJECT TO MANAGER RISK, WHICH IS THE CHANCE THAT THE ADVISER
WILL DO A POOR JOB OF SELECTING STOCKS.
TURNOVER RATE
Although the Fund normally seeks to invest for the long term, it may sell
securities regardless of how long they have been held. The FINANCIAL HIGHLIGHTS
section of this prospectus shows historic turnover rates for the Fund. A
turnover rate of 100%, for example, would mean that the Fund had sold and
replaced securities valued at 100% of its net assets within a one-year period.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
TURNOVER RATE
Before investing in a mutual fund, you should review its turnover rate. This
gives an indication of how transaction costs could affect 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 turnover rates may be more likely
to generate capital gains that must be distributed to shareholders as taxable
income. As of October 31, 2000, the average turnover rate for all domestic stock
funds was approximately XX%, according to Morningstar, Inc.
--------------------------------------------------------------------------------
OTHER INVESTMENT POLICIES AND RISKS
Besides investing in common stocks of growth companies, the Fund may make
certain other kinds of investments to achieve its objective.
Although the Fund typically does not make significant investments in
foreign securities, it reserves the right to invest up to 20% of its assets this
way. Foreign securities may be traded in U.S. or foreign markets. To the extent
that it owns foreign securities, the Fund is subject to (1) country risk, which
is the chance that domestic events--such as political upheaval, financial
troubles, or a natural disaster--will weaken a country's securities markets; and
(2) currency risk, which is the chance that a foreign investment will decrease
in value because of unfavorable changes in currency exchange rates.
The Fund may also invest 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
fund. The Fund will not use futures for speculative purposes or as leveraged
investments that magnify gains or losses. The Fund's obligation under futures
contracts will not exceed 20% of its total assets.
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 reduce the Fund's transaction costs or add value when these instruments
are favorably priced.
The Fund may invest up to 15% of its assets in restricted securities with
limited marketability or other illiquid securities.
<PAGE>
8
The Fund may temporarily depart from its normal investment policies--for
instance, by investing substantially in cash reserves--in response to
extraordinary market, economic, political, or other conditions. In doing so, the
Fund may succeed in avoiding losses but otherwise fail to achieve its investment
objective.
--------------------------------------------------------------------------------
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). Some forms
of derivatives, such as exchange-traded futures and options on securities,
commodities, or indexes, have been trading on regulated exchanges for more than
two decades. These types of derivatives are standardized contracts that can
easily be bought and sold, and whose market values are determined and published
daily. Non-standardized derivatives, on the other hand, tend to be more
specialized or complex, and may be harder to value. If used for speculation or
as leveraged investments, derivatives can carry considerable risks.
--------------------------------------------------------------------------------
COSTS AND MARKET-TIMING
Some investors try to profit from a strategy called market-timing--switching
money into mutual funds when they expect prices to rise and taking money out
when they expect prices 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 do not generate the costs.
This is why all Vanguard funds have adopted special policies to discourage
short-term trading. Specifically:
- Each Vanguard fund reserves the right to reject any purchase
request--including exchanges from other Vanguard funds--that it regards as
disruptive to efficient portfolio management. A purchase request could be
rejected because of the timing of the investment or because of a history of
excessive trading by the investor.
- Each Vanguard fund (except the money market funds) limits the number of
times that an investor can exchange into and out of the fund.
- Each Vanguard fund reserves the right to stop offering shares at any time.
- Certain Vanguard funds charge transaction fees on purchase and/or
redemptions of their shares.
See the INVESTING WITH VANGUARD section of this prospectus for further details
on Vanguard's transaction policies.
THE VANGUARD FUNDS DO NOT PERMIT MARKET-TIMING. DO NOT INVEST WITH VANGUARD
IF YOU ARE A MARKET-TIMER.
THE FUND AND VANGUARD
The Fund is a member of The Vanguard Group, a family of more than 35 investment
companies with more than 100 funds holding assets worth more than $5x0 billion.
All of the Vanguard funds share in the expenses associated with business
operations, such as personnel, office space, equipment, and advertising.
<PAGE>
9
Vanguard also provides marketing services to the funds. Although
shareholders do not pay sales commissions or 12b-1 distribution fees, each fund
pays its allocated share of The Vanguard Group's marketing costs.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group is truly a MUTUAL mutual fund company. It is owned jointly by
the funds it oversees and thus indirectly by the shareholders in those funds.
Most 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 own the
management company's stock. By contrast, Vanguard provides its services on an
"at-cost" basis, and the funds' expense ratios reflect only these costs. No
separate management company reaps profits or absorbs losses from operating the
funds.
--------------------------------------------------------------------------------
INVESTMENT ADVISERS
The Fund uses a multimanager approach. It employs five investment advisers, each
of which independently manages a separate portion of the Fund's assets, subject
to the control of the Trustees and officers of the Fund.
- Granahan Investment Management, Inc. (Granahan), 275 Wyman Street, Waltham,
MA 02154, is an investment advisory firm founded in 1985. As of October 31,
2000, Granahan managed about $2.1 billion in assets.
- Wellington Management Company, LLP (Wellington Management), 75 State
Street, Boston, MA 02109, is an investment advisory firm founded in 1928.
As of October 31, 2000, Wellington Management managed about $269 billion in
assets.
- Chartwell Investment Partners (Chartwell), 1235 Westlake Drive, Suite 330,
Berwyn, PA 19312, is an investment advisory firm founded in 1997. As of
October 31, 2000, Chartwell managed about $5.03 billion in assets.
- The Vanguard Group (Vanguard), P.O. Box 2600, Valley Forge, PA 19482,
founded in 1975, is a wholly owned subsidiary of the Vanguard funds. As of
October 31, 2000, Vanguard served as adviser for about $XX in assets.
- Grantham, Mayo, Van Otterloo & Co. LLC (GMO), 40 Rowes Wharf, Boston, MA
02110, is an investment advisory firm founded in 1977. As of October 31,
2000, GMO managed about $22.3 in assets. The firm specializes in
small-company stock investments.
The Fund pays four of its investment advisers--Granahan, Wellington
Management, Chartwell and GMO--on a quarterly basis. For each adviser, the
quarterly fee is based on certain annual percentage rates applied to average net
assets managed by the adviser over the quarterly period. In addition, the
quarterly fees paid to each adviser are increased or decreased based upon the
adviser's performance in comparison to a benchmark index. For these purposes,
the cumulative total return of each adviser's portion of the Fund over a
trailing 36-month period is compared to the cumulative total return of the
Russell 2000 Growth Index over the same period.
Please consult the Fund's Statement of Additional Information for a
complete explanation of how advisory fees are calculated. The Fund pays no
advisory fees to Vanguard, since it provides services to the Fund on an at-cost
basis. The advisers are authorized to choose broker-dealers to handle the
purchase and sale of the Fund's securities, and to obtain the best available
price and most favorable execution for all transactions. Also, the Fund may
direct the advisers to use a particular broker for cer-
<PAGE>
10
tain transactions in exchange for commission rebates or research services
provided to the Fund.
In the interest of obtaining better execution of a transaction, the
advisers may at times choose brokers who charge higher commissions. If more than
one broker can obtain the best available price and most favorable execution,
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.
The board of trustees may, without prior approval from shareholders, change
the terms of an advisory agreement or hire a new investment adviser--either as a
replacement for an existing adviser or as an additional adviser. Any significant
change in the Fund's advisory arrangements will be communicated to shareholders
in writing. In addition, as the Fund's sponsor and overall manager, The Vanguard
Group may provide investment advisory services to the Fund, on an at-cost basis,
at any time.
For the fiscal year ended October 31, 2000, the advisory fees and expenses
represented an effective annual rate of 0.XX% of the Fund's average net assets
PERFORMANCE INCREASE/DECREASE.
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
THE FUND'S ADVISERS
The managers primarily responsible for overseeing the Fund's investments are:
JOHN J. GRANAHAN. CFA, Founder and President of Granahan Investment Management,
Inc. He has worked in investment management since 1960; has been with Granahan
since 1985; and has managed the Fund since 1990. Education: B.A., St. Joseph's
University; Graduate Fellow of Catholic University of America.
KENNETH L. ABRAMS, Senior Vice President of Wellington Management Company, LLP.
He has worked in investment management since 1982; has been with Wellington
Management since 1986; and has managed the Fund since 1994. Education: B.A. and
M.B.A., Stanford University.
EDWARD N. ANTOIAN, CFA, Partner and one of the founders of Chartwell Investment
Partners in 1997. He has managed equity funds since 1984 ; and has managed the
Fund since 1997. Education: B.S., State University of New York; M.B.A.,
University of Pennsylvania.
CHRISTOPHER M. DARNELL, Chief Investment Officer of Quantitative Investment
Products and Chairman of the U.S. Equity Investment Policy Group at Grantham,
Mayo, Van Otterloo & Co. LLC. He has managed investments for GMO since 1979; and
has managed the Fund since 2000. Education: B.A., Yale University; M.B.A.,
Harvard University.
ROBERT M. SOUCY, Managing Director of U.S. Quantitative Equity at Grantham,
Mayo, Van Otterloo & Co. LLC. He has managed investments for GMO since 1987; and
has managed the Fund since 2000. Education: B.S., University of Massachusetts.
GEORGE U. SAUTER, Managing Director of Vanguard and head of Vanguard's
Quantitative Equity Group. He has worked in investment management since 1985;
and has had primary responsibility for Vanguard's stock indexing investments and
strategy since joining the company in 1987. Education: A.B., Dartmouth College;
M.B.A., University of Chicago.
--------------------------------------------------------------------------------
<PAGE>
11
DIVIDENDS, CAPITAL GAINS, AND TAXES
The Fund distributes to shareholders virtually all of its net income (interest
and dividends less expenses), as well as any capital gains realized from the
sale of its holdings. Distributions generally occur in December.
Your dividends and capital gains distributions will be reinvested in
additional Fund shares and accumulate on a tax-deferred basis if you are
investing through an employer-sponsored retirement or savings plan. You will not
owe taxes on these distributions until you begin withdrawals from the plan. You
should consult your plan administrator, your plan's Summary Plan Description, or
your tax adviser about the tax consequences of plan withdrawals.
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PLAIN TALK ABOUT
DISTRIBUTIONS
As a shareholder, you are entitled to your portion of the fund's income from
interest and dividends, and gains from the sale of investments. You receive such
earnings as either an income dividend or a capital gains distribution. Income
dividends come from both the dividends that the fund earns from any stock
holdings and the interest it receives from any money market and bond
investments. Capital gains are realized whenever the fund sells securities for
higher prices than it paid for them. These capital gains are either short-term
or long-term depending on whether the fund held the securities for one year or
less, or more than one year.
--------------------------------------------------------------------------------
SHARE PRICE
The Fund's share price, called its net asset value, or NAV, is calculated each
business day after the close of regular trading on the New York Stock Exchange
(the NAV is not calculated on holidays or other days when the Exchange is
closed). Net asset value per share is computed by dividing the net assets of the
Fund by the number of Fund shares outstanding.
Knowing the daily net asset value is useful to you as a shareholder because
it indicates the current value of your investment. The Fund's NAV, multiplied by
the number of 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.
A NOTE ON PRICING: The Fund's investments will be priced at their market
value when market quotations are readily available. When these quotations are
not readily available, investments will be priced at their fair value,
calculated according to procedures adopted by the Fund's board of trustees.
