<PAGE> 1
VANGUARD
U.S. GROWTH
PORTFOLIO
Semiannual Report - February 28, 1998
[PHOTO]
[THE VANGUARD GROUP LOGO]
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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--more than 7,000 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 fund reports 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] [PHOTO]
John C. Bogle John J. Brennan
Senior Chairman Chairman and CEO
CONTENTS
<TABLE>
<S> <C>
A MESSAGE TO OUR SHAREHOLDERS ..................................... 1
THE MARKETS IN PERSPECTIVE ........................................ 3
REPORT FROM THE ADVISER ........................................... 5
PORTFOLIO PROFILE ................................................. 6
PERFORMANCE SUMMARY ............................................... 8
FINANCIAL STATEMENTS .............................................. 9
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 3
FELLOW SHAREHOLDER
Vanguard U.S. Growth Portfolio more than kept up with the rollicking bull
market in stocks--and provided returns far in excess of its peers--during the
six months ended February 28, 1998, the first half of the Portfolio's fiscal
year.
The following table presents the six-month returns earned by the Portfolio
and by its two primary benchmarks, the average growth mutual fund and the
unmanaged Standard & Poor's 500 Composite Stock Price Index. As the table
shows, the U.S. Growth Portfolio's +19.6% total return (capital change plus
reinvested dividends) was far in front of that earned by the average competing
fund and comfortably ahead of the return on the S&P 500 Index.
<TABLE>
<CAPTION>
- --------------------------------------------------------------
TOTAL RETURNS
SIX MONTHS ENDED
FEBRUARY 28, 1998
- --------------------------------------------------------------
<S> <C>
Vanguard U.S. Growth Portfolio +19.6%
- --------------------------------------------------------------
Average Growth Fund +12.7%
- --------------------------------------------------------------
S&P 500 Index +17.6%
- --------------------------------------------------------------
</TABLE>
The Portfolio's return is based on an increase in net asset value from
$27.74 per share on August 31, 1997, to $31.84 per share on February 28, 1998,
with the latter figure adjusted for our annual dividend of $0.27 per share paid
from net investment income and distributions totaling $0.89 per share paid from
net realized capital gains.
THE PERIOD IN REVIEW
Solid growth in economic activity, declining interest rates, quiescent
inflation, and strong consumer optimism were the fuel that kept the U.S. stock
market climbing high during the six months ended February 28. Wall Street
generally shrugged off the potential impact of serious economic turmoil in
Asia--where currency devaluations and stock market collapses afflicted a number
of important developing markets, including Thailand, Indonesia, the Philippines,
South Korea, and Malaysia. After a sharp setback in October--during which the
S&P 500 Index fell -7% in a single day--domestic stocks rebounded smartly. The
Index posted gains in five of the six months and ended the period at an all-time
high.
Although all the broad market indexes were up nicely during the six months,
large-capitalization growth stocks--your Portfolio's stock in trade, so to
speak--generally enjoyed the biggest gains. The S&P 500, which is dominated by
large-cap stocks, advanced +17.6%, while the rest of the stock market, as
measured by the Wilshire 4500 Equity Index, earned +11.9%. The growth-stock
component of the S&P 500 gained +20.3%, versus +14.9% for the value component.
This tilt toward large-cap growth stocks accounted in large measure for the
margins your Portfolio achieved over both of its competitive benchmarks. The
average growth fund holds mid- and small-capitalization stocks as well as
large-cap stocks, which was a distinct disadvantage during the past six months,
when bigger was better on Wall Street. For the half-year ended February 28, the
growth portion of the Russell 2000 Index, a small-cap stock benchmark, earned
+6.4%, less than one-third the return on the S&P 500's growth component.
The 2-percentage-point advantage your Portfolio enjoyed over the unmanaged
S&P 500 Index during the period was the result of excellent stock selection,
particularly in the health-care and materials & processing sectors. On balance,
the industry sectors emphasized by our adviser, Lincoln Capital Management, were
a slight negative. In keeping with
1
<PAGE> 4
our growth-stock character, we owned no utility stocks, the S&P 500's
best-performing group (+34.8%) during the period. Much of this handicap was
overcome by a heavier-than-market weighting in health-care stocks, the
second-strongest performers during the six months.
Beating the Index is a difficult task for actively managed mutual funds,
because the Index is a theoretical construct that incurs no operating,
administrative, or transaction costs, all of which are borne by actual funds.
Our operating expenses amount to an annual rate of about 0.40% of average net
assets, which puts us at a disadvantage versus the Index but gives us a hefty
annual edge of more than one percentage point over the 1.53% expense ratio of
the average growth fund.
Our unusually big margin over the average growth fund (+19.6% versus +12.7%)
was based importantly on our greater emphasis on large-cap stocks, abetted by a
combination of a heavier weighting in a solidly performing consumer staples
group and a lighter weighting in a disappointing technology group. Our Portfolio
is typically quite different from those of our peers. As a result, you should
not be surprised when our return varies considerably from theirs. We hope these
differences will fall mostly on the positive side of the ledger.
IN SUMMARY
It's hard to find superlatives adequate to describe the U.S. stock market's
performance over the past 15 1/2 years. Cumulative returns for the past three
years alone exceed 125%. Such returns are to be savored because they are truly
extraordinary. While no one can predict the future, we believe it is safe to say
that future returns will be smaller. It's also safe to say that the future will
bring episodes of negative returns--the risk that is the inseparable companion
of the rewards that stocks provide over the long term.
We'll repeat our opinion from last year's semiannual report: "It is futile to
try to discern the right moment to get into or out of the stock market." That
belief is the foundation of our long-standing counsel to hold a balanced
portfolio of stock funds, bond funds, and money market funds in proportions that
seem right for your investment objectives, financial situation, and risk
tolerance. Such a balanced investment program should help you to "stay the
course" toward your long-term goals, whether the winds from the financial
markets blow fair or foul.
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
Chief Executive Officer
March 16, 1998
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<PAGE> 5
THE MARKETS IN PERSPECTIVE
Six Months Ended February 28, 1998
A rare combination of beneficent influences--robust growth, tame inflation, low
unemployment, and cheerful consumers--continued to delight the U.S. stock and
bond markets (and to puzzle economists) during the fiscal half-year ended
February 28. The Asian financial crisis created some anxiety, dampening returns
in certain market sectors and helping to swell them elsewhere. But the U.S.
markets were buoyed against these concerns by continuing good news about the
domestic economy: Consumer prices rose just 1.4% over the past year, the best
showing in more than a decade. At the same time, the economy's sustained
expansion has pushed the unemployment rate down to 4.6%, its lowest level since
1973. The deceleration of inflation has surprised economic analysts because
inflation and unemployment rates tend to move in opposite directions. Although
wages have shown some increases, it appears that consumer prices have been held
down by an unexpected combination of productivity gains, declining import prices
as a result of the stronger U.S. dollar, and a significant drop in energy
prices.
U.S. EQUITY MARKETS
Despite the uncertainty regarding developments in Asia, the U.S. equity market
provided investors with yet another stunning performance during the six months.
The S&P 500 Index, for example, posted an advance of 17.6% during the fiscal
half-year, with the Russell 2000, the best-known benchmark for smaller
companies' stocks, gaining 9.6%. Clearly, investors found the economic news
significantly more heartening than they had expected.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
TOTAL RETURNS
PERIODS ENDED FEBRUARY 28, 1998
-------------------------------
6 MONTHS 1 YEAR 5 YEARS*
- -------------------------------------------------------------------------------
EQUITY
<S> <C> <C> <C>
S&P 500 Index 17.6% 35.0% 21.7%
Russell 2000 Index 9.6 30.0 17.5
MSCI EAFE Index 8.5 15.8 13.4
- -------------------------------------------------------------------------------
FIXED INCOME
Lehman Aggregate Bond Index 5.7% 10.4% 7.0%
Lehman 10-Year Municipal Bond Index 5.0 9.0 6.7
Salomon Brothers Three-Month
U.S. Treasury Bill Index 2.6 5.3 4.8
- -------------------------------------------------------------------------------
OTHER
Consumer Price Index 0.7% 1.4% 2.5%
- -------------------------------------------------------------------------------
</TABLE>
*Average annual.
For investors in common stocks, the two most important variables are the
growth rate of corporate earnings, which provides the basis for long-run equity
returns, and the level of interest rates, a key influence on equity valuations
(how much investors will pay for a dollar of earnings). Earnings growth
represents the fundamental basis for choosing common stocks as the foundation of
long-term investment programs. The level of interest rates affects equity prices
in two major ways--by showing the potential return on alternative investments
and by indicating the market's consensus expectations concerning inflation. Over
the past six months, both of these variables worked to the benefit of common
stocks: Numerous corporate earnings reports provided positive surprises, and the
news on inflation was exceptionally good.
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The best-performing market sectors appeared to benefit from a combination of
factors. One of these was concern over the "Asian contagion," which led
investors toward companies with the least exposure to Pacific Rim nations. Also
influential were a series of economic reports indicating that the U.S. economy
remains robust and that U.S. consumers remain confident, even ebullient. The
primary beneficiaries of this environment included utilities (gaining 34.8%--an
extraordinary advance for six months), health-care firms (up 30.6%), and
consumer-goods manufacturers (up 19.6%).
Laggards during this period fell into two categories: economically sensitive
companies and energy firms. Technology issues (which rose overall 8.2%) had
widely disparate returns, with software firms very strong but hardware and
semiconductor manufacturers generally declining or posting only modest gains.
Expectations that Asia's weakness would soften the prices of commodity goods
such as paper and metals hurt the stocks of such producers, with materials &
processing stocks advancing a mere 1.5%.
U.S. FIXED-INCOME MARKETS
The continued exceptional news regarding inflation, combined with an apparent
"flight to quality" among bond investors, sent interest rates down sharply
during the six months. The result was a robust 5.7% gain for the Lehman Brothers
Aggregate Bond Index over the period.
