<PAGE> 1
VANGUARD
U.S. GROWTH
PORTFOLIO
Annual Report
August 31, 1996
THE VANGUARD GROUP:
LINKING TRADITION
AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our
course toward the twenty-first century. Our Report cover reflects that blending
of tradition and innovation, of past, present, and future.
The montage includes a bronze medallion with a likeness of our namesake, HMS
Vanguard (Lord Nelson's flagship at The Battle of the Nile); a clock built
circa 1816 in Scotland, featuring a portrait of Nelson (who is also shown,
accepting a surrender, in a detail from a nineteenth-century engraving); and
several views of our recently completed campus, which is steeped in nautical
imagery--from our buildings named after Nelson's warships (Victory, Majestic,
and Goliath are three shown), to our artwork and ornamental compass rose.
[FIGURE 1]
<PAGE> 2
[FIGURE 2]
VANGUARD HAS ALWAYS STRIVED TO BE THE STANDARD-BEARER for mutual fund
disclosure, going well beyond the "letter of the law" in our
shareholder communications. During the past year, we raised the
standard once again by rewriting and reformatting our Fund
prospectuses. They are designed to ensure that prospective investors
fully understand, before they make an investment, each Fund's
investment strategies, risks, and costs. Our Annual Reports to
shareholders, in turn, provide a comprehensive discussion and analysis
of the year's results in the context of each Fund's investment
objectives and policies. Since Vanguard has long been recognized for
the quality and content of these Fund Reports, our overriding
objective was to maintain the spirit and character of the previous
Reports, while adding information to assist shareholders in
understanding the investment characteristics of their Fund.
THE NEW FUND REPORTS INCLUDE A MESSAGE TO SHAREHOLDERS from Chairman John C.
Bogle and President John J. Brennan. This Message continues to provide
a candid assessment of the Fund's performance relative to an
appropriate unmanaged market benchmark and a peer group of mutual
funds with similar investment policies. It also reviews the principal
factors contributing to--and detracting from--the returns earned by
the Fund. To help you evaluate your Fund's current-year performance,
the Message includes a discussion of the Fund's long-term investment
results, as well as a look ahead to the prospects for the coming year.
A recap of the financial markets, which had been included as part of
the Chairman's letter, now appears in The Markets In Perspective. This
overview covers the world's financial markets, putting the results of
the Fund's strategy in a global perspective.
THE PORTFOLIO PROFILE REPRESENTS AN ADDITION TO OUR FUND REPORTS. In this day
and age, many investors use detailed statistical information to
evaluate their mutual fund holdings, and our new Portfolio Profile
furnishes shareholders with comprehensive data on key
characteristics--sector diversification, volatility, top-ten holdings,
among others--that ultimately define how a Fund is likely to perform
in various market environments. For this information to be used
effectively, we include a brief description of the profiled
characteristics. The Report From The Adviser (for our traditionally
managed Funds) now covers specific topics that we have defined as
being the important ones for the adviser to address--and we do our
best to ensure that this Report is written in the same simple and
candid manner that characterizes all Vanguard communications. Finally,
each Adviser's Report will include an inset reminder of the adviser's
basic investment philosophy.
WE TRUST THAT THIS REDESIGNED FUND REPORT will continue to meet your need for a
fair, candid, and clear presentation of your Fund's investment results
and a thorough portfolio review. We welcome any comments that you
might have at any time regarding these Reports.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
3
Report From
The Adviser
5
Performance
Summary
7
Portfolio
Profile
8
Financial
Statements
10
Report of
Independent
Accountants
16
Directors and
Officers
INSIDE BACK COVER
<PAGE> 3
[PHOTO]
JOHN C. BOGLE
Chairman of the Board
[PHOTO]
JOHN J. BRENNAN
President
FELLOW SHAREHOLDER,
Vanguard U.S. Growth Portfolio's fiscal year ended August 31, 1996, was
a terrific period for common stocks and an even better one for our Portfolio,
which garnered a total return of +25.3%. As the economy maintained a
near-perfect balance between moderate growth and low inflation, the stock
market climbed steadily higher, with a few modest interim setbacks.
The following table presents the 1996 fiscal-year total return (capital
change plus reinvested dividends) of the U.S. Growth Portfolio compared to
those of its two primary performance standards: the average growth mutual fund
and the unmanaged Standard & Poor's 500 Composite Stock Price Index. Our
Portfolio's return is based on an increase in net asset value from $18.83 per
share on August 31, 1995, to $22.62 per share on August 31, 1996, with the
ending net asset value adjusted for our annual dividend of $.29 per share paid
from net investment income and a distribution totaling $.57 per share paid from
net realized capital gains.
<TABLE>
<CAPTION>
- --------------------------------------------------------------
TOTAL RETURN
FISCAL YEAR ENDED
AUGUST 31, 1996
- --------------------------------------------------------------
<S> <C>
Vanguard U.S. Growth Portfolio +25.3%
- --------------------------------------------------------------
Average Growth Mutual Fund +12.7%
S&P 500 Index +18.7
- --------------------------------------------------------------
</TABLE>
FISCAL 1996 PERFORMANCE OVERVIEW
With large-capitalization blue-chip stocks leading the market advance during
the past twelve months, it is not surprising that the U.S. Growth Portfolio
counted itself among the performance leaders. Our fiscal-year return of +25.3%
was far above the +18.7% return of the S&P 500 Index and double the +12.7%
return of our peer group of growth funds.
Our margin over the Index was largely the result of our Adviser's
excellent selections of stocks across all market sectors. In particular, our
19% position in health-care stocks achieved an aggregate return of +47%,
compared to a return of +32% for this market-leading sector. Interestingly,
while the technology sector was a market laggard (+7%), our outsize 20%
commitment provided a solid return of +20%.
Our enormous advantage over the average growth fund is fairly easy to
quantify. In a nutshell, large-capitalization growth stocks were the market's
best investments during the past year. For its part, the Portfolio is a pure
growth fund, with large-capitalization stocks accounting for virtually 100% of
its equities. (Indeed, our median market capitalization of $32 billion is among
the largest of any mutual fund.) The typical growth mutual fund holds about
half its assets in medium- and small-cap stocks, and maintains (for whatever
reason) a blend of growth and value stocks. It is difficult to imagine a more
favorable environment for our Portfolio relative to its competitors.
LONG-TERM PERFORMANCE OVERVIEW
As we have often noted, while it is interesting to discuss our performance over
the past twelve months, we hope that shareholders have made a long-term
commitment to the Portfolio. In the nine years since Lincoln Capital Management
took over the reins of the
1
<PAGE> 4
Portfolio, it has achieved a fully satisfactory record of success, outpacing
the S&P 500 Index by about one percentage point annually and the average growth
mutual fund by more than two percentage points annually. (The Portfolio's
record over the past ten years is charted on page 7.) The table below
summarizes the nine-year results.
We are pleased--as we hope you are--with Lincoln Capital's record. Still,
a fund's past results are not necessarily a precursor to the future. While the
past two years have been an especially beneficent environment for the
Portfolio, there will inevitably be periods when the markets are less kind.
Indeed, as recently as fiscal 1993--when large growth stocks lagged the
market--our Portfolio experienced a particularly difficult year relative to the
broad stock market and to other growth funds. Come what may, you can be certain
that we will continue to adhere to the sound investment policies that have
served the Portfolio so well in the past.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
TOTAL RETURN*
9 YEARS ENDED AUGUST 31, 1996
--------------------------------------------
CUMULATIVE ANNUAL RATE
- ----------------------------------------------------------------------------------
<S> <C> <C>
Vanguard U.S. Growth Portfolio +183.2% +12.3%
- ----------------------------------------------------------------------------------
Average Growth Mutual Fund +135.2% +10.0%
S&P 500 Index +161.0 +11.2
- ----------------------------------------------------------------------------------
</TABLE>
*Assuming reinvestment of all dividends and distributions.
IN SUMMARY
Fiscal 1996 closes as the eighth consecutive year in which the U.S. Growth
Portfolio has enjoyed a positive rate of return. But bear in mind that "trees
don't grow to the sky," and there is no predicting whether or not a down year
lies ahead. (The Portfolio's last down year, fiscal 1988, saw a return of
- -22%.) That said, most of our shareholders have owned our shares for more than
two years. If you are among them, you have experienced a +54% return in fiscal
1995-1996 combined. In other words, each $1,000 invested two years ago is now
valued at $1,540. Truly, these have been good times for equity investors.
As we close this letter, you may be wondering how such glad tidings square
with the fairly sedate market returns so far in 1996. The reason is that
absolute returns in the market were much higher during our 1996 fiscal year
than in the first eight months of calendar 1996, which is the "year-to-date"
period for fund performance that most of the financial press emphasize.
The fact that a few months can mean the difference between a so-so year
and a great year should reinforce the need for investors to ignore year-to-year
gains and losses and focus instead on long-term results. With the stock market
again edging toward record highs as we write this letter, investors' commitment
to common stocks may well be tested in the months ahead.
Nonetheless, we would remind you of a statement we repeated in last year's
Annual Report: "The lowest risk and the highest reward--at least in the
past--have been achieved by investors who have 'stayed the course'" with a
sound investment approach that is consistent with their own financial
objectives. While near-term market risks abound, this advice seems as
appropriate today as it was then.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
- ----------------- -------------------
September 11, 1996
2
<PAGE> 5
THE MARKETS IN PERSPECTIVE
[FIGURE 3]
U.S. EQUITY AND BOND MARKETS
During the past twelve months, expectations about economic growth, inflation,
and Federal Reserve policy shifted markedly, generating some pronounced changes
in the U.S. equity and bond markets. In September 1995, for example, the U.S.
economy was widely considered to be slowing after exhibiting fairly robust
growth earlier in the year. Reflecting this view, investors were attracted to
long-term U.S. Treasury bonds (the yield on the 30-year maturity fell from 6.7%
to just below 6.0%) and high-quality, large-capitalization stocks (the
S&P/BARRA Growth Index advanced 10.8%) during the last four months of 1995. By
contrast, shares of more economically sensitive companies, such as technology
firms, dropped sharply during this period, falling -5.7%.
The view that slow but steady economic growth and minimal inflation
would continue was widely held. Even the Open Market Committee of the Federal
Reserve accepted this outlook, as evidenced by its decision last January to cut
both the discount and Fed funds rates by 0.25% in an effort to stimulate the
economy.
By mid-February, however, reports indicated increases in the demand for
technology goods, the number of new jobs, and consumer spending. As a result,
the outlook among investors changed. Common-stock investors began to look for
opportunities offered by a rapidly expanding economy (e.g., rapid earnings
growth among technology and cyclical firms), while bond investors saw the more
rapid growth as an indication of future inflation. The result was a 1.2% rise
in the 30-year U.S. Treasury yield and sharp jumps in the prices of
economically sensitive stocks during the next three months.
This outlook proved to be short-lived, too, with signs of a slowdown
appearing by late spring. As a result, blue-chip growth stocks again became the
preferred segment of the stock market, while smaller-company issues,
particularly technology stocks, declined--often sharply. Bond investors
benefited from the revised outlook, as long-term yields fell -0.3% between
mid-June and mid-August. The tide seemed to turn again in late August,
however, pushing the long-term Treasury yield back up to 7.1%.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED AUGUST 31, 1996
------------------------------------
1 YEAR 3 YEARS 5 YEARS
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Equity
S&P 500 Index 18.7% 15.0% 13.6%
Russell 2000 Index 10.8 12.3 15.1
MSCI-EAFE Index 8.2 6.6 9.1
- ------------------------------------------------------------------------------
Fixed-Income
Lehman Aggregate Bond Index 4.1% 4.5% 7.5%
Lehman 10-Year Municipal
Bond Index 4.4 4.9 7.7
Lipper Money Market 4.9 4.4 3.9
- ------------------------------------------------------------------------------
Other
Consumer Price Index 2.9% 2.8% 2.9%
- ------------------------------------------------------------------------------
</TABLE>
The past year's volatility was a result of wide swings in the expectations
for the economy. Bond investors, in aggregate, suffered as the Lehman Brothers
Aggregate Bond Index posted a total return of 4.1% for the fiscal year, with
income of 6.9% and a -2.8% decline in capital.
3
<PAGE> 6
Equity investors, on the other hand, saw the Standard & Poor's 500
Composite Stock Price Index generate a return of 18.7%, largely due to
continued earnings growth; the S&P 500's performance was only 2.7% below the
strong 21.4% gain generated during the twelve months ended August 1995. The
best performers among the S&P 500's holdings were often the large "traditional"
growth stocks in the health-care (32.1% over the last twelve months) and
consumer-staples (28.7%) sectors. Such issues have historically performed
especially well during periods of economic uncertainty thanks to the
dependability of their earnings. The utilities (6.2%), technology (7.4%), and
basic-materials (10.2%) sectors, by contrast, lagged in this environment of
uncertain growth and rising interest rates.
A number of the worst--and most volatile--performers among domestic common
stocks could be found among small-capitalization technology issues. While
small-company stocks (as measured by the Russell 2000 Small Stock Index) gained
10.8% in aggregate, stocks of small technology companies fell -0.8% for the
year, dropping -18.8% in the last three months alone. The most likely cause was
a number of earnings disappointments within the group.
