<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT (NO. 2-88116) UNDER
THE SECURITIES ACT OF 1933
PRE-EFFECTIVE AMENDMENT NO. [X]
POST-EFFECTIVE AMENDMENT NO. 23
AND
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
AMENDMENT NO. 25
VANGUARD SPECIALIZED PORTFOLIOS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN CHARTER)
POST OFFICE BOX 2600, VALLEY FORGE, PA 19482
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)
REGISTRANT'S TELEPHONE NUMBER (610) 669-1000
RAYMOND J. KLAPINSKY, ESQUIRE
P.O. BOX 876
VALLEY FORGE, PA 19482
IT IS PROPOSED THAT THIS FILING BECOME EFFECTIVE:
On January 7, 1997 pursuant to paragraph (b) of Rule 485.
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
As soon as practicable after this Registration Statement becomes effective.
REGISTRANT ELECTS TO REGISTER AN INDEFINITE NUMBER OF SHARES PURSUANT TO
REGULATION 24F-2 UNDER THE INVESTMENT COMPANY ACT OF 1940. REGISTRANT FILED ITS
RULE 24F-2 NOTICE FOR THE YEAR ENDED JANUARY 31, 1996 ON MARCH 14, 1996.
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<PAGE> 2
VANGUARD SPECIALIZED PORTFOLIOS, INC.
CROSS REFERENCE SHEET
<TABLE>
<CAPTION>
FORM N-1A
ITEM NUMBER LOCATION IN PROSPECTUS
<C> <S> <C>
Item 1. Cover Page.................................... Cover Page
Item 2. Synopsis...................................... Highlights
Item 3. Condensed Financial Information............... Financial Highlights: Fund Expenses
Item 4. General Description of Registrant............. Investment Objectives; Investment
Policies; Investment Limitations;
General Information
Item 5. Management of the Fund........................ Management of the Fund; Investment
Advisers
Item 6. Capital Stock and Other Securities............ Opening an Account and Purchasing
Shares; Selling Your Shares; The
Share Price of each Portfolio;
Dividends, Capital Gains and Taxes;
General Information
Item 7. Purchase of Securities Being Offered.......... Cover Page; Opening an Account and
Purchasing Shares
Item 8. Redemption or Repurchase...................... Selling Your Shares
Item 9. Pending Legal Proceedings..................... Not Applicable
FORM N-1A LOCATION IN STATEMENT
ITEM NUMBER OF ADDITIONAL INFORMATION
Item 10. Cover Page.................................... Cover Page
Item 11. Table of Contents............................. Cover Page
Item 12. General Information and History............... Investment Objectives and Policies;
General Information
Item 13. Investment Objective and Policies............. Investment Objectives and Policies;
Investment Limitations
Item 14. Management of the Fund........................ Management of the Fund
Item 15. Control Persons and Principal Holders of
Securities.................................... Management of the Fund; General
Information
Item 16. Investment Advisory and Other Services........ Management of the Fund; Investment
Advisory Services
Item 17. Brokerage Allocation.......................... Not Applicable
Item 18. Capital Stock and Other Securities............ Financial Statements
Item 19. Purchase, Redemption and Pricing of Securities
Being Offered................................. Purchase of Shares; Redemption of
Shares
Item 20. Tax Status.................................... Appendix
Item 21. Underwriters.................................. Not Applicable
Item 22. Calculations of Yield Quotations of Money
Market Fund................................... Not Applicable
Item 23. Financial Statements.......................... Financial Statements
</TABLE>
<PAGE> 3
VANGUARD
REIT INDEX
PORTFOLIO
Prospectus
January 7, 1997
A Portfolio of Vanguard
Specialized Portfolios
<PAGE> 4
VANGUARD REIT INDEX PORTFOLIO
CONTENTS
Portfolio Expenses 2
Financial Highlights 3
A Word About Risk 4
The Portfolio's
Objective 4
Who Should Invest 4
Investment Strategies 5
Investment Policies 8
Investment Limitations 9
Investment
Performance 9
Share Price 10
Distributions and Taxes 10
The Portfolio and
Vanguard 12
Investment Adviser 12
General Information 12
Investing with
Vanguard 13
Services and
Account Features 13
Types of Accounts 14
Distribution Options 15
Buying Shares 15
Redeeming Shares 16
Fund and Account Updates 19
Glossary Inside Back Cover
INVESTMENT OBJECTIVES AND POLICIES
Vanguard REIT Index Portfolio (the "Portfolio") is a diversified mutual fund, a
part of Vanguard Specialized Portfolios, Inc. (the "Fund"), an open-end
investment company.
The Portfolio seeks to provide a high level of income and moderate long-term
capital growth by investing at least 98% of its assets in stocks issued by real
estate investment trusts (known as "REITs"); these stocks make up the Morgan
Stanley REIT Index (the "Index"), a benchmark of U.S. property trusts. The
Portfolio's remaining assets are invested in cash reserves.
It is important to note that the Portfolio's shares are not guaranteed or
insured by the FDIC or any other agency of the U.S. Government. As with any
investment in common stocks, which are subject to wide fluctuations in market
value, you could lose money by investing in the Portfolio.
FEES AND EXPENSES
The Portfolio is offered on a no-load basis, which means that you pay no sales
commissions or 12b-1 marketing fees. You will, however, incur expenses for
investment advisory, management, administrative, and distribution services,
which are included in the expense ratio.
The REIT Index Portfolio charges a 1% transaction fee if you redeem (that is,
sell or exchange) shares held less than one year.
ADDITIONAL INFORMATION ABOUT THE PORTFOLIO
A Statement of Additional Information (dated January 7, 1997) containing more
information about the Portfolio is, by reference, part of this prospectus and
may be obtained without charge by writing to Vanguard or by calling our Investor
Information Department at 1-800-662-7447.
WHY READING THIS PROSPECTUS IS IMPORTANT
This prospectus explains the objectives, risks, and strategies of the REIT Index
Portfolio. To highlight terms and concepts important to mutual fund investors,
we have provided "Plain Talk" explanations along the way. Reading the prospectus
will help you to decide whether the Portfolio is the right investment for you.
We suggest that you keep it for future reference.
These securities have not been approved or disapproved by the Securities and
Exchange Commission or any state securities commission, nor has the Securities
and Exchange Commission or any state commission passed upon the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
<PAGE> 5
PORTFOLIO PROFILE VANGUARD REIT INDEX PORTFOLIO
WHO SHOULD INVEST (page 4)
- - Investors looking for a simple, low-cost way to diversify their stock,
bond, and cash investments with indirect exposure to real estate.
- - Investors seeking a stock fund that offers the potential for above-average
income. (Historically, the securities that comprise the Index have
provided above-average income relative to the S&P 500 Index.)
- - Investors wanting modest growth of their capital over the long term -- at
least five years.
WHO SHOULD NOT INVEST
- - Investors unwilling to accept significant fluctuations in share price.
- - Investors seeking a mutual fund that invests in a variety of industries.
RISKS OF THE PORTFOLIO (pages 4 - 8)
The Portfolio's total return will fluctuate, so an investor could lose money
over short or even extended periods. The REIT Index Portfolio is subject to,
among other risks:
- - Real estate industry risk (the chance that property values will fall due
to a variety of factors, such as a decline in rental rates).
- - Market risk (the chance that stock market prices will fall, sometimes
suddenly and sharply).
- - Interest rate risk (the chance that changes in interest rates will hurt
real estate values).
DISTRIBUTIONS* (page 10)
Distributions are paid in March, June, September, and December. These
distributions may include dividends and capital gains (which are taxable) and a
return of capital (which is generally non-taxable).
INVESTMENT ADVISER (page 12)
Vanguard Core Management Group, Valley Forge, PA.
INCEPTION DATE: May 13, 1996
NET ASSETS AS OF 7/31/96: $120 million
PORTFOLIO'S ESTIMATED EXPENSE RATIO: 0.35%
LOADS, 12b-1 MARKETING FEES: None
SUITABLE FOR IRAs: Yes
MINIMUM INITIAL INVESTMENT: $3,000; $1,000 for IRAs and custodial accounts for
minors
NEWSPAPER ABBREVIATION: SPREITs
VANGUARD FUND NUMBER: 123
ACCOUNT FEATURES (page 13)
- - Telephone Redemption (sales, not exchanges)
- - Vanguard Direct Deposit Service(SM)
- - Vanguard Automatic Exchange Service(SM)
- - Vanguard Fund Express(R)
- - Vanguard Dividend Express(SM)
TOTAL RETURNS** --
PERIOD ENDED JULY 31, 1996
REIT Index Portfolio 2.7%
Morgan Stanley REIT Index 02.8%
**Since inception
(5/13/96).
* IMPORTANT INFORMATION ABOUT DISTRIBUTIONS AND TAXES
Because REITs cannot provide complete information about the taxability of their
distributions until after the end of the calendar year, Vanguard plans to ask
the Internal Revenue Service each year for an extension on issuing Forms
1099-DIV ("1099s") for the REIT Index Portfolio. If this request is approved, we
expect to mail 1099s to Portfolio shareholders in non-retirement accounts during
February. See page 10 for details.
In evaluating performance, remember that it is not indicative of future
performance. Note, too, that both the return and principal value of an
investment will fluctuate so that an investor's shares, when redeemed, may be
worth more or less than their original cost.
1
<PAGE> 6
PLAIN TALK ABOUT
VANGUARD'S REDEMPTION FEES
Some Vanguard Portfolios charge a redemption fee on shares held less than one
year. Unlike a sales charge or load paid to a broker or fund management company,
the fee is paid directly to the Portfolio to offset the costs of buying and
selling securities. The fee, which is intended to discourage short-term trading,
ensures that short-term investors pay their share of the Portfolio's transaction
costs and that long-term investors do not subsidize the activities of short-term
traders.
PLAIN TALK ABOUT
FUND EXPENSES
All mutual funds have operating expenses. These expenses, which are deducted
from a fund's gross income, are expressed as a percentage of the net assets of a
fund. Vanguard REIT Index Portfolio's expense ratio in its first year of
operations is expected to be 0.35%, or $3.50 per $1,000 of average net assets.
As of December 31, 1995, the average real estate mutual fund had expenses of
1.37%, or $13.70 per $1,000 of average net assets, according to Lipper
Analytical Services, Inc., which reports on the mutual fund industry.
PORTFOLIO EXPENSES
The examples below are designed to help you understand the various costs you
would bear, directly or indirectly, as an investor in the Portfolio. As noted in
this table, you do not pay a load or sales commission when you buy, sell, or
exchange shares of the Portfolio.