The Fund's share price can be found daily in the mutual fund listings of
most major newspapers under the heading "Vanguard Funds."
FINANCIAL HIGHLIGHTS
The following financial highlights table is intended to help you understand the
Fund's financial performance for the past five years, and certain information
reflects financial results for a single Fund share. The total returns in the
table represent the rate that an investor would have earned or lost each year on
an investment in the Fund (assuming reinvestment of all dividend and capital
gains distributions). This information has been derived from the financial
statements audited by PricewaterhouseCoopers LLP, independent accountants, whose
<PAGE>
12
report--along with the Fund's financial statements--is included in the Fund's
most recent annual report to shareholders. You may have the annual report sent
to you without charge by contacting Vanguard.
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------
VANGUARD EXPLORER FUND
YEAR ENDED OCTOBER 31,
-------------------------------------------------------------------------
2000 1999 1998 1997 1996
--------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $61.49 $49.60 $62.31 $55.44 $51.05
--------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .21 .21 .26 .26
Net Realized and Unrealized Gain (Loss)
on Investments 12.18 (6.82) 9.71 8.37
-------------------------------------------------------------------------
Total from Investment Operations 12.39 (6.61) 9.97 8.63
-------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.20) (.25) (.27) (.24)
Distributions from Realized Capital Gains (.30) (5.85) (2.83) (4.00)
-------------------------------------------------------------------------
Total Distributions (.50) (6.10) (3.10) (4.24)
--------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $61.49 $49.60 $62.31 $55.44
====================================================================================================================
TOTAL RETURN 25.14% -11.22% 18.93% 17.97%
--------------------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $2,484 $2,196 $2,550 $2,186
Ratio of Total Expenses to Average Net Assets 0.74% 0.62% 0.62% 0.63%
Ratio of Net Investment Income to Average Net Assets 0.36% 0.37% 0.45% 0.51%
Turnover Rate 79% 72% 84% 51%
====================================================================================================================
</TABLE>
--------------------------------------------------------------------------------
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
The Fund began fiscal 2000 with a net asset value (price) of $61.49 per share.
During the year, the Fund earned $0.XX per share from investment income
(interest and dividends) and $0.XX per share from investments that had
appreciated in value or that were sold for higher prices than the Fund paid for
them.
Shareholders received $0.XX per share in the form of dividend and capital gains
distributions. A portion of each year's distributions may come from the prior
year's income or capital gains.
The earnings ($X.XX per share) minus the distributions ($0.XX per share)
resulted in a share price of $XX.XX at the end of the year. This was an increase
of $0.XX per share (from $61.49 at the beginning of the year to $XX.XX at the
end of the year). For a shareholder who reinvested the distributions in the
purchase of more shares, the total return from the Fund was XX.XX%% for the
year.
As of October 31, 2000, the Fund had $XX billion in net assets. For the year,
its expense ratio was 0.XX% ($X.X0 per $1,000 of net assets); and its net
investment income amounted to 0.XX% of its average net assets. It sold and
replaced securities valued at XX% of its net assets.
--------------------------------------------------------------------------------
<PAGE>
13
INVESTING WITH VANGUARD
The 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 those about
the Fund's investment objective, strategies, or risks, contact Vanguard's
Participant Access Center, 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.
In all cases, your transaction will be based on the Fund's next-determined
net asset value after Vanguard receives your request (or, in the case of new
contributions, the next-determined net asset value after Vanguard receives the
order from your plan administrator). As long as this request is received before
the close of trading on the New York Stock Exchange, generally 4 p.m., Eastern
time, you will receive that day's net asset value.
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. Although we
make every effort to maintain the exchange privilege, Vanguard reserves the
right to revise or terminate this 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 its transaction
costs, Vanguard limits participant exchange activity to no more than FOUR
SUBSTANTIVE "ROUND TRIPS" THROUGH THE FUND (at least 90 days apart) during any
12-month period. A "round trip" is a redemption from the Fund followed by a
purchase back into the Fund. "Substantive" means a dollar amount that Vanguard
determines, in its sole discretion, could adversely affect the management of the
Fund.
Before making an exchange to or from another fund available in your plan,
consider the following:
- Certain investment options, particularly funds made up of company stock or
investment contracts, may be subject to unique restrictions.
- Make sure to read that fund's prospectus. Contact Vanguard's Participant
Access Center, toll-free, at 1-800-523-1188 for a copy.
- Vanguard can accept exchanges only as permitted by your plan. Contact your
plan administrator for details on the exchange policies that apply to your
plan.
<PAGE>
14
ACCESSING FUND INFORMATION BY COMPUTER
VANGUARD ON THE WORLD WIDE WEB 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
online "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.
<PAGE>
GLOSSARY OF INVESTMENT TERMS
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized on securities that a fund
has sold at a profit, minus any realized losses.
CASH RESERVES
Cash deposits, short-term bank deposits, and money market instruments that
include U.S. Treasury bills, bank certificates of deposit (CDs), repurchase
agreements, commercial paper, and banker's 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 chance that domestic events--such as political upheaval, financial troubles,
or a natural disaster--will weaken a country's securities markets.
CURRENCY RISK
The chance that a foreign investment will decrease in value because of
unfavorable changes in currency exchange rates.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by a
fund's investments.
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
distribution fees.
FUND DIVERSIFICATION
Holding a variety of securities so that a fund's return is not badly hurt by the
poor performance of a single security, industry, or country.
INVESTMENT ADVISER
An organization that makes the day-to-day decisions regarding a fund's
investments.
MUTUAL FUND
An investment company that pools the money of many people and invests it in a
variety of securities in an effort 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.
PRICE/EARNINGS (P/E) RATIO
The current share price of a stock, divided by its per-share earnings (profits).
A stock selling for $20, with earnings of $2 per share, has a price/earnings
ratio of 10.
PRINCIPAL
The amount of money you put into an investment.
SECURITIES
Stocks, bonds, money market instruments, and other investment vehicles.
TOTAL RETURN
A percentage change, over a specified time period, in a mutual fund's net asset
value, assuming 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
Income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE>
[SHIP]
[THE VANGUARD GROUP LOGO]
Institutional Division
Post Office Box 2900
Valley Forge, PA 19482-2900
FOR MORE INFORMATION
If you'd like more information about
Vanguard Explorer Fund, the
following documents are available
free upon request:
ANNUAL/SEMIANNUAL REPORTS
TO SHAREHOLDERS
Additional information about the
Fund's investments is available in
the Fund's annual and semiannual
reports to shareholders.
STATEMENT OF ADDITIONAL
INFORMATION (SAI)
The SAI provides more detailed
information about the Fund.
The current annual and semiannual
reports and the SAI are incorporated
by reference into (and are thus
legally a part of) this prospectus.
All market indexes referenced in
this prospectus are the exclusive
property of their respective owners.
To receive a free copy of the latest
annual or semiannual report or the
SAI, or to request additional
information about the Fund or other
Vanguard funds, please contact us
as follows:
THE VANGUARD GROUP
PARTICIPANT ACCESS CENTER
P.O. BOX 2900
VALLEY FORGE, PA 19482-2900
TELEPHONE:
1-800-523-1188
TEXT TELEPHONE:
1-800-523-8004
WORLD WIDE WEB:
WWW.VANGUARD.COM
INFORMATION PROVIDED BY THE
SECURITIES AND EXCHANGE
COMMISSION (SEC)
You can review and copy
information about the Fund
(including the SAI) at the SEC's
Public Reference Room in
Washington, DC. To find out more
about this public service, call the
SEC at 1-202-942-8090. Reports and
other information about the Fund are
also available on the SEC's Internet
site at http:\\www.sec.gov, or you
can receive copies of this
information, for a fee, by electronic
request at the following e-mail
address: [email protected], or by
writing the Public Reference
Section, Securities and Exchange
Commission, Washington, DC
20549-0102.
Fund's Investment Company Act
file number: 811-1530
(C) 2000 The Vanguard Group, Inc.
All rights reserved.
Vanguard Marketing Corporation,
Distributor.
I024N 022001
[/R]
<PAGE>
PART B
VANGUARD (R) EXPLORER TM FUND
(THE FUND)
STATEMENT OF ADDITIONAL INFORMATION
FEBRUARY 27, 2001
This Statement is not a prospectus but should be read in conjunction with the
Fund's current Prospectus (dated February 27, 2001). To obtain, without charge,
the Prospectus or the most recent Annual Report to Shareholders, which contains
the Fund's financial statements as hereby incorporated by reference, please
call:
INVESTOR INFORMATION DEPARTMENT
1-800-662-7447
TABLE OF CONTENTS
PAGE
----
DESCRIPTION OF THE FUND..........................................B-1
INVESTMENT POLICIES..............................................B-3
FUNDAMENTAL INVESTMENT LIMITATIONS...............................B-7
PURCHASE OF SHARES...............................................B-8
REDEMPTION OF SHARES.............................................B-9
SHARE PRICE......................................................B-9
YIELD AND TOTAL RETURN...........................................B-10
MANAGEMENT OF THE FUND...........................................B-12
INVESTMENT ADVISORY SERVICES.....................................B-15
PORTFOLIO TRANSACTIONS...........................................B-24
COMPARATIVE INDEXES..............................................B-22
FINANCIAL STATEMENTS.............................................B-24
DESCRIPTION OF THE FUND
ORGANIZATION
The Fund was originally known as the Explorer Fund, Inc. and was organized as a
Delaware corporation in 1967. The Fund merged into a Maryland corporation in
1973, and was subsequently reorganized as a Delaware business trust in June
1998. Prior to its reorganization as a Delaware business trust, the Fund was
known as Vanguard Explorer Fund, Inc. The Fund is registered with the United
States Securities and Exchange Commission (the Commission) under the Investment
Company Act of 1940 (the 1940 Act) as an open-end, diversified management
investment company. It currently offers a single class of shares, but has the
ability to offer additional share classes. There is no limit on the number of
full and fractional shares that the Fund may issue.
SERVICE PROVIDERS
CUSTODIAN. State Street Bank and Trust Company, 225 Franklin Street,
Boston, Massachusetts 02110, serves as the custodian. The custodian is
responsible for maintaining the Fund's assets and keeping all necessary accounts
and records of Fund assets.
INDEPENDENT ACCOUNTANTS. PricewaterhouseCoopers LLP, Two Commerce Square,
Suite 1700, 2001 Market Street, Philadelphia, Pennsylvania 19103-7042, serves as
the Fund's independent accountants. The accountants audit the Fund's financial
statements and provide other related services.
TRANSFER AND DIVIDEND-PAYING AGENT. The Fund's transfer agent and
dividend-paying agent is The Vanguard Group, Inc., 100 Vanguard Boulevard,
Malvern, Pennsylvania 19355.
B-1
<PAGE>
CHARACTERISTICS OF THE FUND'S SHARES
RESTRICTIONS ON HOLDING OR DISPOSING OF SHARES. There are no restrictions
on the right of shareholders to retain or dispose of the Fund's shares, other
than the possible future termination of the Fund. The Fund may be terminated by
reorganization into another mutual fund or by liquidation and distribution of
its assets. Unless terminated by reorganization or liquidation, the Fund will
continue indefinitely.
SHAREHOLDER LIABILITY. The Fund is organized under Delaware law, which
provides that shareholders of a business trust are entitled to the same
limitations of personal liability as shareholders of a corporation organized
under Delaware law. Effectively, this means that a shareholder of the Fund will
not be personally liable for payment of the Fund's debts except by reason of his
or her own conduct or acts. In addition, a shareholder could incur a financial
loss on account of a Fund obligation only if the Fund itself had no remaining
assets with which to meet such obligation. We believe that the possibility of
such a situation arising is extremely remote.