For bond investors, issues of shorter maturity and lower quality generally
performed better than other segments of the bond market. Mortgage-backed
securities also generated attractive relative returns as rising interest rates
reduced prepayment activity. Municipals, however, were particularly strong
compared to their taxable siblings as concern over a "flat-tax" system eased.
INTERNATIONAL EQUITY MARKETS
Returns for international equity investors were solid, as reflected in the 8.2%
return of the Morgan Stanley Capital International-Europe, Australasia, Far
East (EAFE) Index. Performance in the European and Pacific Rim markets differed
widely, however, with returns of 15.7% and 1.1% (measured in U.S. dollars),
respectively. One reason for the disparity was the strength of the U.S. dollar
versus the Japanese yen. The dollar gained 9.8% against the yen, a move that
reduced the Japanese market's 8.6% increase in local terms to a -2.0% drop for
dollar-based investors. The dollar was essentially unchanged against the major
European currencies.
The strength of the European markets stemmed primarily from two sources:
(1) a decline in inflation expectations consistent with a drop in expected
economic growth; and (2) a new focus among corporate management on "building
shareholder value." As in the U.S. market, reduced growth expectations boosted
the relative performance of "traditional" quality growth stocks, since their
earnings are less dependent on economic cycles. At the same time, corporate
restructuring appears to be gaining favor among the managers of many European
firms in their efforts to enhance returns to shareholders. This shift boosted
the performance of a number of more cyclical stocks. Performance in the United
Kingdom was also aided by a marked increase in merger activity in advance of
the upcoming national election--an election that is widely expected to result
in a change in government.
In Asian markets, Hong Kong (22.2%) and Malaysia (13.4%) stood out for
their gains. A number of the smaller markets (e.g., Singapore, Thailand)
suffered from slower growth and reduced competitiveness as a result of the
weakened Japanese yen. The Japanese market, despite the 8.6% gain in local
currency, proved disappointing to many investors due to slow sustained growth
despite government efforts to spur the economy.
4
<PAGE> 7
REPORT FROM THE ADVISER
[FIGURE 4]
Vanguard U.S. Growth Portfolio earned an impressive 25.3% return for the
fiscal year ended August 31, 1996, well above comparable indexes as was
discussed in the letter to shareholders. These margins are among the best that
the Portfolio has achieved since we at Lincoln Capital assumed management
responsibilities nine years ago. We are delighted, if a bit surprised, at our
collective good fortune.
Our strategy has always been to invest primarily in companies that we
believe are leaders in their industries. Specifically, we continue to emphasize
powerful, relatively mature, growing companies, with a tilt toward the
health-care, consumer, and technology sectors. These three industries
represented roughly two-thirds of the Portfolio's net assets at the end of the
period, about the same weighting they held in some of the better-known growth
indexes.
True to our investment philosophy, we are heavily invested in many of the
largest-capitalization blue-chip growth stocks. In fact, our median market
capitalization is nearly twice that of our typical mutual fund competitor. We
also tend to hold a relatively small number of stocks. Although this portfolio
concentration provided a strong boost to our performance over the past twelve
months, it has hurt us in other years (most notably in fiscal 1993, when our
selections left something to be desired).
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
COMPANY BUSINESS
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
1. Coca-Cola #1 soft drink producer
2. AT&T #1 communications company
3. Cisco Systems #1 provider of computer-connecting equipment
4. Automatic Data Processing #1 payroll service
5. American Home Products #1 manufacturer of medications and hospital supplies
6. Johnson & Johnson #1 health-care/consumer
products company
7. Hewlett-Packard #1 maker of electronic instruments/printers
8. Procter & Gamble #1 household-products company
9. Pfizer Pharmaceutical company
10. SmithKline Beecham Pharmaceutical company
- -----------------------------------------------------------------------------------------------------------
</TABLE>
On balance, we remain convinced that we can best add value to Vanguard
U.S. Growth Portfolio by focusing on those few companies with sustainable
superiority and then holding their stocks for the long term. This does not
imply that we "blindly" hold a company at any valuation level. Rather, it is
simply an affirmation of our belief that the best companies tend to sustain
their leadership over extended periods.
In fiscal 1996, some of our major purchases included Eastman Kodak,
Bristol-Myers, and Household International. Our major sales included Intel,
PepsiCo, Philip Morris, and Disney, each of which had been among our ten
largest positions. We eliminated our positions in General Electric (which had
attained our valuation goals) and Wal-Mart.
INVESTMENT PHILOSOPHY
The adviser believes that superior long-term investment results can be achieved
by emphasizing investments in high-quality established growth companies that
sell at reasonable prices in relation to expected earnings and to valuations in
the broad stock market.
5
<PAGE> 8
The table on the previous page provides a brief summary of the Portfolio's
ten largest holdings, which together represent 33% of our total net assets.
(Most mutual funds hold about 25% of their assets in their ten largest stocks.)
On average, these ten stocks sell at a price/earnings (P/E) ratio of about 19
times our estimates of their 1997 earnings, a 15% premium over the S&P 500
Index's P/E ratio of about 17 times earnings. This is a modestly higher premium
than that of recent years. The average P/E ratio of the total portfolio is just
slightly above the market's valuation.
We continue to feel optimistic about the U.S. Growth Portfolio's prospects
for superior long-term total returns. While there will be the inevitable bumps
along the way, shareholders who can accept these occasional rough patches
should be well rewarded over time.
David Fowler, Portfolio Manager
Parker Hall, Portfolio Manager
Lincoln Capital Management Company
September 5, 1996
6
<PAGE> 9
PERFORMANCE SUMMARY: U.S. GROWTH PORTFOLIO
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Portfolio. Note, too,
that both share price and return can fluctuate widely so that an investment in
the Portfolio could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: 8/31/76-8/31/96
- --------------------------------------------------------------
U.S. GROWTH PORTFOLIO S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- --------------------------------------------------------------
<S> <C> <C> <C> <C>
1977 -0.7% 1.7% 1.0% -1.8%
1978 19.9 2.5 22.4 12.4
1979 10.5 2.7 13.2 11.6
1980 11.9 3.7 15.6 18.2
1981 8.5 3.2 11.7 5.4
1982 -4.8 3.5 -1.3 3.2
1983 51.3 4.2 55.5 44.0
1984 0.9 1.9 2.8 6.1
1985 16.4 3.7 20.1 18.3
1986 23.6 3.0 26.6 39.1
1987 15.1% 2.7% 17.8% 34.5%
1988 -23.5 1.9 -21.6 -17.8
1989 39.6 1.1 40.7 39.2
1990 3.7 1.3 5.0 -5.0
1991 31.9 2.4 34.3 26.9
1992 7.5 1.3 8.8 7.9
1993 0.5 1.2 1.7 15.2
1994 5.5 1.5 7.0 5.5
1995 21.3 1.5 22.8 21.4
1996 23.5 1.8 25.3 18.7
- --------------------------------------------------------------
</TABLE>
See Financial Highlights table on page 14 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE 8/31/86-8/31/96
[FIGURE 5]
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED AUGUST 31, 1996
---------------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- -----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. GROWTH PORTFOLIO 25.28% 12.73% 12.80% $33,361
AVERAGE GROWTH FUND 12.70 11.91 11.57 29,789
S&P 500 INDEX 18.73 13.59 13.39 35,114
- -----------------------------------------------------------------------------------------------------
</TABLE>
Average Annual Total Returns: Periods Ended 6/30/96*
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
10 YEARS
INCEPTION -----------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
U.S. Growth Portfolio 1/6/59 31.28% 15.57% 11.08% 1.68% 12.76%
- --------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter as well as for the Portfolio's fiscal year
end.
7
<PAGE> 10
PORTFOLIO PROFILE: U.S. GROWTH PORTFOLIO
AUGUST 31, 1996
This Profile provides a snapshot of the Portfolio's characteristics, where
appropriate, compared to an unmanaged index. Key elements of this Profile are
defined on page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- ------------------------------------------
U.S. GROWTH S&P 500
- ------------------------------------------
<S> <C> <C>
Number of Stocks 60 500
Median Market Cap $31.6B $20.6B
Price/Earnings Ratio 23.0x 17.6x
Price/Book Ratio 4.8x 3.0x
Dividend Yield 1.5% 2.3%
Return on Equity 25.2% 19.5%
Earnings Growth Rate 16.4% 12.6%
Foreign Holdings 8.1% 3.7%
Turnover Rate 44% --
Expense Ratio 0.43% --
Cash Reserves 6.7% --
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- ------------------------------------------
U.S. GROWTH S&P 500
- ------------------------------------------
<S> <C> <C>
R-Squared 0.86 1.00
Beta 0.90 1.00
</TABLE>
INVESTMENT FOCUS
- ------------------------------------------
[FIGURE 6]
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- --------------------------------------------
<S> <C>
The Coca-Cola Co. 4.6%
AT&T Corp. 3.9
Cisco Systems, Inc. 3.4
Automatic Data Processing, Inc. 3.4
American Home Products Corp. 3.3
Johnson & Johnson 3.2
Hewlett-Packard Co. 2.9
Procter & Gamble Co. 2.9
Pfizer, Inc. 2.8
SmithKline Beecham PLC ADR 2.7
- --------------------------------------------
Top Ten 33.1%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- -------------------------------------------------------------------------------------------
AUGUST 31, 1995 AUGUST 31, 1996
---------------------------------------------
U.S. GROWTH U.S. GROWTH S&P 500
---------------------------------------------
<S> <C> <C> <C>
Basic Materials . . . . . . . . . . . 1.0% 5.4% 6.5%
Capital Goods & Construction . . . . . 7.7 3.3 8.6
Consumer Cyclical . . . . . . . . . . 16.7 13.6 13.3
Consumer Staples . . . . . . . . . . . 21.0 18.6 12.6
Energy . . . . . . . . . . . . . . . . 1.9 2.6 9.4
Financial . . . . . . . . . . . . . . 9.3 9.7 13.5
Health Care . . . . . . . . . . . . . 13.4 20.1 10.5
Technology . . . . . . . . . . . . . . 22.2 21.6 11.2
Transport & Services . . . . . . . . . 0.0 0.0 1.6
Utilities . . . . . . . . . . . . . . 5.3 4.6 10.6
Miscellaneous . . . . . . . . . . . . 1.5 0.5 2.2
- -------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 11
PORTFOLIO CHARACTERISTICS
[FIGURE 7]
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified, and the more likely it is to perform in line with
the overall stock market.
MEDIAN MARKET CAP. Indicates the average market capitalization (market price x
shares outstanding) of stocks in the portfolio.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. For a portfolio, the weighted average P/E of the
stocks it holds. P/E is an indicator of market expectations about corporate
prospects; the higher the P/E, the greater the expectations for a company's
future growth.
PRICE/BOOK RATIO. The share price of a stock, divided by its net worth, or book
value, per share. For a portfolio, the weighted average price/book ratio of the
stocks it holds.
DIVIDEND YIELD. The current, annualized rate of dividends paid on a share of
stock, divided by its current share price. For a portfolio, the weighted
average yield for stocks it holds.
RETURN ON EQUITY. The rate of return generated by a company during the past
year for each dollar of shareholder's equity (net income for the year divided
by shareholder's equity). For a portfolio, the weighted average return on
equity for the companies represented in the portfolio.
EARNINGS GROWTH RATE. The annual average rate of growth in earnings over the
past five years for the stocks now in a portfolio.
FOREIGN HOLDINGS. The percentage of a portfolio's equity holdings invested in
non-U.S. companies.
TURNOVER RATE. Indicates trading activity during the past year. Portfolios with
high turnover rates incur higher transaction costs and are more likely to
realize and distribute capital gains (which are taxable to investors). The
average turnover rate for stock mutual funds is about 80%.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors. The average expense ratio for a stock mutual fund was
1.34% in 1995.
INVESTMENT FOCUS
This grid indicates a portfolio's characteristics in terms of two
attributes--market capitalization and relative valuation (growth, value, or a
blend). For instance, if the upper right box of the grid is shaded, it
indicates that a portfolio emphasizes large capitalization growth stocks.
VOLATILITY MEASURES
R-SQUARED. A measure of how much of a portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio's returns bore no
relationship to the market's returns, its R-squared would be 0.
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the fluctuations in the overall market (or appropriate market
index). The market, or index, has a beta of 1.00, so a portfolio with a beta of
1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
TEN LARGEST HOLDINGS
Indicates the percentage of a portfolio's total net assets in its ten largest
stocks (25% is the average for stock mutual funds). As this percentage rises, a
portfolio's returns are likely to be more volatile, since its return is more
dependent on the fortunes of a few companies.
SECTOR DIVERSIFICATION
Indicates the percentage of a portfolio's common stocks invested in each of the
major industry classifications that compose the stock market.
9
<PAGE> 12
[FIGURE 8]
FINANCIAL STATEMENTS
AUGUST 31, 1996
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Portfolio's holdings, including
each security's market value on the last day of the reporting period.