SHAREHOLDER TRANSACTION EXPENSES
Sales Load Imposed on Purchases: None
Sales Load Imposed on Reinvested Distributions: None
Redemption Fees*: None
Exchange Fees: None
*The REIT Index Portfolio charges a 1% transaction fee on redemptions
(sales and exchanges) of shares that have been held less than one year. The fee
is deducted before your redemption proceeds are mailed to you or used to
purchase shares of another Vanguard Fund; you cannot pay the fee separately. If
some of the shares that you are redeeming have been held one year or more, the
fee will apply to only those shares held less than one year. The fee does not
apply to reinvested distributions.
The next table illustrates the operating expenses that you would incur as
a shareholder of the Portfolio. These expenses are deducted from the Portfolio's
income before it is paid to you, and include investment advisory expenses as
well as the costs of maintaining accounts, administering the Portfolio,
providing shareholder services, and other activities. The expenses shown in the
table are estimates for the Portfolio's first full year since the Portfolio was
not in operation until May 13, 1996.
ESTIMATED ANNUAL PORTFOLIO OPERATING EXPENSES
Management and Administrative Expenses: 0.27%
Investment Advisory Expenses: 0.02%
12b-1 Marketing Fees: None
Other Expenses
Marketing and Distribution Costs: 0.02%
Miscellaneous Expenses (e.g., Taxes, Auditing): 0.04%
Total Other Expenses: 0.06%
TOTAL OPERATING EXPENSES (EXPENSE RATIO): 0.35%
The following example illustrates the hypothetical expenses that you would
incur on a $1,000 investment over various periods. The example assumes (1) that
the Portfolio provides a return of 5% a year and (2) that you redeem your
investment at the end of each period.
1 YEAR 3 YEARS
$4 $11
THIS EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF ACTUAL EXPENSES OR
PERFORMANCE FROM THE PAST OR FOR THE FUTURE, WHICH MAY BE HIGHER OR LOWER THAN
THOSE SHOWN.
2
<PAGE> 7
FINANCIAL HIGHLIGHTS
The following financial highlights table shows the results for a share
outstanding for the period from May 13, 1996 (the first day of operations), to
July 31, 1996. You should read this information in conjunction with the
Portfolio's financial statements and accompanying notes, which appear in the
Portfolio's most recent semi-annual Report to shareholders. The Report is
incorporated by reference in the Statement of Additional Information and in this
prospectus, and contains a more complete discussion of the Portfolio's
performance. You may have the report sent to you without charge by writing to
Vanguard or by calling our Investor Information Department.
<TABLE>
<CAPTION>
MAY 13*, 1996,
FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD TO JULY 31, 1996,
<S> <C>
NET ASSET VALUE, BEGINNING OF PERIOD $ 10.00
INVESTMENT OPERATIONS
Net Investment Income .10
Net Realized and Unrealized Gain (Loss) on Investments .17
TOTAL FROM INVESTMENT OPERATIONS .27
DISTRIBUTIONS
Dividends from Net Investment Income (.03)
Distributions from Realized Capital Gains --
TOTAL DISTRIBUTIONS (.03)
NET ASSET VALUE, END OF PERIOD $ 10.24
TOTAL RETURN** 2.70%
RATIOS/SUPPLEMENTAL DATA
Net Assets, End of Period (Millions) $ 120
Ratio of Expenses to Average Net Assets .35%+
Ratio of Net Investment Income to Average
Net Assets 6.64%+
Portfolio Turnover Rate 0%
Average Commission Rate Paid $ .0271++
</TABLE>
* Commencement of operations.
** Total return figure does not reflect the 1% fee that is assessed on
redemption of shares that are held in the Portfolios for less than one
year.
+ Annualized.
++ Total commissions paid on portfolio securities divided by the total number
of shares bought or sold on which commissions are charged.
From time to time, the Vanguard Funds advertise yield and total return
figures. Yield is an historical measure of dividend income, and total return is
a measure of past dividend income (assuming that it has been reinvested) plus
capital appreciation. Neither yield nor total return should be used to predict
the future performance of a fund.
PLAIN TALK ABOUT
HOW TO READ THE FINANCIAL HIGHLIGHTS TABLE
Vanguard REIT Index Portfolio began operations on May 13, 1996, with a net asset
value (price) of $10.00 per share. As of July 31, 1996, the Portfolio earned
$.10 per share from investment income (interest and dividends) and $.17 per
share from investments that had appreciated in value or that were sold for
higher prices than the Portfolio paid for them. This resulted in total earnings
of $.27 per share, of which $.03 was returned to shareholders in the form of
distributions. The earnings ($.27 per share) less distributions ($.03 per share)
resulted in a share price of $10.24 on July 31, 1996, an increase of $.24 per
share (from $10.00 at the beginning of the period to $10.24 at the end of the
period). Total return from the REIT Index Portfolio was 2.70% for the period.
As of July 31, 1996, the Portfolio has $120 million in net assets; an
annualized expense ratio of 0.35% ($3.50 per $1,000 of net assets); and
annualized net investment income amounting to 6.64% of its average net assets.
3
<PAGE> 8
PLAIN TALK ABOUT
REITs
Rather than owning properties directly -- which can be costly and difficult to
convert into cash when needed -- some investors buy shares in a company that
owns and manages real estate. This company is known as a real estate investment
trust, or REIT. Unlike corporations, REITs do not have to pay income taxes if
they meet certain Internal Revenue Code requirements. To qualify, a REIT must
distribute at least 95% of its taxable income to its shareholders and receive at
least 75% of that income from rents, mortgages, and sales of property. REITs
offer investors greater liquidity and diversification than direct ownership of a
handful of properties, as well as greater income potential than an investment in
common stocks. Like any investment in real estate, however, a REIT's performance
depends on several factors, such as its ability to find tenants for its
properties, to renew leases, and to finance property purchases and renovations.
A WORD ABOUT RISK
This prospectus describes the risks you will face as an investor in Vanguard
REIT Index Portfolio. It is important to keep in mind one of the main axioms of
investing: the higher the risk of losing money, the higher the potential reward.
The reverse, also, is generally true: the lower the risk, the lower the
potential reward. As you consider an investment in the REIT Index Portfolio, you
should also take into account your personal tolerance for the daily fluctuations
of the stock market.
Look for this "warning flag" symbol [FLAG ICON] throughout the
Prospectus. It is used to mark detailed information about each type of risk
that you, as a shareholder of the Portfolio, will confront.
THE PORTFOLIO'S OBJECTIVES
Vanguard REIT Index Portfolio seeks to provide above-average income (relative to
the Standard & Poor's 500 Composite Stock Price Index) and long-term growth of
capital. These objectives are fundamental, which means that they cannot be
changed unless a majority of shareholders vote to do so.
[FLAG ICON] BECAUSE OF THE SEVERAL TYPES OF RISK DESCRIBED ON THE FOLLOWING
PAGES, YOUR INVESTMENT IN THE PORTFOLIO, AS WITH ANY INVESTMENT IN
COMMON STOCKS, COULD LOSE MONEY.
WHO SHOULD INVEST
The REIT Index Portfolio may be a suitable investment for you if:
- - You want to add real estate exposure to your existing mix of stock, bond,
and money market mutual funds.
- - You want a stock fund that seeks to provide a high level of income and
long-term capital growth.
- - You are looking for an investment that performs differently than a
diversified stock or bond fund.
- - You characterize your investment temperament as "somewhat conservative."
This Portfolio is not an appropriate investment if you are a
"market-timer." Investors who engage in excessive in-and-out trading activity
generate additional costs that are borne by all of the Portfolio's shareholders.
To minimize such costs, which reduce the ultimate returns achieved by you and
other shareholders, the Portfolio has adopted the following policies:
- - The Portfolio charges a 1% redemption fee on shares held less than one
year.
4
<PAGE> 9
- - The Portfolio reserves the right to reject any purchase request --
including exchanges from other Vanguard Funds -- that it regards as
disruptive to the efficient management of the Portfolio. This could be
because of the timing of the investment or because of a history of
excessive trading by the investor.
- - There is a limit on the number of times you can exchange into or out of
the Portfolio (see "Redeeming Shares" in the INVESTING WITH VANGUARD
section).
- - Telephone exchanges are not accepted for non-retirement accounts.
- - The Portfolio reserves the right to stop offering shares at any time.
INVESTMENT STRATEGIES
This section explains how the Portfolio's investment adviser tries to provide a
high level of income and long-term capital growth. It also explains three
important risks -- real estate industry risk, market risk, and interest rate
risk -- faced by investors in the Portfolio. Unlike the Portfolio's investment
objectives, the adviser's investment strategies are not fundamental and can be
changed by the Portfolio's Board of Directors without shareholder approval.
However, before making any important change in its strategies, the Portfolio
will give shareholders 30-days notice, in writing.
MARKET EXPOSURE
The Portfolio intends to remain at least 98% invested in the stocks of real
estate investment trusts; the remaining assets will be invested in cash reserves
to maintain liquidity for shareholder redemptions.
[FLAG ICON] THE PORTFOLIO IS SUBJECT TO REAL ESTATE INDUSTRY RISK, WHICH IS THE
POSSIBILITY THAT A REIT'S PROPERTIES COULD FALL IN VALUE.
Because of its emphasis on REIT stocks, the Portfolio's performance is
strongly linked to the ups and downs of the real estate market. In general, real
estate values are affected by a variety of factors, including supply and demand
for properties; the economic health of the country as well as different regions;
and the strength of specific industries renting properties. Ultimately, a REIT's
performance depends on the types and locations of the properties it owns and on
how well the REIT manages its properties. For instance, rental income could
decline because of extended vacancies, increased competition from nearby
properties, tenants' failure to pay rent, or incompetent management. Property
values could decrease because of overbuilding, environmental liabilities,
uninsured damages caused by natural disasters, loss of IRS status as a qualified
REIT, a general decline in the neighborhood, losses due to casualty or
condemnation, increases in property taxes, or changes in zoning laws.
PLAIN TALK ABOUT
INVESTING FOR THE LONG TERM
Vanguard REIT Index Portfolio is intended to be a long-term investment vehicle
and is not designed to provide investors with a means of speculating on
short-term fluctuations in the stock or real estate markets.
PLAIN TALK ABOUT
TYPES OF REITS
An equity REIT, which owns properties, generates income (from rental and lease
payments) and offers the potential for growth (from property appreciation), as
well as occasional capital gains from the sale of property. A mortgage REIT
makes loans to commercial real estate developers. Mortgage REITs earn interest
income, and are subject to credit risks (that is, the chance that a developer
will fail to repay a loan). A hybrid REIT holds properties and mortgages.
5
<PAGE> 10
PLAIN TALK ABOUT
INDEXES
An index is a group of securities whose overall performance is used as a
standard to measure investment performance.