Asia's turmoil apparently led many investors to seek the perceived safety of
high-quality U.S. government bonds, a factor that contributed to the decline in
U.S. interest rates. The yield on the 10-year U.S. Treasury note fell nearly
three-quarters of a point, from 6.34% on August 31, 1997, to 5.62% on February
28, 1998. Shorter-term interest rates did not decline as much, reflecting the
stable monetary policy of the Federal Reserve over the fiscal half-year. The Fed
seems to have taken a "wait and see" approach in determining whether the current
strength of the U.S. economy will offset the expected slowdown resulting from
Asia's woes.
INTERNATIONAL EQUITY MARKETS
Markets were notably strong in Europe but generally dismal in the Pacific over
the half-year. Overall, the Morgan Stanley Capital International Europe,
Australasia, Far East Index gained 8.5% in U.S. dollar terms. European markets,
which have generally kept pace with the S&P 500's amazing run of the past three
years, again posted superb gains; the MSCI Europe Index advanced 23.3% (in U.S.
dollars) for the six months. The dollar remained virtually unchanged against
European currencies in aggregate. The strength in these markets can be
attributed to improving economic conditions, especially in the United Kingdom,
and to increasing confidence that the European Monetary Union is on target to
begin at the end of 1998.
Overall, Pacific returns were nearly the reverse of those in Europe for U.S.
investors, largely due to problems in Japan. The Japanese economy remains weak,
reports of corporate and political crises seem to be daily events, and it seems
questionable whether Japan will be able to provide an "economic kick" to help
its depressed Asian neighbors regain their vitality. In this environment, the
Japanese market declined 9% in local terms, with U.S. investors losing an
additional 4.4% due to continued weakening of the yen. Currency crises and
serious economic imbalances rocked smaller Asian markets such as Malaysia and
Thailand, which fell 23% and 11%, respectively, during the six-month period.
However, these countries have begun instituting major economic reforms, and
their stock markets rebounded sharply (Malaysia's was up 33% and Thailand's,
61%) during the past two months.
4
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REPORT FROM THE ADVISER
After a fiscal 1997 return that was very high in absolute terms at 32.5%, but
was poor relative to that of the S&P 500 Index and just behind the average for
growth mutual funds, Vanguard U.S. Growth Portfolio earned a more consistently
good result in the first half of fiscal 1998. The Portfolio's return during the
six months ended February 28, 1998, was strong at 19.6%, which was well ahead of
the average growth fund and a bit ahead of the Index.
As usual, the Portfolio's characteristics remained quite stable. For example:
<TABLE>
<CAPTION>
- -------------------------------------------
TEN LARGEST HOLDINGS
- -------------------------------------------
PERCENTAGE
COMPANY OF NET ASSETS
- -------------------------------------------
<S> <C>
1. Microsoft Corp. 5.5%
2. Pfizer, Inc. 4.9
3. Monsanto Co. 4.5
4. Intel Corp. 4.3
5. The Coca-Cola Co. 4.1
6. General Electric Co. 3.8
7. Procter & Gamble Co. 3.7
8. Bristol-Myers Squibb Co. 3.2
9. Merck & Co., Inc. 3.2
10. Cisco Systems, Inc. 2.9
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Total 40.1%
- -------------------------------------------
</TABLE>
- Eight of our present top-ten holdings were also among the top ten on August
31, 1997.
- The current top ten represent about 40% of the Portfolio's net assets,
compared with 39% for the top ten six months ago.
- The number of issues held is 62, up from 54. Productivity was good, with 19
issues added. Merck, Microsoft, General Electric, and Dell were the largest
purchases; 11 companies were eliminated, usually because their earnings fell
short of our expectations.
- Turnover ran at a 46% annual rate, a bit above the long-term average for
the Portfolio but well below industry averages.
- Industry diversification did not change materially during the six months.
The largest sectors are still consumer discretionary and staples (at 29% of net
assets, down a little since August 31, 1997), health care (23%, up some), and
technology (almost 20%). Each of these sectors is close to its respective weight
in the large-cap growth stock indexes.
- With respect to people at Lincoln Capital Management, there have been two
changes: the departure and replacement of one equity analyst and the arrival of
a highly experienced chief operating officer.
Equity valuations moved up further in the past six months, as estimates of
future earnings rose 5% while the related price/earnings ratio increased 12%.
The decrease in the yield on the 10-year Treasury note, which dropped sharply
from 6.3% to 5.6%, undoubtedly helped to buoy stock price/earnings multiples.
While the U.S. Growth Portfolio's absolute returns will continue to depend
principally upon overall market returns, we will energetically pursue adding
value above the market.
David Fowler, Portfolio Manager
Parker Hall, Portfolio Manager
Lincoln Capital Management Company
March 5, 1998
INVESTMENT PHILOSOPHY
The adviser believes that superior long-term investment results can be achieved
by emphasizing investments in high-quality, established growth companies that
sell at reasonable prices in relation to expected earnings and to valuations in
the broad stock market.
5
<PAGE> 8
PORTFOLIO PROFILE
U.S. Growth Portfolio
This Profile provides a snapshot of the Portfolio's characteristics as of
February 28, 1998, compared where appropriate to an unmanaged index. Key
elements of this Profile are defined on page 7.
<TABLE>
<CAPTION>
PORTFOLIO CHARACTERISTICS
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U.S. GROWTH S&P 500
- ---------------------------------------------------------
<S> <C> <C>
Number of Stocks 62 500
Median Market Cap $66.7B $40.0B
Price/Earnings Ratio 31.3x 23.1x
Price/Book Ratio 8.3x 4.4x
Yield 0.6% 1.5%
Return on Equity 25.6% 20.6%
Earnings Growth Rate 21.1% 18.2%
Foreign Holdings 4.4% 1.8%
Turnover Rate 46%* --
Expense Ratio 0.38%* --
Cash Reserves 1.8% --
</TABLE>
*Annualized.
INVESTMENT FOCUS
- ----------------------------------
[GRAPHIC]
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- ---------------------------------------------------------
U.S. GROWTH S&P 500
- ---------------------------------------------------------
<S> <C> <C>
R-Squared 0.89 1.00
Beta 0.99 1.00
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- ---------------------------------------------------------
<S> <C>
Microsoft Corp. 5.5%
Pfizer, Inc. 4.9
Monsanto Co. 4.5
Intel Corp. 4.3
The Coca-Cola Co. 4.1
General Electric Co. 3.8
Procter & Gamble Co. 3.7
Bristol-Myers Squibb Co. 3.2
Merck & Co., Inc. 3.2
Cisco Systems, Inc. 2.9
- --------------------------------------------------------
Top Ten 40.1%
</TABLE>
<TABLE>
<CAPTION>
SECTOR DIVERSIFICATION (% OF COMMON STOCK)
- ---------------------------------------------------------------------------------------------------------
FEBRUARY 28, 1997 FEBRUARY 28, 1998
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U.S. GROWTH U.S. GROWTH S&P 500
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<S> <C> <C> <C>
Auto & Transportation ................... 0.0% 0.0% 3.6%
Consumer Discretionary .................. 13.8 9.8 9.9
Consumer Staples ........................ 24.1 19.3 10.9
Financial Services ...................... 12.3 11.8 17.7
Health Care ............................. 19.6 23.1 11.9
Integrated Oils ......................... 0.2 0.0 6.8
Other Energy ............................ 2.2 0.5 1.2
Materials & Processing .................. 7.2 9.5 5.7
Producer Durables ....................... 4.0 0.9 4.2
Technology .............................. 15.5 19.4 12.4
Utilities ............................... 0.0 0.0 10.2
Other ................................... 1.1 5.7 5.5
- ---------------------------------------------------------------------------------------------------------
</TABLE>
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<PAGE> 9
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 instruments. This
figure does not include cash invested in futures contracts to simulate stock
investment.
EARNINGS GROWTH RATE. The average annual rate of growth in earnings over the
past five years for the stocks now in a 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 net assets represented by
stocks or American Depositary 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 HOLDINGS. 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
because they are more dependent on the fortunes of a few companies.
TURNOVER RATE. An indication of trading activity during the period. 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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<PAGE> 10
PERFORMANCE SUMMARY
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 an investment in the
Portfolio could lose money.
U.S. GROWTH PORTFOLIO
TOTAL INVESTMENT RETURNS: AUGUST 31, 1977-FEBRUARY 28, 1998
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
U.S. GROWTH PORTFOLIO S&P 500
FISCAL CAPITAL INCOME TOTAL TOTAL
YEAR RETURN RETURN RETURN RETURN
- ------------------------------------------------------------------
<C> <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
1998* 18.4 1.2 19.6 17.6
- ------------------------------------------------------------------
</TABLE>
*Six months ended February 28, 1998.
See Financial Highlights table on page 13 for dividend and capital gains
information for the past five years.