Securities are grouped and subtotaled by asset type (common stocks, preferred
stocks, bonds, etc.) and by industry sector. Other assets are added to, and
liabilities are subtracted from, the value of Total Investments to calculate
the Portfolio's Net Assets. Finally, Net Assets are divided by the outstanding
shares of the Portfolio to arrive at its share price, or Net Asset Value (NAV)
Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the Portfolio's net assets on both a dollar and
per-share basis. Because all income and any realized gains must be distributed
to shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the Portfolio had available to distribute to shareholders as income
dividends or capital gains as of the statement date. Any Accumulated Net
Realized Losses, and any cumulative excess of distributions over net income or
net realized gains, will appear as negative balances. Unrealized Appreciation
(Depreciation) is the difference between the market value of the Portfolio's
investments and their cost, and reflects the gains (losses) that would be
realized if the Portfolio were to sell all of its investments at their
statement-date values.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
MARKET
VALUE*
U.S. GROWTH PORTFOLIO SHARES (000)
- --------------------------------------------------------------------
COMMON STOCKS (93.3%)
- --------------------------------------------------------------------
<S> <C> <C>
BASIC MATERIALS (5.0%)
W.R. Grace & Co. 1,800,000 $ 118,125
Monsanto Co. 3,440,000 110,510
------------
228,635
------------
CAPITAL GOODS & CONSTRUCTION (3.1%)
The Boeing Co. 900,000 81,450
Honeywell, Inc. 483,000 28,074
Illinois Tool Works, Inc. 423,000 29,240
138,764
CONSUMER CYCLICAL (12.7%)
- - Brinker International, Inc. 1,080,000 16,200
Carnival Corp. Class A 953,000 26,922
- - Circus Circus Enterprises Inc. 272,000 9,248
The Walt Disney Co. 1,247,000 71,079
Eastman Kodak Co. 1,469,000 106,503
- - Kohls Corp. 230,000 8,740
Lowes Cos., Inc. 1,860,000 67,192
Mattel, Inc. 2,570,000 67,784
May Department Stores Co. 1,760,000 80,080
McDonald's Corp. 1,437,000 66,641
- - Mirage Resorts, Inc. 738,000 17,159
- - Payless ShoeSource, Inc. 584,000 20,513
Warnaco Group 800,000 19,800
------------
577,861
------------
CONSUMER STAPLES (17.3%)
The Coca-Cola Co. 4,223,000 211,150
Coca-Cola Enterprises, Inc. 316,000 12,759
Gillette Co. 1,587,000 101,170
PepsiCo, Inc. 4,225,000 121,469
Philip Morris Cos., Inc. 1,297,000 116,406
Procter & Gamble Co. 1,470,000 130,646
Unilever NV 575,000 82,513
Unilever PLC ADR 125,000 10,203
------------
786,316
------------
ENERGY (2.4%)
Enron Oil & Gas Co. 600,000 15,525
- - Renaissance Energy Ltd. 1,600,000 45,021
- - Talisman Energy, Inc. 1,955,000 48,366
------------
108,912
------------
FINANCIAL (9.1%)
Aetna Inc. 318,000 21,028
American International
Group, Inc. 1,192,000 113,240
The Chase Manhattan Corp. 1,560,000 116,025
Federal National
Mortgage Assn. 1,120,000 34,720
Household International, Inc. 1,044,000 82,737
Norwest Corp. 1,200,000 45,150
------------
412,900
------------
HEALTH CARE (18.7%)
American Home Products Corp. 2,560,000 151,680
Bristol-Myers Squibb Co. 1,017,000 89,242
Cardinal Health, Inc. 800,000 58,700
- - HealthCare Compare Corp. 681,000 29,113
Johnson & Johnson 2,954,000 145,485
Eli Lilly & Co. 1,325,000 75,856
Pfizer, Inc. 1,763,000 125,173
Pharmacia & Upjohn, Inc. 1,217,000 51,114
SmithKline Beecham PLC ADR 2,145,000 124,946
------------
851,309
------------
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------
<S> <C> <C>
TECHNOLOGY (20.2%)
- - Altera Corp. 910,000 $ 40,040
AMP, Inc. 1,484,000 56,763
Automatic Data Processing, Inc. 3,688,000 153,513
- - Cisco Systems, Inc. 2,950,000 155,244
Electronic Data Systems Corp. 1,537,000 83,766
First Data Corp. 204,000 15,912
Hewlett-Packard Co. 3,010,000 131,688
- - Informix Corp. 1,520,000 34,200
Intel Corp. 1,096,000 87,406
Molex, Inc. Class A 562,000 16,720
- - Oracle Corp. 1,940,000 68,142
Reuters Holdings PLC ADR 434,000 30,326
- - Xilinx, Inc. 1,243,000 43,505
------------
917,225
------------
UTILITIES (4.3%)
AT&T Corp. 3,347,000 175,717
MCI Communications Corp. 745,000 18,718
------------
194,435
------------
MISCELLANEOUS (0.5%)
Service Corp. International 403,000 22,719
------------
- --------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $3,110,418) 4,239,076
- --------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
FACE
AMOUNT
(000)
- --------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (6.5%)
- --------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled Cash
Account 5.25%, 9/3/96
(COST $294,666) $294,666 294,666
- --------------------------------------------------------------------
TOTAL INVESTMENTS (99.8%)
(COST $3,405,084) 4,533,742
- --------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (0.2%)
- --------------------------------------------------------------------
Other Assets--Note C 25,006
Liabilities (14,484)
------------
10,522
- --------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------
Applicable to 200,877,910 outstanding
$1.00 par value shares
(authorized 500,000,000 shares) $4,544,264
====================================================================
NET ASSET VALUE PER SHARE $22.62
====================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
-Non-Income Producing Security.
ADR--American Depository Receipt.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------
AT AUGUST 31, 1996, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $3,098,659 $15.42
Undistributed Net
Investment Income 31,764 .16
Accumulated Net
Realized Gains 285,183 1.42
Unrealized Appreciation--
Note E 1,128,658 5.62
- --------------------------------------------------------------------
NET ASSETS $4,544,264 $22.62
====================================================================
</TABLE>
11
<PAGE> 14
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Portfolio
during the reporting period, and details the operating expenses charged to the
Portfolio. These expenses directly reduce the amount of investment income
available to pay to shareholders as dividends. This Statement also shows any
Net Gains (Losses) realized on the sale of investments, and the increase or
decrease in the Unrealized Appreciation (Depreciation) on investments during
the period.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------
U.S. GROWTH PORTFOLIO
YEAR ENDED AUGUST 31, 1996
(000)
- --------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 58,257
Interest 9,124
---------
Total Income 67,381
---------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 6,139
The Vanguard Group--Note C
Management and Administrative 9,233
Marketing and Distribution 823
Taxes (other than income taxes) 282
Custodian Fees 13
Auditing Fees 10
Shareholders' Reports 122
Annual Meeting and Proxy Costs 68
Directors' Fees and Expenses 13
---------
Total Expenses 16,703
Expenses Paid Indirectly--Note C (571)
---------
Net Expenses 16,132
- --------------------------------------------------------------------------------------
NET INVESTMENT INCOME 51,249
- --------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 307,968
- --------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 440,659
- --------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $799,876
======================================================================================
</TABLE>
12
<PAGE> 15
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Portfolio's total net assets changed during the
two most recent reporting periods. The Operations section summarizes
information that is detailed in the Statement of Operations. The amounts shown
as Distributions to shareholders from the Portfolio's Net Investment Income and
Realized Capital Gain may not match the amounts shown in the Operations
section, because distributions are determined on a tax basis and may be made in
a period different from the one in which the income was earned or the gains
were realized. The Capital Share Transactions section shows the amount
shareholders invested in the Portfolio, either by purchasing shares or by
reinvesting distributions, as well as the amounts redeemed. The corresponding
numbers of Shares Issued and Redeemed are shown at the end of the Statement.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------
U.S. GROWTH PORTFOLIO
YEAR ENDED AUGUST 31,
------------------------------
1996 1995
(000) (000)
- --------------------------------------------------------------------------------------------
INCREASE IN NET ASSETS
<S> <C> <C>
OPERATIONS
Net Investment Income $ 51,249 $ 38,281
Realized Net Gain 307,968 91,924
Change in Unrealized Appreciation (Depreciation) 440,659 388,046
------------------------------
Net Increase in Net Assets Resulting from Operations 799,876 518,251
------------------------------
DISTRIBUTIONS
Net Investment Income (49,433) (24,203)
Realized Capital Gain (97,161) --
------------------------------
Total Distributions (146,594) (24,203)
------------------------------
Capital Share Transactions(1)
Issued 1,561,164 967,386
Issued in Lieu of Cash Distributions 131,833 23,081
Redeemed (791,065) (458,896)
------------------------------
Net Increase from Capital Share Transactions 901,932 531,571
- --------------------------------------------------------------------------------------------
Total Increase 1,555,214 1,025,619
- --------------------------------------------------------------------------------------------
Net Assets
Beginning of Year 2,989,050 1,963,431
------------------------------
End of Year $4,544,264 $2,989,050
============================================================================================
(1)Shares Issued and Redeemed
Issued 72,254 57,733
Issued in Lieu of Cash Distributions 6,579 1,504
Redeemed (36,694) (27,003)
------------------------------
Net Increase in Shares Outstanding 42,139 32,234
============================================================================================
</TABLE>
13
<PAGE> 16
FINANCIAL HIGHLIGHTS
This table summarizes the Portfolio's investment results and distributions to
shareholders on a per-share basis. It also presents the Portfolio's Total
Return and shows net investment income and expenses as percentages of average
net assets. These data will help you assess: the variability of the Portfolio's
net income and total returns from year to year; the relative contributions of
net income and capital gains to the Portfolio's total return; how much it costs
to operate the Portfolio; and the extent to which the Portfolio tends to
distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in
the Portfolio for one year. Finally, the table lists the Portfolio's Average
Commission Rate Paid, a disclosure required by the SEC beginning in 1996. This
rate is calculated by dividing total commissions paid on portfolio securities
by the total number of shares purchased and sold on which commissions were
charged.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------
U.S. GROWTH PORTFOLIO
YEAR ENDED AUGUST 31,
-------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1996 1995 1994 1993 1992
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $18.83 $15.52 $14.71 $14.71 $13.69
- ------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .26 .25 .20 .21 .19
Net Realized and Unrealized Gain (Loss) on Investments 4.39 3.24 .82 .05 1.02
-------------------------------------------------
Total From Investment Operations 4.65 3.49 1.02 .26 1.21
-------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.29) (.18) (.21) (.18) (.19)
Distributions from Realized Capital Gains (.57) -- -- (.08) --
-------------------------------------------------
Total Distributions (.86) (.18) (.21) (.26) (.19)
- ------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $22.62 $18.83 $15.52 $14.71 $14.71
==================================================================================================================
TOTAL RETURN 25.28% 22.75% 6.98% 1.69% 8.83%
==================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $4,544 $2,989 $1,963 $1,954 $1,441
Ratio of Total Expenses to Average Net Assets--Note C 0.43% 0.47% 0.52% 0.49% 0.49%
Ratio of Net Investment Income to Average Net Assets 1.32% 1.59% 1.30% 1.50% 1.52%
Portfolio Turnover Rate 44% 32% 47% 37% 24%
Average Commission Rate Paid $.0492 N/A N/A N/A N/A
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
14
<PAGE> 17
NOTES TO FINANCIAL STATEMENTS
Vanguard U.S. Growth Portfolio is registered under the Investment Company Act
of 1940 as a diversified open-end investment company, or mutual fund.
A. The following significant accounting policies conform with generally
accepted accounting principles for mutual funds. The Portfolio consistently
follows such policies in preparing its financial statements.
1. SECURITY VALUATION: Securities listed on an exchange are valued at the
latest quoted sales prices as of the close of trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern time) on the valuation date; such
securities not traded on the valuation date are valued at the mean of the
latest quoted bid and asked prices. Securities not listed on an exchange are
valued at the latest quoted bid prices. Temporary cash investments are valued
at cost, which approximates market value.
2. FEDERAL INCOME TAXES: The Portfolio intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for Federal income taxes is required in the financial
statements.
3. REPURCHASE AGREEMENTS: The Portfolio, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. Government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other
party to the agreement, retention of the collateral may be subject to legal
proceedings.
4. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date.
5. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Under a contract that expires March 31, 1997, the Portfolio pays Lincoln
Capital Management Company an investment advisory fee calculated at an annual
percentage rate of average net assets. For the year ended August 31, 1996, the
advisory fee represented an effective annual rate of 0.16% of the Portfolio's
average net assets.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the Portfolio under methods approved by the Board of Directors. At August
31, 1996, the Portfolio had contributed capital of $443,000 to Vanguard
(included in Other Assets), representing 2.2% of Vanguard's capitalization. The
Portfolio's directors and officers are also directors and officers of Vanguard.
Vanguard has asked the Portfolio's investment adviser to direct certain
portfolio trades, subject to obtaining the best price and execution, to brokers
who have agreed to rebate to the Portfolio part of the commissions generated.
Such rebates are used solely to reduce the Portfolio's administrative expenses.
For the year ended August 31, 1996, these arrangements reduced the Portfolio's
expenses by $571,000 (0.01% of average net assets).
D. During the year ended August 31, 1996, the Portfolio purchased
$2,326,132,000 of investment securities and sold $1,644,855,000 of investment
securities, not counting U.S. Government securities and temporary cash
investments.
