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[PHOTO]
VANGUARD
U.S. GROWTH
PORTFOLIO
Annual Report | August 31, 1997
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[PHOTO]
OUR CREW MAKES THE DIFFERENCE
Throughout our history, The Vanguard Group has received considerable attention
as the low-cost provider of mutual funds. While such accolades are gratifying,
we are most proud, not of our low operating expenses or the billions of dollars
we manage, but of our sterling reputation created by the Vanguard crew.
We recognize that it is our crew members--some 6,000 highly motivated men
and women--who form the cornerstone of our operations. As with any
cornerstone, we could not survive long--let alone prosper--without it. That's
why we chose this fiscal year's annual report to celebrate the spirit,
enthusiasm, and achievements of our crew. (We call those who work at Vanguard
crew members, not employees, because they operate as a team to accomplish our
mission of serving you, our clients.)
But while we prize the collective contributions of our crew, we also take
time to recognize the importance of the individual. Each calendar quarter, we
present our Award For Excellence to a handful of crew members who have
demonstrated particular excellence in the performance of their jobs and who
embody "The Vanguard Spirit." Our report cover shows only a few of the more
than 300 crew members who have received this distinction since 1984.
They, along with the rest of our valiant crew, look forward to serving you
in the years ahead.
[PHOTO]
John J. Brennan
President
John C. Bogle
Chairman
<TABLE>
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CONTENTS
<S> <C>
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
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
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FELLOW SHAREHOLDER,
Propelled by a powerful surge in prices for U.S. stocks, Vanguard U.S. Growth
Portfolio provided a remarkable return of +32.5% in the fiscal year ended
August 31, 1997.
While the gain was the fourth-highest for the Portfolio in the past
quarter-century, and comparable to the average growth fund, it fell well short
of the truly stupendous performance of the Standard & Poor's 500 Composite
Stock Price Index. The table at right presents the fiscal year total returns
(capital change plus reinvested dividends) of the U.S. Growth Portfolio, the
unmanaged S&P 500 Index, and the average growth fund. Our Portfolio's return is
based on an increase in net asset value from $22.62 per share on August 31,
1996, to $27.74 on August 31, 1997, with the ending net asset value adjusted
for a dividend of $0.26 per share paid from net investment income and a
distribution totaling $1.62 per share paid from net realized capital gains.
<TABLE>
<CAPTION>
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TOTAL RETURNS
FISCAL YEAR ENDED
AUGUST 31, 1997
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<S> <C>
Vanguard U.S. Growth Portfolio +32.5%
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Average Growth Fund +33.5%
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S&P 500 Index +40.6%
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</TABLE>
FISCAL 1997 PERFORMANCE OVERVIEW
For the third consecutive year, the U.S. stock market surged in the twelve
months ended August 31, bringing its gain for the three years to an incredible
103%. Conditions remained ideal for equity investors. Robust growth in the
economy and in corporate earnings continued, yet inflation decelerated and
interest rates declined. On balance during the year, the yield on the benchmark
30-year U.S. Treasury bond declined by one-half percentage point, to 6.61%.
Such good news heightened the already-ebullient mood of investors. By the end
of the fiscal year, prices of the stocks constituting the S&P 500 Index were at
or near historic highs in relation to such fundamentals as earnings, dividends,
and book values.
Our fiscal-year return of +32.5% was excellent on an absolute basis, and
we virtually matched the +33.5% return on the average growth fund. However, we
substantially lagged the eye-popping gain of +40.6% by the S&P 500 Index. Our
adviser's stock selections, which powered the Portfolio to a big lead (6.6
percentage points) over the Index in fiscal 1996, were the main reason we fell
short of the Index by a relatively comparable amount (8.1 percentage points) in
fiscal 1997.
In general, the Portfolio was in the "right" industry sectors--we had a
heavier presence than the Index in the high-flying technology sector (17% for
the Portfolio during the year versus 12% for the Index) and were nearly absent
from the market-lagging utilities sector, which makes up about 9% of the Index.
However, our holdings' performance within most sectors did not keep pace with
the market's. For example, while technology stocks in your Portfolio returned
+50% during the fiscal year, they rose some +80% for the Index, led by gains
averaging +145% for three of its largest components: Intel, Microsoft, and
Compaq. The average growth fund tends to have even larger concentrations in
technology stocks than does the Portfolio (roughly 25% of assets versus our 17%
weighting), which was a clear advantage in such a year.
LONG-TERM PERFORMANCE OVERVIEW
As we said last year, when the U.S. Growth Portfolio significantly outpaced
both of its
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comparative benchmarks, we hope that our shareholders bring a long-term, not a
short-term, commitment to the fund. Over the long term--the ten years since
Lincoln Capital Management became the Portfolio's investment adviser--our
record is quite good. We outdistanced the average growth fund by 2% a year and
edged the S&P 500 Index by an average of 0.2% annually. If such margins seem
modest, the long-term effects are decidedly not modest. As the table at left
shows, an annual difference of 2 percentage points over ten years amounts to
more than $6,000 on an initial investment of $10,000, or more than 60% of the
original investment.
<TABLE>
<CAPTION>
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TOTAL RETURNS
10 YEARS ENDED AUGUST 31, 1997
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AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
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<S> <C> <C>
Vanguard U.S. Growth Portfolio +14.1% $37,522
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Average Growth Fund +12.1% $31,402
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S&P 500 Index +13.9% $36,711
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</TABLE>
While we wish it were, our past performance relative to our benchmarks is
not necessarily a sign of things to come. No one can foretell how we'll do
against our peers or the Index. And we strongly emphasize that the absolute
returns from the past decade are unlikely to be repeated. The Index return of
13.9% annually over the past ten years is well above the very-long-term average
of just under 11% a year earned by stocks. It would not be unreasonable to
expect returns over the next decade to be considerably lower than those that
stocks have provided over the past decade.
Now that Lincoln has completed a decade as our adviser, we'd like to use
this anniversary as an opportunity to express our thanks for the task its team
has performed so ably. The firm has held to the principles and strategies that
caused us to retain it in 1987. In this era of portfolio manager "stars" whose
longevity with a fund is often astonishingly brief, Lincoln's staff has
remained largely intact, with solid additions to ensure management continuity.
The Portfolio retains its focus on large, proven, financially strong
corporations with solid prospects for long-term earnings growth. This
steadfastness is, we think, what sound long-term investing is all about.
IN SUMMARY
The fiscal year ended August 31 was the ninth consecutive year in which the
U.S. Growth Portfolio produced a positive return. Over the past three years,
large-capitalization U.S. stocks have had an extraordinary run, with both your
Portfolio and the S&P 500 Index providing cumulative returns exceeding 100%.
Such remarkable results are gratifying, but should hardly be taken for granted.
Indeed, they are highly unlikely to recur. After such a period, rewards may be
uppermost in investors' minds. But risk is the flip side of reward, and the
ever-present risks of investing in stocks are especially evident now.
So we suggest that you bear in mind both risk and reward in constructing a
portfolio of stock funds, bond funds, and reserves in proportions suitable to
your investment goals, time horizon, and tolerance for market downturns. "Be
prepared" is not a bad motto to pair with our recurring counsel that you "stay
the course" toward your long-term objectives.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
September 12, 1997
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THE MARKETS IN PERSPECTIVE
Year Ended August 31, 1997
U.S. EQUITY MARKETS
To say that investors in financial assets fared well over the fiscal year ended
August 31, 1997, is to be guilty of understatement. Virtually across the
board, returns in the equity and bond markets ranged from quite strong to
exceptional, relative to historical averages. These results can be attributed
to three factors: continued solid economic growth; harnessed inflation,
remaining at levels not experienced since the 1960s; and growth in corporate
profits that was not only impressive but exceeded expectations. The most
surprising aspect of this remarkable period is that the rate of inflation
actually continued to decline despite robust growth and a very low level of
unemployment. According to traditional economic theory, inflation should have
accelerated rather than slowed at this point in the economic cycle. The most
widely accepted explanation for this paradox involves ongoing and substantial
productivity gains that are not apparent from the productivity measures in use
today. Reports indicate that even the Federal Reserve Board is otherwise at a
loss to explain the current "economic nirvana."
The performance of large-capitalization U.S. common stocks was nothing
short of spectacular during the past year, as illustrated by the 40.6% gain
generated by the Standard & Poor's 500 Composite Stock Price Index. This
advance ranks among the top 5% for all 12-month periods in the last 20 years.
The best-performing sectors were technology and financial services, with
increases of 80.5% and 51.9%, respectively. The surge in technology reflects
the exceptional strength in corporate spending on this industry's products,
particularly desktop computers, networking equipment, and software. By
contrast, utility stocks could be considered laggards despite their overall
return of 18.8%.
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AVERAGE ANNUALIZED RETURNS
PERIODS ENDED AUGUST 31, 1997
------------------------------
1 YEAR 3 YEARS 5 YEARS
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<S> <C> <C> <C>
EQUITY
S&P 500 Index 40.6% 26.6% 19.8%
Russell 2000 Index 29.0 20.0 19.4
MSCI EAFE Index 9.4 6.0 11.0
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FIXED-INCOME
Lehman Aggregate Bond Index 10.0% 8.4% 6.9%
Lehman 10-Year Municipal Bond Index 9.3 7.7 7.3
Salomon Brothers Three-Month
U.S. Treasury Bill Index 5.3 5.4 4.6
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OTHER
Consumer Price Index 2.2% 2.6% 2.7%
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</TABLE>
The performance of small-company stocks, while it failed to match the
outsized advance of the S&P 500 Index, cannot be characterized as weak during
this period--the Russell 2000 Index gained 29.0%. The difference in return
between large and small companies can be attributed, at least in part, to the
superior earnings growth achieved by larger companies during the past 24
months. In addition, large companies generated better-than-expected earnings
60% of the time over the past year, compared to only 40% for small firms.
Within sectors, the most dramatic difference between large and small companies
appeared in technology issues. In the Russell 2000 Index, technology stocks
advanced "only" 32.9% in aggregate, nearly 50 percentage points less than their
large-company counterparts.
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U.S. FIXED-INCOME MARKETS
The fixed-income markets also rewarded investors over the past year, as rates
fell across the yield curve. For example, the rates on 1-, 5-, 10-, and 30-year
U.S. Treasury issues fell 0.33%, 0.51%, 0.60%, and 0.51%, respectively, from
August 31, 1996, to August 31, 1997. These declines reflect the continued good
news regarding inflation and the relative dormancy of the Federal Reserve. The
benefit of the drop in rates can be seen in the 10.0% return of the Lehman
Brothers Aggregate Bond Index, the broadest measure of investment-grade issues.