DIVIDEND RIGHTS. The Fund's shareholders are entitled to receive any
dividends or other distributions declared by the Fund. No shares have priority
or preference over any other shares of the Fund with respect to distributions of
the Fund. Distributions will be made from the assets of the Fund, and will be
paid ratably to all shareholders of the Fund according to the number of shares
of the Fund held by shareholders on the record date.
VOTING RIGHTS. Shareholders are entitled to vote on a matter if: (i) a
shareholder vote is required under the 1940 Act; (ii) the matter concerns an
amendment to the Declaration of Trust that would adversely affect to a material
degree the rights and preferences of the shares of the fund; or (iii) the
trustees determine that it is necessary or desirable to obtain a shareholder
vote. The 1940 Act requires a shareholder vote under various circumstances,
including to elect or remove trustees upon the written request of shareholders
representing 10% or more of the Fund's net assets, and to change any fundamental
policy of the Fund. Unless otherwise required by applicable law, shareholders of
the Fund receive one vote for each dollar of net asset value owned on the record
date, and a fractional vote for each fractional dollar of net asset value owned
on the record date. Voting rights are non-cumulative and cannot be modified
without a majority vote.
LIQUIDATION RIGHTS. In the event of liquidation, shareholders will be
entitled to receive a pro rata share of the Fund's net assets.
PREEMPTIVE RIGHTS. There are no preemptive rights associated with the
Fund's shares.
CONVERSION RIGHTS. There are no conversion rights associated with the
Fund's shares.
REDEMPTION PROVISIONS. The Fund's redemption provisions are described in
its current prospectus and elsewhere in this Statement of Additional
Information.
SINKING FUND PROVISIONS. The Fund has no sinking fund provisions.
CALLS OR ASSESSMENT. The Fund's shares, when issued, are fully paid and
non-assessable.
TAX STATUS OF THE FUND
The Fund intends to continue to qualify as a "regulated investment company"
under Subchapter M of the Internal Revenue Code. This special tax status means
that the Fund will not be liable for federal tax on income and capital gains
distributed to shareholders. In order to preserve its tax status, the Fund must
comply with certain requirements. If the Fund fails to meet these requirements
in any taxable year, it will be subject to tax on its taxable income at
corporate rates, and all distributions from earnings and profits, including any
distributions of net tax-exempt income and net long-term capital gains, will be
taxable to shareholders as ordinary income. In addition, the Fund could be
required to recognize unrealized gains, pay substantial taxes and interest, and
make substantial distributions before regaining its tax status as a regulated
investment company.
B-2
<PAGE>
INVESTMENT POLICIES
The following policies supplement the Fund's investment policies set forth in
the Prospectus.
REPURCHASE AGREEMENTS. The Fund, along with other members of The Vanguard
Group, 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 fixed-income security (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 trustees 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.
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 bankruptcy or other laws, a court may determine that the underlying
security is collateral for a loan by the Fund not within the control of the Fund
and therefore the realization by the Fund on such collateral may be
automatically stayed. Finally, it is possible that the Fund may not be able to
substantiate its interest in the underlying security and may be deemed an
unsecured creditor of the other party to the agreement. While the advisers
acknowledge these risks, it is expected that they will be controlled through
careful monitoring procedures.
LENDING OF SECURITIES. The Fund may lend its portfolio securities to
qualified institutional investors (typically brokers, dealers, banks or other
financial institutions) 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 terms and the structure of such loans must be consistent with the
1940 Act, and the rules or interpretations of the Commission thereunder. These
provisions limit the amount of securities a fund may lend to 33 1/3% of the
Fund's total assets, and 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. 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 trustees.
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 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.
B-3
<PAGE>
VANGUARD INTERFUND LENDING PROGRAM. The Commission has issued an exemptive
order permitting the Fund and other Vanguard funds to participate in Vanguard's
interfund lending program. This program allows the Vanguard funds to borrow
money from and loan money to each other for temporary or emergency purposes. The
program is subject to a number of conditions, including the requirement that no
fund may borrow or lend money through the program unless it receives a more
favorable interest rate than is available from a typical bank for a comparable
transaction. In addition, a Vanguard fund may participate in the program only if
and to the extent that such participation is consistent with the fund's
investment objective and other investment policies. The boards of trustees of
the Vanguard funds are responsible for ensuring that the interfund lending
program operates in compliance with all conditions of the Commission's exemptive
order.
TEMPORARY INVESTMENTS. The Fund may take temporary defensive measures that
are inconsistent with the Fund's normal fundamental or non-fundamental
investment policies and strategies in response to adverse market, economic,
political or other conditions. Such measures could include investments in (a)
highly liquid short-term fixed income securities issued by or on behalf of
municipal or corporate issuers, obligations of the U.S. Government and its
agencies, commercial paper, and bank certificates of deposit; (b) shares of
other investment companies which have investment objectives consistent with
those of the Fund; (c) repurchase agreements involving any such securities; and
(d) other money market instruments. There is no limit on the extent to which the
Fund may take temporary defensive measures. In taking such measures, the Fund
may fail to achieve its investment objective.
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 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 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 the 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
bona fide hedging purposes.
B-4
<PAGE>
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bona fide hedging transactions except to the
extent that the aggregate initial margins and premiums required to establish any
non-hedging positions do not exceed five percent of the value of the Fund's
portfolio. 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 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 a 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 a 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 a 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
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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 these 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. Gains and losses on certain other
futures contracts (primarily non-U.S. futures contracts) are not recognized
until the contracts are closed and are treated as long-term or short-term
depending on the holding period of the contract. 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 or foreign currencies, or other income derived with respect to its
business of investing in securities or currencies. It is anticipated that any
net gain recognized on futures contracts will be considered qualifying income
for purposes of the 90% requirement.
The Fund will distribute to shareholders annually any net capital gains
which have been recognized for federal income tax purposes 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.
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.
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 Fund'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. However, these
foreign withholding
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<PAGE>
taxes are not expected to have a significant impact on the Fund, since it seeks
long-term capital appreciation and any income should be considered incidental.
Federal Tax Treatment of Non-U.S. Transactions. Special rules govern the
Federal income tax treatment of certain transactions denominated in terms of a
currency other than the U.S. dollar or determined by reference to the value of
one or more currencies other than the U.S. dollar. The types of transactions
covered by the special rules include the following: (i) the acquisition of, or
becoming the obligor under, a bond or other debt instrument (including, to the
extent provided in Treasury regulations, preferred stock); (ii) the accruing of
certain trade receivables and payables; and (iii) the entering into or
acquisition of any forward contract, futures contract, option, or similar
financial instrument if such instrument is not marked to market. The disposition
of a currency other than the U.S. dollar by a taxpayer whose functional currency
is the U.S. dollar is also treated as a transaction subject to the special
currency rules. However, foreign currency-related regulated futures contracts
and nonequity options are generally not subject to the special currency rules if
they are or would be treated as sold for their fair market value at year-end
under the marking-to-market rules applicable to other futures contracts unless
an election is made to have such currency rules apply. With respect to
transactions covered by the special rules, foreign currency gain or loss is
calculated separately from any gain or loss on the underlying transaction and is
normally taxable as ordinary income or loss. A taxpayer may elect to treat as
capital gain or loss foreign currency gain or loss arising from certain
identified forward contracts, futures contracts, and options that are capital
assets in the hands of the taxpayer and which are not part of a straddle. The
Treasury Department issued regulations under which certain transactions subject
to the special currency rules that are part of a "section 988 hedging
transaction" (as defined in the Internal Revenue Code of 1986, as amended, and
the Treasury regulations) will be integrated and treated as a single transaction
or otherwise treated consistently for purposes of the Code. Any gain or loss
attributable to the foreign currency component of a transaction engaged in by
the Fund which is not subject to the special currency rules (such as foreign
equity investments other than certain preferred stocks) will be treated as
capital gain or loss and will not be segregated from the gain or loss on the
underlying transaction. It is anticipated that some of the non-U.S.
dollar-denominated investments and foreign currency contracts the Fund may make
or enter into will be subject to the special currency rules described above.
ILLIQUID AND RESTRICTED SECURITIES. The Fund may invest up to 15% of its
net assets in 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.
The Fund may invest in restricted, privately placed securities that, under
the Commission's rules, may be sold only to qualified institutional buyers.
Because these securities can be resold only to qualified institutional buyers or
after they have been held for a number of years, they may be considered illiquid
securities--meaning that they could be difficult for the Fund to convert to cash
if needed.
If a substantial market develops for a restricted security held by the
Fund, it will be treated as a liquid security, in accordance with procedures and
guidelines approved by the Fund's board of trustees. This generally includes
securities that are unregistered that can be sold to qualified institutional
buyers in accordance with Rule 144A under the Securities Act of 1933. While the
Fund's investment advisers determine the liquidity of restricted securities on a
daily basis, the Board oversees and retains ultimate responsibility for the
adviser's decisions. Several factors that the Board considers in monitoring
these decisions include the valuation of a security, the availability of
qualified institutional buyers, and the availability of information about the
security's issuer.
FUNDAMENTAL INVESTMENT LIMITATIONS
The Fund is subject to the following fundamental investment limitations, which
cannot be changed in any material way without the approval of the holders of a
majority of the Fund's outstanding voting shares. For these purposes, a
"majority" of shares means shares representing the lesser of: (i) 67% or more of
the shared votes, so long as more than 50% of the Fund's outstanding shares are
present or represented by proxy; or (ii) more than 50% of the Fund's outstanding
shares.
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<PAGE>
BORROWING. The Fund may not borrow money, except for temporary or emergency
purposes in an amount not exceeding 15% of the Fund's net assets. The Fund may
borrow money through banks, or Vanguard's interfund lending program only, and
must comply with all applicable regulatory conditions. The Fund may not make any
additional investments whenever its outstanding borrowings exceed 5% of net
assets.
COMMODITIES. The Fund may not invest in commodities, except that the Fund
may invest in stock futures contracts, stock options, and options on stock
futures contracts. No more than 5% of the Fund's total assets may be used as
initial margin deposit for futures contracts, and no more than 20% of the Fund's
total assets may be invested in futures contracts or options at any time.
DIVERSIFICATION. With respect to 75% of its total assets, the Fund may not:
(i) purchase more than 10% of the outstanding voting securities of any one
issuer, or (ii) purchase securities of any issuer if, as a result, more than 5%
of the Fund's total assets would be invested in that issuer's securities. This
limitation does not apply to obligations of the United States Government, its
agencies, or instrumentalities.
ILLIQUID SECURITIES. The Fund may not acquire any security if, as a result,
more than 15% of its net assets would be invested in securities that are
illiquid.
INDUSTRY CONCENTRATION. The Fund may not invest more than 25% of its total
assets in any one industry.
INVESTING FOR CONTROL. The Fund may not invest in a company for the purpose
of controlling its management.
INVESTMENT COMPANIES. The Fund may not invest in any other investment
company, except through a merger, consolidation or acquisition of assets, or to
the extent permitted by Section 12 of the 1940 Act. Investment companies whose
shares the Fund acquires pursuant to Section 12 must have investment objectives
and investment policies consistent with those of the Fund.
LOANS. The Fund may not lend money to any person except by purchasing fixed
income securities or by entering into repurchase agreements, by lending its
portfolio securities, or through Vanguard's interfund lending program.