E. At August 31, 1996, net unrealized appreciation of investment securities
for financial reporting and Federal income tax purposes was $1,128,658,000,
consisting of unrealized gains of $1,174,288,000 on securities that had risen
in value since their purchase and $45,630,000 in unrealized losses on
securities that had fallen in value since their purchase.
15
<PAGE> 18
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors of
Vanguard U.S. Growth Portfolio
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard U.S. Growth Portfolio (the "Portfolio") at August 31, 1996, and the
results of its operations, the changes in its net assets and the financial
highlights for each of the periods indicated, in conformity with generally
accepted accounting principles. These financial statements and financial
highlights (hereafter referred to as "financial statements") are the
responsibility of the Portfolio's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits, which included confirmation of securities at August 31, 1996 by
correspondence with the custodian and brokers and the application of
alternative auditing procedures where confirmations from brokers were not
received, provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
September 30, 1996
SPECIAL 1996 TAX INFORMATION (UNAUDITED)
VANGUARD U.S. GROWTH PORTFOLIO
This information for the fiscal year ended August 31, 1996, is included
pursuant to provisions of the Internal Revenue Code.
The Fund designates $251,033,000 as capital gain dividends (from net long-term
capital gains), of which $18,436,000 was distributed to shareholders in
December 1995. The balance of $232,597,000, along with any additional gains
realized through October 31, 1996, will be distributed in December 1996.
For corporate shareholders, 49.8% of investment income (dividend income plus
short-term gains, if any) qualifies for the dividends-received deduction.
16
<PAGE> 19
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director of The Vanguard Group, Inc.
and of each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN, President, Chief Executive Officer, and Director of The
Vanguard Group, Inc. and of each of the investment companies in The
Vanguard Group.
ROBERT E. CAWTHORN, Chairman Emeritus of Rhone-Poulenc Rorer Inc.; Director of
Sun Company, Inc. and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea Co.,
Alco Standard Corp., Raytheon Co., Knight-Ridder, Inc., and
Massachusetts Mutual Life Insurance Co.
BRUCE K. MACLAURY, President Emeritus of The Brookings Institution; Director of
American Express Bank Ltd., The St. Paul Companies, Inc., and National
Steel Corp.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl
Corp., Baker Fentress & Co., The Jeffrey Co., and Southern New England
Communications Co.
ALFRED M. RANKIN, Jr., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich
Co., and The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co.
and President of New York University; Director of Pacific Gas and
Electric Co. and NACCO Industries.
JAMES O. WELCH, Jr., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc.
and Kmart Corp.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas Co.;
Director of Cummins Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies in
The Vanguard Group.
RICHARD F. HYLAND, Treasurer; Principal of The Vanguard Group, Inc.; Treasurer
of each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller; Principal of The Vanguard Group, Inc.; Controller of
each of the investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President,
Information Technology.
JAMES H. GATELY, Senior Vice President,
Individual Investor Group.
IAN A. MACKINNON, Senior Vice President,
Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President,
Institutional.
RALPH K. PACKARD, Senior Vice President and
Chief Financial Officer.
[THE VANGUARD GROUP LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
[email protected] http://www.vanguard.com
This Report has been prepared for shareholders and
may be distributed to others only if preceded or
accompanied by a current prospectus. All Funds in
the Vanguard Family are offered by prospectus only.
<PAGE> 20
THE VANGUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
Growth and Income Funds
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard Selected Value Portfolio
Vanguard/Trustees' Equity-U.S. Portfolio
Vanguard Convertible Securities Fund
Balanced Funds
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LIFEStrategy Portfolios
Growth Funds
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
Aggressive Growth Funds
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
International Funds
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity-International
Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
Money Market Funds
Vanguard Money Market Reserves
Vanguard Admiral Funds
Income Funds
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
Tax-Exempt Money Market Funds
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
Tax-Exempt Income Funds
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
Q810-8/96
[FIGURE 9]
<PAGE> 21
VANGUARD
INTERNATIONAL
GROWTH PORTFOLIO
Annual Report
August 31, 1996
THE VANGUARD GROUP:
LINKING TRADITION
AND INNOVATION
At Vanguard, we treasure our rich nautical heritage--even as we steer our
course toward the twenty-first century. Our Report cover reflects that blending
of tradition and innovation, of past, present, and future.
The montage includes a bronze medallion with a likeness of our namesake, HMS
Vanguard (Lord Nelson's flagship at The Battle of the Nile); a clock built
circa 1816 in Scotland, featuring a portrait of Nelson (who is also shown,
accepting a surrender, in a detail from a nineteenth-century engraving); and
several views of our recently completed campus, which is steeped in nautical
imagery--from our buildings named after Nelson's warships (Victory, Majestic,
and Goliath are three shown), to our artwork and ornamental compass rose.
[FIGURE 1]
<PAGE> 22
[FIGURE 2]
VANGUARD HAS ALWAYS STRIVED TO BE THE STANDARD-BEARER for mutual fund
disclosure, going well beyond the "letter of the law" in our
shareholder communications. During the past year, we raised the
standard once again by rewriting and reformatting our Fund
prospectuses. They are designed to ensure that prospective investors
fully understand, before they make an investment, each Fund's
investment strategies, risks, and costs. Our Annual Reports to
shareholders, in turn, provide a comprehensive discussion and analysis
of the year's results in the context of each Fund's investment
objectives and policies. Since Vanguard has long been recognized for
the quality and content of these Fund Reports, our overriding
objective was to maintain the spirit and character of the previous
Reports, while adding information to assist shareholders in
understanding the investment characteristics of their Fund.
THE NEW FUND REPORTS INCLUDE A MESSAGE TO SHAREHOLDERS from Chairman John C.
Bogle and President John J. Brennan. This Message continues to provide
a candid assessment of the Fund's performance relative to an
appropriate unmanaged market benchmark and a peer group of mutual
funds with similar investment policies. It also reviews the principal
factors contributing to--and detracting from--the returns earned by
the Fund. To help you evaluate your Fund's current-year performance,
the Message includes a discussion of the Fund's long-term investment
results, as well as a look ahead to the prospects for the coming year.
A recap of the financial markets, which had been included as part of
the Chairman's letter, now appears in The Markets In Perspective. This
overview covers the world's financial markets, putting the results of
the Fund's strategy in a global perspective.
THE PORTFOLIO PROFILE REPRESENTS AN ADDITION TO OUR FUND REPORTS. In this day
and age, many investors use detailed statistical information to
evaluate their mutual fund holdings, and our new Portfolio Profile
furnishes shareholders with comprehensive data on key
characteristics--sector diversification, volatility, top-ten holdings,
among others--that ultimately define how a Fund is likely to perform
in various market environments. For this information to be used
effectively, we include a brief description of the profiled
characteristics. The Report From The Adviser (for our traditionally
managed Funds) now covers specific topics that we have defined as
being the important ones for the adviser to address--and we do our
best to ensure that this Report is written in the same simple and
candid manner that characterizes all Vanguard communications. Finally,
each Adviser's Report will include an inset reminder of the adviser's
basic investment philosophy.
WE TRUST THAT THIS REDESIGNED FUND REPORT will continue to meet your need for a
fair, candid, and clear presentation of your Fund's investment results
and a thorough portfolio review. We welcome any comments that you
might have at any time regarding these Reports.
CONTENTS
A Message To
Our Shareholders
1
The Markets
In Perspective
4
Report From
The Adviser
6
Portfolio
Profile
8
Performance
Summary
10
Financial
Statements
11
Report of
Independent
Accountants
19
Directors and
Officers
INSIDE BACK COVER
<PAGE> 23
[PHOTO]
JOHN C. BOGLE
Chairman of the Board
[PHOTO]
JOHN J. BRENNAN
President
FELLOW SHAREHOLDER,
With a total return of +12.7%, Vanguard International Growth Portfolio
significantly outpaced most competing funds in the fiscal year ended August 31,
1996. The Portfolio's performance came against a backdrop of generally solid
returns in international stock markets, although these returns were diminished
by the strong rise in value of the U.S. dollar against the Japanese yen.
The table below presents the fiscal 1996 total return (capital change
plus reinvested dividends) of the International Growth Portfolio compared to
returns on its two primary performance benchmarks: the average international
equity mutual fund and the unmanaged Morgan Stanley Capital
International-Europe, Australasia, Far East Index. The return for the
International Growth Portfolio is based on an increase in its net asset value
from $14.70 per share on August 31, 1995, to $16.13 per share on August 31,
1996, with the ending net asset value adjusted for our annual dividend of $.20
per share paid from net investment income and a distribution of $.21 per share
paid from net realized capital gains.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
TOTAL RETURN
FISCAL YEAR ENDED
AUGUST 31, 1996
- --------------------------------------------------------------------
<S> <C>
Vanguard International
Growth Portfolio +12.7%
- --------------------------------------------------------------------
Average International Mutual Fund + 8.8%
International Index* + 8.2
- --------------------------------------------------------------------
</TABLE>
*Morgan Stanley Capital International-Europe, Australasia, Far East Index.
FISCAL 1996 PERFORMANCE OVERVIEW
Fifteen of the 20 international stock markets in the International Index posted
positive returns in the fiscal year ended August 31, both in local currencies
and when measured in U.S. dollars. In the aggregate, these markets provided a
total return of +12.1% in local currencies. However, the dollar gained about
+10% versus the Japanese yen during the fiscal year. Because Japan is the
dominant component of the Index, accounting for two-fifths of its value, the
- -2.0% return to dollar-based holders of Japanese stocks reduced the total
dollar-based return on the overall Index to +8.2%. The table at right shows the
returns, in local currencies and in U.S. dollars, on key international equity
market segments.
Our substantial edge over the International Index was partly due to our
smaller commitment, in comparison to the Index, to Japanese stocks. On average,
Japanese stocks made up 30% of the Portfolio's net assets, while Japanese
equities made up 40% of the International Index. We also benefited from a
particularly good year, especially in Europe, for the kind of
established-growth companies that are our Portfolio's bread and butter.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
TOTAL RETURN
12 MONTHS ENDED AUGUST 31, 1996
------------------------------------------
BASED ON CURRENCY BASED ON
STOCK MARKET INDEX LOCAL CURRENCY EFFECT U.S. DOLLAR
- ----------------------------------------------------------------------
<S> <C> <C> <C>
International* +12.1% -3.9% + 8.2%
- ----------------------------------------------------------------------
European* +14.8% +0.9% +15.7%
Pacific Basin* + 9.3 -8.2 + 1.1
- ----------------------------------------------------------------------
United States +18.7% -- +18.7%
- ----------------------------------------------------------------------
</TABLE>
*Morgan Stanley Capital International Indexes.
1
<PAGE> 24
LONG-TERM PERFORMANCE OVERVIEW
No matter how favorable, one year's results are not sufficient to judge any
mutual fund's long-term performance. We hope and expect that shareholders
consider their holdings in the International Growth Portfolio to be a long-term
investment. Happily, our Portfolio's long-term record bears up quite well to
close examination, as evidenced by the results shown in the table at
left--although future returns, of course, may be better or worse than those
shown.
As we noted a year ago, currency fluctuations can have a powerful impact
on international stock returns. This is a special risk that U.S. investors do
not face when investing in their own markets.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------
TOTAL RETURN*
10 YEARS ENDED AUGUST 31, 1996
--------------------------------
CUMULATIVE ANNUAL RATE
- ----------------------------------------------------------------------
<S> <C> <C>
Vanguard International
Growth Portfolio +155.9% +9.8%
- ----------------------------------------------------------------------
Average International Mutual Fund +132.7% +8.8%
International Index** +127.9 +8.6
- ----------------------------------------------------------------------
</TABLE>
*Assuming reinvestment of all dividends and distributions.
**Morgan Stanley Capital International-Europe, Australasia, Far East Index.
We would also emphasize that performance figures are extremely
time-dependent--that is, investment returns can look markedly different by the
inclusion or exclusion of an extraordinarily good or bad year. This year's
ten-year returns, for example, were about six percentage points lower than the
ten-year returns shown last year. The reason for the sharp decline is that this
year's ten-year calculations do not include the results achieved in fiscal
1986, which was a fabulous year for international stocks. Total returns (in
dollar terms) for the year were +103.7% on the International Index and +98.9%
for the International Growth Portfolio. What is more, during most of the
decade the dollar was weakening, substantially enhancing international returns.
However, just the opposite occurred last year, as we noted earlier.
Stupendous returns such as we achieved in 1986 are, almost certainly, a
once-in-a-lifetime event. However, the International Growth Portfolio does hold
an enduring edge, namely our substantial cost advantage. The Portfolio's
expense ratio (expenses as a percentage of average net assets) was 0.56% last
year versus 1.58% for the average international equity mutual fund, giving the
Portfolio an annual "head start" of roughly 1% in annual return, which
accounted for our entire edge over the competition. We expect this cost
advantage to continue to help the Portfolio outpace the majority of its peers
over the long haul.