PLAIN TALK ABOUT
LARGE-CAP, MID-CAP, AND SMALL-CAP STOCKS
Stocks of publicly traded companies -- and mutual funds that hold these stocks
- -- can be classified by the companies' market value, or capitalization. Vanguard
defines large-capitalization, or large-cap funds as those holding stocks of
companies with an average total market value exceeding $5 billion. Mid-cap funds
hold stocks of companies with an average market value between $750 million and
$5 billion. Small-cap funds hold stocks of companies with an average market
value of less than $750 million. Note that a fund's capitalization parameters
(that is, what constitutes a large-, mid-, or small-cap stock) may vary from the
parameters set by a particular index.
[FLAG ICON] THE PORTFOLIO IS SUBJECT TO MARKET RISK, WHICH IS THE POSSIBILITY
THAT STOCK PRICES OVERALL WILL DECLINE OVER SHORT OR EVEN EXTENDED
PERIODS. STOCK MARKETS TEND TO MOVE IN CYCLES, WITH PERIODS OF
RISING STOCK PRICES AND PERIODS OF FALLING STOCK PRICES.
To illustrate the volatility of stock prices, the following table shows
the best, worst, and average total returns (dividend income plus change in
market value) for the U.S. stock market over various periods as measured by the
Standard & Poor's 500 Composite Stock Price Index, a widely used barometer of
stock market activity. Note that the returns shown do not include the costs of
buying and selling stocks or other expenses that a real-world investment
portfolio would incur. Note, also, how the gap between best and worst tends to
narrow over the long term.
U.S. STOCK MARKET RETURNS (1926 - 1995)
<TABLE>
<CAPTION>
1 Year 5 Years 10 Years 20 Years
<S> <C> <C> <C> <C>
Best 53.9% 23.9% 20.1% 16.9%
Worst - 43.3 - 12.5 - 0.9 3.1
Average 12.5 10.3 10.7 10.7
</TABLE>
The table covers all of the 1-, 5-, 10-, and 20-year periods from 1926
through 1995. For example, while the average return on stocks for all of the
5-year periods was 10.3%, returns for the 5-year periods ranged from a -12.5%
average (from 1928 through 1932), to 23.9% (from 1951 through 1955). These
average returns reflect past performance on common stocks and should not be
regarded as an indication of future returns from either the stock market as a
whole or the REIT Index Portfolio in particular.
REITs in the Morgan Stanley REIT Index tend to be medium-size and small
companies; their market capitalizations generally range from $75 million to $1.3
billion. Like small-cap stocks in general, REIT stocks can be more volatile than
- -- and at times will perform differently from -- the large-cap stocks found in
the S&P 500 Index.
In addition, because small-cap stocks are typically less liquid than
large-cap stocks, REIT stocks may sometimes experience greater share-price
fluctuations than the stocks of larger companies. Historically, however, the
significant amount of dividend income provided by REITs has tended to soften the
impact of this volatility.
[FLAG ICON] THE PORTFOLIO IS SUBJECT TO INTEREST RATE RISK, WHICH IS THE
POSSIBILITY THAT CHANGES IN INTEREST RATES COULD HURT REIT
PERFORMANCE.
In general, during periods of high interest rates, REITs may lose some of
their appeal for investors who may be able to obtain higher yields from other
income-producing investments, such as long-term
7
<PAGE> 11
bonds. Higher interest rates also mean that financing for property purchases and
improvements is more costly and difficult to obtain.
SECURITY SELECTION AND PORTFOLIO DIVERSIFICATION
The REIT Index Portfolio employs a "passively" managed investment approach.
The Portfolio's adviser, Vanguard Core Management Group, invests at least 98% of
the Portfolio's assets in an attempt to parallel the performance of the
Portfolio's target benchmark, the Morgan Stanley REIT Index.
The REIT Index Portfolio holds each stock contained in the Morgan Stanley REIT
Index in roughly the same proportions as in the Index itself. For example, if 5%
of the Morgan Stanley REIT Index were made up of the stock of a specific REIT,
the Portfolio would invest the same percentage of its non-cash assets in that
stock.
[FLAG ICON] AN INDEX FUND HAS OPERATING EXPENSES; AN UNMANAGED MARKET INDEX DOES
NOT. THEREFORE, AN INDEX FUND -- WHILE EXPECTED TO PARALLEL ITS
TARGET INDEX AS CLOSELY AS POSSIBLE -- WILL NOT BE ABLE TO MATCH THE
PERFORMANCE OF THE TARGET INDEX EXACTLY. THE CORRELATION BETWEEN THE
PERFORMANCE OF THE REIT INDEX PORTFOLIO AND ITS TARGET INDEX IS
EXPECTED TO BE AT LEAST 0.95.
The Morgan Stanley REIT Index is made up of the stocks of all publicly
traded equity REITs (except health care REITs) that meet certain criteria. For
example, to be included in the Index, a REIT must have a total market
capitalization of at least $100 million and have enough shares and trading
volume to be considered liquid. The REIT Index Portfolio invests in equity REITs
only.
As of July 31, 1996, 94 equity REITs were included in the Index. The Index
is rebalanced every calendar quarter as well as each time that a REIT is removed
from the Index because the REIT's market capitalization falls below $75 million
or because of corporate activity such as a merger, acquisition, leveraged buyout
(LBO), bankruptcy, IRS removal of REIT status, fundamental change in business,
or change in shares outstanding.
Stocks in the Morgan Stanley REIT Index represent a broadly diversified
range of property types and regions. The Index's makeup, as of December 31,
1995, follows.
<TABLE>
<S> <C>
Retail Stores 33.1%
Residential 32.6
Office 14.8
Industrial 11.3
Hotels 3.8
Other 4.4
</TABLE>
The Index's ten largest stocks are expected to make up about 30% of its
market value. The Index's largest stocks, as of July 31, 1996, follow.
PLAIN TALK ABOUT
ACTIVE VERSUS PASSIVE MANAGEMENT
Index portfolios are not actively managed by investment advisers who buy and
sell securities based on research and analysis. Instead, passive management --
also known as indexing -- tries to match, as closely as possible, the
performance of a target index by either holding all -- or a representative
sample -- of the securities in the index. Indexing appeals to many investors
because of its simplicity (indexing is a straight-forward market-matching
strategy); diversification (indexes generally cover a wide variety of
companies); relative performance predictability (an index portfolio is expected
to move in the same direction -- up or down -- as its target index); low cost
(index portfolios do not have many of the expenses of an actively managed fund
- -- such as research and company visits -- and keep trading activity -- and,
thus, brokerage commissions -- to a minimum); and low realization of capital
gains.
PLAIN TALK ABOUT
PORTFOLIO DIVERSIFICATION
In general, the more diversified a fund's portfolio of stocks, the less likely
that a specific stock's poor performance will hurt the fund. One measure of a
fund's level of diversification is the percentage of assets represented by its
ten largest holdings. The average U.S. equity mutual fund has about 25% of its
assets invested in its ten largest holdings, while some less-diversified mutual
funds have more than 50% of their assets invested in the stocks of just ten
companies.
7
<PAGE> 12
PLAIN TALK ABOUT
PORTFOLIO TURNOVER
Before investing in a mutual fund, you should review its portfolio turnover rate
for an indication of the potential effect of transaction costs on the fund's
future returns. In general, the greater the volume of buying and selling by the
fund, the greater the impact that brokerage commissions and other transaction
costs will have on its return. Also, funds with high portfolio turnover rates
may be more likely than low-turnover funds to generate capital gains that must
be distributed to shareholders as taxable income. The average turnover rate for
actively managed funds investing in common stocks is 75%.
PLAIN TALK ABOUT
DERIVATIVES
A derivative is a financial contract whose value is based on (or "derived" from)
another security (such as a stock or a bond), an asset (such as a commodity
like gold), or a market index (such as the S&P 500 Index). Futures and options
are derivatives that have been trading on regulated exchanges for more than two
decades. These "traditional" derivatives are standardized contracts that can
easily be bought and sold, and whose market values are determined and published
daily. It is these characteristics that differentiate futures and options from
the relatively new, exotic types of derivatives.
1. Security Capital Pacific Trust
2. Security Capital Industrial Trust
3. Equity Residential Properties Trust
4. Simon Property Group
5. New Plan Realty Trust
6. Weingarten Realty
7. Vornado Realty Trust
8. Kimco Realty Corporation
9. Franchise Financial Corporation
10. Spieker Properties Inc.
Vanguard REIT Index Portfolio is not sponsored, sold, promoted, or
endorsed by Morgan Stanley. The Morgan Stanley REIT Index is the exclusive
property of Morgan Stanley and is a service market of Morgan Stanley Group Inc.
It has been licensed for use by The Vanguard Group, Inc.
PORTFOLIO TURNOVER
Although the Portfolio generally seeks to invest for the long term, it retains
the right to sell securities regardless of how long they have been held.
Generally, a passively managed portfolio sells securities only to respond to
redemption requests or to adjust the number of shares held to reflect a change
in the portfolio's target index. Because of this, the Portfolio's turnover rate
is expected to be less than 25%. (A rate of 100% would occur, for example, if
the Portfolio sold or replaced securities valued at 100% of its total net assets
within a one-year period.)
INVESTMENT POLICIES
Besides investing at least 98% of its assets in REIT stocks, the Portfolio may
follow other investment policies to achieve its objectives.
[FLAG ICON] THE PORTFOLIO RESERVES THE RIGHT TO INVEST, TO A LIMITED EXTENT, IN
STOCK FUTURES AND OPTIONS CONTRACTS, AND SWAP AGREEMENTS. STOCK
FUTURES AND OPTIONS CONTRACTS ARE TRADITIONAL TYPES OF DERIVATIVES
THAT ARE PUBLICLY TRADED ON EXCHANGES. SWAP AGREEMENTS ARE
CUSTOMIZED CONTRACTS, OFTEN ARRANGED THROUGH A BROKER, BETWEEN TWO
INSTITUTIONS. SWAP AGREEMENTS FUNCTION LIKE FUTURES, BUT ARE NOT
PUBLICLY TRADED ON AN EXCHANGE.
Losses (or gains) involving contracts can sometimes be substantial -- in
part because a relatively small price movement in a contract may result in an
immediate and substantial loss (or gain) for a portfolio.
This Portfolio will not use futures, options, or swap agreements for
speculative purposes or as leveraged investments that magnify the gains or
losses of an investment. Rather, the Portfolio will keep separate cash reserves
or other liquid portfolio securities in the amount
8
<PAGE> 13
of the obligation underlying the contract. Only a limited percentage of the
Portfolio's assets -- up to 5% if required for deposit and no more than 20% of
total assets -- may be committed to such contracts. To the extent that such
contracts are utilized, the Portfolio will not have 98% of its assets invested
in the REIT stock. However, such contracts will only be utilized in order to
mirror the performance of the Index.