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997*
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------
10 YEARS
INCEPTION -------------------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
U.S. Growth Portfolio 1/6/1959 25.93% 17.61% 16.75% 1.43% 18.18%
- ----------------------------------------------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
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FINANCIAL STATEMENTS
February 28, 1998 (unaudited)
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 (98.2%)
- --------------------------------------------------------------------------------
CONSUMER DISCRETIONARY (9.6%)
<S> <C> <C>
Avon Products, Inc. 850,000 $ 59,872
Carnival Corp. Class A 1,400,000 82,425
The Walt Disney Co. 2,300,000 257,456
Lowe's Cos., Inc. 1,400,000 81,813
Mattel, Inc. 2,050,000 86,741
May Department Stores Co. 1,640,000 99,630
Rubbermaid, Inc. 1,520,000 44,080
Sears, Roebuck & Co. 1,300,000 68,981
Wal-Mart Stores, Inc. 1,960,000 90,772
----------
871,770
----------
CONSUMER STAPLES (18.9%)
CVS Corp. 300,000 22,219
Campbell Soup Co. 1,190,000 69,094
The Coca-Cola Co. 5,360,000 368,165
Coca-Cola Enterprises, Inc. 780,000 25,789
Colgate-Palmolive Co. 1,400,000 113,662
Gillette Co. 2,050,000 221,144
PepsiCo, Inc. 4,990,000 182,447
Philip Morris Cos., Inc. 5,110,000 221,966
Procter & Gamble Co. 3,930,000 333,804
Unilever NV 2,390,000 153,707
----------
1,711,997
----------
ENERGY (0.5%)
- - Talisman Energy, Inc. 1,540,000 45,815
----------
FINANCIAL SERVICES (11.6%)
American International
Group, Inc. 1,490,000 179,079
Automatic Data
Processing, Inc. 3,510,000 214,329
Beneficial Corp. 440,000 51,920
The Chase Manhattan Corp. 1,510,000 187,334
First Data Corp. 2,400,000 81,600
Household International, Inc. 1,210,000 157,149
Norwest Corp. 2,930,000 119,947
Paychex, Inc. 1,050,000 54,206
----------
1,045,564
----------
HEALTH CARE (22.7%)
- - ALZA Corp. 1,720,000 64,285
American Home Products Corp. 1,310,000 122,813
- - Amgen, Inc. 1,030,000 54,719
Bristol-Myers Squibb Co. 2,920,000 292,548
Cardinal Health, Inc. 950,000 77,781
- - First Health Group Corp. 700,000 34,869
Johnson & Johnson 1,360,000 102,680
Eli Lilly & Co. 3,870,000 254,694
Medtronic, Inc. 800,000 42,500
Merck & Co., Inc. 2,250,000 287,016
Pfizer, Inc. 4,990,000 441,615
- - Quintiles Transnational Corp. 1,600,000 78,200
SmithKline Beecham PLC ADR 1,770,000 109,519
Warner-Lambert Co. 620,000 90,675
----------
2,053,914
----------
MATERIALS & PROCESSING (9.3%)
E.I. du Pont de Nemours & Co. 1,050,000 64,378
W.R. Grace & Co. 2,640,000 221,595
Kimberly-Clark Corp. 1,890,000 105,249
Monsanto Co. 8,020,000 408,018
Solutia, Inc. 1,570,000 42,881
----------
842,121
----------
</TABLE>
9
<PAGE> 12
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
MARKET
VALUE*
U.S. GROWTH PORTFOLIO SHARES (000)
- --------------------------------------------------------------------------------
<S> <C> <C>
PRODUCER DURABLES (0.9%)
Honeywell, Inc. 580,000 $ 45,965
Molex, Inc. Class A 1,300,000 36,887
----------
82,852
----------
TECHNOLOGY (19.0%)
- - Altera Corp. 1,000,000 43,125
- - BMC Software, Inc. 650,000 49,725
- - Cisco Systems, Inc. 4,000,000 263,500
- - Dell Computer Corp. 1,540,000 215,408
Hewlett-Packard Co. 1,290,000 86,430
Intel Corp. 4,310,000 386,553
Lucent Technologies, Inc. 750,000 81,281
- - Microsoft Corp. 5,860,000 496,635
3Com Corp. 1,670,000 59,702
- - Xilinx, Inc. 930,000 40,804
----------
1,723,163
----------
OTHER (5.7%)
General Electric Co. 4,380,000 340,545
Illinois Tool Works, Inc. 1,300,000 77,919
Tyco International Ltd. 1,850,000 93,887
----------
512,351
----------
- --------------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $5,229,779) 8,889,547
- --------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
- --------------------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (1.9%)
- --------------------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.63%, 3/2/1998
(COST $170,248) $170,248 170,248
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS (100.1%)
(COST $5,400,027) 9,059,795
- --------------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-0.1%)
- --------------------------------------------------------------------------------
Other Assets--Note C 47,916
Liabilities (54,122)
-----------
(6,206)
- --------------------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------------------
Applicable to 284,357,255 outstanding
$1.00 par value shares
(authorized 500,000,000 shares) 9,053,589
- --------------------------------------------------------------------------------
NET ASSET VALUE PER SHARE $31.84
- --------------------------------------------------------------------------------
</TABLE>
*See Note A in Notes to Financial Statements.
- -Non-Income-Producing Security.
ADR--American Depositary Receipt.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- --------------------------------------------------------------------------------
AT FEBRUARY 28, 1998, NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $5,245,738 $18.45
Undistributed Net
Investment Income 4,160 .01
Accumulated Net
Realized Gains 143,923 .51
Unrealized Appreciation--
Note E 3,659,768 12.87
- --------------------------------------------------------------------------------
NET ASSETS $9,053,589 $31.84
================================================================================
</TABLE>
10
<PAGE> 13
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
SIX MONTHS ENDED FEBRUARY 28, 1998
(000)
- --------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends $ 38,333
Interest 7,375
-----------
Total Income 45,708
-----------
EXPENSES
Investment Advisory Fees--Note B 5,108
The Vanguard Group--Note C
Management and Administrative 8,686
Marketing and Distribution 1,048
Taxes (other than income taxes) 294
Custodian Fees 7
Auditing Fees 7
Shareholders' Reports 118
Annual Meeting and Proxy Costs 84
Directors' Fees and Expenses 9
-----------
Total Expenses 15,361
Expenses Paid Indirectly--Note C (593)
-----------
Net Expenses 14,768
- --------------------------------------------------------------------------------
NET INVESTMENT INCOME 30,940
- --------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT SECURITIES SOLD 224,387
- --------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
OF INVESTMENT SECURITIES 1,213,345
- --------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $1,468,672
================================================================================
</TABLE>
11
<PAGE> 14
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
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
-------------------------------
SIX MONTHS YEAR
ENDED ENDED
FEB. 28, 1998 AUG. 31, 1997
(000) (000)
- ---------------------------------------------------------------------------------------------------------
INCREASE IN NET ASSETS
OPERATIONS
<S> <C> <C>
Net Investment Income $ 30,940 $ 69,678
Realized Net Gain 224,387 219,862
Change in Unrealized Appreciation (Depreciation) 1,213,345 1,317,765
------------------------------
Net Increase in Net Assets Resulting from Operations 1,468,672 1,607,305
------------------------------
DISTRIBUTIONS
Net Investment Income (72,787) (55,435)
Realized Capital Gain (239,929) (345,580)
------------------------------
Total Distributions (312,716) (401,015)
CAPITAL SHARE TRANSACTIONS(1)
Issued 1,040,536 2,522,416
Issued in Lieu of Cash Distributions 303,008 391,848
Redeemed (891,164) (1,219,565)
------------------------------
Net Increase from Capital Share Transactions 452,380 1,694,699
- --------------------------------------------------------------------------------------------------------
Total Increase 1,608,336 2,900,989
- --------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 7,445,253 4,544,264
------------------------------
End of Period $9,053,589 $7,445,253
========================================================================================================
(1)Shares Issued (Redeemed)
Issued 35,619 98,030
Issued in Lieu of Cash Distributions 10,884 16,774
Redeemed (30,553) (47,275)
------------------------------
Net Increase in Shares Outstanding 15,950 67,529
========================================================================================================
</TABLE>
12
<PAGE> 15
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 Securities and Exchange
Commission 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 SIX MONTHS ENDED ---------------------------------------------------
THROUGHOUT EACH PERIOD FEBRUARY 28, 1998 1997 1996 1995 1994 1993
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $27.74 $22.62 $18.83 $15.52 $14.71 $14.71
- -------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .11 .27 .26 .25 .20 .21
Net Realized and Unrealized Gain (Loss)
on Investments 5.15 6.73 4.39 3.24 .82 .05
---------------------------------------------------------------
Total from Investment Operations 5.26 7.00 4.65 3.49 1.02 .26
---------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.27) (.26) (.29) (.18) (.21) (.18)
Distributions from Realized Capital Gains (.89) (1.62) (.57) -- -- (.08)
---------------------------------------------------------------
Total Distributions (1.16) (1.88) (.86) (.18) (.21) (.26)
- -------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $31.84 $27.74 $22.62 $18.83 $15.52 $14.71
===================================================================================================================
TOTAL RETURN 19.56% 32.50% 25.28% 22.75% 6.98% 1.69%
===================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $9,054 $7,445 $4,544 $2,989 $1,963 $1,954
Ratio of Total Expenses to
Average Net Assets 0.38%* 0.42% 0.43% 0.47% 0.52% 0.49%
Ratio of Net Investment Income to
Average Net Assets 0.77%* 1.13% 1.32% 1.59% 1.30% 1.50%
Portfolio Turnover Rate 46%* 35% 44% 32% 47% 37%
Average Commission Rate Paid $.0494 $.0493 $.0492 N/A N/A N/A
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized.
13
<PAGE> 16
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: Equity securities are valued at the latest quoted
sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date; securities not traded
on the valuation date are valued at the mean of the latest quoted bid and asked
prices. Prices are taken from the primary market in which each security trades.
Temporary cash investments 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 six months ended February 28, 1998, the advisory fee represented
an effective annual rate of 0.13% 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 February
28, 1998, the Portfolio had contributed capital of $533,000 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 six months ended February 28, 1998, these arrangements reduced the
Portfolio's expenses by $593,000 (an annual rate of 0.01% of average net
assets).
D. During the six months ended February 28, 1998, the Portfolio purchased
$2,073,029,000 of investment securities and sold $1,770,246,000 of investment
securities other than temporary cash investments.
E. At February 28, 1998, net unrealized appreciation of investment securities
for financial reporting and federal income tax purposes was $3,659,768,000,
consisting of unrealized gains of $3,662,645,000 on securities that had risen in
value since their purchase and $2,877,000 in unrealized losses on securities
that had fallen in value since their purchase.
14
<PAGE> 17
DIRECTORS AND OFFICERS
JOHN C. BOGLE
Senior 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
Chairman, 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., Massachusetts Mutual Life Insurance Co., and
Ladies Professional Golf Association; 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
Telecommunications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries,
Inc.; Director of NACCO Industries, The BFGoodrich Co., and The Standard
Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., 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. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
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.