IN SUMMARY
In our Annual Report a year ago, we told you that international markets "may
well face the headwind of a stronger U.S. currency." That headwind in fact
proved to be present in fiscal 1996, particularly in Japan, and dampened
returns on both foreign stocks and the International Growth Portfolio. The
volatility inherent in currencies and in stock markets is precisely why shares
in the Portfolio should be considered long-term investments.
We believe that, as a long-term investment, international stocks have a
place in a balanced portfolio that also holds domestic equities, bonds, and
short-term reserves. In this role, international stocks offer additional
diversification and should provide competitive returns over time for the
long-term investor who "stays the course." We, too, will hold to the investment
objective and strategies that have governed the Portfolio since its inception
nearly 15 years ago.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
- ----------------------- ----------------------
September 18, 1996
2
<PAGE> 25
VANGUARD--A PIONEER IN INTERNATIONAL INVESTING
Vanguard International Growth Portfolio celebrated its 15th anniversary on
September 30, 1996, as we completed this Report. When the Portfolio began
operations in autumn 1981, only six other mutual fund managers ran
international portfolios, with total assets of some $200 million. Today, nearly
400 international mutual funds are available to U.S. investors, with total
assets of more than $110 billion.
Vanguard's early acceptance of the importance of international investing
began with the forming of a discrete portfolio within Vanguard World Fund (then
named Ivest Fund). The Portfolio started out with assets of $25 million. On
September 30, 1985, when assets reached $77 million, it was "spun off" as a
separate mutual fund. Since then, it has enjoyed steady growth and acceptance,
with assets now totaling $5.2 billion.
Over the past 15 years, the International Growth Portfolio has achieved
an enviable record of performance, smartly surpassing most of its competitors,
as shown in this table. This record is a tribute to the global investment
skills of Schroder Capital Management International and portfolio manager
Richard Foulkes. He has served in this capacity since our Portfolio's inception
15 years ago--a record of continuity without parallel, as far as we know, in
the international-fund field.
From pioneer in an infant industry group to performance and asset leader
in a major industry component, Vanguard International Growth Portfolio has
served its shareholders well. We look forward to continuing to do so in the
years ahead.
<TABLE>
<CAPTION>
- ----------------------------------------------------------
AVERAGE ANNUAL
TOTAL RETURN
9/30/81-9/30/96
- ----------------------------------------------------------
<S> <C>
Vanguard International
Growth Portfolio +16.6%
Average International Mutual Fund +13.3
Vanguard Advantage + 3.3
- ----------------------------------------------------------
</TABLE>
3
<PAGE> 26
[FIGURE 3]
THE MARKETS IN PERSPECTIVE
U.S. EQUITY AND BOND MARKETS
During the past twelve months, expectations about economic growth, inflation,
and Federal Reserve policy shifted markedly, generating some pronounced changes
in the U.S. equity and bond markets. In September 1995, for example, the U.S.
economy was widely considered to be slowing after exhibiting fairly robust
growth earlier in the year. Reflecting this view, investors were attracted to
long-term U.S. Treasury bonds (the yield on the 30-year maturity fell from 6.7%
to just below 6.0%) and high-quality, large-capitalization stocks (the
S&P/BARRA Growth Index advanced 10.8%) during the last four months of 1995. By
contrast, shares of more economically sensitive companies, such as technology
firms, dropped sharply during this period, falling -5.7%.
The view that slow but steady economic growth and minimal inflation would
continue was widely held. Even the Open Market Committee of the Federal Reserve
accepted this outlook, as evidenced by its decision last January to cut both
the discount and Fed funds rates by 0.25% in an effort to stimulate the
economy.
By mid-February, however, reports indicated increases in the demand for
technology goods, the number of new jobs, and consumer spending. As a result,
the outlook among investors changed. Common-stock investors began to look for
opportunities offered by a rapidly expanding economy (e.g., rapid earnings
growth among technology and cyclical firms), while bond investors saw the more
rapid growth as an indication of future inflation. The result was a 1.2% rise
in the 30-year U.S. Treasury yield and sharp jumps in the prices of
economically sensitive stocks during the next three months.
This outlook proved to be short-lived, too, with signs of a slowdown
appearing by late spring. As a result, blue-chip growth stocks again became the
preferred segment of the stock market, while smaller-company issues,
particularly technology stocks, declined--often sharply. Bond investors
benefited from the revised outlook, as long-term yields fell -0.3% between
mid-June and mid-August. The tide seemed to turn again in late August, however,
pushing the long-term Treasury yield back up to 7.1%.
The past year's volatility was a result of wide swings in the
expectations for the economy. Bond investors, in aggregate, suffered as the
Lehman Brothers Aggregate Bond Index posted a total return of 4.1% for the
fiscal year, with income of 6.9% and a -2.8% decline in capital.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED AUGUST 31, 1996
-------------------------------------
1 YEAR 3 YEARS 5 YEARS
- ---------------------------------------------------------------------
<S> <C> <C> <C>
Equity
S&P 500 Index 18.7% 15.0% 13.6%
Russell 2000 Index 10.8 12.3 15.1
MSCI-EAFE Index 8.2 6.6 9.1
- ---------------------------------------------------------------------
Fixed-Income
Lehman Aggregate Bond Index 4.1% 4.5% 7.5%
Lehman 10-Year Municipal
Bond Index 4.4 4.9 7.7
Lipper Money Market 4.9 4.4 3.9
- ---------------------------------------------------------------------
Other
Consumer Price Index 2.9% 2.8% 2.9%
- ---------------------------------------------------------------------
</TABLE>
4
<PAGE> 27
Equity investors, on the other hand, saw the Standard & Poor's 500
Composite Stock Price Index generate a return of 18.7%, largely due to
continued earnings growth; the S&P 500's performance was only 2.7% below the
strong 21.4% gain generated during the twelve months ended August 1995. The
best performers among the S&P 500's holdings were often the large "traditional"
growth stocks in the health-care (32.1% over the last twelve months) and
consumer-staples (28.7%) sectors. Such issues have historically performed
especially well during periods of economic uncertainty thanks to the
dependability of their earnings. The utilities (6.2%), technology (7.4%), and
basic-materials (10.2%) sectors, by contrast, lagged in this environment of
uncertain growth and rising interest rates.
A number of the worst--and most volatile--performers among domestic
common stocks could be found among small-capitalization technology issues.
While small-company stocks (as measured by the Russell 2000 Small Stock Index)
gained 10.8% in aggregate, stocks of small technology companies fell -0.8% for
the year, dropping -18.8% in the last three months alone. The most likely cause
was a number of earnings disappointments within the group.
For bond investors, issues of shorter maturity and lower quality
generally performed better than other segments of the bond market.
Mortgage-backed securities also generated attractive relative returns as rising
interest rates reduced prepayment activity. Municipals, however, were
particularly strong compared to their taxable siblings as concern over a
"flat-tax" system eased.
INTERNATIONAL EQUITY MARKETS
Returns for international equity investors were solid, as reflected in the 8.2%
return of the Morgan Stanley Capital International-Europe, Australasia, Far
East (EAFE) Index. Performance in the European and Pacific Rim markets differed
widely, however, with returns of 15.7% and 1.1% (measured in U.S. dollars),
respectively. One reason for the disparity was the strength of the U.S. dollar
versus the Japanese yen. The dollar gained 9.8% against the yen, a move that
reduced the Japanese market's 8.6% increase in local terms to a -2.0% drop for
dollar-based investors. The dollar was essentially unchanged against the major
European currencies.
The strength of the European markets stemmed primarily from two sources:
(1) a decline in inflation expectations consistent with a drop in expected
economic growth; and (2) a new focus among corporate management on "building
shareholder value." As in the U.S. market, reduced growth expectations boosted
the relative performance of "traditional" quality growth stocks, since their
earnings are less dependent on economic cycles. At the same time, corporate
restructuring appears to be gaining favor among the managers of many European
firms in their efforts to enhance returns to shareholders. This shift boosted
the performance of a number of more cyclical stocks. Performance in the United
Kingdom was also aided by a marked increase in merger activity in advance of
the upcoming national election--an election that is widely expected to result
in a change in government.
In Asian markets, Hong Kong (22.2%) and Malaysia (13.4%) stood out for
their gains. A number of the smaller markets (e.g., Singapore, Thailand)
suffered from slower growth and reduced competitiveness as a result of the
weakened Japanese yen. The Japanese market, despite the 8.6% gain in local
currency, proved disappointing to many investors due to slow sustained growth
despite government efforts to spur the economy.
5
<PAGE> 28
REPORT FROM THE ADVISER
[FIGURE 4]
Vanguard International Growth Portfolio provided a total return of 12.7% during
fiscal 1996, which ended on August 31. This exceeded the performance of both
the Morgan Stanley Capital International-Europe, Australasia, Far East (EAFE)
Index, which provided an 8.2% return during the year, and the average
international equity mutual fund, which achieved an 8.8% return.
Individual countries and, of course, companies have surprised investors
with both good news and bad, but in general, the past year has not been a
period of excesses. Very few of the larger countries where we invest are
showing signs of overheated economies, the usual scourge of stock markets. On
the contrary, most countries are nervous because their economies are still
struggling to recover. Markets with the potential to strengthen provide ideal
backgrounds for equities; this is what we have seen during the past year.
Ultimately, though, it is up to the companies to deliver the improvement in
profits that this mood anticipates. We have begun to see this, perhaps even
earlier than expected, as companies have been aggressively cutting costs.
There were no stunning market performances over the fiscal year. Sweden
and Switzerland provided total returns, in U.S.-dollar terms, of 29% and 27%,
respectively, followed by the Netherlands (24%) and Hong Kong (22%). Returns
for dollar-based investors in Sweden were boosted by a strong recovery in the
Swedish kronor, which rose 10% against the U.S. dollar.
Elsewhere, currencies were little changed over the year, with the big
exception of the Japanese yen. The yen fell a further -10% against the dollar,
turning the modest 9% rise in the Japanese stock market in yen terms into a -2%
loss for dollar-based investors. Emerging markets generally underperformed the
developed markets, although returns from the larger countries were diverse,
ranging from Brazil's 17% dollar-based return to Korea's -24% return.
Approximately half of the Portfolio was invested in Europe during the
fiscal year; this delivered most of the increase in your share price. We
benefited particularly from the strength of stocks in the Netherlands,
Switzerland, and the United Kingdom. At the same time, we had relatively little
exposure in France and Italy, two countries whose economic problems look
especially challenging. Indeed, business conditions in most of Europe are
tough, with the exception of the UK and the Netherlands.
It takes well-managed companies to fare well in a weak economic
environment, and in Europe the Portfolio has focused on those where recent
changes in management or in corporate shape have created opportunities for
exceptional increases in profitability. The proposed merger between Ciba-Geigy
and Sandoz is a good example; another is the rather smaller merger between Adia
and Ecco to create Europe's largest temporary-employment agency. "Shareholder
value" has become the new watchword of management in several European
countries, notably Germany and, to a limited extent, France. This bodes well
for future results. We have identified several such situations in Germany,
INVESTMENT PHILOSOPHY
The adviser believes that superior long-term investment results can be achieved
by selecting the stocks of companies with the potential for above-average
earnings growth, with particular emphasis on companies in countries with
favorable business and market environments.
6
<PAGE> 29
notably Veba and Bayer, which figure prominently in the portfolio, and over the
past twelve months we have increased the German weighting of the Portfolio
accordingly. Elf, a major French oil company, is yet another example of a
company we hold because of its new focus on creating shareholder value.
About 27% of the Portfolio is now invested in Japan, which continues to
be a source of disappointment. The Japanese government has aggressively pursued
stimulatory fiscal and monetary policies over the past year and has, we
believe, enabled local banks to put the worst of the bad-debt crisis behind
them. However, the private sector of the economy has been slow to respond, and
the Japanese stock market has failed to follow through on its original
enthusiasm of 14 months ago. We have focused in Japan on stocks of companies
that are sensitive to local, rather than export, business and believe that our
patience will be rewarded.
The third major region where the Portfolio is focused is the
faster-growing Asian markets, where 16% of our assets is committed. Hong Kong
shone through as an exception to the region's rather lackluster trend;
fortunately, it made up one-third of our regional exposure, providing
considerable support. Because Hong Kong is increasingly tied to China's
economy, good news from the latter added stimulus to the local economy's
natural cyclical recovery.
Elsewhere in the region, slow growth in demand from Japan and weak prices
for semiconductors worldwide played a part in a temporary economic slowdown
which has discouraged local investors. A year ago, I reported to you fears of
overheating! While these are indeed sensitive economies, they fluctuate around
long-term growth rates that are among the highest in the world. Conditions can
change rapidly, however, and we have recently added to the Portfolio's exposure
in these markets to take advantage of the cheap stock prices now available.
Amid these pluses and minuses, the Portfolio's diversification has kept
us on the positive side. I am encouraged that, particularly in the Pacific
Basin, there is much to look forward to in the coming year. There is no
certainty of it, however, so we shall remain well-balanced. But the time is
approaching when the Pacific area will replace Europe as the region generating
the best returns.