Investors in lower-quality securities fared even better, as illustrated by the
15.2% gain of the Lehman High Yield Bond Index. The strength of the economy
combined with the lack of inflationary pressure produced an ideal environment
for junk bonds.
INTERNATIONAL EQUITY MARKETS
Investments in non-U.S. common stocks did not match the gains in domestic
equities, with the Morgan Stanley Capital International Europe, Australasia,
Far East Index advancing 9.4% in dollars. This Index's relatively modest
performance masks the fact that the European markets were very strong during
the past year, gaining 42.2% in local currency terms and 26.2% in dollars,
while many of the Pacific Basin markets were weak, down 0.7% in local currency
and 9.8% in dollars. The Japanese market declined 11.4% in dollars and 1.9% in
yen terms, despite signs of a strengthening economy. Smaller Asian markets,
such as Malaysia (losing 28.9% in local terms and 39.2% in dollars), suffered
from a variety of challenges, including overvalued currencies, rising interest
rates, and poor earnings.
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REPORT FROM THE ADVISER
Vanguard U.S. Growth Portfolio investors enjoyed a gigantic total return of
32.5% in fiscal 1997. This was the third-best result in our ten-year tenure as
adviser to the Portfolio. A year ago we somewhat humbly remarked of our fiscal
1996 return, which at 25.3% was well above those of our comparative benchmarks,
that it had left us "a bit surprised." We hoped, privately, that it was an
indication that we had become a bit smarter. It turns out we hadn't.
Comparative returns for the just-completed fiscal year were among our least
satisfactory. After beating the Standard & Poor's 500 Composite Stock Price
Index by more than 6 percentage points in fiscal 1996, we trailed it by 8.1
percentage points in fiscal 1997. What a difference a year makes!
The Message To Shareholders, beginning on page 1, touches on the reasons
for the strong equity market, which provided a tailwind for the U.S. Growth
Portfolio. But why did we lag the various market indexes (basically tying the
average return of our peer growth mutual funds)? There are two principal
reasons. First, earnings shortfalls on some important holdings, such as Eastman
Kodak and AT&T, led to declines in the prices of those stocks. Second, after
three years of excellent stock selection in the technology area, our good
fortune reversed in a year of powerful returns for the sector.
<TABLE>
<CAPTION>
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TEN LARGEST STOCKS
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PERCENTAGE
COMPANY OF NET ASSETS
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<S> <C>
1. Intel Corp. 4.7%
2. Monsanto Co. 4.6
3. Philip Morris Cos., Inc. 4.6
4. Cisco Systems, Inc. 4.1
5. Procter & Gamble Co. 4.0
6. The Coca-Cola Co. 3.7
7. Pfizer, Inc. 3.4
8. Bristol-Myers Squibb Co. 3.3
9. American Home Products Corp. 3.3
10. Microsoft Corp. 3.1
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</TABLE>
To put it mildly, we had a frustrating time of it.
Looking ahead, we can say that the character of our individual stock
holdings has not changed--they are mostly large, good-quality, moderately
growing companies. Our fundamental research by experienced analysts continues
unabated. Our valuation disciplines are continually becoming more
sophisticated. Turnover remains moderate--35% for fiscal 1997. Our industry
diversification continues to approximate that of the major growth indexes, and
we remain sensitive to our active stock bets--that is, where we have materially
larger or smaller holdings than the relevant indexes. Our ten largest holdings
continue to account for a substantial 39% of the Portfolio's net assets. We
continue to make decisions through a collegial, team approach.
In sum, the character of the firm, its philosophy, and its processes
remain reassuringly stable.
During the fiscal year the number of companies held declined from 60 to
53. Our two largest purchases were Microsoft and Monsanto. The largest sales
were AT&T and Eastman Kodak, both now eliminated from the Portfolio. Among our
ten largest holdings as of August 31, shown in the table above, five are new to
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the list since last year. But four of these were important holdings a year ago,
and only one, Microsoft, was entirely new to the Portfolio (and even it had
been owned several years ago). In short, an important element of consistency
continues among our holdings.
Within the context of a stock market that is materially higher than one
year ago--with roughly one-third of its rise due to higher earnings estimates
and two-thirds due to higher price/earnings ratios--your U.S. Growth Portfolio
holdings appear attractive.
David Fowler, Portfolio Manager
Parker Hall, Portfolio Manager
Lincoln Capital Management Company
September 9, 1997
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.
6
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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: AUGUST 31, 1977-AUGUST 31, 1997
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U.S. GROWTH PORTFOLIO S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- -----------------------------------------
<S> <C> <C> <C> <C>
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
1997 31.1 1.4 32.5 40.6
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</TABLE>
See Financial Highlights table on page 14 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: AUGUST 31, 1987-AUGUST 31, 1997
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U.S. GROWTH AVERAGE S&P 500
MONTH/YEAR PORTFOLIO GROWTH FUND INDEX
- ---------- ----------- ----------- -------
<S> <C> <C> <C>
Aug-87 $10,000 $10,000 $10,000
Nov-87 7,007 7,130 7,042
Feb-88 8,210 8,395 8,265
May-88 7,860 8,360 8,168
Aug-88 7,838 8,432 8,221
Nov-88 8,166 8,641 8,685
Feb-89 8,694 9,296 9,247
May-89 9,961 10,415 10,357
Aug-89 11,030 11,294 11,447
Nov-89 11,272 11,098 11,363
Feb-90 10,959 10,653 10,995
May-90 12,633 11,718 12,077
Aug-90 11,584 10,491 10,877
Nov-90 11,417 10,297 10,969
Feb-91 13,907 12,111 12,607
May-91 14,885 12,999 13,502
Aug-91 15,555 13,367 13,803
Nov-91 15,010 12,978 13,200
Feb-92 16,859 14,699 14,623
May-92 16,778 14,249 14,832
Aug-92 16,928 14,021 14,897
Nov-92 17,987 15,253 15,639
Feb-93 17,225 15,482 16,181
May-93 16,956 15,971 16,554
Aug-93 17,213 16,660 17,163
Nov-93 17,517 16,720 17,218
Feb-94 18,034 17,432 17,529
May-94 17,821 16,726 17,259
Aug-94 18,414 17,353 18,102
Nov-94 18,153 16,662 17,398
Feb-95 19,638 17,565 18,820
May-95 21,583 18,957 20,743
Aug-95 22,603 20,831 21,984
Nov-95 25,400 21,844 23,832
Feb-96 27,316 22,892 25,351
May-96 28,543 24,488 26,642
Aug-96 28,318 23,494 26,101
Nov-96 32,862 26,496 30,472
Feb-97 34,154 27,061 31,983
May-97 36,711 28,730 34,479
Aug-97 37,522 31,402 36,711
</TABLE>
<TABLE>
<CAPTION>
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AVERAGE ANNUAL TOTAL RETURNS
PERIODS ENDED AUGUST 31, 1997
----------------------------------- FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
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<S> <C> <C> <C> <C>
U.S. Growth Portfolio 32.50% 17.26% 14.14% $37,522
Average Growth Fund 33.51 17.45 12.12 31,402
S&P 500 Index 40.65 19.77 13.89 36,711
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</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED JUNE 30, 1997*
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10 YEARS
INCEPTION ------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
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<S> <C> <C> <C> <C> <C> <C>
U.S. Growth Portfolio 1/6/59 29.24% 18.05% 13.14% 1.57% 14.71%
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</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
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PORTFOLIO PROFILE
U.S. Growth Portfolio
This Profile provides a snapshot of the Portfolio's characteristics as of
August 31, 1997, compared where appropriate to an unmanaged index. Key elements
of this Profile are defined on page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
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U.S. GROWTH S&P 500
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<S> <C> <C>
Number of Stocks 54 500
Median Market Cap $50.0B $32.6B
Price/Earnings Ratio 27.2x 20.6x
Price/Book Ratio 6.5x 3.8x
Yield 1.0% 1.7%
Return on Equity 25.6% 20.3%
Earnings Growth Rate 22.7% 18.0%
Foreign Holdings 5.2% 2.0%
Turnover Rate 35% --
Expense Ratio 0.42% --
Cash Reserves 4.0% --
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
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U.S. GROWTH S&P 500
- --------------------------------------------------
<S> <C> <C>
R-Squared 0.90 1.00
Beta 0.99 1.00
</TABLE>
INVESTMENT FOCUS
- --------------------------------------------------
[GRAPHIC]
<TABLE>
<CAPTION>
TEN LARGEST STOCKS (% OF TOTAL NET ASSETS)
- -----------------------------------------
<S> <C>
Intel Corp. 4.7%
Monsanto Co. 4.6
Philip Morris Cos., Inc. 4.6
Cisco Systems, Inc. 4.1
Procter & Gamble Co. 4.0
The Coca-Cola Co. 3.7
Pfizer, Inc. 3.4
Bristol-Myers Squibb Co. 3.3
American Home Products Corp. 3.3
Microsoft Corp. 3.1
- -----------------------------------------
Top Ten Total 38.8%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- -------------------------------------------------------------------------------------
AUGUST 31, 1996 AUGUST 31, 1997
----------------------------------------------
U.S. GROWTH U.S. GROWTH S&P 500
----------------------------------------------
<S> <C> <C> <C>
Auto & Transportation . . . . . . 0.0% 0.0% 3.6%
Consumer Discretionary . . . . . . 14.5 9.6 9.6
Consumer Staples . . . . . . . . . 19.0 23.8 11.0
Energy . . . . . . . . . . . . . . 0.4 1.4 1.4
Financial Services . . . . . . . 14.8 12.7 16.5
Health Care . . . . . . . . . . . 20.4 18.5 10.6
Integrated Oils . . . . . . . . . 0.0 0.0 7.7
Materials & Processing . . . . . 6.2 8.6 7.0
Producer Durables . . . . . . . . 4.4 3.4 4.6
Technology . . . . . . . . . . . 15.6 20.0 13.5
Utilities . . . . . . . . . . . . 4.7 0.0 9.0
Other . . . . . . . . . . . . . . 0.0 2.0 5.5
- -------------------------------------------------------------------------------------
</TABLE>
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BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a 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%.
CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing investments.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a portfolio.
EXPENSE RATIO. The percentage of a portfolio's average net assets used to pay
its annual administrative and advisory expenses. These expenses directly reduce
returns to investors.
FOREIGN HOLDINGS. The percentage of a portfolio's investments represented by
stocks or American Depository Receipts of companies based outside the United
States.