The reasons for which the Portfolio may use futures, options, and swap
agreements are:
- - To execute trades more easily.
- - To reduce costs -- and to improve returns -- by buying futures, options,
or swap agreements instead of actual stocks when they are cheaper.
- - To keep cash on hand to meet shareholder redemptions or other needs while
simulating full investment in stocks.
Although up to 2% of its assets will be invested in cash reserves to
maintain liquidity, the Portfolio will not invest in cash reserves, futures,
options, or swap agreements to protect against a decline in the values of REITs.
INVESTMENT LIMITATIONS
To reduce risk and maintain diversification, the Portfolio has adopted limits on
some of its investment practices. Specifically, the Portfolio will not:
- - Invest more than 25% of its assets in any one industry other than real
estate.
- - Borrow money, except for the purpose of meeting shareholder requests to
redeem shares.
With respect to 75% of its assets, this Portfolio will not:
- - Invest more than 5% of its assets in the securities of any one company.
- - Buy more than 10% of the outstanding voting securities of any company.
The limitations listed in this prospectus and in the Statement of
Additional Information may be changed only by approval of a majority of the
Portfolio's shareholders.
INVESTMENT PERFORMANCE
Vanguard REIT Index Portfolio invests primarily in stocks of real estate
investment trusts, so its performance may be correlated to the performance of
the overall stock market. Historically, stock market performance has been
characterized by sharp up-and-down swings in the short term and by more stable
growth over the long term. There may be periods, however, when REITs perform
quite differently from the broader market.
9
<PAGE> 14
PLAIN TALK ABOUT
PAST PERFORMANCE
Whenever you see information on a fund's performance, do not consider the
figures to be an indication of the performance you could expect by making an
investment in the fund today. The past is an imperfect guide to the future;
history does not repeat itself in neat, predictable patterns.
PLAIN TALK ABOUT
DISTRIBUTIONS
As a shareholder, you are entitled to your share of the Portfolio's earnings.
You receive such earnings from the REIT Index Portfolio as either a quarterly
distribution or as an annual capital gains distribution. The Portfolio's
quarterly payments come from distributions that the Portfolio receives from its
REIT holdings and interest it earns from any cash reserves. Capital gains are
realized when the Portfolio sells REIT stocks for higher prices than its
adjusted cost basis in the stocks. These gains may be short-term or long-term
depending on whether the Portfolio held the securities for less than or more
than one year.
TOTAL RETURNS* FOR PERIOD ENDED JULY 31, 1996
REIT Index Portfolio 2.7%
Morgan Stanley REIT Index 2.8%
*Since inception (5/13/96)
SHARE PRICE
The Portfolio's share price, called its net asset value, is calculated each
business day after the close of regular trading (generally 4:00 p.m. Eastern
time) of the New York Stock Exchange. Net asset value per share is computed by
adding up the total value of the Portfolio's investments and other assets,
subtracting any of its liabilities, or debts, and then dividing by the number of
Portfolio shares outstanding:
TOTAL ASSETS - LIABILITIES
NET ASSET VALUE = ----------------------------
NUMBER OF SHARES OUTSTANDING
Daily net asset value, or NAV, is useful to you as a shareholder because
the NAV, multiplied by the number of Portfolio shares you own, gives you the
dollar amount you would have received had you sold all of your shares back to
the Portfolio that day.
The Portfolio's share price can be found daily in the mutual fund listings
of most major newspapers under the heading Vanguard Group. Different newspapers
use different abbreviations of the Portfolio's name, but the most common is
SPREITs.
DISTRIBUTIONS AND TAXES
Each March, June, September, and December, the REIT Index Portfolio will provide
shareholders with virtually all of the distributions it receives from its REIT
investments. Any capital gains realized from the sale of securities will be
distributed in December.
You may receive distributions in cash, or you may have them automatically
reinvested in more shares of the Portfolio.
If you own Portfolio shares in a non-retirement account, Vanguard will
notify you each year of the amount and taxability of the Portfolio's
distributions paid during the previous year (that is, the amount of dividends,
capital gains, and return of capital that you receive). You will also be
notified of the amount, if any, of Federal income taxes withheld from the
distribution.
REITs do not provide complete information about the taxability of their
distributions until after the calendar year end. As a result, Vanguard cannot
determine how much of the REIT Index Portfolio's annual distributions is taxable
for shareholders until after the traditional January 31 deadline for issuing
Forms 1099-DIV ("1099"). Therefore, we plan to request permission each year from
the Internal Revenue Service (IRS) for an extension. IF OUR REQUEST IS APPROVED,
10
<PAGE> 15
WE WILL MAIL FORMS 1099-DIV TO REIT INDEX PORTFOLIO SHAREHOLDERS WITH
NON-RETIREMENT ACCOUNTS IN FEBRUARY.
TAXABILITY OF DISTRIBUTIONS
The portions of your distributions that are classified as dividends and
short-term capital gains are taxable to you as ordinary dividend income. Any
distributions of net long-term capital gains by the Portfolio are taxable to you
as long-term capital gains, no matter how long you've owned shares in the
Portfolio. Both dividends and capital gains are taxable to you whether received
in cash or reinvested in additional shares. In addition, distributions that are
declared in December -- even if paid to you in January -- are taxed as if they
had been paid to you in December.
Although the Portfolio does not seek to realize any particular amount of
capital gains during a year, such gains are realized from time to time as
byproducts of its ordinary investment activities and distributions paid by
REITs. Consequently, distributions may vary from year to year.
If you sell or exchange shares of the Portfolio, any gain or loss you have
is generally a taxable event, which means that you may have a capital gain or a
capital loss to report when you complete your Federal income tax return.
Distributions -- as well as capital gains or losses from your sale or exchange
of Portfolio shares -- may be subject to state and local income taxes, too.
Note that any dividends distributed by REITs -- and funds that invest in
REITs -- are not eligible for the dividends-received deduction for corporations.
RETURN OF CAPITAL
The portion of your distributions that is classified as a return of capital is
generally not taxable to you. However, when you receive a return of capital,
your cost basis (that is, the adjusted cost of your investment, which is used to
determine a capital gain or loss for tax purposes) is decreased by the amount of
the return of capital. This, in turn, will affect the capital gain or loss you
realize when you sell or exchange any of your REIT Index Portfolio shares.
Two other important tax considerations about return of capital:
- - If you do not reinvest your distributions (that is, you receive your
distributions in cash), your original investment in the Portfolio will be
reduced by the amount of return of capital and capital gains included in
the distribution.
- - A return of capital is generally not taxable to you; however, any return
of capital distribution would be taxable as a capital gain once your cost
basis is reduced to zero (which could happen if you do not reinvest your
distributions and return of capital in those distributions is
significant).
Keep in mind that the tax information in this prospectus is provided as
general information. You should consult your own tax adviser about the tax
consequences of an investment in the REIT Index Portfolio.
PLAIN TALK ABOUT
RETURN OF CAPITAL
The Internal Revenue Code requires a REIT to distribute at least 95% of its
taxable income to investors. In many cases, however, because of "non-cash"
expenses such as property depreciation, an equity REIT's cash flows will exceed
its taxable income. The REIT may distribute this excess cash to offer a more
competitive yield (in other words, provide investors with a higher
distribution). This portion of the distribution is classified as a return of
capital.
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<PAGE> 16
PLAIN TALK ABOUT
VANGUARD'S UNIQUE CORPORATE STRUCTURE
The Vanguard Group, Inc. is the only MUTUAL mutual fund company. It is owned
jointly by the Funds it oversees and by the shareholders in those funds. Other
mutual funds are operated by for-profit management companies that may be owned
by one person, by a group of individuals, or by investors who bought the
management company's publicly traded stock. Because of its structure, Vanguard
operates its Funds at cost. Instead of distributing profits as other mutual fund
companies do, Vanguard returns profits to fund shareholders in the form of
lower operating expenses.
PLAIN TALK ABOUT
THE PORTFOLIO'S ADVISER
Vanguard Core Management Group provides investment advisory services to many
Vanguard Funds; as of July 31, 1996, the Group managed $44 billion in assets.
The individual who oversees the REIT Index Portfolio is:
GEORGE U. SAUTER, Principal of Vanguard, 11 years investment experience, 9
years primary responsibility for Vanguard Core Management Group; A.B. from
Dartmouth College, M.B.A. from the University of Chicago.
THE PORTFOLIO AND VANGUARD
The Fund is a member of The Vanguard Group, a family of more than 30 investment
companies with more than 90 distinct investment portfolios and total net assets
of more than $230 billion. All of the Vanguard Funds share in the expenses
associated with business operations, such as personnel, office space, equipment,
and advertising.
Vanguard also provides marketing services to the Funds. Although
shareholders do not pay sales commissions or 12b-1 marketing fees, each Fund
pays its allocated share of The Vanguard Group's costs.
A list of the Fund's Directors and Officers, and their present positions
and principal occupations during the past five years, can be found in the
Statement of Additional Information.
INVESTMENT ADVISER
Vanguard Core Management Group, P.O. Box 2600, Valley Forge, PA 19482, provides
investment advisory services on an at-cost basis to the Portfolio.
The Group is authorized to choose brokers and dealers to handle the
purchase and sale of the Portfolio's securities, and is directed to get the best
available price and most favorable execution from these brokers with respect to
all transactions.
GENERAL INFORMATION
The REIT Index Portfolio is one of five Portfolios of Vanguard Specialized
Portfolios, Inc., a corporation organized under the laws of the State of
Maryland. The other Portfolios are the Energy, Gold & Precious Metals, Health
Care, and Utilities Income Portfolios. The Portfolios are all combined under one
corporation for administrative purposes, but operate as separate corporations in
virtually all respects.
Shareholders of the REIT Index Portfolio have rights and privileges
similar to those enjoyed by other corporate shareholders. For example,
shareholders will not be responsible for any liabilities of the corporation. If
any matters are to be voted on by shareholders (such as a change in a
fundamental investment objective or the election of directors), each share
outstanding at that point would be entitled to one vote. The Portfolio will not
hold annual meetings except as required by the Investment Company Act of 1940. A
meeting will be scheduled (for example, to vote on the removal of a director) if
the holders of at least 10% of the Portfolio's shares request a meeting in
writing.
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<PAGE> 17
INVESTING WITH VANGUARD
Are you looking for the most convenient way to open or add money to a Vanguard
account? Obtain instant access to Fund information? Establish an account for a
minor child or for your retirement savings?