MARGIN. The Fund may not purchase securities on margin or sell securities
short, except as permitted by the Fund's investment policies relating to
commodities.
PLEDGING ASSETS. The Fund may not pledge, mortgage, or hypothecate more
than 15% of its net assets.
REAL ESTATE. The Fund may not invest directly in real estate, although it
may invest in securities of companies that deal in real estate and bonds secured
by real estate.
SENIOR SECURITIES. The Fund may not issue senior securities, except in
compliance with the 1940 Act.
UNDERWRITING. The Fund may not engage in the business of underwriting
securities issued by other persons. The Fund will not be considered an
underwriter when disposing of its investment securities.
None of these limitations prevents the Fund from participating in The
Vanguard Group (Vanguard). Because the Fund is a member of Vanguard, the Fund
may own securities issued by Vanguard, make loans to Vanguard, and contribute to
Vanguard's costs or other financial requirements. See "Management of the Fund"
for more information.
The investment limitations set forth above are considered at the time
investment securities are purchased. If a percentage restriction is adhered to
at the time the investment is made, a later increase in percentage resulting
from a change in the market value of assets will not constitute a violation of
such restriction.
PURCHASE OF SHARES
The purchase price of shares of the Fund is the net asset value per share next
determined after the order is received. The net asset value per share is
calculated as of the close of the New York Stock Exchange (the 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
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<PAGE>
(iii) to reduce or waive the minimum investment for, or any other restrictions
on, initial and subsequent investments for certain fiduciary accounts such as
employee benefit plans or under circumstances where certain economies can be
achieved in sales of the Fund's shares.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment (i)
during any period that the Exchange is closed, or trading on the Exchange is
restricted as determined by 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.
No charge is made by the Fund for redemptions. Shares redeemed may be worth
more or less than what was paid for them, depending on the market value of the
securities held by the Fund.
If Vanguard determines that it would be detrimental to the best interests
of the remaining shareholders of the Fund to make payment wholly or partly in
cash, the Fund may pay the redemption price in whole or in part by a
distribution in kind of readily marketable securities held by the Fund in lieu
of cash in conformity with applicable rules of the Commission. Investors may
incur brokerage charges on the sale of such securities so received in payment of
redemptions. 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.
SIGNATURE GUARANTEES. To protect your account, the Fund, and Vanguard from
fraud, signature guarantees are required for certain redemptions. Signature
guarantees enable the Fund to verify the identity of a person who has authorized
a redemption from your account. Signature guarantees are required in connection
with: (1) all redemptions, regardless of the amount involved, when the proceeds
are to be paid to someone other than the registered owner(s); and (2) share
transfer requests. These requirements are not applicable to redemptions in
Vanguard's prototype plans except in connection with: (1) distributions made
when the proceeds are to be paid to someone other than the plan participant; (2)
certain authorizations to effect exchanges by telephone; and (3) when proceeds
are to be wired. These requirements may be waived by the Fund in certain
instances.
Signature guarantees can be obtained from a bank, broker, or any other
guarantor that Vanguard deems acceptable. Notaries public are not acceptable
guarantors.
The signature guarantees must appear either: (1) on the written request for
redemption; (2) on a separate instrument for assignment (stock power) which
should specify the total number of shares to be redeemed; or (3) on all stock
certificates tendered for redemption and, if shares held by the Fund are also
being redeemed, on the letter of stock power.
SHARE PRICE
The Fund's share price, or "net asset value" per share, is calculated by
dividing the total assets of the Fund, less all liabilities, by the total number
of shares outstanding. The net asset value is determined as of the close of the
Exchange, (generally 4:00 p.m. Eastern time), on each day that the Exchange is
open for trading.
Portfolio securities for which market quotations are readily available
(which include those securities listed on national securities exchanges, as well
as those quoted on the NASDAQ Stock Market) will be valued at the last quoted
sales price or the official closing price on the day the valuation is made. Such
securities which are not traded on the valuation date are valued at the mean of
the bid and ask prices. Price information on exchange-listed securities is taken
from the exchange where the security is primarily traded. Securities may be
valued on the basis of prices provided by a pricing service when such prices are
believed to reflect the fair market value of such securities.
Short term instruments (those with remaining maturities of 60 days or less)
may be valued at cost, plus or minus any amortized discount or premium, which
approximates market value.
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Bonds and other fixed income securities may be valued on the basis of
prices provided by a pricing service when such prices are believed to reflect
the fair market value of such securities. The prices provided by a pricing
service may be determined without regard to bid or last sale prices of each
security, but take into account institutional-size transactions in similar
groups of securities as well as any developments related to specific securities.
Foreign securities are valued at the last quoted sales price, according to
the broadest and most representative market, available at the time the Fund is
valued. If events which materially affect the value of the Fund's investments
occur after the close of the securities markets on which such securities are
primarily traded, those investments may be valued by such methods as the board
of trustees deems in good faith to reflect fair value.
In determining the Fund's net asset value per share, all assets and
liabilities initially expressed in foreign currencies will be converted into
U.S. dollars using the officially quoted daily exchange rates used by Morgan
Stanley Capital International in calculating various benchmarking indexes. This
officially quoted exchange rate may be determined prior to or after the close of
a particular securities market. If such quotations are not available, or do not
reflect market conditions at the time the Fund is valued, the rate of exchange
will be determined in accordance with policies established in good faith by the
board of trustees.
Other assets and securities for which no quotations are readily available
or which are restricted as to sale (or resale) are valued by such methods as the
board of trustees deems in good faith to reflect the fair value.
The share price for the Fund can be found daily in the mutual fund listings
of most major newspapers under the heading of Vanguard Funds.
YIELD AND TOTAL RETURN
The yield of the Vanguard Explorer Fund for the thirty-day period ended October
31, 2000 was .%. The average annual total returns for the Fund for the one-,
five-, and ten-year periods ended October 31, 2000, were 12.86%, 12.86%, and .%,
respectively.
AVERAGE ANNUAL TOTAL RETURN
Average annual total return is the average annual compounded rate of return for
the periods of one year, five years, ten years or the life of the Fund, all
ended on the last day of a recent month. Average annual total return quotations
will reflect changes in the price of the Fund's shares and assume that all
dividends and capital gains distributions during the respective periods were
reinvested in Fund shares.
Average annual total return is calculated by finding the average annual
compounded rates of return of a hypothetical investment over such periods
according to the following formula (average annual total return is then
expressed as a percentage):
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T = (ERV/P)1/N - 1
Where:
T = average annual total return
P = a hypothetical initial investment of $1,000
n = number of years
ERV = ending redeemable value: ERV is the value, at the end
of the applicable period, of a hypothetical $1,000
investment made at the beginning of the applicable
period
AVERAGE ANNUAL AFTER-TAX TOTAL RETURN QUOTATION
We calculate the Fund's average annual after-tax total return by finding the
average annual compounded rate of return over the 1-, 5-, and 10-year periods
that would equate the initial amount invested to the after-tax value, according
to the following formulas:
P (1+T)N = ATV
Where:
P = a hypothetical initial payment of $1,000
T = average annual after-tax total return
n = number of years
ATV = after-tax value at the end of the 1-, 5-, or 10-year
periods of a hypothetical $1,000 payment made at the
beginning of the time period, assuming no liquidation
of the investment at the end of the measurement periods
Instructions:
1. Assume all distributions by the Fund are reinvested--less the taxes due on
such distributions--at the price on the reinvestment dates during the
period. Adjustments may be made for subsequent re-characterizations of
distributions.
2. Calculate the taxes due on distributions by the Fund by applying the
highest federal marginal tax rates to each component of the distributions
on the reinvestment date (e.g., ordinary income, short-term capital gain,
long-term capital gain, etc.). For periods after December 31, 1997, the
federal marginal tax rates used for the calculations are 39.6% for ordinary
income and short-term capital gains and 20% for long-term capital gains.
Note that the applicable tax rates may vary over the measurement period.
Assume no taxes are due on the portions of any distributions classified as
exempt interest or non-taxable (i.e., return of capital). Ignore any
potential tax liabilities other than federal tax liabilities (e.g., state
and local taxes).
3. Include all recurring fees that are charged to all shareholder accounts.
For any account fees that vary with the size of the account, assume an
account size equal to the Fund's mean (or median) account size. Assume that
no additional taxes or tax credits result from any redemption of shares
required to pay such fees.
4. State the total return quotation to the nearest hundredth of one percent.
CUMULATIVE TOTAL RETURN
Cumulative total return is the cumulative rate of return on a hypothetical
initial investment of $1,000 for a specified period. Cumulative total return
quotations reflect changes in the price of the Fund's shares and assume that all
dividends and capital gains distributions during the period were reinvested in
Fund shares. Cumulative total return is calculated by finding the cumulative
rates of a return of a hypothetical investment over such periods, according to
the following formula (cumulative total return is then expressed as a
percentage):
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C = (ERV/P) - 1
Where:
C = cumulative total return
P = a hypothetical initial investment of $1,000
ERV = ending redeemable value: ERV is the value, at the end
of the applicable period, of a hypothetical $1,000
investment made at the beginning of the applicable
period
SEC YIELDS
Yield is the net annualized yield based on a specified 30-day (or one month)
period assuming semiannual compounding of income. Yield is calculated by
dividing the net investment income per share earned during the period by the
maximum offering price per share on the last day of the period, according to the
following formula:
YIELD = 2[((A-B)/CD+1)6 - 1]
Where:
a = dividends and interest earned during the period
b = expenses accrued for the period (net of
reimbursements)
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends
d = the maximum offering price per share on the last day
of the period
MANAGEMENT OF THE FUND
OFFICERS AND TRUSTEES
The officers of the Fund manage its day-to-day operations and are responsible to
the Fund's board of trustees. The trustees set broad policies for the Fund and
choose its officers. The following is a list of the trustees and officers of the
Fund and a statement of their present positions and principal occupations during
the past five years. As a group, the Fund's trustees and officers own less than
1% of the outstanding shares of the Fund. Each trustee (except Mr. MacLaury)
serves as a director of The Vanguard Group, Inc. In addition, each trustee
serves as a trustee of each of the 109 funds administered by Vanguard (107 in
the case of Mr. Malkiel and 99 in the case of Mr. MacLaury). The mailing address
of the trustees and officers of the Fund is Post Office Box 876, Valley Forge,
PA 19482.
JOHN J. BRENNAN, (DOB:7/29/1954) Chairman, Chief Executive Officer, and Trustee*
Chairman, Chief Executive Officer and Director of The Vanguard Group, Inc., and
Trustee of each of the investment companies in The Vanguard Group.
JOANN HEFFERNAN HEISEN, (DOB: 1/25/1950) Trustee
Vice President, Chief Information Officer, and member of the Executive Committee
of Johnson & Johnson (Pharmaceuticals/Consumer Products), Director of Johnson &
Johnson*MERCK Consumer Pharmaceuticals Co., The Medical Center at Princeton, and
Women's Research and Education Institute.
BRUCE K. MACLAURY, (DOB: 5/7/1931) Trustee
President Emeritus of The Brookings Institution (Independent Non-Partisan
Research Organization); Director of American Express Bank, Ltd., The St. Paul
Companies, Inc. (Insurance and Financial Services), and National Steel Corp.
BURTON G. MALKIEL, (DOB: 8/28/1932) Trustee
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Banco Bilbao Argentaria, Gestion, BKF
Capital (Investment Management), The Jeffrey Co. (Holding Company), NeuVis, Inc.