15
<PAGE> 18
VANGUARD FAMILY OF FUNDS
STOCK FUNDS
Convertible Securities Fund
Equity Income Fund
Explorer Fund
Growth and Income Portfolio
Horizon Fund
Aggressive Growth Portfolio
Capital Opportunity Portfolio
Global Equity Portfolio
Index Trust
500 Portfolio
Extended Market Portfolio
Growth Portfolio
Small Capitalization Stock
Portfolio
Total Stock Market Portfolio
Value Portfolio
Institutional Index Fund
International Equity Index Fund
Emerging Markets Portfolio
European Portfolio
Pacific Portfolio
International Growth Portfolio
International Value Portfolio
Morgan Growth Fund
PRIMECAP Fund
Selected Value Portfolio
Specialized Portfolios
Energy Portfolio
Gold & Precious Metals
Portfolio
Health Care Portfolio
REIT Index Portfolio
Utilities Income Portfolio
Tax-Managed Fund
Capital Appreciation
Portfolio
Growth and Income Portfolio
Total International Portfolio
Trustees' Equity Fund
U.S. Portfolio
U.S. Growth Portfolio
Windsor Fund
Windsor II
BALANCED FUNDS
Asset Allocation Fund
Balanced Index Fund
Horizon Fund
Global Asset Allocation
Portfolio
LifeStrategy Portfolios
Conservative Growth
Portfolio
Growth Portfolio
Income Portfolio
Moderate Growth Portfolio
STAR Portfolio
Tax-Managed Fund
Balanced Portfolio
Wellesley Income Fund
Wellington Fund
BOND FUNDS
Admiral Funds
Intermediate-Term U.S.
Treasury Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term U.S. Treasury
Portfolio
Bond Index Fund
Intermediate-Term Bond
Portfolio
Long-Term Bond Portfolio
Short-Term Bond Portfolio
Total Bond Market Portfolio
Fixed Income Securities Fund
GNMA Portfolio
High Yield Corporate Portfolio
Intermediate-Term Corporate
Portfolio
Intermediate-Term U.S.
Treasury Portfolio
Long-Term Corporate
Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term Corporate
Portfolio
Short-Term Federal Portfolio
Short-Term U.S. Treasury
Portfolio
Municipal Bond Fund
High-Yield Portfolio
Insured Long-Term Portfolio
Intermediate-Term Portfolio
Limited-Term Portfolio
Long-Term Portfolio
Short-Term Portfolio
Preferred Stock Fund
State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
MONEY MARKET FUNDS
Admiral Funds
U.S. Treasury Money Market
Portfolio
Money Market Reserves
Federal Portfolio
Prime Portfolio
Municipal Bond Fund
Money Market Portfolio
Treasury Money Market Portfolio
State Tax-Free Funds
(CA, NJ, NY, OH, PA)
Q232-2/1998
(C) 1998 Vanguard Marketing
Corporation, Distributor
[THE VANGUARD LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
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.
<PAGE> 19
VANGUARD
INTERNATIONAL GROWTH
PORTFOLIO
Semiannual Report-- February 28, 1998
[PHOTO]
[THE VANGUARDGROUP LOGO]
<PAGE> 20
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--more than 7,000 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 fund reports 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
Chairman & CEO
John C. Bogle
Senior Chairman
<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
</TABLE>
All comparative mutual fund data are from Lipper Analytical Services, Inc., or
Morningstar unless otherwise noted.
<PAGE> 21
FELLOW SHAREHOLDER,
Economic turmoil in Asia rippled across world markets during the first
half of Vanguard International Growth Portfolio's fiscal year, but many
international bourses quickly brushed aside the global upset to post
solid--and in some cases, spectacular--gains.
The following table presents the six-month returns earned by the Portfolio
and its two primary performance benchmarks: the average international equity
mutual fund and the unmanaged Morgan Stanley Capital International Europe,
Australasia, Far East (EAFE) Index. As shown here, during the six months ended
February 28, 1998, our Portfolio's return of +5.1% fell 1.6 percentage points
behind that of its average peer and 3.4 points behind that of its benchmark
index. The Portfolio's return is based on an increase in net asset value from
$17.86 per share on August 31, 1997, to $17.95 per share on February 28, 1998,
with the latter figure adjusted for our annual dividend of $0.21 per share paid
from net investment income and a distribution of $0.52 per share paid from net
realized capital gains.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------
TOTAL RETURNS
SIX MONTHS ENDED
FEBRUARY 28, 1998
- ------------------------------------------------------------------
<S> <C>
Vanguard International Growth Portfolio +5.1%
- ------------------------------------------------------------------
Average International Fund +6.7%
- ------------------------------------------------------------------
MSCI EAFE Index +8.5%
- ------------------------------------------------------------------
</TABLE>
THE PERIOD IN REVIEW
Reaping the rewards of international investing during the six months required
some careful stepping, as it often does. For the most part, venturing into the
Asian markets during the period was a losing proposition. Currency devaluations
and stock market collapses afflicted a number of important developing markets,
including Thailand, Indonesia, the Philippines, South Korea, and Malaysia. The
disturbances came to a head in October, when stocks in the Pacific region,
which is dominated by Japan, posted a negative return of -12.1% in U.S. dollar
terms, according to Morgan Stanley Capital International. In Japan, concern
over the weak domestic economy and political scandals, combined with the yen's
weakness versus the U.S. dollar, resulted in a decline of -13.4% in dollar
terms for the six months.
In many parts of the world, the turbulence in Asia resulted in only a
temporary market blip. Europe's bourses continued rising at an impressive
clip--despite an October slide--even topping returns from the powerful U.S.
stock market. Some foreign markets posted remarkable gains during the six
months (Portugal, +47%; Italy, +37%; Switzerland, +34%; all in local currency).
However, the overall return of the EAFE Index, which was pulled down
considerably by the poor performance of the Japanese market, was just +8.5%,
about half the +17.6% return of the Standard & Poor's 500 Composite Stock Price
Index. By comparison, the European component of the EAFE Index rose +23.3% in
U.S. dollar terms, while the Pacific component declined -13.7%, also in
dollars.
The U.S. dollar played a significant role in shaping the returns in some
international markets. It was strong in the Pacific region, sharply reducing a
local return of -8.9% to -13.7% in dollars, but held generally steady in
Europe, where the local currency return of +23.4% was virtually identical to
the dollar-based return. On balance, the exchange value of the dollar had a
negative impact on returns to U.S. investors, reducing the EAFE Index's +10.7%
in local returns to +8.5% in dollars.
1
<PAGE> 22
The subpar performance of Vanguard International Growth Portfolio versus
its benchmarks can be traced to its commitments to Asian and emerging markets
and its relatively light exposure to companies in continental Europe and the
United Kingdom. We note that our performance shortfalls for the six months came
after our strong performance for the previous fiscal year ended August 31,
1997, when we outpaced both of our benchmarks.
Although we had a relatively light weighting in Japan (21% of assets for
our Portfolio versus 25% for the Index), this advantage was not enough to
offset our underweighting versus the Index in several of the world's stronger
markets for the period--notably the United Kingdom (+22% in dollars) and
Germany (+18% in dollars). Asian stocks, excluding Japan, made up about 10% of
the Portfolio's assets--a bigger share than the Index. On the plus side, we had
heavier exposure than the Index to several markets, including France, the
Netherlands, and Switzerland, that turned in an excellent six months.
Compared with our mutual fund peers, our Portfolio had a larger stake in
the Pacific region and smaller stakes in continental Europe and the United
Kingdom. These distinctions were a competitive disadvantage during the
half-year.
Over long periods we expect our low expenses to provide our Portfolio with
a substantial and enduring advantage over our peers. The International Growth
Portfolio has an expense ratio (expenses as a percentage of average net assets)
of 0.56%, more than one percentage point below the 1.67% in expenses charged by
the average international mutual fund.
IN SUMMARY
U.S. investors are often urged to include international stocks in their
investment portfolios because foreign markets are not closely correlated with
those in the United States and thus provide valuable diversification. This lack
of correlation has become abundantly clear over the past several years, much to
the dismay of many U.S. investors in international markets who likely could
have earned much higher returns simply by staying home.
However, returns from international markets have exceeded those of the
U.S. market from time to time in the past, and certainly will in the future.
Exactly when, for how long, and by how much is, of course, anybody's guess. We
believe that international holdings have a place--albeit a limited one of
perhaps 10% to 20% of overall assets--in a balanced portfolio that includes
stock funds, bond funds, and money market funds, always provided that investors
are aware of the ever-present risks of placing assets abroad.
We look forward to reporting to you on the full 1998 fiscal year six
months hence.
<TABLE>
<S> <C>
/s/ JOHN C. BOGLE /s/ JOHN J. BRENNAN
John C. Bogle John J. Brennan
Senior Chairman Chairman and
Chief Executive Officer
</TABLE>
March 18, 1998
2
<PAGE> 23
THE MARKETS IN PERSPECTIVE
Six Months Ended February 28, 1998
A rare combination of beneficent influences--robust growth, tame inflation, low
unemployment, and cheerful consumers--continued to delight the U.S. stock and
bond markets (and to puzzle economists) during the fiscal half-year ended
February 28. The Asian financial crisis created some anxiety, dampening returns
in certain market sectors and helping to swell them elsewhere. But the U.S.
markets were buoyed against these concerns by continuing good news about the
domestic economy: Consumer prices rose just 1.4% over the past year, the best
showing in more than a decade. At the same time, the economy's sustained
expansion has pushed the unemployment rate down to 4.6%, its lowest level since
1973. The deceleration of inflation has surprised economic analysts because
inflation and unemployment rates tend to move in opposite directions. Although
wages have shown some increases, it appears that consumer prices have been held
down by an unexpected combination of productivity gains, declining import
prices as a result of the stronger U.S. dollar, and a significant drop in
energy prices.