Vanguard can help. Our goal is to make it easy and pleasant for you to do
business with us.
The following sections of the prospectus briefly explain the many services we
offer you as a Vanguard REIT Index Portfolio shareholder. Booklets providing
detailed information are available on the services marked with a [open book
icon]. Please call us to request copies.
SERVICES AND ACCOUNT FEATURES
Vanguard offers many services that make it convenient to purchase, sell, or
exchange shares.
TELEPHONE REDEMPTIONS Automatically set up for this Portfolio unless
(SALES FOR NON-RETIREMENT you notify us otherwise.
ACCOUNTS ONLY; EXCHANGES
FOR RETIREMENT ACCOUNTS ONLY)
VANGUARD DIRECT DEPOSIT Automatic method for depositing your paycheck
SERVICE or U.S. Government payment (including Social
[OPEN BOOK ICON] Security and Government pension checks) into
your account.
VANGUARD AUTOMATIC EXCHANGE Automatic method for moving a fixed amount of
SERVICE money from one Vanguard Fund account to
[OPEN BOOK ICON] another.(*)
VANGUARD FUND EXPRESS Electronic method for buying or selling shares.
[OPEN BOOK ICON] You can transfer money between your Vanguard Fund
account and an account at your bank, savings and
loan, or credit union on a systematic
schedule(*)
VANGUARD DIVIDEND EXPRESS Electronic method for transferring distributions
[OPEN BOOK ICON] directly from your Vanguard Fund account to your
bank, savings and loan, or credit union account
or to another Vanguard Fund account.
VANGUARD BROKERAGE SERVICES A cost-effective way to trade stocks, bonds, and
(VBS) options on major exchanges, Nasdaq, and other
[OPEN BOOK ICON] domestic over-the-counter markets at reduced
rates, and to buy and sell shares of non-Vanguard
mutual funds. Call VBS (1-800-992-8327) for
additional information and the appropriate forms.
*Can be used to "dollar-cost average" [OPEN BOOK ICON] or to contribute to an
IRA or other retirement plan.
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<PAGE> 18
TYPES OF ACCOUNTS
INDIVIDUAL OR OTHER ENTITY
Vanguard's account registration form can be used to establish a variety of
non-retirement accounts.
FOR ONE OR MORE PEOPLE To open an account in the name of one
(individual) or more (joint tenants)
people. $3,000 minimum initial investment.
FOR A MINOR CHILD To open an account as an UGMA/UTMA (Uniform
[OPEN BOOK ICON] Gifts/Transfers to Minors Act). Age of
majority and other transfer requirements
are set by state law. $1,000 minimum
initial investment.
FOR HOLDING TRUST ASSETS To invest assets held in an existing trust.
[OPEN BOOK ICON] $3,000 minimum initial investment.
FOR THIRD-PARTY TRUSTEE To open an account as a retirement trust or
RETIREMENT INVESTMENTS plan based on an existing corporate or
(Vanguard is not the custodian institutional plan. These accounts are
or trustee.) established by the custodian or trustee of
the existing plan.
FOR AN ORGANIZATION To open an account as a corporation,
partnership, or other entity. These
accounts may require a corporate resolution
or other documents to name the individuals
authorized to act. $3,000 minimum initial
investment.
RETIREMENT
You establish these accounts with a Vanguard adoption agreement -- not a
Vanguard account registration form. To request the appropriate adoption
agreement and forms, or to receive answers to your questions about investing for
retirement, call Investor Information.
FOR AN INDIVIDUAL RETIREMENT To open a retirement account in the name of
ACCOUNT (IRA) an individual. IRAs can also be established
(Vanguard Fiduciary Trust with a regular contribution, a direct
Company is the custodian.) rollover from an employer's plan such as a
401(k), or an asset transfer or rollover
from another financial institution such as
a bank or mutual fund company. $1,000
minimum initial investment.
FOR A SIMPLIFIED EMPLOYEE To open a retirement account in the name of
PENSION PLAN ACCOUNT (SEP-IRA) an employee. SEPs allow employers to make
(Vanguard Fiduciary Trust deductible contributions directly to IRAs
Company is the custodian.) established by their employees. A SEP can
be established by people who are
self-employed, small business owners,
partnerships, or corporations.
FOR A QUALIFIED RETIREMENT To open a retirement account that allows
PROGRAM ACCOUNT small business owners or people who are
(Vanguard Fiduciary Trust self-employed to make tax-deductible
Company can be the custodian.) retirement contributions for themselves and
their employees into Profit-Sharing and
Money Purchase Pension (Keogh) plans.
INVESTOR INFORMATION 1-800-662-7447 CLIENT SERVICES 1-800-662-2739
TELE-ACCOUNT 1-800-662-6273
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<PAGE> 19
TYPES OF ACCOUNTS (continued)
FOR A 403(b)(7) CUSTODIAL ACCOUNT To open a retirement account that allows
(Vanguard Fiduciary Trust employees of tax-exempt institutions (for
Company is the custodian.) example, schools or hospitals) to make pre-
tax retirement contributions.
DISTRIBUTION OPTIONS
You can receive Portfolio distributions in two ways:
REINVESTMENT Distributions are automatically reinvested
in additional shares of the Portfolio.
DISTRIBUTIONS IN CASH Distributions are paid by check and mailed
to your account's address of record. Note:
If you do not reinvest your distributions,
your original investment will be reduced by
the amount of the return of capital in the
distribution. See "Distributions and
Taxes."
To electronically transfer cash distributions to your bank, savings and loan, or
credit union account, or to another Vanguard Fund account, see Vanguard Dividend
Express under "Services and Account Features."
BUYING SHARES
You buy your shares at the Portfolio's next-determined net asset value after
Vanguard receives your request, provided we receive your request before 4:00
p.m. Eastern time (the close of trading on the New York Stock Exchange). The
Portfolio is offered on a no-load basis, meaning that you do not pay sales
commissions or 12b-1 marketing fees.
<TABLE>
<CAPTION>
OPEN A NEW ACCOUNT ADD TO AN EXISTING ACCOUNT
<S> <C> <C>
MINIMUM INVESTMENT $3,000 (regular account); $1,000 $100 by mail or exchange; $1,000
(IRAs and custodial accounts for by wire.
minors).
BY MAIL Complete and sign the applica- Mail your check with an Invest-
[LETTER ICON] tion form. By-Mail form detached from
your confirmation statement to
FIRST-CLASS mail to: the address listed on the form.
The Vanguard Group
P.O. Box 2600 Make your check payable to: Make your check payable to:
Valley Forge, PA 19482 The Vanguard Group-123. The Vanguard Group-123.
EXPRESS OR REGISTERED mail to:
The Vanguard Group All purchases must be made in All purchases must be made in
455 Devon Park Drive U.S. dollars, and checks must be U.S. dollars, and checks must be
Wayne, PA 19087 drawn on U.S. banks. drawn on U.S. banks.
</TABLE>
IMPORTANT NOTE: TO PREVENT CHECK FRAUD, VANGUARD WILL NOT ACCEPT CHECKS MADE
PAYABLE TO THIRD PARTIES.
INVESTOR INFORMATION 1-800-662-7447 CLIENT SERVICES 1-800-662-2739
TELE-ACCOUNT 1-800-662-6273
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<PAGE> 20
BUYING SHARES (continued)
<TABLE>
<S> <C> <C>
BY TELEPHONE FOR RETIREMENT ACCOUNTS ONLY: FOR RETIREMENT ACCOUNTS ONLY:
[PHONE ICON] Call Vanguard Tele-Account* 24 Call Vanguard Tele-Account* 24
hours a day -- or Client Services hours a day -- or Client Services
1-800-662-6273 during business hours -- to ex- during business hours -- to ex-
Vanguard Tele-Account(R) change from another Vanguard change from another Vanguard
Fund account with the same reg- Fund account with the same reg-
1-800-662-2739 istration (name, address, taxpay- istration (name, address, taxpay-
Client Services er I.D., and account type). er I.D., and account type).
*You must obtain a Personal Identification Number through Tele-Account
at least seven days before you request your first exchange.
</TABLE>
IMPORTANT NOTE: ONCE A TELEPHONE TRANSACTION HAS BEEN APPROVED BY YOU AND A
CONFIRMATION NUMBER ASSIGNED, IT CANNOT BE REVOKED. WE RESERVE THE RIGHT TO
REFUSE ANY PURCHASE.
<TABLE>
<CAPTION>
OPEN A NEW ACCOUNT ADD TO AN EXISTING ACCOUNT
<S> <C> <C>
BY WIRE Call Client Services to arrange your Call Client Services to arrange your
[WIRE ICON] wire transaction. wire transaction.
Wire to: Wire transactions are not available Wire transactions are not available
CoreStates Bank, N.A. for retirement accounts. for retirement accounts.
ABA 031000011
CoreStates No 01019897
[Temporary Account Number]
Vanguard REIT Index Portfolio
[Account Registration]
Attn Vanguard
AUTOMATICALLY -- Vanguard offers a variety of ways
[ARROW ICON] that you can add to your account
automatically. See "Services and
Account Features."
</TABLE>
YOU CAN REDEEM (THAT IS, SELL OR EXCHANGE) SHARES PURCHASED BY CHECK OR VANGUARD
FUND EXPRESS AT ANY TIME. HOWEVER, WHILE YOUR REDEMPTION REQUEST WILL BE
PROCESSED AS SOON AS IT IS RECEIVED, YOUR REDEMPTION PROCEEDS WILL NOT BE
AVAILABLE UNTIL PAYMENT FOR YOUR PURCHASE IS COLLECTED, WHICH MAY TAKE UP TO TEN
DAYS.
It is important that you call Vanguard before you invest a large dollar
amount by wire or check. We must consider the interests of all Portfolio
shareholders and so reserve the right to delay or refuse any purchase that may
disrupt the Portfolio's operation or performance.
REDEEMING SHARES
IMPORTANT TAX NOTE: ANY SALE OR EXCHANGE OF SHARES IN A NON-RETIREMENT ACCOUNT
COULD RESULT IN A TAXABLE GAIN OR A LOSS.
A 1% FEE IS CHARGED FOR ALL REDEMPTIONS (SALES AND EXCHANGES) OF PORTFOLIO
SHARES HELD LESS THAN ONE YEAR.
INVESTOR INFORMATION 1-800-662-7447 CLIENT SERVICES 1-800-662-2739
TELE-ACCOUNT 1-800-662-6273
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<PAGE> 21
REDEEMING SHARES (continued)
The ability to sell Portfolio shares by telephone is automatically established
for your non-retirement account unless you tell us in writing that you do not
want this option.