(Software Company), and Select Sector SPDR Trust (Exchange-Traded Mutual Fund).
ALFRED M. RANKIN, JR., (DOB: 10/8/1941) Trustee
Chairman, President, Chief Executive Officer, and Director of NACCO Industries,
Inc. (Machinery/Coal/ Appliances); and Director of The BFGoodrich Co. (Aircraft
Systems/Manufacturing/Chemicals).
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JAMES O. WELCH, JR., (DOB: 5/13/1931) Trustee
Retired Chairman of Nabisco Brands, Inc. (Food Products); retired Vice Chairman
and Director of RJR Nabisco (Food and Tobacco Products); Director of TECO
Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON, (DOB: 3/2/1936) Trustee
Retired Chairman and CEO of Rohm & Haas Co. (Chemicals); Director of Cummins
Engine Co. (Diesel Engines^), The Mead Corp. (Paper Products); and AmeriSource
Health Corp. (Pharmaceutical Distribution); and Trustee of Vanderbilt
University.
RAYMOND J. KLAPINSKY, (DOB: 12/7/1938) Secretary*
Managing Director of The Vanguard Group, Inc.; Secretary of The Vanguard Group,
Inc. and of each of the investment companies in The Vanguard Group.
THOMAS J. HIGGINS, (DOB: 5/21/1957) Treasurer*
Principal of The Vanguard Group, Inc.; Treasurer of each of the investment
companies in The Vanguard Group.
*Officers of the Fund are "interested persons" as defined in the 1940 Act.
THE VANGUARD GROUP
The Fund is a member of The Vanguard Group of Investment Companies, which
consists of more than 100 funds. Through their jointly-owned subsidiary, The
Vanguard Group, Inc. (Vanguard), the Fund, and the other funds in The Vanguard
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 several of the Vanguard funds.
Vanguard employs a supporting staff of management and administrative
personnel needed to provide the requisite services to the funds and also
furnishes the funds with necessary office space, furnishings, and equipment.
Each fund pays its share of Vanguard's total expenses, which are allocated among
the funds under procedures approved by the board of trustees of each fund. In
addition, each fund bears its own direct expenses, such as legal, auditing, and
custodian fees.
The funds' 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.
Vanguard and the Fund's advisers have adopted Codes of Ethics designed to
prevent employees who may have access to nonpublic information about the trading
activities of the Fund (access persons) from profiting from that information.
The Codes permit access persons to invest in securities for their own accounts,
including securities that may be held by the Fund, but place substantive and
procedural restrictions on their trading activities. For example, the Codes
require that access persons receive advance approval for every securities trade
to ensure that there is no conflict with the trading activities of the Fund.
Vanguard was established and operates under an Amended and Restated Funds'
Service Agreement which was approved by the shareholders of each of the funds.
The Amended and Restated Funds' Service Agreement provides for the following
arrangement: (a) each Vanguard fund may be called upon to invest up to 0.40% of
its current net assets in Vanguard, and (b) there is no other limitation on the
dollar 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, 2000, Vanguard Explorer Fund had contributed capital of $. to
Vanguard, representing .%% of the Fund's net assets and .% 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.
DISTRIBUTION. Vanguard Marketing Corporation, a wholly-owned subsidiary of
Vanguard, provides all distribution and marketing activities for the funds in
the Group. 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 Vanguard Group. The
trustees and officers of Vanguard determine the amount to be spent
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<PAGE>
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 Vanguard, and
that no fund shall incur annual distribution expenses in excess of 0.20 of 1% of
its average month-end net assets.
During the fiscal years ended October 31, 1998, 1999, and 2000, Vanguard
Explorer Fund incurred the following approximate amounts of The Vanguard Group's
management (including transfer agency), distribution, and marketing expenses:
$10,360,000, $11,114,000, and $., respectively.
INVESTMENT ADVISORY SERVICES
Vanguard provides investment advisory services to the Fund and several other
Vanguard funds. 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.
TRUSTEE COMPENSATION
The same individuals serve as trustees of all Vanguard funds (with two
exceptions, which are noted in the table appearing on page B-15), and each fund
pays a proportionate share of the trustees' compensation. The funds employ their
officers on a shared basis, as well. However, officers are compensated by
Vanguard, not the funds.
INDEPENDENT TRUSTEES. The funds compensate their independent trustees--that
is, the ones who are not also officers of the fund--in three ways:
- The independent trustees receive an annual fee for their service to the
funds, which is subject to reduction based on absences from scheduled Board
meetings.
- The independent trustees are reimbursed for the travel and other expenses
that they incur in attending Board meetings.
- Upon retirement, the independent trustees receive an aggregate annual fee
of $1,000 for each year served on the Board, up to fifteen years of
service. This annual fee is paid for ten years following retirement, or
until each Trustee's death.
"INTERESTED" TRUSTEES. Mr. Brennan serves as a Trustee, but is not paid in
this capacity. He is, however, paid in his role as officer of The Vanguard
Group, Inc.
COMPENSATION TABLE. The following table provides compensation details for
each of the trustees. We list the amounts paid as compensation and accrued as
retirement benefits by the Fund for each trustee. In addition, the table shows
the total amount of benefits that we expect each trustee to receive from all
Vanguard funds upon retirement, and the total amount of compensation paid to
each trustee by all Vanguard funds.
B-14
<PAGE>
VANGUARD EXPLORER FUND COMPENSATION TABLE
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
PENSION OR
RETIREMENT TOTAL
BENEFITS ACCRUED COMPENSATION
AGGREGATE AS PART OF THIS ESTIMATED ANNUAL FROM ALL VANGUARD
COMPENSATION FUND'S BENEFITS UPON FUNDS PAID TO
NAMES OF TRUSTEES FROM THIS FUND(1) EXPENSES(1) RETIREMENT TRUSTEES(2)
----------------------------------------------------------------------------------------------------
John C. Bogle(3) None None None None
John J. Brennan None None None None
Barbara Barnes
Hauptfuhrer(3) $. $. $15,000 $0
JoAnn Heffernan Heisen $. $. $15,000 $80,000
Bruce K. MacLaury $. $. $12,000 $75,000
Burton G. Malkiel $. $. $15,000 $80,000
Alfred M. Rankin, Jr. $. $. $15,000 $80,000
James O. Welch, Jr. $. $. $15,000 $80,000
J. Lawrence Wilson $. $. $15,000 $80,000
</TABLE>
---------
(1) The amounts shown in this column are based on the Fund's fiscal year ended
October 31, 2000.
(2) The amounts reported in this column reflect the total compensation paid to
each trustee for his or her service as trustee of 109 Vanguard funds (108
in the case of Mr. Malkiel; 99 in the case of Mr. MacLaury).
(3) Mr. Bogle and Mrs. Hauptfuhrer have retired from the funds' Board,
effective December 31, 1999 and December 31, 1998, respectively.
INVESTMENT ADVISORY SERVICES
The Fund currently employs five 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, Wellington
Management Company, LLP was sole investment adviser to the Fund (then known
simply as Explorer Fund), and Granahan Investment Management, Inc. served as
sole investment adviser to Explorer II, the acquired Fund. Chartwell Investment
Partners and Vanguard were added as advisers on August 1, 1997, and Grantham,
Mayo, Van Otterloo & Co. LLC was added on April 3, 2000.
The proportion of the net assets of the Fund managed by each adviser was
established by the board of trustees and may be changed in the future by the
board of trustees 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 trustees
monitors portfolio activity in order to minimize any possible adverse
consequences.
WELLINGTON MANAGEMENT COMPANY, LLP
The Fund has entered into an advisory agreement with Wellington Management
Company, LLP (Wellington Management) under which Wellington Management manages
the investment and reinvestment of a portion of the Fund's assets (the
Wellington Management Portfolio) and continuously reviews, supervises and
administers the Fund's investment program with respect to those assets. As of
October 31, 2000, Wellington Management managed approximately .% of the Fund's
net assets. Wellington Management discharges its responsibilities subject to the
control of the officers and trustees of the Fund.
Wellington Management is a professional investment counseling firm which
globally provides investment services to investment companies and other
institutions. Wellington Management is a Massachusetts limited liability
partnership of which the following persons are managing partners: Laurie A.
Gabriel, Duncan M. McFarland, and John R. Ryan. Wellington Management and its
predecessor organizations have provided investment advisory services to
investment companies since 1928 and to investment counseling clients since 1960.
B-15
<PAGE>
Kenneth L. Abrams, Senior Vice President of Wellington Management, serves
as portfolio manager of the assets of the Fund assigned to Wellington
Management. Mr. Abrams has been employed by Wellington Management since 1986 and
has served as portfolio manager of the Fund since 1994.
The Fund pays Wellington Management a basic fee at the end of each of the
fund's fiscal quarters, calculated by applying a quarterly rate, based on the
following annual percentage rates, to the average month-end net assets of the
Wellington Management Portfolio for the quarter:
NET ASSETS RATE
---------- ----
First $500 million. . . . . . . . .250%
Next $250 million. . . . . . . . .200%
Next $250 million. . . . . . . . .150%
Assets in excess of $1 billion. . .100%
The basic fee, as provided above, shall be increased or decreased by
applying a performance fee adjustment based on the investment performance of the
Wellington Management Portfolio relative to the investment performance of the
Russell 2000 Growth Index (the Index). The investment performance of Wellington
Management Portfolio will be based on the cumulative return over a trailing
36-month period ending with the applicable quarter, relative to the cumulative
total return of the Index for the same period. The adjustment applies as
follows:
CUMULATIVE 36-MONTH PERFORMANCE PERFORMANCE FEE
VERSUS THE INDEX ADJUSTMENT*
---------------- ----------------
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 by -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
* For purposes of determining the fee adjustment calculation, the basic fee
is calculated by applying the quarterly rate against the net assets of the Fund
averaged over the same time period for which the performance is measured.
The Index will not be fully operable as the sole performance index used to
determine the adjustment until the quarter ending July 31, 2003. Until that
date, the adjustment will be determined by linking the investment performance of
the Index and that of the Small Company Growth Fund Stock Index (the "Prior
Index") as follows.
(A) QUARTER ENDING OCTOBER 31, 2000. The adjustment will be determined by
linking the investment performance of the Prior Index for the eleven quarters
ending July 31, 2000, with that of the Index for the quarter ending October 31,
2000.
(B) QUARTER ENDING JANUARY 31, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for the ten quarters
ending July 31, 2000, with that of the Index for the two quarters ending January
31, 2001.
(C) QUARTER ENDING APRIL 30, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for the nine quarters
ending July 31, 2000, with that of the Index for the three quarters ending April
30, 2001.
(D) QUARTER ENDING JULY 31, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for eight quarters ending
July 31, 2000, with that of the Index for the four quarters ending July 31,
2001.
(E) QUARTER ENDING OCTOBER 31, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for the seven quarters
ending July 31, 2000, with that of the Index for the five quarters ending
October 31, 2001.
B-16
<PAGE>
(F) QUARTER ENDING JANUARY 31, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for the six quarters
ending July 31, 2000, with that of the Index for the six quarters ending January
31, 2002.
(G) QUARTER ENDING APRIL 30, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for the five quarters
ending July 31, 2000, with that of the Index for the seven quarters ending April
30, 2002.
(H) QUARTER ENDING JULY 31, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for four quarters ending
July 31, 2000, with that of the Index for the eight quarters ending July 31,
2002.