INVESTMENT FOCUS. This grid indicates the focus of a portfolio in terms of two
attributes: market capitalization (large, medium, or small) and relative
valuation (growth, value, or a blend).
MEDIAN MARKET CAP. The midpoint of market capitalization (market price x shares
outstanding) of the stocks in a portfolio. Half the stocks in the portfolio
have higher market capitalizations and half lower.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified it is and the more likely to perform in line with
the overall stock market.
PRICE/BOOK RATIO. The share price of a stock divided by its net worth, or book
value, per share. For a portfolio, the weighted average price/book ratio of the
stocks it holds.
PRICE/EARNINGS RATIO. The ratio of a stock's current price to its per-share
earnings over the past year. 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.
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.
RETURN ON EQUITY. The annual average rate of return generated by a company
during the past five years for each dollar of shareholder's equity (net income
divided by shareholder's equity). For a portfolio, the weighted average return
on equity for the companies whose stocks it holds.
SECTOR DIVERSIFICATION. The percentages of a portfolio's common stocks that
come from each of the major industry groups that compose the stock market.
TEN LARGEST STOCKS. The percentage of net assets that a portfolio has invested
in its ten largest holdings. (The average for stock mutual funds is about 30%).
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.
TURNOVER RATE. An indication of trading activity during the past year.
Portfolios with high turnover rates incur higher transaction costs and are more
likely to distribute capital gains (which are taxable to investors).
YIELD. A snapshot of a portfolio's income from interest and dividends. The
yield, expressed as a percentage of the portfolio's net asset value, is based
on income earned over the past 30 days and is annualized, or projected forward
for the coming year. The index yield is based on the current annualized rate of
dividends paid on stocks in the index.
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FINANCIAL STATEMENTS
August 31, 1997
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 (96.0%)
- --------------------------------------------------------------------------
CONSUMER DISCRETIONARY (9.2%)
<S> <C> <C>
Carnival Corp. Class A 1,400,000 $ 61,337
The Walt Disney Co. 1,400,000 107,537
Lowe's Cos., Inc. 2,200,000 76,038
Mattel, Inc. 3,200,000 107,000
May Department Stores Co. 1,800,000 96,862
Sears, Roebuck & Co. 2,700,000 153,225
Service Corp. International 1,600,000 51,200
Warnaco Group 1,000,000 32,438
--------------
685,637
--------------
CONSUMER STAPLES (22.8%)
CVS Corp. 160,000 9,020
Campbell Soup Co. 2,000,000 92,750
The Coca-Cola Co. 4,770,000 273,381
Coca-Cola Enterprises, Inc. 1,090,000 29,975
Colgate-Palmolive Co. 1,400,000 87,850
Gillette Co. 2,050,000 169,766
PepsiCo, Inc. 6,100,000 219,600
Philip Morris Cos., Inc. 7,900,000 344,637
Procter & Gamble Co. 2,220,000 295,399
Unilever NV 810,000 163,012
Unilever PLC ADR 125,000 14,055
--------------
1,699,445
--------------
ENERGY (1.3%)
Renaissance Energy Ltd. 1,400,000 36,047
Talisman Energy, Inc. 1,900,000 62,195
--------------
98,242
--------------
FINANCIAL SERVICES (12.2%)
American International
Group, Inc. 1,820,000 171,762
Automatic Data
Processing, Inc. 3,700,000 168,581
Chase Manhattan Corp. 1,440,000 160,110
First Data Corp. 3,600,000 147,825
Household International, Inc. 1,400,000 155,312
Norwest Corp. 1,600,000 91,900
Paychex, Inc. 470,000 15,951
--------------
911,441
--------------
HEALTH CARE (17.7%)
American Home Products Corp. 3,440,000 247,680
Bristol-Myers Squibb Co. 3,260,000 247,760
Cardinal Health, Inc. 1,230,000 81,487
- - HealthCare COMPARE Corp. 700,000 38,763
Johnson & Johnson 1,900,000 107,706
Eli Lilly & Co. 1,430,000 149,614
Pfizer, Inc. 4,600,000 254,725
- - Quintiles Transnational Corp. 800,000 62,400
SmithKline Beecham PLC ADR 3,020,000 130,804
--------------
1,320,939
--------------
MATERIALS & PROCESSING (8.3%)
W.R. Grace & Co. 2,470,000 169,967
Illinois Tool Works, Inc. 1,300,000 62,888
Kimberly-Clark Corp. 800,000 37,950
Monsanto Co. 7,850,000 344,909
--------------
615,714
--------------
PRODUCER DURABLES (3.3%)
The Boeing Co. 2,900,000 157,869
Honeywell, Inc. 700,000 48,388
Molex, Inc. Class A 1,030,000 37,338
--------------
243,595
--------------
TECHNOLOGY (19.2%)
- - Altera Corp. 1,740,000 92,546
- - Cisco Systems, Inc. 4,010,000 302,003
- - DSC Communications Corp. 1,000,000 29,063
Hewlett-Packard Co. 3,150,000 193,134
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- --------------------------------------------------------------------------
<S> <C> <C>
Intel Corp. 3,800,000 $ 349,362
Linear Technology Corp. 510,000 33,405
- - Microsoft Corp. 1,750,000 231,328
- - Oracle Corp. 4,050,000 154,153
- - Xilinx, Inc. 930,000 44,059
--------------
1,429,053
--------------
OTHER (2.0%)
General Electric Co. 2,320,000 145,000
--------------
- --------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $4,702,643) 7,149,066
- --------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (4.3%)
- --------------------------------------------------------------------------
REPURCHASE AGREEMENT
<S> <C> <C>
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.56%, 9/2/97
(COST $322,218) $322,218 322,218
- --------------------------------------------------------------------------
TOTAL INVESTMENTS (100.3%)
(COST $5,024,861) 7,471,284
- --------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.3%)
- --------------------------------------------------------------------------
Other Assets--Note C 43,591
Liabilities (69,622)
--------------
(26,031)
- --------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------
Applicable to 268,407,090 outstanding
$1.00 par value shares
(authorized 500,000,000 shares) $7,445,253
==========================================================================
NET ASSET VALUE PER SHARE $27.74
==========================================================================
</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, 1997, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $4,793,358 $17.86
Undistributed Net
Investment Income 46,007 .17
Accumulated Net
Realized Gains 159,465 .59
Unrealized Appreciation--
Note E 2,446,423 9.12
- --------------------------------------------------------------------------
NET ASSETS $7,445,253 $27.74
==========================================================================
</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 Gain (Loss) realized on the sale of investments, and the increase or
decrease in the Unrealized Appreciation (Depreciation) on investments during
the period.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------
U.S. GROWTH PORTFOLIO
YEAR ENDED AUGUST 31, 1997
(000)
- -------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 77,701
Interest 16,605
-----------
Total Income 94,306
-----------
EXPENSES
Investment Advisory Fees--Note B 8,475
The Vanguard Group--Note C
Management and Administrative 15,165
Marketing and Distribution 1,409
Taxes (other than income taxes) 450
Custodian Fees 14
Auditing Fees 9
Shareholders' Reports 215
Annual Meeting and Proxy Costs 36
Directors' Fees and Expenses 16
-----------
Total Expenses 25,789
Expenses Paid Indirectly--Note C (1,161)
-----------
Net Expenses 24,628
- -------------------------------------------------------------------------------------
NET INVESTMENT INCOME 69,678
- -------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 219,862
- -------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) OF INVESTMENT SECURITIES 1,317,765
- -------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $1,607,305
=====================================================================================
</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 income and capital
gains may not match the amounts shown in the Operations section, because
distributions are determined on a tax basis and may be made in a period
different from the one in which the income was earned or the gains were
realized on the financial statements. The Capital Share Transactions section
shows the amount shareholders invested in the 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,
-------------------------
1997 1996
(000) (000)
- -------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 069,678 $ 051,249
Realized Net Gain 219,862 307,968
Change in Unrealized Appreciation (Depreciation) 1,317,765 440,659
--------------------------
Net Increase in Net Assets Resulting from Operations 1,607,305 799,876
--------------------------
DISTRIBUTIONS
Net Investment Income (55,435) (49,433)
Realized Capital Gain (345,580) (97,161)
--------------------------
Total Distributions (401,015) (146,594)
--------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 2,522,416 1,561,164
Issued in Lieu of Cash Distributions 391,848 131,833
Redeemed (1,219,565) (791,065)
--------------------------
Net Increase from Capital Share Transactions 1,694,699 901,932
- -------------------------------------------------------------------------------------
Total Increase 2,900,989 1,555,214
- -------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 4,544,264 2,989,050
--------------------------
End of Year $7,445,253 $4,544,264
=====================================================================================
(1)Shares Issued (Redeemed)
Issued 98,030 72,254
Issued in Lieu of Cash Distributions 16,774 6,579
Redeemed (47,275) (36,694)
--------------------------
Net Increase in Shares Outstanding 67,529 42,139
=====================================================================================
</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 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $22.62 $18.83 $15.52 $14.71 $14.71
- ---------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .27 .26 .25 .20 .21
Net Realized and Unrealized Gain (Loss) on Investments 6.73 4.39 3.24 .82 .05
-------------------------------------------------------
Total from Investment Operations 7.00 4.65 3.49 1.02 .26
-------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.26) (.29) (.18) (.21) (.18)
Distributions from Realized Capital Gains (1.62) (.57) -- -- (.08)
-------------------------------------------------------
Total Distributions (1.88) (.86) (.18) (.21) (.26)
- ---------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $27.74 $22.62 $18.83 $15.52 $14.71
=====================================================================================================================
TOTAL RETURN 32.50% 25.28% 22.75% 6.98% 1.69%
=====================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $7,445 $4,544 $2,989 $1,963 $1,954
Ratio of Total Expenses to Average Net Assets 0.42% 0.43% 0.47% 0.52% 0.49%
Ratio of Net Investment Income to Average Net Assets 1.13% 1.32% 1.59% 1.30% 1.50%
Portfolio Turnover Rate 35% 44% 32% 47% 37%
Average Commission Rate Paid $.0493 $.0492 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 to 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. Lincoln Capital Management Company provides investment advisory services to
the Portfolio for a fee calculated at an annual percentage rate of average net
assets. For the year ended August 31, 1997, the advisory fee represented an
effective annual rate of 0.14% 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, 1997, the Portfolio had contributed capital of $556,000 to Vanguard
(included in Other Assets), representing 2.8% 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, 1997, these arrangements reduced the Portfolio's
expenses by $1,161,000 (an annual rate of 0.02% of average net assets).