To protect your account from unauthorized or fraudulent telephone
instructions, Vanguard follows specific security procedures. When we receive a
call requesting an account transaction, we require the caller to provide:
- Portfolio name.
- 10-digit account number.
- Name and address exactly as registered on that account.
- Social Security or Employer Identification number as registered on
that account.
If you call to sell shares, the sale proceeds will be made payable to you,
as the registered shareholder, and mailed to your account's address of record.
If we follow reasonable security procedures, neither the Portfolio nor
Vanguard will be responsible for the authenticity of transaction instructions
received by telephone. We believe that these procedures are reasonable and that,
if we follow them, you bear the risk of any losses resulting from unauthorized
or fraudulent telephone transactions on your account. However, if we do not
follow these or other reasonable procedures, Vanguard may be liable for any
losses resulting from unauthorized or fraudulent transactions.
HOW TO SELL SHARES
You may withdraw any part of your account, at any time, by selling shares.
Sale proceeds are normally mailed within two business days after Vanguard
receives your request. The sale price of your shares will be the Portfolio's
next-determined net asset value after Vanguard receives all required documents
in good order.
Good order means that the request includes:
- Portfolio name and account number.
- Amount of the transaction (in dollars or shares).
- Signatures of all owners exactly as registered on the account.
- Signature guarantees (if required).
- Any supporting legal documentation that may be required.
- Any certificates you are holding for the account.
Sales or exchange requests received after the close of trading on the New
York Stock Exchange (generally 4:00 p.m. Eastern time) are processed at the next
business day's net asset value.
The Portfolio reserves the right to close any non-retirement or UGMA/UTMA
account whose balance falls below the minimum initial investment. The Portfolio
will deduct a $10 annual fee if your non-retirement account balance falls below
$2,500 or if your UGMA/UTMA account balance falls below $500. The fee is waived
if your total Vanguard Fund account assets are $50,000 or more.
SOME WRITTEN REQUESTS REQUIRE A SIGNATURE GUARANTEE FROM A BANK, BROKER,
OR OTHER ACCEPTABLE INSTITUTION. A NOTARY PUBLIC CANNOT PROVIDE A
SIGNATURE GUARANTEE.
HOW TO EXCHANGE SHARES
An exchange is the selling of shares of one Vanguard Fund to purchase shares of
another.
Although every effort will be made to maintain the exchange privilege,
Vanguard reserves the right to revise or terminate the exchange privilege, limit
the amount of an exchange, or reject any exchange, at any time, without notice.
Because excessive exchanges can potentially disrupt the management of the
Portfolio and increase transaction costs, Vanguard limits exchange activity to
TWO SUBSTANTIVE EXCHANGE REDEMPTIONS (at least 30 days apart) from the Portfolio
during any 12-month period.
INVESTOR INFORMATION 1-800-662-7447 CLIENT SERVICES 1-800-662-2739
TELE-ACCOUNT 1-800-662-6273
17
<PAGE> 22
REDEEMING SHARES (continued)
"Substantive" means either a dollar amount large enough to have a negative
impact on the Portfolio or a series of movements between Vanguard Funds.
Before you exchange into a new Vanguard Fund, please read its prospectus.
For a copy and for answers to questions you might have, please call Investor
Information.
SELLING OR EXCHANGING SHARES ACCOUNT TYPE
BY TELEPHONE ALL TYPES EXCEPT RETIREMENT:
[TELEPHONE ICON]
Call Vanguard Tele-Account* 24 hours a day --
1-800-662-6273 or Client Services during business hours -- to
Vanguard Tele-Account request a sale of shares. You cannot exchange
shares of this Portfolio by telephone.
1-800-662-2739 RETIREMENT:
Client Services You can exchange -- but not sell -- shares by
calling Tele-Account or Client Services.
*You must obtain a Personal Identification
Number through Tele-Account at least seven
days before you request your first sale of
shares.
BY MAIL ALL TYPES EXCEPT RETIREMENT:
[LETTER ICON]
Send a letter of instruction signed by all
FIRST-CLASS mail to: registered account holders. Include the
The Vanguard Group Portfolio name and account number and (if you
Vanguard REIT Index Portfolio are selling) a dollar amount or number of
P.O. Box 1120 shares OR (if you are exchanging) the name of
Valley Forge, PA 19482 the Fund you want to exchange into and a
dollar amount or number of shares.
EXPRESS OR REGISTERED mail to: RETIREMENT:
The Vanguard Group For information on how to request
Vanguard REIT Index Portfolio distributions from . . .
455 Devon Park Drive
Wayne, PA 19087
- IRAs, call Client Services.
- SEP-IRAs, 403(b)(7) custodial accounts, and
Profit-Sharing and Money Purchase Pension
(Keogh) Plans, call Individual Retirement
Services at 1-800-662-2003.
Depending on your account registration type,
additional documentation may be required.
AUTOMATICALLY ALL TYPES EXCEPT RETIREMENT:
[ARROW ICON] Vanguard offers several ways to sell or
exchange shares automatically (see "Services
and Account Features"). Call Investor
Information for the appropriate booklet and
application if you did not elect a feature
when you opened your account.
It is important that you call Vanguard before you redeem a large dollar
amount. We must consider the interests of all Portfolio shareholders and so
reserve the right to delay your redemption proceeds -- up to seven days -- if
the amount will disrupt the Portfolio's operation or performance.
INVESTOR INFORMATION 1-800-662-7447 CLIENT SERVICES 1-800-662-2739
TELE-ACCOUNT 1-800-662-6273
18
<PAGE> 23
REDEEMING SHARES (continued)
A NOTE ON UNUSUAL CIRCUMSTANCES
VANGUARD RESERVES THE RIGHT TO REVISE OR TERMINATE THE TELEPHONE REDEMPTION
PRIVILEGE AT ANY TIME, WITHOUT NOTICE. IN ADDITION, VANGUARD CAN STOP SELLING
SHARES OR POSTPONE PAYMENT AT TIMES WHEN THE NEW YORK STOCK EXCHANGE IS CLOSED
OR UNDER ANY EMERGENCY CIRCUMSTANCES AS DETERMINED BY THE UNITED STATES
SECURITIES AND EXCHANGE COMMISSION. IF YOU EXPERIENCE DIFFICULTY MAKING A
TELEPHONE REDEMPTION DURING PERIODS OF DRASTIC ECONOMIC OR MARKET CHANGE, YOU
CAN SEND US YOUR REQUEST BY REGULAR OR EXPRESS MAIL. FOLLOW THE INSTRUCTIONS ON
SELLING OR EXCHANGING SHARES BY MAIL IN THE "REDEEMING SHARES" SECTION.
FUND AND ACCOUNT UPDATES
STATEMENTS AND REPORTS
We will send you clear, concise account and tax statements to help you keep
track of your Portfolio account throughout the year as well as when you are
preparing your income tax returns.
In addition, you will receive financial reports about Vanguard REIT Index
Portfolio twice a year. These comprehensive reports include an assessment of the
Portfolio's performance (and a comparison to its industry benchmark), an
overview of the markets, a report from the adviser, as well as a listing of its
holdings and other financial statements.
CONFIRMATION STATEMENT Sent each time you buy, sell, or exchange
shares; confirms the date and the amount of
your transaction.
PORTFOLIO SUMMARY Mailed quarterly; shows the market value of
your account at the close of the statement
period, as well as distributions, purchases,
sales, and exchanges for the current
calendar year.
FUND FINANCIAL REPORTS Mailed in March and September for this
Portfolio.
TAX STATEMENTS Generally mailed in January; report previous
year's distributions, proceeds from the sale
of shares, and distributions from IRAs or
other retirement accounts.
AVERAGE COST STATEMENT Issued annually for taxable accounts; shows
[OPEN BOOK ICON] the average cost of shares that you redeemed
during the previous year, using the average
cost single category method.
AUTOMATED TELEPHONE ACCESS
VANGUARD TELE-ACCOUNT Toll-free access to Vanguard Fund and
1-800-662-6273 account information -- as well as some
transactions -- through any TouchTone(TM)
Any time, seven days a week, telephone. Tele-Account provides total
from anywhere in the continental return, share price, price change, and yield
United States and Canada. quotations for all Vanguard Funds; gives
your account balances and history (e.g.,
[OPEN BOOK ICON] last transaction and latest distribution);
and allows you to sell or exchange Fund
shares.
INVESTOR INFORMATION 1-800-662-7447 CLIENT SERVICES 1-800-662-2739
TELE-ACCOUNT 1-800-662-6273
19
<PAGE> 24
FUND AND ACCOUNT UPDATES (continued)
COMPUTER ACCESS
VANGUARD ONLINE(SM) Use your personal computer to learn more
about Vanguard Funds and services; keep in
Keyword: Vanguard touch with your Vanguard accounts; map out a
long-term investment strategy; and ask
questions, make suggestions, and send
messages to Vanguard. Vanguard Online is
offered through America Online(R) (AOL). To
establish an AOL account, call
1-800-238-6336.
VANGUARD ON THE Use your personal computer to visit
WORLD WIDE WEB Vanguard's education-oriented website, which
http://www.vanguard.com provides timely news and information about
Vanguard Funds and services; an online
"university" that offers a variety of mutual
fund classes; and easy-to-use, interactive
tools to help you create your own investment
and retirement strategies.
SHARES OF THE PORTFOLIO MAY ONLY BE SOLD IN THOSE STATES IN WHICH THEY ARE
REGISTERED. THE PORTFOLIO'S SHARES ARE CURRENTLY REGISTERED FOR SALE IN ALL 50
STATES, AND THE PORTFOLIO INTENDS TO MAINTAIN SUCH REGISTRATION.
INVESTOR INFORMATION 1-800-662-7447 CLIENT SERVICES 1-800-662-2739
TELE-ACCOUNT 1-800-662-6273
20
<PAGE> 25
GLOSSARY OF INVESTMENT TERMS
ACTIVE MANAGEMENT
An investment approach that seeks to exceed the average returns of the financial
markets. Active managers rely on research, market forecasts, and their own
judgment and experience in selecting securities to buy and sell.
CAPITAL GAINS DISTRIBUTION
Payment to mutual fund shareholders of gains realized on securities that the
fund has sold at a profit (minus any realized losses) or gains distributed by
the fund's holdings themselves.
COMMON STOCK
A security representing ownership rights in a corporation. A stockholder is
entitled to share in the company's profits, some of which are paid out as
dividends.
COST BASIS
The adjusted cost of an investment used to determine a capital gain or loss for
tax purposes.
DISTRIBUTIONS
Payments to shareholders of dividend income, capital gains, and return of
capital generated by the fund's investment activities and distribution policies,
after expenses.
DIVIDEND INCOME
Payment to shareholders of income from interest or dividends generated by the
fund's investments. For tax purposes, dividend income also includes short-term
capital gains.