(I) QUARTER ENDING OCTOBER 31, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for the three quarters
ending July 31, 2000, with that of the Index for the nine quarters ending
October 31, 2002.
(J) QUARTER ENDING JANUARY 31, 2003. The adjustment will be determined by
linking the investment performance of the Prior Index for the two quarters
ending July 31, 2000, with that of the Index for the ten quarters ending January
31, 2003.
(K) QUARTER ENDING APRIL 30, 2003. The adjustment will be determined by
linking the investment performance of the Prior Index for the one quarter ending
July 31, 2000, with that of the Index for the eleven quarters ending April 30,
2003.
(L) QUARTER ENDING JULY 31, 2003. The Index is fully operable.
The investment performance of the Wellington Management Portfolio for any
period, expressed as a percentage of the "Wellington Management Portfolio unit
value" per share at the beginning of such period, is the sum of: (i) the change
in the Wellington Management Portfolio's net assets value during such period;
(ii) the unit value of the Fund's cash distributions from the Wellington
Management Portfolio net investment income and realized net capital gains
(whether short or long 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 Wellington Management Portfolio. For this purpose, the unit
value of distributions per share of realized capital gains, of dividends per
share paid from investment income and of capital gains taxes per share paid or
payable on undistributed realized long-term capital gains taxes per share paid
or payable on undistributed realized long-term capital gains shall be treated as
reinvested in the Wellington Management Portfolio at the unit value in effect at
the close of business on the record date for the payment of such distributions
and dividends and the date on which provision is made for such taxes, after
giving effect to such distributions, dividends and taxes.
The Wellington Management Portfolio unit value is determined by dividing
the total net assets of the Wellington Management Portfolio by a given number of
units. Initially, the number of units in the Wellington Management Portfolio
will equal the total shares outstanding of the Fund on August 1, 2000.
Subsequently, as assets are added to or withdrawn from the Wellington Management
Portfolio, the number of units of the Wellington Management Portfolio will be
adjusted based on the unit value of the Wellington Management Portfolio on the
day such changes are executed. Any cash buffer maintained by the Fund outside of
the Wellington Management Portfolio shall neither be included in the total net
assets of the Wellington Management Portfolio nor included in the computation of
the Wellington Management Portfolio unit value.
The investment record of the Index for any period, expressed as a
percentage of the Index at the beginning of such period, will be the sum of (i)
the change in the level of the Index during such period and (ii) the value,
computed consistently with the Index, of cash distributions having an
ex-dividend date occurring within such period made by companies whose securities
comprise the Index. For this purpose, cash distributions on the securities which
comprise the Index will be treated as reinvested in the Index at least as
frequently as the end of each calendar quarter following the payment of the
dividend. The calculation will be gross of applicable costs and expenses.
During the fiscal years ended October 31, 1998, 1999, and 2000, the Fund
paid Wellington Management the following advisory fees:
B-17
<PAGE>
1998 1999 2000
Basic Fee $1,647,928 $1,588,542 $.
Increase/(Decrease) for Performance Adjustment (288,253) 659,915 .
--------- ------- ----
Total $1,359,675 $2,248,457 $.
========== ======== =====
GRANAHAN INVESTMENT MANAGEMENT, INC.
On February 28, 1990, effective with the acquisition of the assets of Explorer
II, the Fund retained Granahan Investment Management, Inc. (Granahan) as a
second investment adviser. Under its advisory agreement with the Fund, Granahan
manages the investment and reinvestment of a portion of the Fund's assets (the
Granahan Portfolio) and continuously reviews, supervises, and administers the
Fund's investment program with respect to those assets. As of October 31, 2000,
Granahan managed approximately .% of the Fund's net assets. Granahan discharges
its responsibilities subject to the control of the officers and trustees 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.
The Fund pays Granahan a basic fee at the end of each of the Fund's fiscal
quarters, 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:
NET ASSETS RATE
---------- ----
First $500 million. . . . . . . . .300%
Next $250 million. . . . . . . . .200%
Next $250 million. . . . . . . . .150%
Assets in excess of $1 billion. . .100%
The basic fee, as provided above, will be increased or decreased by
applying a performance fee adjustment based on the investment performance of the
Granahan Portfolio relative to the investment performance of the Russell 2000
Growth Index (the Index). The investment performance of the Granahan Portfolio
will be based on the cumulative return over a trailing 36-month period ending
with the applicable quarter, relative to the cumulative total return of the
Index for the same time period. The adjustment applies as follows:
CUMULATIVE 36-MONTH PERFORMANCE PERFORMANCE FEE
DIFFERENTIAL VERSUS THE INDEX ADJUSTMENT*
----------------------------- -----------
Trails by -12% or more. . . . Decrease by .01875%
Trails by more than -6% up to -12% Decrease by .009375%
Trails/exceeds from -6% through 6% No Adjustment
Exceeds by more than 6% but less than 12% Increase by .009375%
Exceeds by 12% or more. . . . Increase by .01875%
*For purposes of determining the fee adjustment calculation, the basic fee
is calculated by applying the quarterly rate against the net assets of the Fund
averaged over the same time period for which the performance is measured.
The investment performance of the Granahan Portfolio for any period,
expressed as a percentage of the "Granahan Portfolio unit value" per share at
the beginning of such period, is the sum of: (i) the change in the Granahan
Portfolio net asset 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 short or long 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. For this purpose,
the unit value of distributions per share of realized capital gains, of
dividends per share paid from investment income and of capital gains taxes per
share paid or payable on undistributed realized long-term
B-18
<PAGE>
capital gains shall be treated as reinvested in the Granahan Portfolio at the
unit value in effect at the close of business on the record date for the payment
of such distributions and dividends and the date on which provision is made for
such taxes, after giving effect to such distributions, dividends and taxes.
The Granahan Portfolio unit value will be determined by dividing the total
net assets of the Granahan Portfolio by a given number of units. Initially, the
number of units in the Granahan Portfolio will equal the total shares
outstanding of the Fund on August 1, 2000. Subsequently, as assets are added to
or withdrawn from the Granahan Portfolio, the number of units of the Granahan
Portfolio will be adjusted based on the unit value of the Granahan Portfolio on
the day such changes are executed. Any cash buffer maintained by the Fund
outside of the Granahan Portfolio shall neither be included in the total net
assets of the Granahan Portfolio nor included in the computation of the Granahan
Portfolio unit value.
The investment record of the Index for any period, expressed as a
percentage of the Index at the beginning of such period, will be the sum of (i)
the change in the level of the Index during such period and (ii) the value,
computed consistently with the Index , of cash distributions having an
ex-dividend date occurring within such period made by companies whose securities
comprise the Index. For this purpose, cash distributions on the securities which
comprise the Index will be treated as reinvested in the Index at least as
frequently as the end of each calendar quarter following the payment of the
dividend. The calculation will be gross of applicable costs and expenses.
The Index will not be fully operable as the sole performance index used to
determine Granahan's performance fee adjustment until the quarter ending July
31, 2003. Until that date, Granahan's performance fee adjustment shall be
determined by linking the investment performance of the Index and that of the
Small Company Growth Fund Stock Index (the Prior Index) as follows:
(A) QUARTER ENDED OCTOBER 31, 2000. Granahan's performance fee adjustment
was determined by linking the investment performance of the Prior Index for the
eleven quarters ended July 31, 2000 with that of the Index for the quarter ended
October 31, 2000.
(B) QUARTER ENDED JANUARY 31, 2001. Granahan's performance fee adjustment
was determined by linking the investment performance of the Prior Index for the
ten quarters ended July 31, 2000 with that of the Index for the two quarters
ended January 31, 2001.
(C) QUARTER ENDED APRIL 30, 2001. Granahan's performance fee adjustment was
determined by linking the investment performance of the Prior Index for the nine
quarters ended July 31, 2000 with that of the Index for the three quarters ended
April 30, 2001.
(D) QUARTER ENDED JULY 31, 2001. Granahan's performance fee adjustment was
determined by linking the investment performance of the Prior Index for the
eight quarters ended July 31, 2000 with that of the Index for the four quarters
ended July 31, 2001.
(E) QUARTER ENDED OCTOBER 31, 2001. Granahan's performance fee adjustment
was determined by linking the investment performance of the Prior Index for the
seven quarters ended July 31, 2000 with that of the Index for the five quarters
ended October 31, 2001.
(F) QUARTER ENDED JANUARY 31, 2002. Granahan's performance fee adjustment
was determined by linking the investment performance of the Prior Index for the
six quarters ended July 31, 2000 with that of the Index for the six quarters
ended January 31, 2002.
(G) QUARTER ENDED APRIL 30, 2002. Granahan's performance fee adjustment was
determined by linking the investment performance of the Prior Index for the five
quarters ended July 31, 2000 with that of the Index for the seven quarters ended
April 30, 2002.
(H) QUARTER ENDED JULY 31, 2002. Granahan's performance fee adjustment was
determined by linking the investment performance of the Prior Index for the four
quarters ended July 31, 2000 with that of the Index for the eight quarters ended
July 31, 2002.
(I) QUARTER ENDED OCTOBER 31, 2002. Granahan's performance fee adjustment
was determined by linking the investment performance of the Prior Index for the
three quarters ended July 31, 2000 with that of the Index for the nine quarters
ended October 31, 2002.
B-19
<PAGE>
(J) QUARTER ENDED JANUARY 31, 2003. Granahan's performance fee adjustment
was determined by linking the investment performance of the Prior Index for the
two quarters ended July 31, 2000 with that of the Index for the ten quarters
ended January 31, 2003.
(K) QUARTER ENDED APRIL 30, 2003. Granahan's performance fee adjustment
shall be determined by linking the investment performance of the Prior Index for
the one quarter ended July 31, 2000 with that of the Index for the eleven
quarters ended April 30, 2003.
(L) QUARTER ENDING JULY 31, 2003. The Index shall be fully operable.
During the fiscal years ended October 31, 1998, 1999, and 2000, the Fund
paid Granahan the following advisory fees:
1998 1999 2000
Basic Fee $2,508,538 $2,476,006 $.
Increase/(Decrease) for Performance Adjustment (479,000) 0 .
----------- ----------- ------
Total $2,029,538 $2,476,006 $.
=========== =========== ======
CHARTWELL INVESTMENT PARTNERS
The Fund also employs Chartwell Investment Partners (Chartwell) under an
investment advisory agreement to manage the investment and reinvestment of a
portion of the Fund's assets (the Chartwell Portfolio). As of October 31, 2000,
Chartwell managed approximately .% of the Fund's assets. Chartwell discharges
its responsibilities subject to the control of the officers and trustees 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:
NET ASSETS RATE
---------- ----
First $250 million. . . . . . . . 0.40%
Next $250 million. . . . . . . . 0.30%
Assets in excess of $500 million. 0.20%
The basic fee, as provided above, will be increased or decreased by
applying a performance fee adjustment based on the investment performance of the
Chartwell Portfolio relative to the investment performance of the Russell 2000
Growth Index (the Index). The investment performance of the Chartwell Portfolio
will be based on the cumulative total return of the Index for the same time
period. The adjustment applies as follows:
THREE-YEAR CUMULATIVE PERFORMANCE PERFORMANCE FEE
DIFFERENTIAL VERSUS THE INDEX ADJUSTMENT*
----------------------------- -----------
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% or more. . . . +0.20 X Basic Fee
* For purposes of determining the fee adjustment calculation, the basic fee
is calculated by applying the quarterly rate against the net assets of the Fund
averaged over the same time period for which the performance is measured.