D. During the year ended August 31, 1997, the Portfolio purchased
$3,442,596,000 of investment securities and sold $2,069,213,000 of investment
securities other than temporary cash investments.
E. At August 31, 1997, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $2,446,423,000,
consisting of unrealized gains of $2,472,390,000 on securities that had risen
in value since their purchase and $25,967,000 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, 1997, the
results of its operations for the year then ended, the changes in its net
assets for each of the two years in the period then ended and the financial
highlights for each of the five years in the period then ended, in conformity
with generally accepted accounting principles. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the 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, 1997 by
correspondence with the custodian and the application of alternative auditing
procedures where securities purchased had not been settled, provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
October 3, 1997
SPECIAL 1997 TAX INFORMATION (UNAUDITED) FOR VANGUARD U.S. GROWTH PORTFOLIO
This information for the fiscal year ended August 31, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Portfolio designates $217,573,000 as capital gain dividends (from
net long-term capital gains), of which $59,653,000 was distributed to
shareholders in December 1996. The balance of $157,920,000, along with any
additional gains realized through October 31, 1997, will be distributed in
December 1997.
For corporate shareholders, 97.6% of investment income (dividend income
plus short-term gains, if any) qualifies for the dividends-received
deduction.
16
<PAGE> 19
[PHOTO]
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 and Director of Rhone-Poulenc Rorer, Inc.; Managing Director
of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun
Company, Inc., and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions,
Inc., Raytheon Co., Knight-Ridder, Inc., and Massachusetts Mutual Life
Insurance Co.; Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
BURTON G. MALKIEL
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Amdahl Corp., Baker Fentress & Co., The
Jeffrey Co., and Southern New England Communications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., and
NACCO Industries.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director 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
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM MCNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R)," "S&P(R)," and
"500" are trademarks of The McGraw-Hill Companies, Inc. Frank Russell
Company is the owner of trademarks and copyrights relating to the
Russell Indexes. "Wilshire 4500" and "Wilshire 5000" are
trademarks of Wilshire Associates.
<PAGE> 20
[PHOTO]
THE VANGUARD
FAMILY OF FUNDS
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard/Windsor Fund
Vanguard/Windsor II
Vanguard Equity Income Fund
Vanguard Growth and Income Portfolio
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 International Value 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 Treasury Money Market Portfolio
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, NY, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds (CA, FL, NJ, NY, OH, PA)
Q230-8/97 | (C) 1997 Vanguard Marketing Corporation, Distributor
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
http://www.vanguard.com
[email protected]
All Vanguard funds are offered by prospectus only. Prospectuses contain more
complete information on advisory fees, distribution charges, and other
expenses and should be read carefully before you invest or send money.
Prospectuses can be obtained directly from The Vanguard Group.
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482
<PAGE> 21
VANGUARD
INTERNATIONAL GROWTH
PORTFOLIO
Annual Report - August 31, 1997
[PHOTO]
[THE VANGUARD GROUP LOGO]
<PAGE> 22
[FLAGS]
OUR CREW MAKES THE DIFFERENCE
Throughout our history, The Vanguard Group has received considerable attention
as the low-cost provider of mutual funds. While such accolades are gratifying,
we are most proud, not of our low operating expenses or the billions of dollars
we manage, but of our sterling reputation created by the Vanguard crew.
We recognize that it is our crew members--some 6,000 highly motivated men
and women--who form the cornerstone of our operations. As with any
cornerstone, we could not survive long--let alone prosper--without it. That's
why we chose this fiscal year's annual report to celebrate the spirit,
enthusiasm, and achievements of our crew. (We call those who work at Vanguard
crew members, not employees, because they operate as a team to accomplish our
mission of serving you, our clients.)
But while we prize the collective contributions of our crew, we also take
time to recognize the importance of the individual. Each calendar quarter, we
present our Award For Excellence to a handful of crew members who have
demonstrated particular excellence in the performance of their jobs and who
embody "The Vanguard Spirit." Our report cover shows only a few of the more
than 300 crew members who have received this distinction since 1984.
They, along with the rest of our valiant crew, look forward to serving you
in the years ahead.
[PHOTO]
John C. Bogle John J. Brennan
Chairman President
<TABLE>
<CAPTION>
CONTENTS
<S> <C>
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 19
----------------------------------
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 23
FELLOW SHAREHOLDER,
Vanguard International Growth Portfolio earned +15.8% in the fiscal
year ended August 31, 1997. This represents the net result of a banner year of
returns abroad (the weak Japanese market was an important exception), sharply
reduced for U.S. investors by the strength of the dollar against most other
currencies. Even so, your Portfolio's performance was excellent in absolute
terms and in comparison both with competing mutual funds and international
stock market indexes.
The table at right presents the total returns (capital change plus
reinvested dividends) of the Portfolio and of its primary performance
benchmarks: the average international mutual fund and the unmanaged Morgan
Stanley Capital International Europe, Australasia, Far East (EAFE) Index. The
Portfolio's return is based on an increase in net asset value from $16.13 per
share on August 31, 1996, to $17.86 on August 31, 1997, with the latter figure
adjusted for a dividend of $0.19 per share paid from net investment income and
a distribution of $0.55 per share paid from net realized capital gains.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------
TOTAL RETURNS
FISCAL YEAR ENDED
AUGUST 31, 1997
- ----------------------------------------------------------------
<S> <C>
Vanguard International Growth Portfolio +15.8%
- ----------------------------------------------------------------
Average International Fund +14.0%
- ----------------------------------------------------------------
MSCI EAFE Index + 9.4%
- ----------------------------------------------------------------
</TABLE>
FISCAL 1997 PERFORMANCE OVERVIEW
The international business outlook generally brightened during the year.
Investor optimism about equities--already high in America--spread to most other
markets. Europe's bourses were especially buoyant, with returns averaging
+42.2% in local currency terms, even a tad higher than the truly remarkable
+40.6% return in the United States on the Standard & Poor's 500 Composite Stock
Price Index. Japan was a far different story. There stock prices traced a V
shape, falling sharply during the first half of the fiscal year, then rallying
to finish the period with a slight decline in local currency terms. The
performances of emerging stock markets varied widely, with exceptional gains in
Latin America and mixed results in Asia.
Currency exchange rates had a big impact on the returns U.S. investors
received. During fiscal 1997, the dollar rose in value against most other
currencies, which cut returns to U.S. investors by more than 50%, from +21.8%
to +9.4%, a pattern reflected in the table at right.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------
TOTAL RETURNS
12 MONTHS ENDED
AUGUST 31, 1997
----------------------------------------
BASED ON
LOCAL CURRENCY BASED ON
STOCK MARKET INDEX CURRENCY EFFECT U.S. DOLLARS
- ---------------------------------------------------------------------------------
<S> <C> <C> <C>
MSCI EAFE +21.8% -12.4% + 9.4%
- ---------------------------------------------------------------------------------
European* +42.2% -16.0% +26.2%
Pacific* - 0.7 - 9.1 - 9.8
Select Emerging Markets* +30.0 -29.0 + 1.0
- ---------------------------------------------------------------------------------
U.S. (S&P 500 Index) +40.6% -- +40.6%
- ---------------------------------------------------------------------------------
</TABLE>
*Morgan Stanley Capital International indexes.
To be sure, currency risk is not a one-way street. When the dollar falls
versus other currencies, returns from abroad are enhanced for U.S. investors.
The unpredictability of currency fluctuations explains why returns on foreign
stocks often do not correlate with those on U.S. stocks, which, in turn, is why
international stocks should help to diversify portfolios containing U.S.
securities.
The +15.8% return on the International Growth Portfolio in fiscal 1997 was
nearly
1
<PAGE> 24
2 percentage points higher than the average international fund's return and
more than 6 percentage points ahead of the return on the EAFE Index. Excellent
stock selection--especially in Japan--by our adviser, Schroder Capital
Management International, was a key factor in our strong showing. Also, we had
a heavier exposure than most funds to the Netherlands, a leader in Europe's
stock surge. On the negative side of the ledger, we were underweighted in the
United Kingdom, a strong performer.
Compared with the Index, most mutual funds--including your
Portfolio--benefited from a lower weighting in Japanese stocks. While Japanese
stocks constituted nearly one-third of the EAFE Index during the year, they
made up, on average, about 26% of the Portfolio's net assets. The average
international fund had an even lighter commitment (around 15% of assets) to
Japanese stocks. Fortunately, our holdings in Japan earned a return of about
+13% versus a decline of roughly -11% for the Japanese market as a whole.
LONG-TERM PERFORMANCE OVERVIEW
One year--even a good one--is not particularly meaningful in judging a mutual
fund's merits. We urge shareholders to consider their investment in the
Portfolio a long-term commitment, and we take pride in our record. The table
below displays the past decade's results for the Portfolio, our average peer,
and the EAFE Index.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
TOTAL RETURNS
10 YEARS ENDED AUGUST 31, 1997
-------------------------------
AVERAGE FINAL VALUE OF
ANNUAL A $10,000
RATE INITIAL INVESTMENT
- ------------------------------------------------------------------
<S> <C> <C>
Vanguard International
Growth Portfolio +8.4% $22,451
- ------------------------------------------------------------------
Average International Fund +7.0% $19,592
- ------------------------------------------------------------------
MSCI EAFE Index +5.5% $17,067
- ------------------------------------------------------------------
</TABLE>
While our returns during the decade were nicely superior to those earned
by our comparative standards, the period was surely disappointing for U.S.
investors in international stocks. The S&P 500 Index averaged an annual return
of 13.9% during the decade, 21/2 times the 5.5% return on the EAFE Index. The
Index's anemic return was importantly shaped by the weak Japanese market, with
a negative average return of -1.1%. As a result, the Japanese market, which
represented 55% of the market capitalization of the EAFE Index when the decade
began, had fallen to 31% at its close.
Future returns may prove to be either higher or lower than the
disappointing results of the past decade. But we believe the Portfolio has an
enduring advantage: Our annual operating expenses amount to 0.57% of net
assets, more than a percentage point below the average international fund's
expense ratio of about 1.70%. We expect this cost advantage to give the
Portfolio a head start each year in its quest to provide superior returns.