Richard Foulkes
Schroder Capital Management International
September 17, 1996
7
<PAGE> 30
PORTFOLIO PROFILE: INTERNATIONAL GROWTH PORTFOLIO
AUGUST 31, 1996
This Profile provides a snapshot of the Portfolio's characteristics, where
appropriate, compared to an unmanaged index. Key elements of this Profile are
defined on page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- ---------------------------------------------
INTERNATIONAL
GROWTH MSCI-EAFE
- ---------------------------------------------
<S> <C> <C>
Number of Stocks 172 1,103
Turnover Rate 22% --
Expense Ratio 0.56% --
Cash Reserves 1.9% --
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- ---------------------------------------------
INTERNATIONAL
GROWTH MSCI-EAFE
- ---------------------------------------------
<S> <C> <C>
R-Squared 0.76 1.00
Beta 0.79 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- --------------------------------------------
<S> <C>
Ciba-Geigy AG (Registered) 3.1%
Internationale Nederlanden
Groep NV 2.5
British Petroleum Co., PLC 2.4
Veba AG 2.4
ABB AG (Bearer) 2.4
Fuji Photo Film Co., Ltd. 2.3
Heineken NV 2.1
Ito-Yokado Co. Ltd. 2.1
Takeda Chemical Industries 2.0
Bayer AG 1.7
- --------------------------------------------
Top Ten 23.0%
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION
- ------------------------------------------
<S> <C>
EUROPE 50%
JAPAN 27%
PACIFIC (MINUS JAPAN) 11%
EMERGING MARKETS 8%
OTHER 4%
</TABLE>
<TABLE>
<CAPTION>
COUNTRY DIVERSIFICATION (% OF COMMON STOCK)
- ---------------------------------------------------
INTERNATIONAL
GROWTH MSCI-EAFE
- ---------------------------------------------------
<S> <C> <C>
Argentina 0.1% --
Australia 1.6 2.7%
Belgium -- 1.2
Brazil 0.9 --
Canada 2.6 --
Chile 0.2 --
Denmark 0.6 0.8
Finland 0.4 0.5
France 4.2 6.5
Germany 7.4 7.1
Hong Kong 5.3 3.2
Indonesia 1.3 --
Italy 1.2 2.7
Japan 27.0 39.0
Korea 1.5 --
Malaysia 2.3 2.4
Mexico 0.3 --
Netherlands 11.9 4.3
Philippines 1.8 --
Singapore 2.1 1.4
Spain -- 1.9
Sweden 2.4 2.2
Switzerland 10.1 6.0
Thailand 1.6 --
United Kingdom 13.2 16.6
Other -- 1.5
- ---------------------------------------------------
Total 100% 100%
</TABLE>
8
<PAGE> 31
[FIGURE 6]
PORTFOLIO CHARACTERISTICS
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified, and the more likely it is to perform in line with
the overall stock market.
TURNOVER RATE. Indicates trading activity during the past year. Portfolios with
high turnover rates incur higher transaction costs and are more likely to
realize and distribute capital gains (which are taxable to investors). The
average turnover rate for international equity mutual funds is about 60%.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors. The average expense ratio for an international equity
mutual fund was 1.58% in 1995.
CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing investments.
PORTFOLIO ALLOCATION
This chart shows the distribution, by geographic region, of the portfolio's
holdings.
VOLATILITY MEASURES
R-SQUARED. A measure of how much of a portfolio's past returns can be explained
by the returns from the overall market (or its benchmark index). If a
portfolio's total return were precisely synchronized with the overall market's
return, its R-squared would be 1.00. If a portfolio's returns bore no
relationship to the market's returns, its R-squared would be 0.
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the fluctuations in the overall market (or appropriate market
index). The market, or index, has a beta of 1.00, so a portfolio with a beta of
1.20 would have seen its share price rise or fall by 12% when the overall
market rose or fell by 10%.
COUNTRY DIVERSIFICATION
Indicates the percentage of a portfolio's common stock invested in securities
of various countries.
TEN LARGEST HOLDINGS
Indicates the percentage of a portfolio's total net assets in its ten largest
stocks (25% is the average for stock mutual funds). As this percentage rises, a
portfolio's returns are likely to be more volatile, since its return is more
dependent on the fortunes of a few companies.
9
<PAGE> 32
PERFORMANCE SUMMARY: INTERNATIONAL GROWTH PORTFOLIO
All of the data on this page represent past performance, which cannot be used
to predict future returns that may be achieved by the Portfolio. Note, too,
that both share price and return can fluctuate widely so that an investment in
the Portfolio could lose money.
<TABLE>
<CAPTION>
TOTAL INVESTMENT RETURNS: 9/30/81-8/31/96
- ------------------------------------------------------------------
INTERNATIONAL GROWTH PORTFOLIO MSCI-EAFE
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ------------------------------------------------------------------
<S> <C> <C> <C> <C>
1982 -5.7% 0.0% -5.7% -4.7%
1983 57.1 4.3 61.4 31.0
1984 5.7 1.6 7.3 14.7
1985 15.7 2.1 17.8 32.3
1986 96.4 2.5 98.9 103.7
1987 31.2 0.8 32.0 46.0
1988 -10.8 0.9 -9.9 -6.2
1989 22.7 1.8 24.5 22.4
1990 4.0 1.2 5.2 -11.8
1991 -6.8 1.7 -5.1 -0.3
1992 -0.4 1.9 1.5 0.4
1993 18.4 2.7 21.1 27.1
1994 19.5 0.9 20.4 11.1
1995 2.4 1.4 3.8 0.8
1996 11.3 1.4 12.7 8.2
- ------------------------------------------------------------------
</TABLE>
See Financial Highlights table on page 16 for dividend and capital gains
information for the past five years.
CUMULATIVE PERFORMANCE: 8/31/86-8/31/96
[FIGURE 7]
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED AUGUST 31, 1996
---------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
INTERNATIONAL GROWTH PORTFOLIO 12.72% 11.60% 9.85% $25,586
AVERAGE INTERNATIONAL FUND 8.83 9.32 8.81 23,267
MSCI-EAFE INDEX 8.19 9.13 8.59 22,790
- ----------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED 6/30/96*
- ---------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION -------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
International Growth Portfolio 9/30/81 17.95% 12.31% 9.65% 1.49% 11.14%
- ---------------------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter as well as for the Portfolio's fiscal year
end.
10
<PAGE> 33
[FIGURE 8]
FINANCIAL STATEMENTS
AUGUST 31, 1996
STATEMENT OF NET ASSETS
This Statement provides a detailed list of the Portfolio's holdings, including
each security's market value on the last day of the reporting period.
Securities are grouped and subtotaled by asset type (common stocks, bonds,
etc.) and by country. Other assets are added to, and liabilities are subtracted
from, the value of Total Investments to calculate the Portfolio's Net Assets.
Finally, Net Assets are divided by the outstanding shares of the Portfolio to
arrive at its share price, or Net Asset Value (NAV) Per Share.
At the end of the Statement of Net Assets, you will find a table
displaying the composition of the Portfolio's net assets on both a dollar and
per-share basis. Because all income and any realized gains must be distributed
to shareholders each year, the bulk of net assets consists of Paid in Capital
(money invested by shareholders). The amounts shown for Undistributed Net
Investment Income and Accumulated Net Realized Gains usually approximate the
sums the Portfolio had available to distribute to shareholders as income
dividends or capital gains as of the statement date, but may differ because
certain investments or transactions may be treated differently for financial
statement and tax purposes. Any Accumulated Net Realized Losses, and any
cumulative excess of distributions over net income or net realized gains, will
appear as negative balances. Unrealized Appreciation (Depreciation) is the
difference between the market value of the Portfolio's investments and their
cost, and reflects the gains (losses) that would be realized if the Portfolio
were to sell all of its investments at their statement-date values.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------
MARKET
INTERNATIONAL VALUE*
GROWTH PORTFOLIO SHARES (000)
- ------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (98.1%)
- ------------------------------------------------------------------
ARGENTINA (0.1%)
Perez Companc SA B 576,300 $ 3,298
---------------
AUSTRALIA (1.6%)
Amcor Ltd. 807,000 4,942
Australia & New Zealand
Banking Group Ltd. 964,000 5,042
Broken Hill Proprietary Ltd. 1,125,500 15,335
Comalco A Ltd. 910,096 5,098
Lend Lease Corp. 321,031 5,253
Mayne Nickless Ltd. 975,000 6,534
News Corp. Ltd. 1,512,763 8,068
Normandy Mining Ltd. 3,913,212 6,471
- - Normandy Mining Ltd.
Warrants Exp. 4/30/01 16,450 8
Qantas Airways Ltd. 3,057,482 4,838
QNI Ltd. 2,500,000 5,499
TABCORP Holdings Ltd. 1,465,000 6,688
WMC Ltd. 854,937 5,953
---------------
79,729
---------------
BRAZIL (0.8%)
Telecomunicacoes
Brasileiras SA 147,460,000 8,923
Telecomunicacoes
Brasileiras SA Pfd. 313,665,755 23,302
Usinas Siderurgicas
de Minas Gerais SA ADR 440,000 4,510
Usinas Siderurgicas
de Minas Gerais SA Pfd. 4,612,149,000 4,810
---------------
41,545
---------------
CANADA (2.6%)
Canadian Pacific Ltd. 1,650,000 36,961
Noranda A Inc. 1,500,000 31,628
NOVA Corp. 3,450,000 30,636
Royal Bank of Canada 1,200,000 30,126
---------------
129,351
---------------
CHILE (0.2%)
Compania de Telecomunicaciones
de Chile SA ADR 54,000 5,279
Sociedad Quimica Y Minera
de Chile ADR 60,000 3,165
---------------
8,444
---------------
DENMARK (0.5%)
Den Danske Bank 376,000 26,858
---------------
FINLAND (0.4%)
- - UPM-Kymmene Oy 832,000 19,028
---------------
FRANCE (4.2%)
Cie. Generale des Eaux 436,000 42,116
Elf Aquitaine SA 1,133,600 82,687
Michelin Series B (Registered) 789,270 36,934
Primagaz Cie. 84,668 9,093
- - Primagaz Cie. Warrants
Exp. 6/30/98 7,697 148
- - SGS-Thomson Microelectronics
NV ADR 350,000 14,306
Valeo SA 447,000 22,544
---------------
207,828
---------------
GERMANY (7.3%)
Bayer AG 2,391,640 85,612
Friedrich Grohe AG Pfd. 18,747 5,138
Linde AG 60,000 37,353
Mannesmann AG 100,000 36,135
SGL Carbon AG 60,000 7,333
</TABLE>
11
<PAGE> 34
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
MARKET
INTERNATIONAL VALUE*
GROWTH PORTFOLIO SHARES (000)
- ------------------------------------------------------------------
<S> <C> <C>
Siemens AG 1,355,000 $ 71,702
Veba AG 2,295,000 120,589
---------------
363,862
---------------
HONG KONG (5.2%)
Cheung Kong Holdings Ltd. 5,580,000 39,147
Citic Pacific Ltd. 2,440,000 10,728
Hong Kong Electric Holdings Ltd. 4,450,000 13,294
HSBC Holdings PLC 2,362,943 40,795
Hutchison Whampoa Ltd. 6,810,000 41,216
Sun Hung Kai Properties Ltd. 5,343,400 52,172
Swire Pacific Ltd. A 4,704,000 41,822
Wharf Holdings Ltd. 5,500,000 20,769
---------------
259,943
---------------
INDONESIA (1.3%)
PT Indocement Tunggal
(Foreign) 2,062,000 5,987
PT Indofood Sukses Makmur
(Foreign) 10,450,800 21,196
PT Indosat ADR 528,000 16,500
PT Indosat (Foreign) 1,748,000 5,523
PT Telekomunikasi
Indonesia ADR 480,000 13,380
---------------
62,586
---------------
ITALY (1.1%)
Fiat SPA 7,000,000 21,710
Parmalat Finanziaria SPA 13,206,240 18,116
Telecom Italia Mobile SPA 8,000,000 16,488
---------------
56,314
---------------
JAPAN (26.5%)
Bridgestone Corp. 4,755,000 77,936
Dai Nippon Printing Co., Ltd. 1,500,000 26,381
DDI Corp. 8,000 63,720
East Japan Railway Co. 6,245 29,212
Fuji Photo Film Co., Ltd. 3,780,000 113,818
Hirose Electronics Co., Ltd. 315,000 18,970
Hitachi Ltd. 4,600,000 42,273
Ito-Yokado Co. Ltd. 1,980,000 104,470
Japan Airport Terminal Co., Ltd. 160,000 2,254
Keyence Corp. 130,000 16,519
Kuraray Co., Ltd. 2,250,000 22,997
Kyocera Corp. 317,000 21,542
Mabuchi Motor Co. 663,300 36,402
Matsushita Electric Industrial
Co., Ltd. 4,075,000 68,667
Mitsubishi Electric Corp. 1,969,000 12,637
Mitsui & Co., Ltd. 6,450,000 54,463
Murata Manufacturing Co., Ltd. 2,216,000 78,356
Nippon Television Network 39,300 11,725
Omron Corp. 2,488,000 45,590
Sankyo Co., Ltd. 935,000 23,246
Seino Transportation Co., Ltd. 425,000 6,262
Shin-Etsu Chemical Co., Ltd. 1,050,000 18,564
Showa Shell Sekiyu 2,760,000 26,685
Skylark Co., Ltd. 88,000 1,661
SMC Corp. 986,000 69,002
Sumitomo Electric 3,000,000 39,779
Takeda Chemical 5,731,000 99,211
Tokyo Marine & Fire
Insurance Co. 4,050,000 46,243
Tokyo Electron Ltd. 545,000 14,252
Toppan Printing Co., Ltd. 1,450,000 18,292
Toray Industries Inc. 2,200,000 13,715
Toyota Motor Corp. 2,350,000 56,694
Yamazaki Baking Co., Ltd. 400,000 6,814
Yasuda Fire & Marine
Insurance Co. 5,190,000 33,835
Yokohama Reito Co., Ltd. 211,000 2,662
---------------
1,324,849
---------------
KOREA (1.5%)
- - Hyundai Motor Co., Ltd. GDR Rfd. 466,000 5,848
Korea Electric Power Corp. 441,050 15,747
Korea Mobile
Telecommunications Corp. 14,242 16,160
Korean Air Lines 463,102 11,133
Pohang Iron & Steel Co., Ltd. 80,000 6,208
Samsung Electronics Co. Ltd.