The Index will not be fully operable as the sole performance index used to
determine the adjustment until the quarter ending July 31, 2003. Until that
date, the adjustment will be determined by linking the investment performance of
the Index and that of the Small Company Growth Fund Stock Index (the Prior
Index) as follows:
B-20
<PAGE>
(A) QUARTER ENDING OCTOBER 31, 2000. The adjustment will be determined by
linking the investment performance of the Prior Index for the eleven quarters
ending July 31, 2000, with that of the Index for the one quarter ending October
31, 2000.
(B) QUARTER ENDING JANUARY 31, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for the ten quarters
ending July 31, 2000, with that of the Index for the two quarters ending January
31, 2001.
(C) QUARTER ENDING APRIL 30, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for the nine quarters
ending July 31, 2000, with that of the Index for the three quarters ending April
30, 2001.
(D) QUARTER ENDING JULY 31, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for eight quarters ending
July 31, 2000, with that of the Index for the four quarters ending July 31,
2001.
(E) QUARTER ENDING OCTOBER 31, 2001. The adjustment will be determined by
linking the investment performance of the Prior Index for the seven quarters
ending July 31, 2000, with that of the Index for the five quarters ending
October 31, 2001.
(F) QUARTER ENDING JANUARY 31, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for the six quarters
ending July 31, 2000, with that of the Index for the six quarters ending January
31, 2002.
(G) QUARTER ENDING APRIL 30, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for the five quarters
ending July 31, 2000, with that of the Index for the seven quarters ending April
30, 2002.
(H) QUARTER ENDING JULY 31, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for four quarters ending
July 31, 2000, with that of the Index for the eight quarters ending July 31,
2002.
(I) QUARTER ENDING OCTOBER 31, 2002. The adjustment will be determined by
linking the investment performance of the Prior Index for the three quarters
ending July 31, 2000, with that of the Index for the nine quarters ending
October 31, 2002.
(J) QUARTER ENDING JANUARY 31, 2003. The adjustment will be determined by
linking the investment performance of the Prior Index for the two quarters
ending July 31, 2000, with that of the Index for the ten quarters ending January
31, 2003.
(K) QUARTER ENDING APRIL 30, 2003. The adjustment will be determined by
linking the investment performance of the Prior Index for the one quarter ending
July 31, 2000, with that of the Index for the eleven quarters ending April 30,
2003.
(L) QUARTER ENDING JULY 31, 2003. The Index is fully operable.
The investment performance of the Chartwell Portfolio, for any period,
expressed as a percentage of the "Chartwell Portfolio unit value" at the
beginning of such period, will be the sum of: (i) the change in the Chartwell
Portfolio's net asset value during such period; (ii) the unit value of the
Fund's cash distributions from Chartwell Portfolio's net investment income and
realized net capital gains (whether short or long 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
by the Chartwell Portfolio. For this purpose, the unit value of distributions
per share of realized capital gains, of dividends per share paid from investment
income and of capital gains taxes per share paid or payable on undistributed
realized long-term capital gains shall be treated as reinvested in the Chartwell
Portfolio at the unit value in effect at the close of business on the record
date for the payment of such distributions and dividends and the date on which
provision is made for such taxes, after giving effect to such distributions,
dividends and taxes.
The Chartwell Portfolio unit value will be determined by dividing the total
net assets of the Chartwell Portfolio by a given number of units. Initially, the
number of units in the Chartwell Portfolio will equal the total shares
outstanding of the Fund on August 1, 2000. Subsequently as assets are added to
or withdrawn from the
B-21
<PAGE>
Chartwell Portfolio, the number of units of the Chartwell Portfolio will be
adjusted based on the unit value of the Chartwell Portfolio on the day such
changes are executed. Any cash buffer maintained by the Fund outside of the
Chartwell Portfolio shall neither be included in the total net assets of the
Chartwell Portfolio nor included in the computation of the Chartwell Portfolio
unit value.
The investment record of the Index for any period, expressed as a
percentage of the Index at the beginning of such period, will be the sum of: (i)
the change in the level of the Index during the period; (ii) the value, computed
consistently with the Index, of cash distributions having an exdividend date
occurring within the period made by companies whose securities comprise the
Index will be treated as reinvested in the Index at least as frequently as the
end of each calendar quarter following the payment of the dividend. The
calculation will be gross of applicable costs and expenses.
For the fiscal years ended October 31, 1998, 1999, and 2000, the Fund paid
Chartwell the following advisory fees:
1998 1999 2000
Basic Fee $952,259 $1,042,721 $.
Increase/(Decrease) for Performance Adjustment (71,146) 70,879 .
--------- ------------ ------
Total $881,113 $1,113,600 $.
========= ============ ======
GRANTHAM, MAYO, VAN OTTERLOO & CO. LLC
The Fund also employs Grantham, Mayo, Van Otterloo & Co. LLC (GMO) under an
investment advisory agreement to manage the investment and reinvestment of a
portion of the Fund's assets (the GMO Portfolio). GMO discharges its
responsibilities subject to the control of the officers and trustees of the
Fund.
The Fund pays GMO 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 GMO Portfolio for the quarter:
NET ASSETS RATE
---------- ----
First $500 million. . . . . . . . 0.275%
Next $500 million. . . . . . . . 0.225%
Assets in excess of $1 billion. . 0.200%
Subject to the transition rule described below, the basic fee, as provided
above, will be increased or decreased by the amount of a Performance Fee
Adjustment ("Adjustment"). The Adjustment will be calculated as a percentage of
the average net assets managed by GMO for the 36-month period ending with the
then-ended quarter, and the Adjustment will change proportionately with the
investment performance of the GMO Portfolio relative to the investment
performance of the Russell 2000 Growth Index (the "Index") for the same period.
The Adjustment is computed as follows:
CUMULATIVE 36-MONTH PERFORMANCE ADJUSTMENT AS A PERCENTAGE
VERSUS THE INDEX OF AVERAGE ASSETS*
---------------- ------------------
Trails by any amount. . -0.15%
Equals-to-exceeds by up to 3%. Linear decrease from 0% to -0.15%
Exceeds by 3% to 6%. . . Linear increase from 0% to +0.15%
Exceeds by more than 6%. +0.15%
*For purposes of this calculation, the Adjustment is calculated by applying the
quarterly rate against the net assets of the GMO Portfolio over the same time
period for which the performance is measured.
B-22
<PAGE>
The Adjustment will not be fully operable until the close of the quarter
ending April 30, 2003. Until that time, the following transition rules will
apply:
(A) APRIL 3, 2000 THROUGH JANUARY 31, 2001. GMO's compensation will be the
Basic Fee. No Adjustment will apply during this period.
(B) FEBRUARY 1, 2001 THROUGH APRIL 30, 2003. Beginning February 1, 2001,
the Adjustment will take effect on a progressive basis with regards to the
number of months elapsed between May 1, 2000, and the quarter for which GMO's
fee is being computed. During this period, the Adjustment that has been
determined as provided above will be multiplied by a fraction. The fraction's
numerator will equal the number of months elapsed since May 1, 2000 and the
denominator will be thirty-six (36).
(C) ON AND AFTER MAY 1, 2003. Commencing May 1, 2003, the Adjustment will
be fully operable.
The investment performance of the GMO Portfolio for any period, expressed
as a percentage of the "GMO Portfolio unit value" at the beginning of such
period will be the sum of: (i) the change in the GMO Portfolio unit value during
such period; (ii) the unit value of the Fund's cash distributions from the GMO
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 capital gains taxes paid or accrued during
such period by the Fund for undistributed realized long-term capital gains
realized from the GMO Portfolio.
The "GMO Portfolio unit value" will be determined by dividing the total net
assets of the GMO Portfolio by a given number of units. Initially, the number of
units in the GMO Portfolio will equal a nominal value as determined by dividing
initial assets by a unit value of $100.00 on April 3, 2000. Subsequently, as
assets are added to or withdrawn from the GMO Portfolio, the number of units of
the GMO Portfolio will be adjusted based on the unit value of the GMO Portfolio
on the day such changes are executed. Any cash buffer maintained by the Fund
outside of the GMO Portfolio shall neither be included in the total net assets
of the GMO Portfolio nor included in the computation of the "GMO portfolio unit
value."
The investment record of the Index for any period, expressed as a
percentage of the Index at the beginning of such period, shall be the sum of:
(i) the change in the level of the Index during such period, and (ii) the value,
computed consistently with the Index, of cash distributions having an
ex-dividend date occurring within such period made by companies whose securities
comprise the Index. For this purpose, cash distributions on the securities which
comprise the Index shall be treated as reinvested in the Index at least as
frequently as the end of each calendar quarter following the payment of the
dividend.
THE VANGUARD GROUP, INC.
Vanguard's Quantitative Equity Group provides investment advisory services on an
at-cost basis with respect to .% (as of October 31, 2000) of Vanguard Explorer
Fund's assets, and any cash reserves held by the Fund (.% as of October 31,
2000). Vanguard's Quantitative Equity Group is supervised by the officers of the
funds.
For the fiscal years ended October 31, 1998, 1999, and 2000, the Fund
incurred expenses for investment advisory services provided by Vanguard in the
following approximate amounts: $38,000, $170,000, and $., respectively.
DURATION AND TERMINATION OF INVESTMENT ADVISORY AGREEMENTS
The Fund's current agreements with Wellington Management, Granahan, Chartwell,
GMO, and Vanguard are renewable for successive one year periods, only if (1)
each renewal is specifically approved by a vote of the Fund's board of trustees,
including the affirmative votes of a majority of the trustees who are not
parties to the agreement or "interested persons" (as defined in the 1940 Act) of
any such party, cast in person at a meeting called for the purpose of
considering such approval or (2) each renewal is specifically approved by a vote
of a majority of the Fund's outstanding voting securities. An agreement is
automatically terminated if assigned, and may be terminated without penalty at
any time (1) either by vote of the board of trustees of the Fund on 60 days'
written notice to an adviser, (2) by a vote of a majority of the Fund's
outstanding voting securities, or (3) by an adviser upon 90 days' written notice
to the Fund.
B-23
<PAGE>
PORTFOLIO TRANSACTIONS
The Advisers are authorized (with the approval of the Fund's board of trustees)
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 the best available price and most favorable execution. The
full range and quality of brokerage services available will be considered in
making these determinations. In those instances where it is reasonably
determined that more than one broker can offer the brokerage services needed to
obtain the best available price and most favorable execution, consideration may
be given to those brokers which supply investment research and statistical
information and provide other services in addition to execution services to the
Fund and/or 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 trustees, the Advisers may cause the Fund to pay
a broker-dealer which furnishes 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 generally will not pay higher
commission rates specifically for the purpose of obtaining research services.
During the fiscal years ended October 31, 1998, 1999, and 2000, the Fund
paid $3,023,496, $3,178,526, and $5,747,752 in brokerage commissions,
respectively.
Some securities considered for investment by the Fund may also be
appropriate for other Vanguard funds and/or clients served by each Adviser. 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. Although there may be no specified formula for allocating such
transactions, the allocation methods used, and the results of such allocations,
will be subject to periodic review by the Fund's board of trustees.