U.S. EQUITY MARKETS
Despite the uncertainty regarding developments in Asia, the U.S. equity market
provided investors with yet another stunning performance during the six months.
The S&P 500 Index, for example, posted an advance of 17.6% during the fiscal
half-year, with the Russell 2000, the best-known benchmark for smaller
companies' stocks, gaining 9.6%. Clearly, investors found the economic news
significantly more heartening than they had expected.
For investors in common stocks, the two most important variables are the
growth rate of corporate earnings, which provides the basis for long-run equity
returns, and the level of interest rates, a key influence on equity valuations
(how much investors will pay for a dollar of earnings). Earnings growth
represents the fundamental basis for choosing common stocks as the foundation
of long-term investment programs. The level of interest rates affects equity
prices in two major ways--by showing the potential return on alternative
investments and by indicating the market's consensus expectations concerning
inflation. Over the past six months, both of these variables worked to the
benefit of common stocks: Numerous corporate earnings reports provided positive
surprises, and the news on inflation was exceptionally good.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
TOTAL RETURNS
PERIODS ENDED FEBRUARY 28, 1998
------------------------------------
6 MONTHS 1 YEAR 5 YEARS*
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
EQUITY
S&P 500 Index 17.6% 35.0% 21.7%
Russell 2000 Index 9.6 30.0 17.5
MSCI EAFE Index 8.5 15.8 13.4
- ----------------------------------------------------------------------------------
FIXED INCOME
Lehman Aggregate Bond Index 5.7% 10.4% 7.0%
Lehman 10-Year Municipal Bond Index 5.0 9.0 6.7
Salomon Brothers Three-Month
U.S. Treasury Bill Index 2.6 5.3 4.8
- ----------------------------------------------------------------------------------
OTHER
Consumer Price Index 0.7% 1.4% 2.5%
- ----------------------------------------------------------------------------------
</TABLE>
*Average annual.
3
<PAGE> 24
The best-performing market sectors appeared to benefit from a combination
of factors. One of these was concern over the "Asian contagion," which led
investors toward companies with the least exposure to Pacific Rim nations. Also
influential were a series of economic reports indicating that the U.S. economy
remains robust and that U.S. consumers remain confident, even ebullient. The
primary beneficiaries of this environment included utilities (gaining 34.8%--an
extraordinary advance for six months), health-care firms (up 30.6%), and
consumer-goods manufacturers (up 19.6%).
Laggards during this period fell into two categories: economically
sensitive companies and energy firms. Technology issues (which rose overall
8.2%) had widely disparate returns, with software firms very strong but
hardware and semiconductor manufacturers generally declining or posting only
modest gains. Expectations that Asia's weakness would soften the prices of
commodity goods such as paper and metals hurt the stocks of such producers,
with materials & processing stocks advancing a mere 1.5%.
U.S. FIXED-INCOME MARKETS
The continued exceptional news regarding inflation, combined with an apparent
"flight to quality" among bond investors, sent interest rates down sharply
during the six months. The result was a robust 5.7% gain for the Lehman
Brothers Aggregate Bond Index over the period.
Asia's turmoil apparently led many investors to seek the perceived safety
of high-quality U.S. government bonds, a factor that contributed to the decline
in U.S. interest rates. The yield on the 10-year U.S. Treasury note fell nearly
three-quarters of a point, from 6.34% on August 31, 1997, to 5.62% on February
28, 1998. Shorter-term interest rates did not decline as much, reflecting the
stable monetary policy of the Federal Reserve over the fiscal half-year. The
Fed seems to have taken a "wait and see" approach in determining whether the
current strength of the U.S. economy will offset the expected slowdown
resulting from Asia's woes.
INTERNATIONAL EQUITY MARKETS
Markets were notably strong in Europe but generally dismal in the Pacific over
the half-year. Overall, the Morgan Stanley Capital International Europe,
Australasia, Far East Index gained 8.5% in U.S. dollar terms. European markets,
which have generally kept pace with the S&P 500's amazing run of the past three
years, again posted superb gains; the MSCI Europe Index advanced 23.3% (in U.S.
dollars) for the six months. The dollar remained virtually unchanged against
European currencies in aggregate. The strength in these markets can be
attributed to improving economic conditions, especially in the United Kingdom,
and to increasing confidence that the European Monetary Union is on target to
begin at the end of 1998.
Overall, Pacific returns were nearly the reverse of those in Europe for
U.S. investors, largely due to problems in Japan. The Japanese economy remains
weak, reports of corporate and political crises seem to be daily events, and it
seems questionable whether Japan will be able to provide an "economic kick" to
help its depressed Asian neighbors regain their vitality. In this environment,
the Japanese market declined 9% in local terms, with U.S. investors losing an
additional 4.4% due to continued weakening of the yen. Currency crises and
serious economic imbalances rocked smaller Asian markets such as Malaysia and
Thailand, which fell 23% and 11%, respectively, during the six-month period.
However, these countries have begun instituting major economic reforms, and
their stock markets rebounded sharply (Malaysia's was up 33% and Thailand's,
61%) during the past two months.
4
<PAGE> 25
REPORT FROM THE ADVISER
Vanguard International Growth Portfolio provided a total return of 5.1% during
the six months ended February 28, 1998. This fell short of both of our
benchmarks, the Morgan Stanley Capital International Europe, Australasia, Far
East (EAFE) Index, which rose by 8.5%, and the average international equity
mutual fund, which rose by 6.7%. In my letter six months ago, I reported on a
strong year relative to our benchmarks; events since then have pushed us back
into line with other funds for the 18 months since August 31, 1996, although we
are still ahead of the EAFE Index during that period by more than 3 percentage
points.
The latest six months again underlined how a broad geographical spread of
investments helps to control risk. European markets rose during the period by
23% in U.S. dollar terms, but every one of the 14 other markets outside North
America where I typically look for stocks declined in dollar terms. Of course,
this was for exceptional reasons, namely the Asian financial crisis. Clearly,
I, like you, wish that I had foreseen the crisis, but diversification is meant
for just such a situation, the event that you didn't foresee. In this case, the
misperception was not the riskiness of Thailand, which I understood. What I did
not realize was that, like dominoes, other much stronger countries would be
destabilized by the shockwaves from Thailand's currency crisis last summer. I
apologize to you all.
Europe, like the United States, shuddered briefly in October, but then
resumed its bullish uptrend. In continental Europe, investment conditions
remained excellent. Economic recovery, which started on the periphery of the
region--in Sweden, Spain, and the Netherlands--broadened to include Italy and
France. Germany and Switzerland are at the back of the line, but markets
anticipate the probable, and stocks there have been rising nevertheless.
Recovery has not been too rapid, however, and considerable spare capacity
exists to be filled before inflationary pressures build up. Corporations have
been reporting strong profit growth and, in addition, have encouraged investors
by making increasingly clear commitments to increase profitablility.
Governments, too, have been playing a part, if more reluctantly. One by one,
they are sanctioning share buybacks on a more tax-efficient basis than
hitherto. Nineteen of the 45 continental European companies in the Portfolio
have restructured significantly in the past year. However, share prices in
continental Europe are not cheap, and the new stocks that I may add to the
Portfolio in the coming months will probably be defensive.
The United Kingdom is at a very mature stage of the economic cycle, and
its stock market has been maintained more by share buybacks and takeovers than
by increases in corporate profits. U.K. monetary and fiscal policy are both
restrictive, although arguably the latter should have been used more
aggressively to slow the growth in consumer expenditures. As a consequence of
this imbalance between monetary and fiscal policy, interest rates have been
relatively high and the pound sterling has been strong, rising even against the
U.S. dollar during the past six months. This has damaged the profitability of
exporters, particularly manufacturers, and most of the Portfolio's recent
purchases have therefore avoided this area of the economy. Less than 20% of our
total European exposure is in U.K. stocks.
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.
5
<PAGE> 26
I am conscious that most of Europe is moving purposefully toward a single
currency zone, to start at the end of 1998. I have stressed in the past that
this new environment will greatly challenge corporate managements, which is why
I believe that the best-managed companies will show their quality and perform
best in the medium and longer term. Such companies are well represented in the
Portfolio. From an investment standpoint, this is more important than which
countries will benefit most from the single currency. The United Kingdom will
initially stay outside the single-currency zone; in the short term, this will
give it more flexibility in economic policy. But it remains to be proven
whether U.K. companies and the U.K. economy will suffer thereafter.
Japan now makes up 21% of the Portfolio, as I have been reducing the
exposure over the past six months in favor of Europe. Many of your Portfolio's
Japanese stocks have performed very well in the rather miserable context of the
local market, and it is these that I have been selling. The Japanese government
has been reluctant to stimulate domestic demand to the extent necessary to have
a lasting effect, and it remains debatable whether this will happen anytime
soon. Anticipating a large stimulus, cyclical stocks have risen strongly in the
past two months. Some stocks in the Portfolio have benefited from the market's
anticipation, but the central thrust of our investment approach is visible
growth, which has discouraged me from buying a lot of cyclicals.
The rest of Asia makes up 10% of the Portfolio, of which a little over
half is invested (and indeed was invested throughout the financial crisis) in
the comparative safety of Hong Kong. Hong Kong-based companies have suffered
relatively little damage to their businesses; much of the fall in the stock
market there has been due to lower price/earnings multiples, not lower
earnings. That said, the whole region is clearly entering a year of very modest
and patchy economic growth, which will limit the extent of any rebound. Among
those countries most severely affected by the Asian crisis, we have added
modestly to our exposure in South Korea since the crisis struck. The Korean
government has shown enormous determination to tackle its problems, and we
anticipate that this will be rewarded by continued recovery in the currency and
stock market later this year.
Richard Foulkes
Schroder Capital Management International
March 16, 1998
6
<PAGE> 27
PERFORMANCE SUMMARY
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 an investment in the
Portfolio could lose money.