IN SUMMARY
International stocks, by adding diversification and the prospect of competitive
returns, play an important role in an investment program that also contains
domestic equity funds, bond funds, and cash reserves. Such balanced portfolios,
we believe, can help investors to stay the course toward their long-term
objectives.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
September 17, 1997
2
<PAGE> 25
THE MARKETS IN PERSPECTIVE
Year Ended August 31, 1997
U.S. EQUITY MARKETS
To say that investors in financial assets fared well over the fiscal year ended
August 31, 1997, is to be guilty of understatement. Virtually across the
board, returns in the equity and bond markets ranged from quite strong to
exceptional, relative to historical averages. These results can be attributed
to three factors: continued solid economic growth; harnessed inflation,
remaining at levels not experienced since the 1960s; and growth in corporate
profits that was not only impressive but exceeded expectations. The most
surprising aspect of this remarkable period is that the rate of inflation
actually continued to decline despite robust growth and a very low level of
unemployment. According to traditional economic theory, inflation should have
accelerated rather than slowed at this point in the economic cycle. The most
widely accepted explanation for this paradox involves ongoing and substantial
productivity gains that are not apparent from the productivity measures in use
today. Reports indicate that even the Federal Reserve Board is otherwise at a
loss to explain the current "economic nirvana."
The performance of large-capitalization U.S. common stocks was nothing
short of spectacular during the past year, as illustrated by the 40.6% gain
generated by the Standard & Poor's 500 Composite Stock Price Index. This
advance ranks among the top 5% for all 12-month periods in the last 20 years.
The best-performing sectors were technology and financial services, with
increases of 80.5% and 51.9%, respectively. The surge in technology reflects
the exceptional strength incorporate spending on this industry's products,
particularly desktop computers, networking equipment, and software. By
contrast, utility stocks could be considered laggards despite their overall
return of 18.8%.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
AVERAGE ANNUALIZED RETURNS
PERIODS ENDED AUGUST 31, 1997
-----------------------------
1 YEAR 3 YEARS 5 YEARS
- --------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 40.6% 26.6% 19.8%
Russell 2000 Index 29.0 20.0 19.4
MSCI EAFE Index 9.4 6.0 11.0
- --------------------------------------------------------------------
FIXED-INCOME
Lehman Aggregate Bond Index 10.0% 8.4% 6.9%
Lehman 10-Year Municipal Bond Index 9.3 7.7 7.3
Salomon Brothers Three-Month
U.S. Treasury Bill Index 5.3 5.4 4.6
- --------------------------------------------------------------------
OTHER
Consumer Price Index 2.2% 2.6% 2.7%
- --------------------------------------------------------------------
</TABLE>
The performance of small-company stocks, while it failed to match the
outsized advance of the S&P 500 Index, cannot be characterized as weak during
this period--the Russell 2000 Index gained 29.0%. The difference in return
between large and small companies can be attributed, at least in part, to the
superior earnings growth achieved by larger companies during the past 24
months. In addition, large companies generated better-than-expected earnings
60% of the time over the past year, compared to only 40% for small firms.
Within sectors, the most dramatic difference between large and small companies
appeared in technology issues. In the Russell 2000 Index, technology stocks
advanced "only" 32.9% in aggregate, nearly 50 percentage points less than their
large-company counterparts.
3
<PAGE> 26
U.S. FIXED-INCOME MARKETS
The fixed-income markets also rewarded investors over the past year, as rates
fell across the yield curve. For example, the rates on 1-, 5-, 10-, and 30-year
U.S. Treasury issues fell 0.33%, 0.51%, 0.60%, and 0.51%, respectively, from
August 31, 1996, to August 31, 1997. These declines reflect the continued good
news regarding inflation and the relative dormancy of the Federal Reserve. The
benefit of the drop in rates can be seen in the 10.0% return of the Lehman
Brothers Aggregate Bond Index, the broadest measure of investment-grade issues.
Investors in lower-quality securities fared even better, as illustrated by the
15.2% gain of the Lehman High Yield Bond Index. The strength of the economy
combined with the lack of inflationary pressure produced an ideal environment
for junk bonds.
INTERNATIONAL EQUITY MARKETS
Investments in non-U.S. common stocks did not match the gains in domestic
equities, with the Morgan Stanley Capital International Europe, Australasia,
Far East Index advancing 9.4% in dollars. This Index's relatively modest
performance masks the fact that the European markets were very strong during
the past year, gaining 42.2% in local currency terms and 26.2% in dollars,
while many of the Pacific Basin markets were weak, down 0.7% in local currency
and 9.8% in dollars. The Japanese market declined 11.4% in dollars and 1.9% in
yen terms, despite signs of a strengthening economy. Smaller Asian markets,
such as Malaysia (losing 28.9% in local terms and 39.2% in dollars), suffered
from a variety of challenges, including overvalued currencies, rising interest
rates, and poor earnings.
4
<PAGE> 27
REPORT FROM THE ADVISER
Vanguard International Growth Portfolio provided a total return of 15.8%
during fiscal 1997, which ended on August 31. This exceeded the performance of
both the Morgan Stanley Capital International Europe, Australasia, Far East
Index, which returned 9.4% during the year, and the average international
equity mutual fund, which achieved 14.0%.
Diversified portfolios invariably contain both good and relatively bad news.
This past year has been more extreme than usual. Continental European
currencies fell, on average, by some 17% against the U.S. dollar, but their
equity markets soared by 50% in local currency terms. The U.K. market rose by
"only" 27% in local terms, but the pound sterling rose 4% against the dollar.
The Japanese market appeared to break the mold as the market index fell 2% in
yen terms, even though the yen fell 10% versus the dollar. But the pattern was
not so different in Japan when you focus on the stocks in the Portfolio, which
rose by nearly 25% in yen terms against the weak currency background. In the
developed Southeast Asia countries, Hong Kong was up over 20%, while Malaysia
fell by roughly 40% in dollar terms. Finally, among emerging markets, Latin
America rose by more than 40%, while the Asian markets fell 18%.
Some of these contrasts seem self-explanatory: Continental European markets
rose, in part, because their currencies were weak, and the U.K. market would
have risen more had the pound sterling's strength not damaged the profits of
U.K. exporters. By the same token, some of our stock performance in Japan came
from the boost to companies' profits caused by the weak yen. However, elsewhere
in Asia and in Latin America, stock markets simply reflected--and in some cases
exaggerated--varied local economic conditions.
Markets usually perform best when there is spare capacity in the economy and
growth is just beginning to pick up. This was the case in many continental
European countries last year, with the Netherlands among those leading the
procession and Germany, Switzerland, and France trailing it. The German, Swiss,
and French economies are still in the early stages of recovery, which suggests
that their markets have strong reasons to rise further. But any ascent will
have to surmount "walls of fear" because stock prices have risen dramatically
over the past two years. I have begun to take some profits, but have done so
selectively because many of the companies in the Portfolio are restructuring
both industrially and financially and their results for at least the next two
years will provide more-than-adequate support for their share prices.
The United Kingdom, like the United States, is at a more advanced stage in
the economic cycle; monetary policy has already been tightened to dampen
growth, and there are strong expectations that it will be tightened further
over the next six months. Although U.K. stocks are among the cheapest in
Europe, there will be good reason for this if monetary policy is further
tightened. The Portfolio's exposure to the United Kingdom, at 9.3%, is the
lowest it has been in many years.
We began to look for opportunities to add to our holdings in Asia during the
past few months--first in Japan, then in Hong Kong, and most recently in the
5
<PAGE> 28
smaller countries. Investors now have very modest expectations for Japan, and
the market would be receptive to a positive surprise. The best surprise would
be signs that Japanese consumers were ready to increase spending, but tax
increases there in April have diminished disposable income, and the employment
outlook is not yet encouraging enough to prompt people to spend more. Foreign
trade remains strong and so does investment spending by companies, but these
factors have yet to boost consumer confidence.
The obverse of a dull jobs environment is continued cost-cutting by Japanese
companies, particularly those that compete globally. These are predominant in
our Portfolio, and their continued successes have produced strong performance
for us, as mentioned earlier. The balance sheets of companies in the Portfolio
are flush with cash, and we are aware that the emergence of share buybacks
would provide a considerable further stimulus to these stocks' prices. Buybacks
are practicable under newly changed Japanese tax law, but we do not expect
companies to move rapidly in this direction. The emergence of executive
stock-option schemes helps by making Japanese companies more conscious of
boosting shareholder value, but this too will only slowly grow in popularity.
We increased exposure to Hong Kong because we anticipated a successful
handover of the territory to China, and we take an increasingly positive view
of economic developments there. The recent currency turmoil in southern Asia
has affected sentiment in Hong Kong's stock market but should not materially
affect developments in China or Hong Kong. It is less easy to be sanguine about
near-term prospects in Malaysia and the smaller emerging markets of Asia. We
have negligible exposure to Thailand, the epicenter of the problems, but have
been taken aback by the spread of the currency difficulties to the sounder
economies of Indonesia and the Philippines. That said, these markets have
fallen sharply in U.S. dollar terms, and many industrial and commercial stocks
will be well placed to recover strongly; banks, on the other hand, remain
vulnerable to bad-debt problems resulting from the crisis. We have
insignificant exposure to banks in the area.
In contrast to Southeast Asia, Latin American markets have been very strong
and have provided the highest return to the Portfolio of any region in fiscal
1997. We continue to limit our holdings in emerging markets. The past year
provides ample proof of the riskiness of individual markets and of the benefits
of diversification.