COMPARATIVE INDEXES
Each of the investment company members of the Group, including Vanguard Explorer
Fund, may from time to time use one or more of the following unmanaged indexes
for comparative performance purposes:
SMALL COMPANY GROWTH FUND STOCK INDEX--is composed of the various domestic
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. determines the composition of the Index and
Vestek Systems calculates the monthly total return. Neither The Vanguard Group,
Inc., Wellington Management, Granahan, nor Chartwell are affiliated with
Morningstar or Vestek Systems in any way.
STANDARD & POOR'S 500 COMPOSITE STOCK PRICE INDEX--includes stocks selected by
Standard & Poor's Index Committee to include leading companies in leading
industries and to reflect the U.S. stock market.
STANDARD & POOR'S MIDCAP 400 INDEX--is composed of 400 medium sized domestic
stocks.
B-24
<PAGE>
STANDARD & POOR'S 500/BARRA VALUE INDEX--consists of the stocks in the Standard
and Poor's 500 Composite Stock Price Index (S&P 500) with the lowest
price-to-book ratios, comprising 50% of the market capitalization of the S&P
500.
STANDARD & POOR'S SMALLCAP 600/BARRA VALUE INDEX--contains stocks of the S&P
SmallCap 600 Index which have a lower than average price-to-book ratio.
STANDARD & POOR'S SMALLCAP 600/BARRA GROWTH INDEX--contains stocks of the S&P
SmallCap 600 Index which have a higher than average price-to-book ratio.
RUSSELL 1000 VALUE INDEX--consists of the stocks in the Russell 1000 Index
(comprising the 1,000 largest U.S.-based companies measured by total market
capitalization) with the lowest price-to-book ratios, comprising 50% of the
market capitalization of the Russell 1000.
WILSHIRE 5000 TOTAL MARKET 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 COMPLETION INDEX--consists of all stocks in the Wilshire 5000
except for the 500 stocks in the Standard & Poor's 500 Index.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX--is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia, Asia, 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 BROTHERS LONG-TERM TREASURY BOND INDEX--is a market weighted index that
contains individually priced U.S. Treasury securities with maturities of ten
years or greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND INDEX--consists of over 4,500 U.S.
Treasury, agency, and investment grade corporate bonds.
LEHMAN BROTHERS CORPORATE (BAA) BOND INDEX--all publicly offered fixed rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than one year and with more than $100 million outstanding. This index
includes over 1,500 issues.
LEHMAN BROTHERS LONG-TERM CORPORATE BOND INDEX--is a subset of the Lehman
Brothers Corporate Bond Index covering all corporate, publicly issued,
fixed-rate, nonconvertible U.S. debt issues rated at least Baa, with at least
$100 million principal outstanding and maturity greater than ten 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.
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 Brothers
Long-Term Corporate AA or Better Bond Index.
COMPOSITE INDEX--65% Lehman Brothers Long-Term Corporate AA or Better Bond Index
and a 35% weighting in a blended equity composite (75% Standard & Poor's/BARRA
Value Index, 12.5% Standard & Poor's Utilities Index, and 12.5% Standard &
Poor's Telephone Index).
B-25
<PAGE>
LEHMAN BROTHERS 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
$5 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 one and five years. The index has a market value of over $1.6 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 five and
ten years. The index has a market value of over $800 billion.
LEHMAN BROTHERS 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 ten years. The
index has a market value of over $1.1 trillion.
LIPPER SMALL COMPANY GROWTH FUND AVERAGE--the average performance of small
company growth funds as defined by Lipper 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 GROWTH INDEX--contains stocks from the Russell 2000 Index with a
better-than-average growth orientation.
RUSSELL 2000 STOCK INDEX--is composed of approximately 2,000 small
capitalization stocks.
LIPPER BALANCED FUND AVERAGE--an industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper 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 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 Inc.
LIPPER GENERAL EQUITY FUND AVERAGE--an industry benchmark of average general
equity funds with similar investment objectives and policies, as measured by
Lipper Inc.
LIPPER FIXED INCOME FUND AVERAGE--an industry benchmark of average fixed income
funds with similar investment objectives and policies, as measured by Lipper
Inc.
FINANCIAL STATEMENTS
The Fund's audited Financial Statements for the year ended October 31, 2000,
including the financial highlights for each of the five fiscal years in the
period ended October 31, 2000, appearing in the Vanguard Explorer Fund 2000
Annual Report to Shareholders, and the report thereon of PricewaterhouseCoopers
LLP, independent accountants, also appearing therein, are incorporated by
reference in this Statement of Additional Information. For a more complete
discussion of the performance, please see the Fund's Annual Report to
Shareholders, which may be obtained without charge.
B-26
<PAGE>
SAI024-022001
B-27
<PAGE>
PART C
VANGUARD EXPLORER FUND
OTHER INFORMATION
ITEM 23. EXHIBITS
(a) Declaration of Trust**
(b) By-Laws**
(c) Reference is made to Articles III and V of the Registrant's Declaration
of Trust
(d) Investment Advisory Contracts+
(e) Not applicable
(f) Reference is made to the section entitled "Management of the Fund" in the
Registrant's Statement of Additional Information
(g) Custodian Agreements**
(h) Amended and Restated Funds' Service Agreement**
(i) Legal Opinion**
(j) Consent of Independent Accountants*
(k) Not Applicable
(l) Not Applicable
(m) Not Applicable
(n) Not Applicable
(o) Not Applicable
(p) Codes of Ethics**
---------
** To be filed by amendment
** Filed previously
+ Filed herewith for Wellington Management Company, Granahan Investment
Management, and Chartwell Investment Partners; filed previously for Grantham,
Mayo, Van Otterloo & Co. LLC.
ITEM 24. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT
Registrant is not controlled by or under common control with any person.
ITEM 25. INDEMNIFICATION
The Registrant's organizational documents contain provisions indemnifying
Trustees and officers against liability incurred in their official capacity.
Article VII, Section 2 of the Declaration of Trust provides that the Registrant
may indemnify and hold harmless each and every Trustee and officer from and
against any and all claims, demands, costs, losses, expenses, and damages
whatsoever arising out of or related to the performance of his or her duties as
a Trustee or officer. However, this provision does not cover any liability to
which a Trustee or officer would otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence, or reckless disregard of the duties
involved in the conduct of his or her office. Article VI of the By-Laws
generally provides that the Registrant shall indemnify its Trustees and officers
from any liability arising out of their past or present service in that
capacity. Among other things, this provision excludes any liability arising by
reason of willful misfeasance, bad faith, gross negligence, or the reckless
disregard of the duties involved in the conduct of the Trustee's or officer's
office with the Registrant.
C-1
<PAGE>
ITEM 26. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
Wellington Management Company, LLP (Wellington Management) is an investment
adviser registered under the Investment Advisers Act of 1940, as amended (the
Advisers Act). The list required by this Item 26 of officers and partners of
Wellington Management, together with any information as to any business
profession, vocation, or employment of a substantial nature engaged in by such
officers and partners during the past two years, is incorporated herein by
reference from Schedules B and D of Form ADV filed by Wellington Management
pursuant to the Advisers Act (SEC File No. 801-15908).
Granahan Investment Management, Inc. (Granahan) is an investment adviser
registered under the Advisers Act. The list required by this Item 26 of officers
and directors of Granahan, together with any information as to any business
profession, vocation, or employment of a substantial nature engaged in by such
officers and directors during the past two years, is incorporated herein by
reference from Schedules B and D of Form ADV filed by Granahan pursuant to the
Advisers Act (SEC File No. 801-23705).
Chartwell Investment Partners (Chartwell) is an investment adviser
registered under the Advisers Act. The list required by this Item 26 of officers
and partners of Chartwell, together with any information as to any business
profession, vocation, or employment of a substantial nature engaged in by such
officers and partners during the past two years, is incorporated herein by
reference from Schedules B and D of Form ADV filed by Chartwell pursuant to the
Advisers Act (SEC File No. 801-54124).
The Vanguard Group, Inc. (Vanguard) is an investment adviser registered
under the Advisers Act. The list required by this Item 26 of officers and
directors of Vanguard, together with any information as to any business
profession, vocation, or employment of a substantial nature engaged in by such
officers and directors during the past two years, is incorporated herein by
reference from Schedules B and D of Form ADV filed by Vanguard pursuant to the
Advisers Act (SEC File No. 801-11953).
Grantham, Mayo, Van Otterloo & Co. LLC (GMO) is an investment adviser
registered under the Advisers Act. The list required by this Item 26 of officers
and directors of GMO, together with any information as to any business
profession, vocation, or employment of a substantial nature engaged in by such
officers and directors during the past two years, is incorporated herein by
reference from Schedules B and D of Form ADV filed by GMO pursuant to the
Advisers Act (SEC File No. 801-15028).
ITEM 27. PRINCIPAL UNDERWRITERS
(a) Not Applicable
(b) Not Applicable
(c) Not Applicable
ITEM 28. LOCATION OF ACCOUNTS AND RECORDS
The books, accounts, and other documents required to be maintained by Section 31
(a) of the Investment Company Act and the rules promulgated thereunder will be
maintained at the offices of Registrant; Registrant's Transfer Agent, The
Vanguard Group, Inc., 100 Vanguard Boulevard, Malvern, Pennsylvania 19355; and
the Registrant's Custodian, State Street Bank and Trust Company, 225 Franklin
Street, Boston, Massachusetts 02110.
ITEM 29. MANAGEMENT SERVICES
Other than as set forth under the description of The Vanguard Group in Part B of
this Registration Statement, the Registrant is not a party to any
management-related service contract.
ITEM 30. UNDERTAKINGS
Not Applicable
C-2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the Investment
Company Act of 1940, the Registrant hereby certifies that it has duly caused
this Post-Effective Amendment to this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the Town of Valley
Forge and the Commonwealth of Pennsylvania, on the 29th day of December, 2000.
VANGUARD EXPLORER FUND
BY:_____________(signature)________________
(HEIDI STAM) JOHN J. BRENNAN* CHAIRMAN AND
CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment to the Registration Statement has been signed below by
the following persons in the capacities and on the date indicated:
By:/S/ JOHN J. BRENNAN President, Chairman, Chief December 29, 2000
---------------------------Executive Officer, and Trustee
(Heidi Stam)
John J. Brennan*
By:/S/ JOANN HEFFERNAN HEISEN Trustee December 29, 2000
---------------------------
(Heidi Stam)
JoAnn Heffernan Heisen*
By:/S/ BRUCE K. MACLAURY Trustee December 29, 2000
---------------------------
(Heidi Stam)
Bruce K. MacLaury*
By:/S/ BURTON G. MALKIEL Trustee December 29, 2000
---------------------------
(Heidi Stam)
Burton G. Malkiel*
By:/S/ ALFRED M. RANKIN, JR. Trustee December 29, 2000
---------------------------
(Heidi Stam)
Alfred M. Rankin, Jr.*
By:/S/ JAMES O. WELCH, JR. Trustee December 29, 2000
---------------------------
(Heidi Stam)
James O. Welch, Jr.*
By:/S/ J. LAWRENCE WILSON Trustee December 29, 2000
---------------------------
(Heidi Stam)
J. Lawrence Wilson*
By:/S/ THOMAS J. HIGGINS Treasurer and Principal December 29, 2000
---------------------------Financial Officer and Principal
(Heidi Stam) Accounting Officer
Thomas J. Higgins*
*By Power of Attorney. See File Number 33-4424, filed on January 25, 1999.
Incorporated by Reference.
<PAGE>
INDEX TO EXHIBITS
Investment Advisory Contracts. . . . . . . . . . . . . . Ex-99.BD