EQUITY REIT
A type of real estate investment trust (REIT) that earns rental income by
investing in land and buildings.
EXPENSE RATIO
The percentage of a fund's average net assets used to pay its expenses. The
expense ratio includes management fees, administrative fees, and any 12b-1
marketing fees.
FIXED-INCOME SECURITIES
Investments, such as bonds, that have a fixed payment schedule. While the level
of income offered by these securities is predetermined, their prices may
fluctuate.
INDUSTRY CONCENTRATION
Focusing on the securities of a specific industry (such as real estate,
technology, or utilities).
LIQUIDITY
The degree of a security's marketability (that is, how quickly the security can
be sold at a fair price and converted to cash).
MUTUAL FUND
An investment company that pools the money of many people and invests it in a
variety of securities in an effort to achieve a specific objective over time.
PASSIVE MANAGEMENT
A low-cost investment strategy in which a mutual fund tries to match -- rather
than outperform -- a particular market index. Also known as indexing.
PRINCIPAL
The amount of your own money you put into an investment.
REAL ESTATE INVESTMENT TRUST (REIT)
A company that owns and manages a portfolio of properties, mortgages, or both.
RETURN OF CAPITAL
A non-taxable portion of distributions. In general, the cost basis of an
investment is reduced when a return of capital is distributed, deferring taxes
until the investment is sold.
TOTAL RETURN
A percentage change, over a specified time period, in a mutual fund's net asset
value, with the ending net asset value adjusted to account for the reinvestment
of all distributions of dividends and capital gains.
VOLATILITY
The fluctuations in value of a mutual fund or other security. The greater a
fund's volatility, the wider the fluctuations between its high and low prices.
YIELD
Current income (interest or dividends) earned by an investment, expressed as a
percentage of the investment's price.
<PAGE> 26
[THE VANGUARD GROUP LOGO]
Post Office Box 2600
Valley Forge, PA 19482
INVESTOR INFORMATION
DEPARTMENT
1-800-662-7447 (SHIP)
TEXT TELEPHONE:
1-800-952-3335
For information on our Funds,
Fund services, and retirement accounts; requests for
literature
CLIENT SERVICES DEPARTMENT
1-800-662-2739 (CREW)
TEXT TELEPHONE:
1-800-662-2738
For information on your
account, account transactions,
account statements
VANGUARD BROKERAGE
SERVICES
1-800-992-8327
For information on trading
stocks, bonds, and options
at reduced commissions
VANGUARD TELE-ACCOUNT(R)
1-800-662-6273 (ON-BOARD)
For 24-hour automated access
to price and yield, information
on your account, certain
transactions
ELECTRONIC ACCESS TO THE
VANGUARD MUTUAL FUND
EDUCATION AND INFORMATION
CENTER
On America Online(R)
Keyword: Vanguard
On the World Wide Web
http://www.vanguard.com
To send e-mail to Vanguard
[email protected]
(C) 1997 Vanguard Marketing
Corporation, Distributor
P123N
<PAGE> 27
PART B
VANGUARD SPECIALIZED PORTFOLIOS
STATEMENT OF ADDITIONAL INFORMATION
JANUARY 7, 1997
This Statement is not a prospectus but should be read in conjunction with
the Fund's current Prospectuses (dated May 13, 1996 [January 7, 1997 for the
REIT Index Portfolio]). To obtain the Prospectus please call the Investor
Information Department:
1-800-662-7447
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Investment Objectives and Policies........................................................ 1
Investment Policies....................................................................... 2
Investment Limitations.................................................................... 5
Management of the Fund.................................................................... 8
Investment Advisory Services.............................................................. 10
Securities Transactions................................................................... 12
Purchase of Shares........................................................................ 13
Redemption of Shares...................................................................... 13
Share Price of Each Portfolio............................................................. 13
Comparative Indexes....................................................................... 14
Yield and Total Return.................................................................... 16
Financial Statements...................................................................... 16
</TABLE>
INVESTMENT OBJECTIVES AND POLICIES
The following policies supplement the Fund's investment objectives and
policies set forth in the Prospectus.
FOREIGN INVESTMENTS As indicated in the Prospectus, each Portfolio may
include foreign securities to a certain extent. Investors should recognize that
investing in foreign companies involves certain special considerations which are
not typically associated with investing in U.S. companies. Since the stocks of
foreign companies are frequently denominated in foreign currencies, and since
the Portfolio may temporarily hold uninvested reserves in bank deposits in
foreign currencies, the Portfolio will be affected favorably or unfavorably by
changes in currency rates and in exchange control regulations, and may incur
costs in connection with conversions between various currencies. The investment
policies of each Portfolio permit it to enter into forward foreign currency
exchange contracts in order to hedge the Portfolio's holdings and commitments
against changes in the level of future currency rates. Such contracts involve an
obligation to purchase or sell a specific currency at a future date at a price
set at the time of the contract.
As foreign companies are not generally subject to uniform accounting,
auditing and financial reporting standards and practices comparable to those
applicable to domestic companies, there may be less publicly available
information about certain foreign companies than about domestic companies.
Securities of some foreign companies are generally less liquid and more volatile
than securities of comparable domestic companies. There is generally less
government supervision and regulation of stock exchanges, brokers and listed
companies than in the U.S. In addition, with respect to certain foreign
countries, there is the possibility of expropriation or confiscatory taxation,
political or social instability, or diplomatic developments which could affect
U.S investments in those countries.
Although each Portfolio will endeavor to achieve most favorable execution
costs in its portfolio transactions in foreign securities, fixed commissions on
many foreign stock exchanges are generally higher than
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<PAGE> 28
negotiated commissions on U.S. exchanges. In addition, it is expected that the
expenses for custodial arrangements of the Portfolio's foreign securities will
be somewhat greater than the expenses for the custodial arrangements for
handling U.S. securities of equal value.
Certain foreign governments levy withholding taxes against dividend and
interest income. Although in some countries a portion of these taxes is
recoverable, the non-recovered portion of foreign withholding taxes will reduce
the income the Portfolio receives from its foreign investments. However, these
foreign withholding taxes are not expected to have a significant impact on the
Portfolios, since each Portfolio's investment objective is to seek long-term
capital appreciation and any income should be considered incidental.
PORTFOLIO TURNOVER While the rate of Portfolio turnover is not a limiting
factor when management deems changes appropriate, it is anticipated that each
Portfolio's annual portfolio turnover rate will not normally exceed 100%. One
way a portfolio turnover rate of 100% can occur is if all of the Portfolio's
securities, exclusive of U.S. Government securities and other securities whose
maturities at the time of acquisition are one year or less, are replaced in the
period of one year. Turnover rates may vary greatly from year to year as well as
within a particular year and may also be affected by cash requirements for
redemptions of each Portfolio's shares and by requirements which enable the Fund
to receive certain favorable tax treatments. The portfolio turnover rates will,
of course, depend in large part on the level of purchases and redemptions of
shares of each Portfolio. Higher portfolio turnover can result in corresponding
increases in brokerage costs to the Portfolios of the Fund and their
shareholders.
INVESTMENT POLICIES
FUTURES CONTRACTS Each Portfolio may enter into futures contracts,
options, and options on futures contracts for several reasons: to maintain cash
reserves while remaining fully invested, to facilitate trading, to reduce
transaction costs, or to seek higher investment returns when a futures contract
is priced more attractively than the underlying equity security or index.
Futures contracts provide for the future sale by one party and purchase by
another party of a specified amount of a specific security at a specified future
time and at a specified price. Futures contracts which are standardized as to
maturity date and underlying financial instrument are traded on national futures
exchanges. Futures exchanges and trading are regulated under the Commodity
Exchange Act by the Commodity Futures Trading Commission ("CFTC"), a U.S.
Government Agency. Assets committed to futures contracts will be segregated at
the Fund's custodian bank to the extent required by law.
Although futures contracts by their terms call for actual delivery or
acceptance of the underlying securities, in most cases the contracts are closed
out before the settlement date without the making or taking of delivery. Closing
out an open futures position is done by taking an opposite position ("buying" a
contract which has previously been "sold," or "selling" a contract previously
purchased) in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
government securities with a broker or custodian to initiate and maintain open
positions in futures contracts. The Fund's margin deposits will be placed in a
segregated account maintained by the Fund's custodian bank. A margin deposit is
intended to assure completion of the contract (delivery or acceptance of the
underlying security) if it is not terminated prior to the specified delivery
date. Minimal initial margin requirements are established by the futures
exchange and may be changed. Brokers may establish deposit requirements which
are higher than the exchange minimums. Futures contracts are customarily
purchased and sold on margin which may range upward from less than 5% of the
value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked to market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Fund
expects to earn interest income on its margin deposits.
2
<PAGE> 29
Traders in futures contracts may be broadly classified as either "hedgers"
or "speculators." Hedgers use the futures markets primarily to offset
unfavorable changes in the value of securities otherwise held for investment
purposes or expected to be acquired by them. Speculators are less inclined to
own the securities underlying the futures contracts which they trade, and use
futures contracts with the expectation of realizing profits from fluctuations in
the prices of underlying securities.
Regulations of the CFTC applicable to the Fund require that all of its
futures transactions constitute bona fide hedging transactions. A Portfolio will
only sell futures contracts to protect securities it owns against price declines
or purchase contracts to protect against an increase in the price of securities
it intends to purchase. As evidence of this hedging interest, the Fund expects
that approximately 75% of its futures contract purchases will be "completed,"
that is, equivalent amounts of related securities will have been purchased or
are being purchased by the Portfolio upon sale of open futures contracts.
Although techniques other than the sale and purchase of futures contracts
could be used to control a Portfolio's exposure to market fluctuations, the use
of futures contracts may be a more effective means of hedging this exposure.
While a Portfolio will incur commission expenses in both opening and closing out
futures positions, these costs are lower than transaction costs incurred in the
purchase and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS A Portfolio will not enter
into futures contract transactions to the extent that, immediately thereafter,
the sum of its initial margin deposits on open contracts exceeds 5% of the
market value of its total assets. In addition, a Portfolio will not enter into
futures contracts to the extent that its outstanding obligations to purchase
securities under these contracts would exceed 20% of the its total assets.
RISK FACTORS IN FUTURES TRANSACTIONS Positions in futures contracts may be
closed out only on an Exchange which provides a secondary market for such
futures. However, there can be no assurance that a liquid secondary market will
exist for any particular futures contract at any specific time. Thus, it may not
be possible to close a futures position. In the event of adverse price
movements, a Portfolio would continue to be required to make daily cash payments
to maintain its required margin. In such situations, if the Portfolio has
insufficient cash, it may have to sell portfolio securities to meet daily margin
requirements at a time when it may be disadvantageous to do so. In addition, a
Portfolio may be required to make delivery of the instruments underlying futures
contracts it holds. The inability to close options and futures positions also
could have an adverse impact on the ability to effectively hedge.