Richard Foulkes
Schroder Capital Management International
September 15, 1997
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
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: SEPTEMBER 30, 1981-AUGUST 31, 1997
- ------------------------------------------
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
1997 14.5 1.3 15.8 9.4
</TABLE>
See Financial Highlights table on page 16 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
CUMULATIVE PERFORMANCE: AUGUST 31, 1987-AUGUST 31, 1997
- --------------------------------------------------------------------------------
AVERAGE
INTERNATIONAL INTERNATIONAL MSCI
MONTH-YEAR GROWTH PORTFOLIO FUND EAFE INDEX
- ---------- --------------- ------------- ----------
<S> <C> <C> <C>
Aug-87 $10,000 $10,000 $10,000
Nov-87 8,044 7,700 8,552
Feb-88 9,085 8,434 9,568
May-88 9,508 8,856 9,979
Aug-88 9,008 8,421 9,375
Nov-88 10,059 9,419 11,261
Feb-89 9,977 9,746 11,589
May-89 9,871 9,772 10,850
Aug-89 11,213 10,608 11,473
Nov-89 11,793 10,954 12,100
Feb-90 11,702 11,027 11,244
May-90 12,271 11,618 11,141
Aug-90 11,802 10,985 10,119
Nov-90 10,862 10,210 9,481
Feb-91 12,111 11,229 11,023
May-91 11,709 11,174 10,581
Aug-91 11,199 10,965 10,084
Nov-91 10,894 10,943 10,307
Feb-92 11,377 11,561 10,237
May-92 11,847 11,970 10,259
Aug-92 11,366 11,335 10,129
Nov-92 10,716 10,835 9,506
Feb-93 10,978 11,302 9,851
May-93 12,580 12,843 11,983
Aug-93 13,759 13,798 12,877
Nov-93 14,022 13,976 11,849
Feb-94 16,018 15,885 13,749
May-94 15,706 15,475 13,645
Aug-94 16,572 16,185 14,311
Nov-94 15,810 15,293 13,643
Feb-95 14,913 14,397 13,172
May-95 16,621 15,452 14,359
Aug-95 17,194 15,986 14,425
Nov-95 17,452 16,037 14,721
Feb-96 18,601 16,972 15,440
May-96 19,562 17,769 15,939
Aug-96 19,382 17,416 15,606
Nov-96 20,655 18,393 16,500
Feb-97 20,968 18,667 15,986
May-97 22,904 19,818 17,191
Aug-97 22,439 19,592 17,067
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS
-----------------------------
PERIODS ENDED AUGUST 31, 1997 FINAL VALUE OF A
1 YEAR 5 YEARS 10 YEARS $10,000 INVESTMENT
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
International Growth Portfolio 15.84% 14.58% 8.42% $22,451
Average International Fund 13.97 11.52 6.96 19,592
MSCI EAFE Index 9.36 11.00 5.49 17,067
- -----------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED JUNE 30, 1997*
- --------------------------------------------------------------------------------------
10 YEARS
INCEPTION ------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
International Growth Portfolio 9/30/81 22.19% 15.68% 8.60% 1.53% 10.13%
- --------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
7
<PAGE> 30
PORTFOLIO PROFILE
International Growth Portfolio
This Profile provides a snapshot of the Portfolio's characteristics as of
August 31, 1997, compared where appropriate to an unmanaged index. Key elements
of this Profile are defined on page 9.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
- -----------------------------------------
INTERNATIONAL MSCI
GROWTH EAFE
- -----------------------------------------
<S> <C> <C>
Number of Stocks 178 1,083
Turnover Rate 22% --
Expense Ratio 0.57% --
Cash Reserves 6.0% --
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION
- -----------------------------------------
<S> <C>
Europe 32%
Pacific (minus Japan) 12%
Japan 28%
Emerging Markets 7%
Other 1%
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- -----------------------------------------
INTERNATIONAL MSCI
GROWTH EAFE
- -----------------------------------------
<S> <C> <C>
R-Squared 0.86 1.00
Beta 0.94 1.00
</TABLE>
<TABLE>
<CAPTION>
COUNTRY DIVERSIFICATION (% OF COMMON STOCK)
- -----------------------------------------
INTERNATIONAL MSCI
GROWTH EAFE
- -----------------------------------------
<S> <C> <C>
Argentina 0.4% --
Australia 1.3 2.7%
Austria 0.3 0.4
Belgium -- 1.2
Brazil 2.2 --
Canada 0.8 --
Chile 0.3 --
Denmark 0.7 0.9
Finland -- 0.7
France 8.5 6.7
Germany 6.5 9.5
Hong Kong 6.9 3.8
Indonesia 0.7 --
Italy 0.4 3.1
Japan 28.4 31.1
Korea 1.1 --
Malaysia 1.7 1.8
Mexico 1.0 --
Netherlands 11.2 5.3
Philippines 1.1 --
Singapore 1.9 1.1
Spain -- 2.2
Sweden 1.7 2.5
Switzerland 12.7 6.5
Thailand 0.3 --
United Kingdom 9.9 19.3
Other -- 1.2
- -----------------------------------------
Total 100.0% 100.0%
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST STOCKS (% OF TOTAL NET ASSETS)
- -----------------------------------------
<S> <C>
Novartis AG (Registered) 4.2%
ING Groep NV 3.9
ABB AG (Bearer) 3.3
Takeda Chemical Industries Ltd. 3.0
Fuji Photo Film Co., Ltd. 2.7
Elf Aquitaine SA 2.4
Philips Electronics NV 2.4
Veba AG 1.9
British Petroleum Co., PLC 1.9
Murata Manufacturing Co., Ltd. 1.8
- -----------------------------------------
Top Ten 27.5%
</TABLE>
8
<PAGE> 31
BETA. A measure of the magnitude of a portfolio's past share-price fluctuations
in relation to the ups and downs of the overall market (or appropriate market
index). The market (or index) is assigned a beta of 1.00, so a 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%.
CASH RESERVES. The percentage of a portfolio's net assets invested in "cash
equivalents"--highly liquid, short-term, interest-bearing investments.
COUNTRY DIVERSIFICATION. The percentages of a portfolio's common stock invested
in securities of various countries.
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.
NUMBER OF STOCKS. An indicator of diversification. The more stocks a portfolio
holds, the more diversified it is and the more likely to perform in line with
the overall stock market.
PORTFOLIO ALLOCATION. This chart shows the geographic distribution of a
portfolio's holdings.
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.
TEN LARGEST STOCKS. The percentage of net assets that a portfolio has invested
in its ten largest holdings. (The average for stock mutual funds is about 30%).
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.
TURNOVER RATE. An indication of trading activity during the past year.
Portfolios with high turnover rates incur higher transaction costs and are more
likely to distribute capital gains (which are taxable to investors).
9
<PAGE> 32
FINANCIAL STATEMENTS
August 31, 1997
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)
- ---------------------------------------------------------------------------
COMMON STOCKS (94.0%)
- ---------------------------------------------------------------------------
<S> <C> <C>
ARGENTINA (0.3%)
Banco de Galicia y Buenos
Aires SA de CV ADR 250,000 $ 7,406
YPF SA ADR 500,000 16,282
-------------
23,688
-------------
AUSTRALIA (1.3%)
Australia & New Zealand Bank
Group Ltd. 814,000 5,847
Broken Hill Proprietary Ltd. 1,210,500 15,185
Lend Lease Corp. 321,031 6,921
Lion Nathan Ltd. 2,176,000 5,545
Mayne Nickless Ltd. 1,325,000 7,571
Mount Isa Mines Holdings Ltd. 2,820,000 3,376
National Australia Bank Ltd. 373,000 5,177
News Corp. Ltd. 1,512,763 6,813
Normandy Mining Ltd. 3,183,212 3,857
# Normandy Mining Ltd.
Warrants Exp. 4/30/01 16,450 3
QNI Ltd. 3,000,000 4,517
Tabcorp Holdings Ltd. 1,755,400 8,741
WMC Ltd. 594,937 3,015
Westfield Holdings Ltd. 400,000 7,142
Westpac Banking Corp., Ltd. 1,073,000 6,218
-------------
89,928
-------------
AUSTRIA (0.3%)
# Bank Austria AG Pfd. 515,622 19,496
BRAZIL (2.1%)
Companhia Energetica de
Minas Gerais Pfd. 269,500,000 12,095
Telecomunicacoes
Brasileiras SA 297,460,000 31,877
Telecomunicacoes
Brasileiras SA ADR 439,000 51,802
Telecomunicacoes
Brasileiras SA Pfd. 313,665,755 36,774
Usiminas-Usinas
Siderurgicas de Minas
Gerais SA ADR 490,000 4,900
Usiminas-Usinas
Siderurgicas de Minas
Gerais SA Pfd. 961,215 9,772
-------------
147,220
-------------
CANADA (0.7%)
Noranda, Inc. 2,557,000 50,000
-------------
CHILE (0.3%)
Chilectra SA ADR 250,000 7,813
Compania de
Telecomunicaciones de
Chile SA ADR 229,500 6,899
Sociedad Quimica y Minera
de Chile ADR 120,000 7,245
-------------
21,957
-------------
DENMARK (0.7%)
Den Danske Bank A/S 506,000 47,982
-------------
</TABLE>
10
<PAGE> 33
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ---------------------------------------------------------------------------
<S> <C> <C>
FINLAND
Rauma Oy 14,187 $ 294
-------------
FRANCE (8.0%)
Compagnie de Saint-Gobain SA 359,405 49,417
Compagnie des Gaz de Petrole
Primagaz SA 84,668 7,189
# Compagnie des Gaz de Petrole
Primagaz SA
Warrants Exp. 6/30/98 7,697 120
Compagnie Generale des
Eaux SA 761,337 85,102
# Compagnie Generale des
Eaux SA Warrants Exp. 5/2/01 580,500 325
Compagnie Generale des
Establissements Michelin
SCA B Shares 1,011,111 56,844
Elf Aquitaine SA 1,531,000 170,376
SGS-Thomson Microelectronics
NV NY Shares 900,800 83,662
Synthelabo SA 316,440 38,241
Total SA B Shares 552,000 51,782
Valeo SA 447,000 26,899
-------------
569,957
-------------
GERMANY (6.1%)
Adidas AG 264,000 31,897
Bayer AG 2,650,000 97,762
Friederich Grohe AG Pfd. 18,747 5,207
Hoechst AG 500,000 19,846
Linde AG 60,000 40,496
Mannesmann AG 125,000 58,050
SGL Carbon AG 60,000 7,466
Siemens AG 608,000 37,389
Veba AG 2,500,000 136,099
-------------
434,212
-------------
HONG KONG (6.5%)
Cheung Kong Holdings Ltd. 7,304,000 77,291
China Resources
Enterprise Ltd. 3,070,000 12,876
Citic Pacific Ltd. 8,860,000 47,221
HSBC Holdings PLC 2,362,943 71,964
Hong Kong Electric
Holdings Ltd. 6,214,000 21,732
Hutchison Whampoa Ltd. 8,406,000 69,968
Mandarin Oriental
International Ltd. 4,311,369 4,829
New World Development
Co., Ltd. 4,326,000 26,964
Sun Hung Kai Properties Ltd. 6,043,400 68,630
Swire Pacific Ltd. A Shares 4,704,000 35,967
Wharf Holdings Ltd. 5,500,000 19,909
-------------