<TABLE>
<CAPTION>
INTERNATIONAL GROWTH PORTFOLIO
TOTAL INVESTMENT RETURNS: SEPTEMBER 30, 1981-FEBRUARY 28, 1998
- --------------------------------------------------------------
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
1998* 3.8 1.3 5.1 8.5
- --------------------------------------------------------------
</TABLE>
*Six months ended February 28, 1998.
See Financial Highlights table on page 16 for dividend and capital gains
information for the past five years.
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS: PERIODS ENDED DECEMBER 31, 1997*
- -------------------------------------------------------------------------------------
10 YEARS
INCEPTION -------------------------
DATE 1 YEAR 5 YEARS CAPITAL INCOME TOTAL
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
International Growth Portfolio 9/30/1981 4.12% 14.87% 7.67% 1.56% 9.23%
- -------------------------------------------------------------------------------------
</TABLE>
*SEC rules require that we provide this average annual total return information
through the latest calendar quarter.
7
<PAGE> 28
PORTFOLIO PROFILE
International Growth Portfolio
This Profile provides a snapshot of the Portfolio's characteristics as of
February 28, 1998, 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 161 1,081
Turnover Rate 26%* --
Expense Ratio 0.56%* --
Cash Reserves 2.1% --
</TABLE>
*Annualized.
<TABLE>
<CAPTION>
PORTFOLIO ALLOCATION
- -----------------------------------------
<S> <C>
EMERGING MARKETS 5%
PACIFIC (MINUS JAPAN) 10%
EUROPE 64%
JAPAN 21%
</TABLE>
<TABLE>
<CAPTION>
VOLATILITY MEASURES
- -----------------------------------------
INTERNATIONAL MSCI
GROWTH EAFE
- -----------------------------------------
<S> <C> <C>
R-Squared 0.88 1.00
Beta 0.95 1.00
</TABLE>
<TABLE>
<CAPTION>
COUNTRY DIVERSIFICATION (% OF COMMON STOCK)
- -------------------------------------------
INTERNATIONAL MSCI
GROWTH EAFE
- -------------------------------------------
<S> <C> <C>
Argentina 0.3% --
Australia 1.9 2.7%
Austria 0.5 0.4
Belgium -- 1.2
Brazil 1.3 --
Chile 0.3 --
Denmark 0.9 1.0
Finland -- 0.9
France 10.0 8.1
Germany 7.4 9.7
Hong Kong 5.0 2.6
Indonesia 0.1 --
Ireland 0.4 0.4
Italy 3.3 4.2
Japan 20.5 24.9
Malaysia 1.5 1.0
Mexico 1.3 --
Netherlands 12.5 5.7
Philippines 0.9 --
Portugal -- 0.6
Singapore 1.5 0.8
South Korea 0.7 --
Spain 1.2 2.9
Sweden 2.0 2.6
Switzerland 14.1 8.0
Thailand 0.1 --
United Kingdom 12.3 21.6
Other -- 0.7
- -------------------------------------------
Total 100.0% 100.0%
</TABLE>
<TABLE>
<CAPTION>
TEN LARGEST HOLDINGS (% OF TOTAL NET ASSETS)
- -------------------------------------------------
<S> <C>
Novartis AG (Registered) 5.2%
ING Groep NV 4.3
Fuji Photo Film Co., Ltd. 3.4
Takeda Chemical Industries Ltd. 2.9
Philips Electronics NV 2.7
Elf Aquitaine SA 2.4
Compagnie Generale des Eaux SA 2.3
ABB AG (Bearer) 2.0
British Petroleum Co., PLC 1.8
Union Bank of Switzerland AG (Bearer) 1.8
- -------------------------------------------------
Top Ten 28.8%
</TABLE>
8
<PAGE> 29
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 securities. This
figure does not include cash invested in futures contracts to simulate stock
investment.
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 HOLDINGS. 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 because they are more dependent on the fortunes of a few
companies.
TURNOVER RATE. An indication of trading activity during the period. Portfolios
with high turnover rates incur higher transaction costs and are more likely to
distribute capital gains (which are taxable to investors).
9
<PAGE> 30
FINANCIAL STATEMENTS
February 28, 1998 (unaudited)
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 (97.9%)
- ---------------------------------------------------------------------------
<S> <C> <C>
ARGENTINA (0.3%)
Banco de Galicia y Buenos Aires
SA de CV ADR 293,750 $ 7,270
YPF SA ADR 500,000 15,813
-----------
23,083
-----------
AUSTRALIA (1.8%)
Broken Hill Proprietary Ltd. 2,246,836 22,194
Lend Lease Corp. 221,031 5,564
Lion Nathan Ltd. 2,176,000 5,381
Mayne Nickless Ltd. 1,026,289 5,663
National Australia Bank Ltd. 668,000 9,238
Normandy Mining Ltd. 3,183,212 3,166
- - Normandy Mining Ltd.
Warrants Exp. 4/30/2001 16,450 2
Orica Ltd. 328,000 2,234
Tabcorp Holdings Ltd. 625,400 3,328
Telstra Corp. Ltd. 5,766,000 15,359
WMC Ltd. 594,937 2,018
Westfield Holdings Ltd. 685,891 3,364
Westpac Banking Corp., Ltd. 8,309,000 57,623
-----------
135,134
-----------
AUSTRIA (0.4%)
(1) Bank Austria AG Pfd. 515,622 33,639
-----------
BRAZIL (1.3%)
Telecomunicacoes
Brasileiras SA 297,460,000 29,483
Telecomunicacoes
Brasileiras SA ADR 439,000 53,750
Usiminas-Usinas Siderurgicas
de Minas Gerais SA ADR 490,000 3,308
Usiminas-Usinas Siderurgicas
de Minas Gerais SA Pfd. 961,215 6,508
-----------
93,049
-----------
CHILE (0.2%)
Chilectra SA ADR 250,000 6,563
Compania de
Telecomunicaciones de Chile
SA ADR 229,500 6,283
Sociedad Quimica y Minera
de Chile ADR 120,000 5,160
-----------
18,006
-----------
DENMARK (0.9%)
Den Danske Bank A/S 506,000 65,094
-----------
FRANCE (9.7%)
Accor SA 242,500 55,993
Compagnie Generale des Eaux
SA 1,053,998 165,821
- - Compagnie Generale des Eaux
SA Warrants Exp. 5/2/2001 580,500 582
Compagnie Generale des
Etablissements Michelin
SCA B Shares 1,011,110 62,600
Compagnie de Saint-Gobain SA 256,000 35,861
Compagnie des Gaz de Petrole
Primagaz SA 84,668 7,258
- - Compagnie des Gaz de Petrole
Primagaz SA Warrants
Exp. 6/30/1998 7,697 95
</TABLE>
10
<PAGE> 31
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
MARKET
VALUE*
SHARES (000)
- ---------------------------------------------------------------------------
<S> <C> <C>
Elf Aquitaine SA 1,531,000 $ 174,238
SGS-THOMSON
Microelectronics NV
NY Shares 864,400 65,802
Societe Generale SA 281,500 42,438
Synthelabo SA 316,440 44,172
Total SA B Shares 552,000 60,555
-----------
715,415
-----------
GERMANY (7.2%)
Adidas AG 208,000 32,551
Allianz AG 224,000 70,542
Bayer AG 3,032,600 127,837
Deutsche Bank AG 1,072,560 73,671
Friederich Grohe AG Pfd. 18,747 5,191
Mannesmann AG 175,000 105,110
SGL Carbon AG 60,000 7,108
Veba AG 1,597,275 107,159
-----------
529,169
-----------
HONG KONG (4.9%)
Cheung Kong Holdings Ltd. 7,304,000 51,178
China Resources Enterprise Ltd. 8,215,000 17,931
Citic Pacific Ltd. 8,860,000 34,330
HongKong Land Holdings, Ltd. 4,578,000 8,195
HSBC Holdings PLC 2,362,943 68,363
Hong Kong Electric
Holdings Ltd. 7,188,000 25,531
Hutchison Whampoa Ltd. 8,406,000 59,442
- - Mandarin Oriental
International Ltd. 4,311,369 3,600
New World Development
Co., Ltd. 4,326,000 15,952
Sun Hung Kai Properties Ltd. 6,043,400 45,272
Swire Pacific Ltd. A Shares 4,704,000 28,312
-----------
358,106
-----------
INDONESIA (0.1%)
PT Indofood Sukses Makmur 8,019,960 2,447
PT Telekomunikasi Indonesia 16,204,000 6,408
PT Telekomunikasi Indonesia
ADR 219,500 1,866
-----------
10,721
-----------
IRELAND (0.4%)
Bank of Ireland PLC 1,539,900 29,499
-----------
ITALY (3.2%)
- - Banca di Roma 54,252,000 74,885
Telecom Italia Mobile SPA 15,000,000 68,610
Telecom Italia SPA 13,500,000 91,866
-----------
235,361
-----------
JAPAN (20.3%)
Bridgestone Corp. 747,000 17,207
Chiyoda Fire & Marine
Insurance Co., Ltd. 2,000,000 7,868
DDI Corp. 7,368 19,188
Dai-Nippon Printing Co., Ltd. 2,334,000 39,722
Dowa Fire & Marine
Insurance Co. 2,000,000 7,124
East Japan Railway Co. 14,000 66,160
Fuji Photo Film Co., Ltd. 6,423,000 251,673
Hirose Electric Co., Ltd. 315,000 16,582
Keyence Corp. 143,000 20,941
Kuraray Co., Ltd. 2,250,000 19,770
Mabuchi Motor Co. 731,000 39,058
Matsushita Electric
Industrial Co., Ltd. 6,460,000 94,090
Mitsui & Co., Ltd. 7,300,000 46,864
Mitsui Fudosan Co., Ltd. 3,142,000 33,825
Murata Manufacturing Co., Ltd. 3,112,000 98,782
Nippon Fire & Marine
Insurance Co., Ltd. 2,000,000 7,916
Nippon Steel Corp. 25,000,000 46,901
Nippon Television Network 103,500 31,297
Omron Corp. 2,488,000 40,177
SMC Corp. 1,141,000 99,351
Shin-Etsu Chemical Co., Ltd. 1,050,000 23,106
Showa Shell Sekiyu K.K. 2,721,000 18,502
Sumitomo Corp. 6,300,000 43,785
Takeda Chemical Industries Ltd. 7,660,000 212,222
Tokio Marine & Fire