GDR 1/2 Non-voting Stock 282,679 6,572
- - Samsung Electronics Co. Ltd.
GDR 1/2 Voting Stock 22,392 1,030
Shinhan Bank 465,162 10,756
---------------
73,454
---------------
MALAYSIA (2.3%)
Genting Bhd. 4,047,000 29,860
Malayan Banking Bhd. 4,333,000 41,179
Renong Bhd. 9,200,000 13,429
Tan Chong Motor Holdings Bhd. 2,242,000 3,974
Telekom Malaysia Bhd. 2,863,000 25,257
---------------
113,699
---------------
MEXICO (0.3%)
Apasco SA de CV 1,066,000 7,194
Cemex SA de CV 614,720 2,253
Cifra SA de CV Series C 4,309,000 6,683
---------------
16,130
---------------
Netherlands (11.7%)
Ceteco Holdings NV 123,522 6,599
(1) Delft Instruments NV 454,330 11,162
Elsevier NV 3,275,000 52,191
Getronics NV 2,283,588 55,691
Hagemeyer NV 248,818 18,625
Heineken NV 477,000 106,307
Internationale Nederlanden
Groep NV 3,955,000 123,430
KLM Royal Dutch Airlines NV 573,658 15,825
Koninklijke Ahold NV 480,000 26,889
Oce Van-Der Grinten NV 498,000 51,345
Otra NV 789,500 14,965
Philips Electronics NV
(non-voting) 2,150,000 72,809
Sphinx Gustavsberg NV 396,046 6,383
VNU-Verenigde Nederlandse
Uitgeversbedrijven Verenigd
Bezit NV 1,270,000 22,079
---------------
584,300
---------------
PHILIPPINES (1.8%)
Ayala Land Inc. B 29,900,155 38,238
Manila Electric Co. B 598,000 4,589
Manila Electric Co. GDR 395,605 14,637
Philippines Long Distance
Telephone Co. 502,000 30,375
---------------
87,839
---------------
</TABLE>
12
<PAGE> 35
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ------------------------------------------------------------------
<S> <C> <C>
SINGAPORE (2.0%)
DBS Land Ltd. 3,948,000 $ 13,130
Development Bank of Singapore
Ltd. (Foreign) 1,575,000 18,468
Keppel Corp., Ltd. 2,416,000 18,371
Mandarin Oriental
International Ltd. 4,311,369 5,993
Oversea-Chinese Banking Corp.
Ltd. (Foreign) 1,312,850 15,767
Singapore Airlines Ltd. (Foreign) 1,268,000 13,426
Singapore Press Holdings Ltd.
(Foreign) 796,320 13,808
Wing Tai Holdings Ltd. 917,000 1,968
---------------
100,931
---------------
SWEDEN (2.3%)
Astra AB Series B 1,700,000 70,413
LM Ericsson Telephone AB
Series B 1,470,000 34,332
Stora Kopparbergs Berglags
Aktiebolag Series A 900,000 12,652
---------------
117,397
---------------
SWITZERLAND (9.9%)
ABB AG (Bearer) 97,000 119,797
Adecco SA (Bearer) 102,800 29,014
Ciba-Geigy AG (Registered) 121,500 153,707
CS Holding AG (Registered) 613,000 63,729
Nestle SA (Registered) 45,000 52,795
Roche Holding AG 5,000 38,182
Sandoz AG (Registered) 33,248 39,646
---------------
496,870
---------------
THAILAND (1.6%)
Bangkok Bank Public Co., Ltd.
(Foreign) 1,215,000 15,365
Electricity Generating Public
Co., Ltd. (Foreign) 654,100 1,939
Land and House Public Co., Ltd.
(Foreign) 1,966,700 28,290
Siam Cement Public Co., Ltd.
(Foreign) 51,300 1,971
Thai Farmers Bank Public
Co., Ltd. (Foreign) 1,523,000 16,453
United Communication Industry
Public Co., Ltd. (Foreign) 1,550,000 15,313
---------------
79,331
---------------
UNITED KINGDOM (12.9%)
Asda Group PLC 13,000,000 22,859
British Aerospace PLC 3,000,000 46,749
- - British Aerospace PLC
Warrants Exp. 11/15/00 120,000 908
British Airways PLC 2,050,000 16,886
British Land Co., PLC 5,880,000 42,276
British Petroleum Co. PLC 12,490,000 121,230
British Steel PLC 7,000,000 20,350
Burton Group PLC 14,000,000 33,369
Cable and Wireless PLC 4,000,000 26,321
Courtaulds PLC 2,750,200 18,548
De La Rue PLC 972,200 9,725
EMI Group PLC 1,300,000 29,300
Enterprise Oil PLC 3,300,000 26,357
Lucas Industries PLC 1,288,000 4,831
Peninsular & Oriental Steam
Navigation Co. 1,700,000 13,684
Rank Organisation PLC 6,465,000 45,168
RTZ Corp. PLC 3,060,000 45,484
David S. Smith Holdings PLC 3,500,000 18,052
Tesco PLC 8,090,000 38,187
- - Thorn PLC 1,300,000 7,884
United News & Media PLC 2,500,000 27,938
Vodafone Group PLC 4,400,000 16,574
Zeneca Group PLC 600,000 14,329
---------------
647,009
---------------
- ------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $4,078,030) 4,900,595
- ------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Face
Amount
(000)
- ------------------------------------------------------------------
<S> <C> <C>
TEMPORARY CASH INVESTMENT (2.4%)
- ------------------------------------------------------------------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled Cash Account
5.25%, 9/3/96
(COST $122,432) $122,432 122,432
- ------------------------------------------------------------------
TOTAL INVESTMENTS (100.5%)
(COST $4,200,462) 5,023,027
- ------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.5%)
- ------------------------------------------------------------------
Other Assets--Notes C and F 441,365
Liabilities--Note F (467,167)
---------------
(25,802)
- ------------------------------------------------------------------
NET ASSETS (100%)
- ------------------------------------------------------------------
Applicable to 309,895,483 outstanding
$1.00 par value shares
(authorized 550,000,000 shares) $4,997,225
==================================================================
NET ASSET VALUE PER SHARE $16.13
==================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
- - Non-Income Producing Security.
(1)Considered an affiliated company as the Portfolio owns more than 5% of
the outstanding voting securities of such company.
ADR--American Depository Receipt.
GDR--Global Depository Receipt.
Rfd.--Rank for Dividend.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ------------------------------------------------------------------
AT AUGUST 31, 1996, NET ASSETS CONSISTED OF:
- ------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $3,970,430 $12.82
Undistributed Net
Investment Income--Note D 44,960 .15
Accumulated Net Realized
Gains--Notes D and E 167,186 .54
Unrealized Appreciation
(Depreciation)--Note E:
Investment Securities 822,565 2.65
Foreign Currencies and
Forward Currency Contracts (7,916) (.03)
- ------------------------------------------------------------------
NET ASSETS $4,997,225 $16.13
==================================================================
</TABLE>
13
<PAGE> 36
STATEMENT OF OPERATIONS
This Statement shows dividend and interest income earned by the Portfolio
during the reporting period, and details the operating expenses charged to the
Portfolio. These expenses directly reduce the amount of investment income
available to pay to shareholders as dividends. This Statement also shows any
Net Gains (Losses) realized on the sale of investments in securities, and the
increase or decrease in the Unrealized Appreciation (Depreciation) on
investments during the period; these amounts include the effect of foreign
currency movements on the value of the Portfolio's securities. Currency Gains
(Losses) on the translation of other assets and liabilities, combined with the
results of any investments in forward currency contracts during the period, are
shown separately.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
INTERNATIONAL GROWTH PORTFOLIO
YEAR ENDED AUGUST 31, 1996
(000)
- ----------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends(1) $ 70,516
Interest 8,099
-------------
Total Income 78,615
-------------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 5,892
Performance Adjustment 1,545
The Vanguard Group--Note C
Management and Administrative 11,543
Marketing and Distribution 938
Taxes (other than income taxes) 274
Custodian Fees 2,846
Auditing Fees 10
Shareholders' Reports 204
Annual Meeting and Proxy Costs 101
Directors' Fees and Expenses 15
-------------
Total Expenses 23,368
Expenses Paid Indirectly--Note C (831)
-------------
Net Expenses 22,537
- ----------------------------------------------------------------------------
NET INVESTMENT INCOME 56,078
- ----------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 136,883
Foreign Currencies and Forward Currency Contracts 108,911
- ----------------------------------------------------------------------------
REALIZED NET GAIN 245,794
- ----------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 210,144
Foreign Currencies and Forward Currency Contracts (48,226)
- ----------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 161,918
- ----------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $463,790
============================================================================
</TABLE>
(1)Dividends are net of foreign withholding taxes of $9,872,000.
14
<PAGE> 37
STATEMENT OF CHANGES IN NET ASSETS
This Statement shows how the Portfolio's total net assets changed during the
two most recent reporting periods. The Operations section summarizes
information that is detailed in the Statement of Operations. The amounts shown
as Distributions to shareholders from the Portfolio's Net Investment Income and
Realized Capital Gain may not match the amounts shown in the Operations
section, because distributions are determined on a tax basis and may be made in
a period different from the one in which the income was earned or the gains
were realized. The Capital Share Transactions section shows the amount
shareholders invested in the Portfolio, either by purchasing shares or by
reinvesting distributions, as well as the amounts redeemed. The corresponding
numbers of Shares Issued and Redeemed are shown at the end of the Statement.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------
INTERNATIONAL GROWTH PORTFOLIO
YEAR ENDED AUGUST 31,
--------------------------------
1996 1995
(000) (000)
- -----------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 56,078 $ 46,145
Realized Net Gain (Loss) 245,794 (16,215)
---------------------------------
Change in Unrealized Appreciation (Depreciation) 161,918 82,767
---------------------------------
Net Increase in Net Assets Resulting from
Operations 463,790 112,697
---------------------------------
DISTRIBUTIONS
Net Investment Income (47,382) (38,607)
Realized Capital Gain (49,751) --
---------------------------------
Total Distributions (97,133) (38,607)
---------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 1,967,623 1,123,240
Issued in Lieu of Cash Distributions 90,182 36,111
Redeemed (780,882) (868,954)
---------------------------------
Net Increase from Capital Share Transactions 1,276,923 290,397
- -----------------------------------------------------------------------------------------
Total Increase 1,643,580 364,487
- -----------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 3,353,645 2,989,158
---------------------------------
End of Year $4,997,225 $3,353,645
=========================================================================================
(1)Shares Issued (Redeemed)
Issued 125,890 80,730
Issued in Lieu of Cash Distributions 6,000 2,719
Redeemed (50,140) (63,495)
---------------------------------
Net Increase in Shares Outstanding 81,750 19,954
=========================================================================================
</TABLE>
15
<PAGE> 38
FINANCIAL HIGHLIGHTS
This table summarizes the Portfolio's investment results and distributions to
shareholders on a per-share basis. It also presents the Portfolio's Total
Return and shows net investment income and expenses as percentages of average
net assets. These data will help you assess: the variability of the Portfolio's
net income and total returns from year to year; the relative contributions of
net income and capital gains to the Portfolio's total return; how much it costs
to operate the Portfolio; and the extent to which the Portfolio tends to
distribute capital gains.