457,351
-------------
INDONESIA (0.6%)
PT Bank Internasional
Indonesia (Foreign) 14,080,500 3,938
PT Indofood Sukses Makmur
(Foreign) 12,660,460 16,308
PT Telekomunikasi
Indonesia ADR 480,000 9,420
PT Telekomunikasi Indonesia
(Foreign) 16,204,000 14,694
-------------
44,360
-------------
ITALY (0.4%)
Telecom Italia Mobile SPA 8,000,000 27,716
-------------
JAPAN (26.8%)
Bridgestone Corp. 4,755,000 105,544
Chiyoda Fire & Marine
Insurance Co., Ltd. 2,000,000 7,100
DDI Corp. 8,000 41,899
Dai-Nippon Printing Co., Ltd. 2,921,000 61,193
Dowa Fire & Marine
Insurance Co. 1,000,000 3,932
East Japan Railway Co. 14,000 64,012
Fuji Photo Film Co., Ltd. 5,025,000 193,831
Hirose Electric Co., Ltd. 315,000 22,128
Ito-Yokado Co., Ltd. 1,980,000 106,991
Keyence Corp. 143,000 20,923
Kuraray Co., Ltd. 2,250,000 20,014
Kyocera Corp. 317,000 20,028
Mabuchi Motor Co. 731,000 39,014
Matsushita Electric Industrial
Co., Ltd. 6,460,000 119,222
Mitsui & Co., Ltd. 8,100,000 66,260
Mitsui Fudosan Co., Ltd. 1,000,000 11,638
Murata Manufacturing Co., Ltd. 3,112,000 127,026
Nippon Fire & Marine
Insurance Co., Ltd. 1,000,000 4,323
Nippon Steel Corp. 25,000,000 63,596
Nippon Television Network 103,500 36,396
Omron Corp. 2,488,000 46,331
SMC Corp. 986,000 82,788
Shin-Etsu Chemical Co., Ltd. 1,050,000 26,885
Showa Shell Sekiyu K.K. 2,760,000 19,159
Sumitomo Corp. 6,300,000 52,373
Sumitomo Electric
Industries Ltd. 3,000,000 45,390
Takeda Chemical
Industries Ltd. 7,860,000 209,748
Tokio Marine & Fire
Insurance Co. 7,140,000 81,912
Tokyo Electron Ltd. 437,500 23,823
Toppan Printing Co., Ltd. 5,692,000 81,862
Toyota Motor Corp. 2,350,000 61,539
Yamazaki Baking Co., Ltd. 400,000 5,520
Yasuda Fire & Marine
Insurance Co. 5,190,000 29,468
-------------
1,901,868
-------------
KOREA (1.0%)
# Daewoo Securities Co. 550,000 8,837
Korea Electric Power Corp. 776,050 20,293
L.G. Electronics Co. 503,350 10,820
Pohang Iron & Steel Co., Ltd. 80,000 6,929
SK Telecom Co., Ltd. 14,669 11,071
Samsung Electronics Co.,
Ltd. GDR 4,578 250
</TABLE>
11
<PAGE> 34
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
MARKET
INTERNATIONAL VALUE*
GROWTH PORTFOLIO SHARES (000)
- ---------------------------------------------------------------------------
<S> <C> <C>
# Samsung Electronics Co.,
Ltd. GDR 1/2 Non-Voting Stock 275,931 $ 6,967
# Samsung Electronics Co.,
Ltd. GDR 1/2 Voting Stock 483 26
Shinhan Bank Co. 465,162 4,763
Yukong Ltd. 36,010 826
-------------
70,782
-------------
MALAYSIA (1.6%)
Genting Bhd. 4,047,000 13,881
Malayan Banking Bhd. 4,333,000 28,832
RHB Capital Bhd. 3,996,000 6,853
Sime Darby Bhd. 7,105,000 16,815
Telekom Malaysia Bhd. 4,294,500 13,109
Tenaga Nasional Bhd. 6,954,000 20,751
United Engineers
Malaysia Bhd. 3,981,000 16,249
-------------
116,490
-------------
MEXICO (0.9%)
Apasco SA de CV 1,066,000 7,969
Cemex SA de CV (CPO) 3,114,720 15,254
Cifra SA de CV Series A 1,016,253 1,886
Cifra SA de CV Series C 8,309,000 14,778
# Grupo Televisa SA GDR 440,000 14,355
Telefonos de Mexico SA
Class L ADR 200,000 9,175
-------------
63,417
-------------
NETHERLANDS (10.5%)
Baan Co., NV 500,000 30,176
Ceteco Holdings NV 124,535 6,391
Delft Instruments NV 463,068 9,255
Elsevier NV 1,545,310 23,487
Getronics NV 2,296,274 69,689
Hagemeyer NV 497,636 25,662
Heineken NV 327,000 51,718
ING Groep NV 6,255,364 273,187
Oce-Van Der Grinten NV 500,382 59,040
Philips Electronics NV 2,362,000 168,660
Verenigde Nederlandse
Uitgeversbedrijven
Verenigd Bezit 1,270,000 26,572
-------------
743,837
-------------
PHILIPPINES (1.0%)
Ayala Land, Inc. Class B 42,402,243 20,922
Meralco Class B 179,400 608
# Meralco GDR 514,286 8,712
Metropolitan Bank & Trust Co. 660,000 7,273
Philippine Long Distance
Telephone Co. 1,295,000 32,801
-------------
70,316
-------------
SINGAPORE (1.8%)
City Developments Ltd. 496,000 3,132
DBS Land Ltd. 3,948,000 10,128
Development Bank of
Singapore Ltd. (Foreign) 1,820,000 19,253
Keppel Corp. Ltd. 3,878,000 13,845
Oversea-Chinese Banking
Corp., Ltd. (Foreign) 1,575,420 12,291
Singapore Airlines Ltd.
(Foreign) 2,495,000 18,145
Singapore Press Holdings Ltd.
(Foreign) 1,784,320 22,532
United Overseas Bank Ltd.
(Foreign) 2,184,000 16,894
Wing Tai Holdings Ltd. 4,074,000 8,619
-------------
124,839
-------------
SWEDEN (1.6%)
LM Ericsson Telephone AB
B Shares 1,100,000 45,956
Svenska Handelsbanken AB
A Shares 2,200,000 67,813
-------------
113,769
-------------
SWITZERLAND (11.9%)
ABB AG (Bearer) 156,700 231,551
Adecco SA (Bearer) 150,000 51,244
Novartis AG (Registered) 210,000 298,284
Roche Holdings AG
(Dividend-Right Certificates) 11,090 93,781
Union Bank of Switzerland AG
(Bearer) 85,500 84,976
Zurich Insurance Co.
(Registered) 234,000 85,143
-------------
844,979
-------------
THAILAND (0.3%)
Land & House PLC (Foreign) 4,062,788 4,605
PTT Exploration & Production
PLC (Foreign) 486,500 5,179
Siam Cement PLC (Foreign) 172,700 2,647
# TelecomAsia PLC (Foreign) 878,900 771
Thai Farmers Bank PLC
(Foreign) 1,048,900 3,006
Total Access Communication
PLC (Local) 1,724,400 6,898
-------------
23,106
-------------
UNITED KINGDOM (9.3%)
Asda Group PLC 26,750,000 62,472
British Aerospace PLC 2,700,000 63,231
# British Aerospace PLC
Warrants Exp. 11/15/00 120,000 1,746
British Airways PLC 2,050,000 21,378
British Land Co., PLC 3,620,000 33,464
British Petroleum Co., PLC 9,595,895 134,150
Cable and Wireless PLC 6,790,000 59,465
David S. Smith Holdings PLC 3,500,000 12,034
EMI Group PLC 4,622,400 41,681
# EMI Group PLC Class B 1,100,000 1,784
Enterprise Oil PLC 3,300,000 36,982
Reckitt & Colman PLC 1,184,000 18,280
Rio Tinto PLC 1,460,000 23,051
Tesco PLC 10,000,000 66,818
United News & Media PLC 1,800,000 19,909
Vodafone Group PLC 3,600,000 18,041
Zeneca Group PLC 1,400,000 44,389
-------------
658,875
-------------
- ---------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $5,325,358) 6,666,439
- ---------------------------------------------------------------------------
</TABLE>
12
<PAGE> 35
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
FACE MARKET
AMOUNT VALUE*
(000) (000)
- ----------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (6.7%)
- ----------------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.56%, 9/2/97
(COST $475,155) $475,155 $ 475,155
- ----------------------------------------------------------------------------
TOTAL INVESTMENTS (100.7%)
(COST $5,800,513) 7,141,594
- ----------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.7%)
- ----------------------------------------------------------------------------
Other Assets--Notes C and F 261,310
Liabilities--Note F (314,152)
--------------
(52,842)
- ----------------------------------------------------------------------------
NET ASSETS (100%)
- ----------------------------------------------------------------------------
Applicable to 396,989,644 outstanding
$1.00 par value shares
(authorized 550,000,000 shares) $ 7,088,752
============================================================================
NET ASSET VALUE PER SHARE $17.86
============================================================================
</TABLE>
*See Note A in Notes to Financial Statements.
#Non-Income Producing Security.
ADR--American Depository Receipt.
GDR--Global Depository Receipt.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ----------------------------------------------------------------------------
AT AUGUST 31, 1997, NET ASSETS CONSISTED OF:
- ----------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $5,503,808 $13.86
Undistributed Net
Investment Income--Note D 58,733 .15
Accumulated Net Realized
Gains--Notes D and E 196,419 .49
Unrealized Appreciation
(Depreciation)--Note E
Investment Securities 1,341,081 3.38
Foreign Currencies and
Forward Currency Contracts (11,289) (.02)
- ----------------------------------------------------------------------------
NET ASSETS $7,088,752 $17.86
============================================================================
</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 Gain (Loss) realized on the sale of investments, 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, 1997
(000)
- --------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends* $ 97,351
Interest 12,457
---------
Total Income 109,808
---------
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 8,245
Performance Adjustment 1,980
The Vanguard Group--Note C
Management and Administrative 18,164
Marketing and Distribution 1,456
Taxes (other than income taxes) 412
Custodian Fees 3,575
Auditing Fees 10
Shareholders' Reports 338
Annual Meeting and Proxy Costs 51
Directors' Fees and Expenses 17
---------
Total Expenses 34,248
Expenses Paid Indirectly--Note C (472)
---------
Net Expenses 33,776
- --------------------------------------------------------------------------------------
NET INVESTMENT INCOME 76,032
- --------------------------------------------------------------------------------------
REALIZED NET GAIN
Investment Securities Sold 135,492
Foreign Currencies and Forward Currency Contracts 69,760
- --------------------------------------------------------------------------------------
REALIZED NET GAIN 205,252
- --------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 518,516
Foreign Currencies and Forward Currency Contracts (3,373)
- --------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 515,143
- --------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $796,427
======================================================================================
</TABLE>
*Dividends are net of foreign withholding taxes of $11,828,000.