Insurance Co. 4,089,000 46,286
Tokyo Electron Ltd. 293,000 10,530
Toppan Printing Co., Ltd. 5,592,000 65,955
Toyota Motor Corp. 1,077,000 29,753
Yamazaki Baking Co., Ltd. 400,000 4,496
Yasuda Fire & Marine
Insurance Co. 5,190,000 29,539
-----------
1,488,670
-----------
MALAYSIA (1.5%)
Genting Bhd. 4,047,000 13,435
Malayan Banking Bhd. 4,333,000 16,860
Resorts World Bhd. 3,880,000 8,446
Sime Darby Bhd. 7,105,000 9,280
Telekom Malaysia Bhd. 6,529,500 22,209
Tenaga Nasional Bhd. 12,891,000 34,025
United Engineers Malaysia Bhd. 3,981,000 4,831
-----------
109,086
-----------
MEXICO (1.3%)
Apasco SA de CV 1,066,000 6,341
- - Cemex SA de CV (CPO) 3,114,720 12,352
Cifra SA de CV Series C 8,309,000 14,838
Cifra SA de CV Series V 1,698,869 3,261
- - Grupo Televisa SA GDR 440,000 15,400
Telefonos de Mexico SA
Class L ADR 790,000 40,043
-----------
92,235
-----------
NETHERLANDS (12.2%)
- - Baan Co. NV 1,200,000 54,229
Ceteco Holdings NV 124,535 6,693
Delft Instruments NV 463,068 6,470
Elsevier NV 1,545,310 29,066
Getronics NV 2,296,274 91,205
Hagemeyer NV 497,636 23,096
Heineken NV 357,000 66,241
ING Groep NV 5,922,740 313,370
Oce-Van Der Grinten NV 500,382 67,398
Philips Electronics NV 2,562,000 199,013
Verenigde Nederlandse
Uitgeversbedrijven
Verenigd Bezit 1,270,000 39,957
-----------
896,738
-----------
</TABLE>
11
<PAGE> 32
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
MARKET
INTERNATIONAL VALUE*
GROWTH PORTFOLIO SHARES (000)
- ---------------------------------------------------------------------------
PHILIPPINES (0.9%)
<S> <C> <C>
Ayala Land, Inc. 42,402,243 $ 21,254
Meralco GDR 514,286 7,586
Philippine Long Distance
Telephone Co. 1,295,000 34,890
-----------
63,730
-----------
SINGAPORE (1.4%)
City Developments Ltd. 3,111,000 14,106
DBS Land Ltd. 3,948,000 6,113
Development Bank of
Singapore Ltd. (Foreign) 2,162,000 16,938
Keppel Corp., Ltd. 3,878,000 11,148
Oversea-Chinese Banking
Corp., Ltd. (Foreign) 1,575,420 9,379
Singapore Airlines Ltd. (Foreign) 977,000 7,233
Singapore Press Holdings Ltd.
(Foreign) 1,988,320 28,457
United Overseas Bank Ltd.
(Foreign) 2,184,000 11,856
-----------
105,230
-----------
SOUTH KOREA (0.7%)
Korea Electric Power Corp. 1,326,050 17,702
- - L.G. Electronics Co. 503,350 7,583
- - SK Telecom Co. 15,109 7,176
Samsung Electronics Co., Ltd. 208,770 12,081
Samsung Electronics Co., Ltd.
GDR 1/2 Non-Voting Stock 275,931 3,898
-----------
48,440
-----------
SPAIN (1.2%)
ENDESA-Empresa Nacional de
Electricidad SA 3,894,000 85,963
-----------
SWEDEN (2.0%)
LM Ericsson Telephone AB
B Shares 1,100,000 50,010
Svenska Handelsbanken AB
A Shares 2,200,000 94,112
-----------
144,122
-----------
SWITZERLAND (13.8%)
ABB AG (Bearer) 108,500 147,861
Adecco SA (Bearer) 150,000 48,498
Alusuisse-Lonza Holding AG
(Registered) 40,000 46,198
Novartis AG (Registered) 210,000 383,055
Roche Holdings AG
(Dividend-Right Certificates) 11,090 129,822
Union Bank of Switzerland AG
(Bearer) 85,500 133,179
Zurich Insurance Co.
(Registered) 234,000 127,555
-----------
1,016,168
-----------
THAILAND (0.1%)
PTT Exploration & Production
PLC (Foreign) 486,500 6,321
-----------
UNITED KINGDOM (12.1%)
Airtours PLC 2,762,100 20,761
Asda Group PLC 26,750,000 88,638
British Aerospace PLC 2,820,000 88,591
British Airways PLC 3,660,000 34,349
British Land Co., PLC 3,620,000 43,808
British Petroleum Co., PLC 9,751,878 134,553
Cable and Wireless PLC 6,790,000 74,234
EMI Group PLC 4,670,915 39,838
Enterprise Oil PLC 3,300,000 30,509
Glaxo Wellcome PLC 2,060,000 57,661
Granada Group PLC 2,000,000 31,251
LucasVarity PLC 10,300,000 39,684
Reckitt & Colman PLC 1,184,000 20,888
Rio Tinto PLC 1,460,000 19,712
David S. Smith Holdings PLC 3,500,000 11,583
Tesco PLC 10,000,000 85,042
United News & Media PLC 3,484,000 41,187
Vodafone Group PLC 2,659,442 23,645
-----------
885,934
-----------
- ---------------------------------------------------------------------------
TOTAL COMMON STOCKS
(COST $5,551,755) 7,188,913
- ---------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
FACE
AMOUNT
(000)
- ---------------------------------------------------------------------------
TEMPORARY CASH INVESTMENTS (12.3%)
- ---------------------------------------------------------------------------
<S> <C> <C>
REPURCHASE AGREEMENTS
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.63%, 3/2/1998 $129,956 129,956
Collateralized by U.S. Government
Obligations in a Pooled
Cash Account
5.64%, 3/2/1998--Note F 775,245 775,245
- ---------------------------------------------------------------------------
TOTAL TEMPORARY CASH INVESTMENTS
(COST $905,201) 905,201
- ---------------------------------------------------------------------------
TOTAL INVESTMENTS (110.2%)
(COST $6,456,956) 8,094,114
- ---------------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-10.2%)
- ---------------------------------------------------------------------------
Other Assets--Note C 66,196
Security Lending Collateral
Payable to Brokers--Note F (775,245)
Other Liabilities (43,337)
-----------
(752,386)
- ---------------------------------------------------------------------------
NET ASSETS (100%)
- ---------------------------------------------------------------------------
Applicable to 408,905,169 outstanding
$1.00 par value shares
(authorized 550,000,000 shares) $7,341,728
===========================================================================
NET ASSET VALUE PER SHARE $17.95
===========================================================================
</TABLE>
* See Note A in Notes to Financial Statements.
- - Non-Income-Producing Security.
(1)New issue that has not paid a dividend as of February 28, 1998.
ADR--American Depositary Receipt.
GDR--Global Depositary Receipt.
12
<PAGE> 33
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
AMOUNT PER
(000) SHARE
- ---------------------------------------------------------------------------
AT FEBRUARY 28, 1998, NET ASSETS CONSISTED OF:
- ---------------------------------------------------------------------------
<S> <C> <C>
Paid in Capital $5,706,552 $13.95
Overdistributed Net
Investment Income--Note D (9,525) (.02)
Accumulated Net
Realized Gains--Note D 7,688 .02
Unrealized Appreciation
(Depreciation)--Note E
Investment Securities 1,637,158 4.00
Foreign Currencies (145) --
- ---------------------------------------------------------------------------
NET ASSETS $7,341,728 $17.95
===========================================================================
</TABLE>
13
<PAGE> 34
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
SIX MONTHS ENDED FEBRUARY 28, 1998
(000)
- -------------------------------------------------------------------------------------
<S> <C>
INVESTMENT INCOME
INCOME
Dividends* $ 23,949
Interest 12,316
Total Income 36,265
EXPENSES
Investment Advisory Fees--Note B
Basic Fee 4,669
Performance Adjustment 1,368
The Vanguard Group--Note C
Management and Administrative 10,112
Marketing and Distribution 1,070
Taxes (other than income taxes) 266
Custodian Fees 2,134
Auditing Fees 7
Shareholders' Reports 160
Annual Meeting and Proxy Costs 111
Directors' Fees and Expenses 9
-------------
Total Expenses 19,906
Expenses Paid Indirectly--Note C (633)
-------------
Net Expenses 19,273
- -------------------------------------------------------------------------------------
NET INVESTMENT INCOME 16,992
- -------------------------------------------------------------------------------------
REALIZED NET GAIN (LOSS)
Investment Securities Sold (5,395)
Foreign Currencies and Forward Currency Contracts 23,006
- -------------------------------------------------------------------------------------
REALIZED NET GAIN 17,611
- -------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION)
Investment Securities 296,077
Foreign Currencies and Forward Currency Contracts 11,144
- -------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION (DEPRECIATION) 307,221
- -------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $341,824
=====================================================================================
</TABLE>
*Dividends are net of foreign withholding taxes of $2,936,000.