The table also shows the Portfolio Turnover Rate, a measure of trading
activity. A turnover rate of 100% means that the average security is held in
the Portfolio for one year. Finally, the table lists the Portfolio's Average
Commission Rate Paid, a disclosure required by the SEC beginning in 1996. This
rate is calculated by dividing total commissions paid on portfolio securities
by the total number of shares purchased and sold on which commissions were
charged.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------
INTERNATIONAL GROWTH PORTFOLIO
YEAR ENDED AUGUST 31,
-----------------------------------------------------------
FOR A SHARE OUTSTANDING THROUGHOUT EACH YEAR 1996 1995 1994 1993 1992
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $14.70 $14.36 $12.02 $10.15 $10.31
- -----------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .19 .20 .14 .12 .20
Net Realized and Unrealized Gain (Loss) on Investments 1.65 .32 2.31 1.96 (.05)
------------------------------------------------------------
Total From Investment Operations 1.84 .52 2.45 2.08 .15
------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.20) (.18) (.11) (.21) (.19)
Distributions from Realized Capital Gains (.21) -- -- -- (.12)
------------------------------------------------------------
Total Distributions (.41) (.18) (.11) (.21) (.31)
- -----------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $16.13 $14.70 $14.36 $12.02 $10.15
=======================================================================================================================
TOTAL RETURN 12.72% 3.76% 20.44% 21.06% 1.49%
=======================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $4,997 $3,354 $2,989 $1,477 $919
Ratio of Total Expenses to Average Net Assets--Note C 0.56% 0.59% 0.46% 0.59% 0.58%
Ratio of Net Investment Income to Average Net Assets 1.35% 1.53% 1.37% 1.27% 2.04%
Portfolio Turnover Rate 22% 31% 28% 51% 58%
Average Commission Rate Paid $.0223 N/A N/A N/A N/A
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
16
<PAGE> 39
NOTES TO FINANCIAL STATEMENTS
Vanguard International Growth Portfolio is registered under the Investment
Company Act of 1940 as a diversified open-end investment company, or mutual
fund. The Portfolio invests in securities of foreign issuers which may subject
it to investment risks not normally associated with investing in securities of
United States corporations.
A. The following significant accounting policies conform with generally
accepted accounting principles for mutual funds. The Portfolio consistently
follows such policies in preparing its financial statements.
1. SECURITY VALUATION: Foreign securities listed on an exchange are valued
at the latest quoted sales prices on the appropriate exchange as of the close
of trading on the New York Stock Exchange (generally 4:00 p.m. Eastern time) on
the valuation date. Securities not listed on an exchange are valued at the
latest quoted bid prices. Temporary cash investments are valued at cost, which
approximates market value.
2. FOREIGN CURRENCY: Securities and other assets and liabilities
denominated in foreign currencies are translated into U.S. dollars at the bid
prices of those currencies against U.S. dollars last quoted by major banks as
of 5:00 p.m. Geneva time on the valuation date.
Realized gains (losses) and unrealized appreciation (depreciation) on
investment securities include the effects of changes in exchange rates since
the securities were purchased, combined with the effects of changes in security
prices. Fluctuations in the value of other assets and liabilities resulting
from changes in exchange rates are recorded as unrealized foreign currency
gains (losses) until the asset or liability is settled in cash, when they are
recorded as realized foreign currency gains (losses).
3. FORWARD CURRENCY CONTRACTS: The Portfolio enters into forward currency
contracts to protect the value of securities and related receivables and
payables against changes in future foreign exchange rates. The Portfolio's
risks in using these contracts include movement in the values of the foreign
currencies relative to the U.S. dollar and the ability of the counterparties to
fulfill their obligations under the contracts.
Forward currency contracts are valued at their quoted daily settlement
prices. The aggregate principal amounts of the contracts are not recorded in
the financial statements. Fluctuations in the value of the contracts are
recorded in the Statement of Net Assets as an asset (liability) and in the
Statement of Operations as unrealized appreciation (depreciation) until the
contracts are closed, when they are recorded as realized forward currency
contract gains (losses).
4. FEDERAL INCOME TAXES: The Portfolio intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for Federal income taxes is required in the financial
statements.
5. REPURCHASE AGREEMENTS: The Portfolio, along with other members of The
Vanguard Group, transfers uninvested cash balances to a Pooled Cash Account,
which is invested in repurchase agreements secured by U.S. Government
securities. Securities pledged as collateral for repurchase agreements are held
by a custodian bank until the agreements mature. Each agreement requires that
the market value of the collateral be sufficient to cover payments of interest
and principal; however, in the event of default or bankruptcy by the other
party to the agreement, retention of the collateral may be subject to legal
proceedings.
6. DISTRIBUTIONS: Distributions to shareholders are recorded on the
ex-dividend date. Distributions are determined on a tax basis and may differ
from net investment income and realized capital gains for financial reporting
purposes. See Note E.
7. OTHER: Dividend income is recorded on the ex-dividend date. Security
transactions are accounted for on the date securities are bought or sold. Costs
used to determine realized gains (losses) on the sale of investment securities
are those of the specific securities sold.
B. Under a contract that expires March 31, 1997, the Portfolio pays Schroder
Capital Management International an investment advisory fee calculated at an
annual percentage rate of average
17
<PAGE> 40
net assets. The basic fee is subject to quarterly adjustments based on
performance relative to the Morgan Stanley Capital International-Europe,
Australasia, Far East Index. For the year ended August 31, 1996, the advisory
fee represented an effective annual basic rate of 0.14% of the Portfolio's
average net assets before an increase of $1,545,000 (0.04%) based on
performance.
C. The Vanguard Group furnishes at cost corporate management, administrative,
marketing, and distribution services. The costs of such services are allocated
to the Portfolio under methods approved by the Board of Directors. At August
31, 1996, the Portfolio had contributed capital of $494,000 to Vanguard
(included in Other Assets), representing 2.5% of Vanguard's capitalization. The
Portfolio's directors and officers are also directors and officers of Vanguard.
Vanguard has asked the Portfolio's investment adviser to direct certain
portfolio trades, subject to obtaining the best price and execution, to brokers
who have agreed to rebate to the Portfolio part of the commissions generated.
Such rebates are used solely to reduce the Portfolio's administrative expenses.
For the year ended August 31, 1996, these arrangements reduced the Portfolio's
expenses by $831,000 (0.02% of average net assets).
D. During the year ended August 31, 1996, the Portfolio purchased
$2,232,893,000 of investment securities and sold $880,692,000 of investment
securities, not counting U.S. Government securities and temporary cash
investments.
During the year ended August 31, 1996, the Portfolio realized net foreign
currency gains of $647,000, which increased distributable net income for tax
purposes; accordingly, such gains have been reclassified from accumulated net
realized gains to undistributed net investment income.
E. At August 31, 1996, net unrealized appreciation of investment securities
for financial reporting and Federal income tax purposes was $822,565,000,
consisting of unrealized gains of $924,302,000 on securities that had risen in
value since their purchase and $101,737,000 in unrealized losses on securities
that had fallen in value since their purchase.
At August 31, 1996, the Portfolio had open forward currency contracts to
deliver foreign currency in exchange for U.S. dollars as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------
(000)
------------------------------------------------
UNREALIZED
CONTRACT FOREIGN U.S. APPRECIATION
SETTLEMENT DATE CURRENCY DOLLARS (DEPRECIATION)
- ----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Deliver:
9/16/96 CHF 250,000 $199,105 $(9,905)
9/20/96 JPY 25,700,000 239,114 1,948
- ----------------------------------------------------------------------------------------------
</TABLE>
CHF--Swiss Francs.
JPY--Japanese Yen.
Net unrealized depreciation of $7,957,000 related to open forward currency
contracts is required to be treated as realized loss for tax purposes. After
adjusting the Portfolio's accumulated net realized gains for the unrealized
depreciation on forward currency contracts, the Portfolio had $159,229,000 of
capital gains available for distribution.
The Portfolio had net unrealized foreign currency gains of $41,000
resulting from the translation of other assets and liabilities at August 31,
1996.
F. The market value of securities on loan to broker/dealers at August 31,
1996, was $392,792,000, for which the Portfolio held cash collateral of
$416,254,000.
18
<PAGE> 41
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and
Board of Directors of
Vanguard International Growth Portfolio
In our opinion, the accompanying statement of net assets and the related
statements of operations and of changes in net assets and the financial
highlights present fairly, in all material respects, the financial position of
Vanguard International Growth Portfolio (the "Portfolio") at August 31, 1996,
and the results of its operations, the changes in its net assets and the
financial highlights for each of the periods indicated, in conformity with
generally accepted accounting principles. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Portfolio's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits, which included confirmation of securities at August 31, 1996 by
correspondence with the custodian and brokers and the application of
alternative auditing procedures where confirmations from brokers were not
received, provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
September 30, 1996
19
<PAGE> 42
SPECIAL 1996 TAX INFORMATION (UNAUDITED)
FOR VANGUARD INTERNATIONAL GROWTH PORTFOLIO
This information for the fiscal year ended August 31, 1996, is included
pursuant to provisions of the Internal Revenue Code.
The Portfolio designates $172,963,000 as capital gain dividends (from net
long-term capital gains), of which $28,953,000 was distributed to shareholders
in December 1995. The balance of $144,010,000, along with any additional gains
realized through October 31, 1996, will be distributed in December 1996. The
Portfolio has elected to pass through the credit for taxes paid in foreign
countries. The foreign income and foreign tax per share outstanding on August
31, 1996 are as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------
GROSS FOREIGN FOREIGN
COUNTRY DIVIDENDS TAX
---------------------------------------------------------------
<S> <C> <C>
Argentina $.0002 $.0000
Australia .0061 .0003
Belgium .0001 .0000
Brazil .0044 .0005
Canada .0070 .0010
Chile .0007 .0002
Finland .0025 .0004
France .0182 .0000
Germany .0195 .0019
Hong Kong .0222 .0000
Indonesia .0029 .0004
Italy .0060 .0009
Japan .0248 .0037
Korea .0016 .0003
Luxembourg .0001 .0000
Malaysia .0032 .0009
Mexico .0004 .0000
Netherlands .0356 .0053
Philippines .0009 .0002
Singapore .0047 .0011
Sweden .0053 .0008
Switzerland .0218 .0033
Thailand .0039 .0004
United Kingdom .0674 .0101
---------------------------------------------------------------
</TABLE>
The pass-through of foreign tax credit will affect only shareholders on the
dividend record date in December 1996. Shareholders will receive more detailed
information along with their Form 1099-DIV in January 1997.
20
<PAGE> 43
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman of the Board and Director of The Vanguard Group, Inc.
and of each of the investment companies in The Vanguard Group.
JOHN J. BRENNAN, President, Chief Executive Officer, and Director of The
Vanguard Group, Inc. and of each of the investment companies in The
Vanguard Group.
ROBERT E. CAWTHORN, Chairman Emeritus of Rhone-Poulenc Rorer Inc.; Director of
Sun Company, Inc. and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea Co.,
Alco Standard Corp., Raytheon Co., Knight-Ridder, Inc., and
Massa-chusetts Mutual Life Insurance Co.
BRUCE K. MACLAURY, President Emeritus of The Brookings Institution; Director of
American Express Bank Ltd., The St. Paul Companies, Inc., and National
Steel Corp.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl
Corp., Baker Fentress & Co., The Jeffrey Co., and Southern New England
Communications Co.
ALFRED M. RANKIN, Jr., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich
Co., and The Standard Products Co.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co.
and President of New York University; Director of Pacific Gas and
Electric Co. and NACCO Industries.
JAMES O. WELCH, Jr., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc.
and Kmart Corp.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas Co.;
Director of Cummins Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies in
The Vanguard Group.
RICHARD F. HYLAND, Treasurer; Principal of The Vanguard Group, Inc.; Treasurer
of each of the investment companies in The Vanguard Group.
KAREN E. WEST, Controller; Principal of The Vanguard Group, Inc.; Controller of
each of the investment companies in The Vanguard Group.
OTHER VANGUARD OFFICERS
ROBERT A. DISTEFANO, Senior Vice President,
Information Technology.
JAMES H. GATELY, Senior Vice President,
Individual Investor Group.
IAN A. MACKINNON, Senior Vice President,
Fixed Income Group.
F. WILLIAM MCNABB III, Senior Vice President,
Institutional.
RALPH K. PACKARD, Senior Vice President and
Chief Financial Officer.
[THE VANGUARD GROUP LOGO]
Please send your comments to us at:
Post Office Box 2600, Valley Forge, Pennsylvania 19482
Fund Information: 1-800-662-7447
Individual Account Services: 1-800-662-2739
Institutional Investor Services: 1-800-523-1036
[email protected] http://www.vanguard.com
This Report has been prepared for shareholders and
may be distributed to others only if preceded or
accompanied by a current prospectus. All Funds in
the Vanguard Family are offered by prospectus only.
<PAGE> 44
THE VANGUARD FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
Growth and Income Funds
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard Selected Value Portfolio
Vanguard/Trustees' Equity-U.S. Portfolio
Vanguard Convertible Securities Fund
Balanced Funds
Vanguard/Wellington Fund
Vanguard/Wellesley Income Fund
Vanguard STAR Portfolio
Vanguard Asset Allocation Fund
Vanguard LIFEStrategy Portfolios
Growth Funds
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
Aggressive Growth Funds
Vanguard Explorer Fund
Vanguard Specialized Portfolios
Vanguard Horizon Fund
International Funds
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity-International
Portfolio
INDEX FUNDS
Vanguard Index Trust
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
Vanguard Bond Index Fund
Vanguard International Equity Index Fund
Vanguard Total International Portfolio
FIXED-INCOME FUNDS
Money Market Funds
Vanguard Money Market Reserves
Vanguard Admiral Funds
Income Funds
Vanguard Fixed Income Securities Fund
Vanguard Admiral Funds
Vanguard Preferred Stock Fund
Tax-Exempt Money Market Funds
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, NJ, OH, PA)
Tax-Exempt Income Funds
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
Q230-8/96
[FIGURE 9]