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 income and capital
gains may not match the amounts shown in the Operations section, because
distributions are determined on a tax basis and may be made in a period
different from the one in which the income was earned or the gains were
realized on the financial statements. The Capital Share Transactions section
shows the amount shareholders invested in the 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,
----------------------------------
1997 1996
(000) (000)
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 76,032 $ 56,078
Realized Net Gain 205,252 245,794
Change in Unrealized Appreciation (Depreciation) 515,143 161,918
----------------------------------
Net Increase in Net Assets Resulting from Operations 796,427 463,790
----------------------------------
DISTRIBUTIONS
Net Investment Income (61,180) (47,382)
Realized Capital Gain (177,098) (49,751)
----------------------------------
Total Distributions (238,278) (97,133)
----------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 2,762,825 1,967,623
Issued in Lieu of Cash Distributions 218,868 90,182
Redeemed (1,448,315) (780,882)
----------------------------------
Net Increase from Capital Share Transactions 1,533,378 1,276,923
- -----------------------------------------------------------------------------------------------
Total Increase 2,091,527 1,643,580
- -----------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year 4,997,225 3,353,645
----------------------------------
End of Year $7,088,752 $4,997,225
===============================================================================================
(1)Shares Issued (Redeemed)
Issued 156,951 125,890
Issued in Lieu of Cash Distributions 13,654 6,000
Redeemed (83,511) (50,140)
----------------------------------
Net Increase in Shares Outstanding 87,094 81,750
===============================================================================================
</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 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR $16.13 $14.70 $14.36 $12.02 $10.15
- -------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .19 .19 .20 .14 .12
Net Realized and Unrealized Gain (Loss) on Investments 2.28 1.65 .32 2.31 1.96
------------------------------------------------
Total from Investment Operations 2.47 1.84 .52 2.45 2.08
------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.19) (.20) (.18) (.11) (.21)
Distributions from Realized Capital Gains (.55) (.21) -- -- --
------------------------------------------------
Total Distributions (.74) (.41) (.18) (.11) (.21)
- -------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR $17.86 $16.13 $14.70 $14.36 $12.02
=============================================================================================================
TOTAL RETURN 15.84% 12.72% 3.76% 20.44% 21.06%
=============================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Year (Millions) $7,089 $4,997 $3,354 $2,989 $1,477
Ratio of Total Expenses to Average Net Assets 0.57% 0.56% 0.59% 0.46% 0.59%
Ratio of Net Investment Income to Average Net Assets 1.26% 1.35% 1.53% 1.37% 1.27%
Portfolio Turnover Rate 22% 22% 31% 28% 51%
Average Commission Rate Paid $.0015 $.0223 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 to 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.
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. Schroder Capital Management International provides investment advisory
services to the Portfolio for a fee calculated at an annual percentage rate of
average net assets. The basic fee is subject to quarterly adjustments based on
performance relative to the Morgan Stanley Capital
17
<PAGE> 40
International Europe, Australasia, Far East Index. For the year ended August
31, 1997, the advisory fee represented an effective annual basic rate of 0.14%
of the Portfolio's average net assets before an increase of $1,980,000 (an
annual rate of 0.03%) 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, 1997, the Portfolio had contributed capital of $534,000 to Vanguard
(included in Other Assets), representing 2.7% 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, 1997, these arrangements reduced the Portfolio's
expenses by $472,000 (0.01% of average net assets).
D. During the year ended August 31, 1997, the Portfolio purchased
$2,400,830,000 of investment securities and sold $1,266,687,000 of investment
securities other than temporary cash investments.
During the year ended August 31, 1997, the Portfolio realized net foreign
currency losses of $1,079,000, which decreased distributable net income for tax
purposes; accordingly, such losses have been reclassified from accumulated net
realized gains to undistributed net investment income.
Certain of the Portfolio's investments are in securities considered to be
"passive foreign investment companies," for which any unrealized appreciation
and/or realized gains are required to be included in distributable net
investment income for tax purposes. The cumulative total of distributions
related to passive foreign investment company holdings at August 31, 1997, was
$1,309,000. The Portfolio had an additional $1,475,000 of unrealized
appreciation on passive foreign investment companies which was available for
distribution at August 31, 1997.
E. At August 31, 1997, net unrealized appreciation of investment securities
for federal income tax purposes was $1,338,297,000, consisting of unrealized
gains of $1,615,312,000 on securities that had risen in value since their
purchase and $277,015,000 in unrealized losses on securities that had fallen in
value since their purchase.
At August 31, 1997, the Portfolio had open forward currency contracts to
deliver foreign currency in exchange for U.S. dollars as follows:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
(000)
------------------------------------------------------
CONTRACT AMOUNT
-------------------- UNREALIZED
CONTRACT FOREIGN U.S. MARKET VALUE IN APPRECIATION
SETTLEMENT DATE CURRENCY DOLLARS U.S. DOLLARS (DEPRECIATION)
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Deliver:
9/11/97 FRF 2,340,000 $369,937 $385,991 $(16,054)
9/19/97 JPY 45,000,000 380,064 374,937 5,127
- -------------------------------------------------------------------------------
</TABLE>
FRF--French franc.
JPY--Japanese yen.
Net unrealized depreciation of $10,927,000 related to open forward currency
contracts is required to be treated as realized loss for tax purposes.
The Portfolio had net unrealized foreign currency losses of $362,000
resulting from the translation of other assets and liabilities at August 31,
1997.
F. The market value of securities on loan to broker/dealers at August 31,
1997, was $206,694,000, for which the Portfolio held cash collateral of
$219,654,000.
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, 1997,
the results of its operations for the year then ended, the changes in its net
assets for each of the two years in the period then ended and the financial
highlights for each of the five years in the period then ended, in conformity
with generally accepted accounting principles. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Fund's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits, which included confirmation of securities at August 31, 1997 by
correspondence with the custodian and the application of alternative auditing
procedures where securities purchased had not been settled, provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Thirty South Seventeenth Street
Philadelphia, Pennsylvania 19103
October 3, 1997
19
<PAGE> 42
SPECIAL 1997 TAX INFORMATION (UNAUDITED)
FOR VANGUARD INTERNATIONAL GROWTH PORTFOLIO
This information for the fiscal year ended August 31, 1997, is included
pursuant to provisions of the Internal Revenue Code.
The Portfolio designates $153,604,000 as capital gain dividends (from
net long-term capital gains), of which $12,159,000 was distributed to
shareholders in December 1996. The balance of $141,445,000, along with any
additional gains realized through October 31, 1997, will be distributed in
December 1997. 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, 1997, are as follows:
<TABLE>
<CAPTION>
-----------------------------------------------
GROSS FOREIGN FOREIGN
COUNTRY DIVIDENDS TAX
-----------------------------------------------
<S> <C> <C>
Argentina $.0005 $.0000
Australia .0082 .0003
Brazil .0073 .0001
Canada .0095 .0013
Chile .0013 .0003
Denmark .0032 .0005
Finland .0011 .0002
France .0286 .0000
Germany .0176 .0018
Hong Kong .0261 .0011
Indonesia .0015 .0002
Italy .0008 .0001
Japan .0226 .0031
Korea .0023 .0004
Malaysia .0026 .0008
Mexico .0035 .0000
Netherlands .0283 .0041
Philippines .0014 .0003
Singapore .0049 .0011
Sweden .0064 .0010
Switzerland .0344 .0052
Thailand .0019 .0002
United Kingdom .0612 .0079
-----------------------------------------------
</TABLE>
The pass-through of foreign tax credit will affect only shareholders on the
dividend record date in December 1997. Shareholders will receive more
detailed information along with their Form 1099-DIV in January 1998.
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<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 and Director of Rhone-Poulenc Rorer, Inc.; Managing Director
of Global Health Care Partners/DLJ Merchant Banking Partners; Director of Sun
Company, Inc., and Westinghouse Electric Corp.
BARBARA BARNES HAUPTFUHRER
Director of The Great Atlantic and Pacific Tea Co., IKON Office Solutions,
Inc., Raytheon Co., Knight-Ridder, Inc., and Massachusetts Mutual Life
Insurance Co.; Trustee Emerita of Wellesley College.
BRUCE K. MACLAURY
President Emeritus of The Brookings Institution; Director of American Express
Bank Ltd., The St. Paul Companies, Inc., and National Steel Corp.
BURTON G. MALKIEL
Chemical Bank Chairman's Professor of Economics, Princeton University; Director
of Prudential Insurance Co. of America, Amdahl Corp., Baker Fentress & Co., The
Jeffrey Co., and Southern New England Communications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., and
NACCO Industries.
JAMES O. WELCH, JR.
Retired Chairman of Nabisco Brands, Inc.; retired Vice Chairman and Director of
RJR Nabisco; Director of TECO Energy, Inc., and Kmart Corp.
J. LAWRENCE WILSON
Chairman and Chief Executive Officer of Rohm & Haas Co.; Director of Cummins
Engine Co.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director 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
R. GREGORY BARTON
Managing Director, Legal Department.
ROBERT A. DISTEFANO
Managing Director, Information Technology.
JAMES H. GATELY
Managing Director, Individual Investor Group.
KATHLEEN C. GUBANICH
Managing Director, Human Resources.
IAN A. MACKINNON
Managing Director, Fixed Income Group.
F. WILLIAM MCNABB, III
Managing Director, Institutional Investor Group.
MICHAEL S. MILLER
Managing Director, Planning and Development.
RALPH K. PACKARD
Managing Director and Chief Financial Officer.
GEORGE U. SAUTER
Managing Director, Core Management Group.
"Standard & Poor's 500," "S&P 500(R)," "Standard & Poor's(R),"
"S&P(R)," and "500" are trademarks of The McGraw-Hill Companies, Inc.
Frank Russell Company is the owner of trademarks and copyrights relating
to the Russell Indexes. "Wilshire 4500" and "Wilshire 5000"
are trademarks of Wilshire Associates.
<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 Growth and Income Portfolio
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 International Value 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 Treasury Money Market Portfolio
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, NY, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds (CA, FL, NJ, NY, OH, PA)
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
http://www.vanguard.com
[email protected]
All Vanguard funds are offered by
prospectus only. Prospectuses
contain more complete information
on advisory fees, distribution charges,
and other expenses and should be read
carefully before you invest or send
money. Prospectuses can be obtained
directly from The Vanguard Group.
[THE VANGUARD GROUP LOGO]
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Q810-8/97 - (C) 1997 Vanguard Marketing Corporation, Distributor