14
<PAGE> 35
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 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
------------------------------------
SIX MONTHS YEAR
ENDED ENDED
FEB. 28, 1998 AUG. 31, 1997
(000) (000)
- -----------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income $ 16,992 $ 76,032
Realized Net Gain 17,611 205,252
Change in Unrealized Appreciation (Depreciation) 307,221 515,143
------------------------------------
Net Increase in Net Assets Resulting from Operations 341,824 796,427
------------------------------------
DISTRIBUTIONS
Net Investment Income (83,882) (61,180)
Realized Capital Gain (207,710) (177,098)
------------------------------------
Total Distributions (291,592) (238,278)
------------------------------------
CAPITAL SHARE TRANSACTIONS(1)
Issued 1,415,264 2,762,825
Issued in Lieu of Cash Distributions 263,657 218,868
Redeemed (1,476,177) (1,448,315)
------------------------------------
Net Increase from Capital Share Transactions 202,744 1,533,378
- -----------------------------------------------------------------------------------------------
Total Increase 252,976 2,091,527
- -----------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Period 7,088,752 4,997,225
------------------------------------
End of Period $7,341,728 $7,088,752
===============================================================================================
(1)Shares Issued (Redeemed)
Issued 81,299 156,951
Issued in Lieu of Cash Distributions 16,489 13,654
Redeemed (85,873) (83,511)
------------------------------------
Net Increase in Shares Outstanding 11,915 87,094
===============================================================================================
</TABLE>
15
<PAGE> 36
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 Securities and Exchange
Commission 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 SIX MONTHS ENDED -----------------------------------------------------
THROUGHOUT EACH PERIOD FEBRUARY 28, 1998 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $17.86 $16.13 $14.70 $14.36 $12.02 $10.15
- ---------------------------------------------------------------------------------------------------------------------
INVESTMENT OPERATIONS
Net Investment Income .04 .19 .19 .20 .14 .12
Net Realized and Unrealized Gain (Loss)
on Investments .78 2.28 1.65 .32 2.31 1.96
----------------------------------------------------------------
Total from Investment Operations .82 2.47 1.84 .52 2.45 2.08
----------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income (.21) (.19) (.20) (.18) (.11) (.21)
Distributions from Realized Capital Gains (.52) (.55) (.21) -- -- --
----------------------------------------------------------------
Total Distributions (.73) (.74) (.41) (.18) (.11) (.21)
- ---------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF PERIOD $17.95 $17.86 $16.13 $14.70 $14.36 $12.02
=====================================================================================================================
TOTAL RETURN 5.09% 15.84% 12.72% 3.76% 20.44% 21.06%
=====================================================================================================================
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $7,342 $7,089 $4,997 $3,354 $2,989 $1,477
Ratio of Total Expenses to
Average Net Assets 0.56%* 0.57% 0.56% 0.59% 0.46% 0.59%
Ratio of Net Investment Income to
Average Net Assets 0.48%* 1.26% 1.35% 1.53% 1.37% 1.27%
Portfolio Turnover Rate 26%* 22% 22% 31% 28% 51%
Average Commission Rate Paid $.0049 $.0015 $.0223 N/A N/A N/A
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
*Annualized.
16
<PAGE> 37
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: Equity securities are valued at the latest quoted
sales prices as of the close of trading on the New York Stock Exchange
(generally 4:00 p.m. Eastern time) on the valuation date; such securities not
traded on the valuation date are valued at the mean of the latest quoted bid
and asked prices. Prices are taken from the primary market in which each
security trades. Temporary cash investments 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> 38
NOTES TO FINANCIAL STATEMENTS (continued)
International Europe, Australasia, Far East Index. For the six months ended
February 28, 1998, the advisory fee represented an effective annual basic rate
of 0.13% of the Portfolio's average net assets before an increase of $1,368,000
(an annual rate of 0.04%) based on performance.
C. The Vanguard Group furnishes at cost corporate management,
administrative, marketing, and distribution services. The costs of such
services are allocated to the Portfolio under methods approved by the Board of
Directors. At February 28, 1998, the Portfolio had contributed capital of
$438,000 to Vanguard (included in Other Assets), representing 2.2% of
Vanguard's capitalization. The Portfolio's Directors and officers are also
Directors and officers of Vanguard.
Vanguard has asked the Portfolio's investment adviser to direct
certain portfolio trades, subject to obtaining the best price and execution, to
brokers who have agreed to rebate to the Portfolio part of the commissions
generated. Such rebates are used solely to reduce the Portfolio's
administrative expenses. For the six months ended February 28, 1998, these
arrangements reduced the Portfolio's expenses by $633,000 (an annual rate of
0.02% of average net assets).
D. During the six months ended February 28, 1998, the Portfolio purchased
$1,114,767,000 of investment securities and sold $882,975,000 of investment
securities other than temporary cash investments.
During the six months ended February 28, 1998, the Portfolio realized
net foreign currency losses of $2,046,000, 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. Distributions from passive foreign
investment company income during the six months ended February 28, 1998, were
$1,475,000; the cumulative total of such distributions related to passive
foreign investment company holdings at February 28, 1998, was $2,106,000.
During the six months ended February 28, 1998, the Portfolio realized gains on
the sale of passive foreign investment companies of $678,000, which were
included in prior years' distributable net income; accordingly such gains have
been reclassified from accumulated net realized gains to undistributed net
investment income.
E. At February 28, 1998, net unrealized appreciation of investment
securities for federal income tax purposes was $1,635,052,000, consisting of
unrealized gains of $2,006,961,000 on securities that had risen in value since
their purchase and $371,909,000 in unrealized losses on securities that had
fallen in value since their purchase.
The Portfolio had net unrealized foreign currency losses of $145,000
resulting from the translation of other assets and liabilities at February 28,
1998.
F. The market value of securities on loan to brokers/dealers at February
28, 1998, was $739,639,000, for which the Portfolio held cash collateral of
$775,245,000.
18
<PAGE> 39
DIRECTORS AND OFFICERS
JOHN C. BOGLE
Senior 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
Chairman, 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., Massachusetts Mutual Life Insurance
Co., and Ladies Professional Golf Association; 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 Telecommunications Co.
ALFRED M. RANKIN, JR.
Chairman, President, and Chief Executive Officer of NACCO Industries, Inc.;
Director of NACCO Industries, The BFGoodrich Co., and The Standard Products Co.
JOHN C. SAWHILL
President and Chief Executive Officer of The Nature Conservancy; formerly,
Director and Senior Partner of McKinsey & Co. and President of New York
University; Director of Pacific Gas and Electric Co., Procter & Gamble Co., 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. and The Mead Corp.; Trustee of Vanderbilt University.
OTHER FUND OFFICERS
RAYMOND J. KLAPINSKY
Secretary; Managing Director and Secretary of The Vanguard Group, Inc.;
Secretary of each of the investment companies in The Vanguard Group.
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> 40
VANGUARD FAMILY OF FUNDS
STOCK FUNDS
Convertible Securities Fund
Equity Income Fund
Explorer Fund
Growth and Income Portfolio
Horizon Fund
Aggressive Growth Portfolio
Capital Opportunity Portfolio
Global Equity Portfolio
Index Trust
500 Portfolio
Extended Market Portfolio
Growth Portfolio
Small Capitalization Stock
Portfolio
Total Stock Market Portfolio
Value Portfolio
Institutional Index Fund
International Equity Index Fund
Emerging Markets Portfolio
European Portfolio
Pacific Portfolio
International Growth Portfolio
International Value Portfolio
Morgan Growth Fund
PRIMECAP Fund
Selected Value Portfolio
Specialized Portfolios
Energy Portfolio
Gold & Precious Metals
Portfolio
Health Care Portfolio
REIT Index Portfolio
Utilities Income Portfolio
Tax-Managed Fund
Capital Appreciation
Portfolio
Growth and Income Portfolio
Total International Portfolio
Trustees' Equity Fund
U.S. Portfolio
U.S. Growth Portfolio
Windsor Fund
Windsor II
BALANCED FUNDS
Asset Allocation Fund
Balanced Index Fund
Horizon Fund
Global Asset Allocation
Portfolio
LifeStrategy Portfolios
Conservative Growth
Portfolio
Growth Portfolio
Income Portfolio
Moderate Growth Portfolio
STAR Portfolio
Tax-Managed Fund
Balanced Portfolio
Wellesley Income Fund
Wellington Fund
BOND FUNDS
Admiral Funds
Intermediate-Term U.S.
Treasury Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term U.S. Treasury
Portfolio
Bond Index Fund
Intermediate-Term Bond
Portfolio
Long-Term Bond Portfolio
Short-Term Bond Portfolio
Total Bond Market Portfolio
Fixed Income Securities Fund
GNMA Portfolio
High Yield Corporate Portfolio
Intermediate-Term Corporate
Portfolio
Intermediate-Term U.S.
Treasury Portfolio
Long-Term Corporate
Portfolio
Long-Term U.S. Treasury
Portfolio
Short-Term Corporate
Portfolio
Short-Term Federal Portfolio
Short-Term U.S. Treasury
Portfolio
Municipal Bond Fund
High-Yield Portfolio
Insured Long-Term Portfolio
Intermediate-Term Portfolio
Limited-Term Portfolio
Long-Term Portfolio
Short-Term Portfolio
Preferred Stock Fund
State Tax-Free Funds
(CA, FL, NJ, NY, OH, PA)
MONEY MARKET FUNDS
Admiral Funds
U.S. Treasury Money Market
Portfolio
Money Market Reserves
Federal Portfolio
Prime Portfolio
Municipal Bond Fund
Money Market Portfolio
State Tax-Free Funds
(CA, NJ, NY, OH, PA)
Treasury Money Market Portfolio
Q812-2/1998
(C) 1998 Vanguard Marketing
Corporation, Distributor
[THE VANGUARDGROUP LOGO]
Post Office Box 2600
Valley Forge, Pennsylvania 19482
FUND INFORMATION
1-800-662-7447
INDIVIDUAL ACCOUNT SERVICES
1-800-662-2739
INSTITUTIONAL INVESTOR SERVICES
1-800-523-1036
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.