Each Portfolio will minimize the risk that it will be unable to close out a
futures contract by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required, and the extremely
high degree of leverage involved in futures pricing. As a result, a relatively
small price movement in a futures contract may result in immediate and
substantial loss (as well as gain) to the investor. For example, if at the time
of purchase, 10% of the value of the futures contract is deposited as margin, a
subsequent 10% decrease in the value of the futures contract would result in a
total loss of the margin deposit, before any deduction for the transaction
costs, if the account were then closed out. A 15% decrease would result in a
loss equal to 150% of the original margin deposit if the contract were closed
out. Thus, a purchase or sale of a futures contract may result in losses in
excess of the amount invested in the contract. However, because the futures
strategies of the Fund are engaged in only for hedging purposes, the Adviser
does not believe that the Portfolios are subject to the risks of loss frequently
associated with futures transactions. A Portfolio would presumably have
sustained comparable losses if, instead of the futures contract, it had invested
in the underlying financial instrument and sold it after the decline.
Utilization of futures transactions by a Portfolio does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is also
possible that a Portfolio could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by a Portfolio of margin deposits in the
3
<PAGE> 30
event of bankruptcy of a broker with whom the Portfolio has an open position in
a futures contract or related option. Additionally, investments in futures
contracts and options involve the risk that the investment advisers will
incorrectly predict stock market and interest rate trends.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades may
be made on that day at a price beyond that limit. The daily limit governs only
price movement during a particular trading day and therefore does not limit
potential losses, because the limit may prevent the liquidation of unfavorable
positions. Futures contract prices have occasionally moved to the daily limit
for several consecutive trading days with little or no trading, thereby
preventing prompt liquidation of future positions and subjecting some futures
traders to substantial losses.
FEDERAL TAX TREATMENT OF FUTURES CONTRACTS Each Portfolio is required for
Federal income tax purposes to recognize as income for each taxable year its net
unrealized gains and losses on certain futures contracts as of the end of the
year as well as those actually realized during the year. In most cases, any gain
or loss recognized with respect to a futures contract is considered to be 60%
long-term capital gain or loss and 40% short-term capital gain or loss, without
regard to the holding period of the contract. Furthermore, sales of futures
contracts which are intended to hedge against a change in the value of
securities held by a Portfolio may affect the holding period of such securities
and, consequently, the nature of the gain or loss on such securities upon
disposition. A Portfolio may be required to defer the recognition of losses on
futures contracts to the extent of any unrecognized gains on related positions
held by the Portfolio.
In order for a Portfolio to continue to qualify for Federal income tax
treatment as a regulated investment company, at least 90% of its gross income
for a taxable year must be derived from qualifying income; i.e., dividends,
interest, income derived from loans of securities, gains from the sale of
securities or foreign currencies or other income derived with respect to the
Fund's business of investing in securities or currencies. In addition, gains
realized on the sale or other disposition of securities held for less than three
months must be limited to less than 30% of the Portfolio's annual gross income.
It is anticipated that any net gain realized from the closing out of futures
contracts will be considered gain from the sale of securities and therefore be
qualifying income for purposes of the 90% requirement. In order to avoid
realizing excessive gains on securities held less than three months, the
Portfolio may be required to defer the closing out of futures contracts beyond
the time when it would otherwise be advantageous to do so. It is anticipated
that unrealized gains on futures contracts, which have been open for less than
three months as of the end of the Portfolio's fiscal year and which are
recognized for tax purposes, will not be considered gains on sales of securities
held less than three months for the purpose of the 30% test.
A Portfolio will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes (including unrealized
gains at the end of the Fund's fiscal year) on futures transactions. Such
distributions will be combined with distributions of capital gains realized on
the Portfolio's other investments and shareholders will be advised on the nature
of the transactions.
REPURCHASE AGREEMENTS Each Portfolio may invest in repurchase agreements
with commercial banks, brokers or dealers either for defensive purposes due to
market conditions or to generate income from its excess cash balances. A
repurchase agreement is an agreement under which the Fund acquires a money
market instrument (generally a security issued by the U.S Government or an
agency thereof, a banker's acceptance or a certificate of deposit) from a
commercial bank, broker or dealer, subject to resale to the seller at an agreed
upon price and date (normally, the next business day). A repurchase agreement
may be considered a loan collateralized by securities. The resale price reflects
an agreed upon interest rate effective for the period the instrument is held by
the Portfolio and is unrelated to the interest rate on the underlying
instrument. In these transactions, the securities acquired by the Portfolio
(including accrued interest earned thereon) must have a total value in excess of
the value of the repurchase agreement and are held by a custodian bank until
repurchased. In addition, the Fund's Board of Directors will monitor each
Portfolio's repurchase agreement transactions generally and will establish
guidelines and standards for review by the investment adviser of the
4
<PAGE> 31
creditworthiness of any bank, broker or dealer party to a repurchase agreement
with any Portfolio of the Fund. No more than an aggregate of 15% of a
Portfolio's assets, at the time of investment, will be invested in repurchase
agreements having maturities longer than seven days and securities subject to
legal or contractual restrictions on resale for which there are no readily
available market quotations. From time to time, the Fund's Board of Directors
may determine that certain restricted securities known as Rule 144A securities
are liquid and not subject to the 15% limitation described above.
The use of repurchase agreements involves certain risks. For example, if
the other party to the agreement defaults on its obligation to repurchase the
underlying security at a time when the value of the security has declined, the
Portfolio may incur a loss upon disposition of the security. If the other party
to the agreement becomes insolvent and subject to liquidation or reorganization
under the Bankruptcy Code or other laws, a court may determine that the
underlying security is collateral for a loan by the Portfolio not within the
control of the Portfolio and therefore the realization by the Portfolio on such
collateral may be automatically stayed. Finally, it is possible that the
Portfolio may not be able to substantiate its interest in the underlying
security and may be deemed an unsecured creditor of the other party to the
agreement. While the Fund's management acknowledges these risks, it is expected
that they can be controlled through careful monitoring procedures.
LENDING OF SECURITIES Each Portfolio may lend its securities on a
short-term basis or long-term basis to qualified institutional investors who
need to borrow securities in order to complete certain transactions, such as
covering short sales, avoiding failures to deliver securities or completing
arbitrage operations. By lending its securities, the Portfolio will be
attempting to increase its net investment income through the receipt of interest
on the loan. Any gain or loss in the market price of the securities loaned that
might occur during the term of the loan would be for the account of the
Portfolio. Each Portfolio may lend its portfolio securities to qualified
brokers, dealers, banks or other financial institutions, so long as the terms,
the structure and the aggregate amount of such loans are not inconsistent with
the Investment Company Act of 1940, or the Rules and Regulations or
interpretations of the Securities and Exchange Commission (the "Commission")
thereunder, which currently require that (a) the borrower pledge and maintain
with the Fund collateral consisting of cash, an irrevocable letter of credit or
securities issued or guaranteed by the United States Government having a value
at all times not less than 100% of the value of the securities loaned, (b) the
borrower add to such collateral whenever the price of the securities loaned
rises (i.e., the borrower "marks to the market" on a daily basis), (c) the loan
be made subject to termination by the Portfolio at any time and (d) the
Portfolio receives reasonable interest on the loan which may include the
Portfolio's investing any cash collateral in interest bearing short-term
investments, any distribution on the loaned securities and any increase in their
market value. A Portfolio will not lend its portfolio securities, if as a
result, the aggregate value of such loans exceeds 33 1/3% of the value of the
Portfolio's total assets. Loan arrangements made by a Portfolio will comply with
all other applicable regulatory requirements, including the rules of the New
York Stock Exchange, which rules presently require the borrower, after notice,
to redeliver the securities within the normal settlement time of three business
days. All relevant facts and circumstances, including the creditworthiness of
the broker, dealer or institution, will be considered in making decisions with
respect to the lending of securities, subject to review by the Fund's Board of
Directors.
At the present time, the Staff of the Commission does not object if an
investment company pays reasonably negotiated fees in connection with loaned
securities, so long as such fees are set forth in a written contract and
approved by the investment company's Directors (Trustees). In addition, voting
rights pass with the loaned securities, but if a material event will occur
affecting an investment on loan, the loan must be called and the securities
voted.
INVESTMENT LIMITATIONS
The following policies supplement the Fund's investment limitations set
forth in the Prospectus. It is a fundamental policy of each Portfolio not to
engage in any of the following activities or business practices. These
restrictions may not be changed with respect to a particular Portfolio without
the approval of a majority
5
<PAGE> 32
of the outstanding shares (as defined in the Investment Company Act of 1940 (the
"1940 Act")) of that Portfolio. A Portfolio may not:
1) Issue senior securities;
2) Borrow money, except from banks (or through reverse repurchase
agreements), for temporary or emergency (not leveraging) purposes,
including the meeting of redemption requests which might otherwise
require the untimely disposition of securities, in an amount not in
excess of 15% of the value of the net assets of the Portfolio
(including the amount borrowed and the value of any outstanding reverse
repurchase agreements) at the time the borrowing is made. Whenever
borrowings exceed 5% of the value of the net assets of the Portfolio,
the Portfolio will not make any additional investments;
3) With respect to 75% of the value of its total assets, purchase the
securities of any issuer (except obligations of the United States
government and its instrumentalities) if as a result the Portfolio
would hold more than 10% of the outstanding voting securities of the
issuer, or more than 5% of the value of the Portfolio's total assets
would be invested in the securities of such issuer;
4) Engage in the business of underwriting securities issued by others,
except to the extent that the Portfolio may technically be deemed to be
an underwriter under the Securities Act of 1933, as amended, in
disposing of portfolio securities;
5) Purchase or otherwise acquire any security if, as a result, more than
15% of its net assets would be invested in securities that are illiquid
(including the Fund's investment in The Vanguard Group, Inc., as
described on page 9);
6) Make loans except (i) by purchasing bonds, debentures or similar
obligations (including repurchase agreements, subject to the limitation
described in (5) above) which are either publicly distributed or
customarily purchased by institutional investors, and (ii) by lending
its securities to banks, brokers, dealers and other financial
institutions so long as such loans are not inconsistent with the
Investment Company Act or the Rules and Regulations or interpretations
of the Commission thereunder and the aggregate value of all securities
loaned does not exceed 33 1/3% of the market value of the Portfolio's
total assets;
7) Pledge, mortgage, or hypothecate its assets, except to secure
borrowings permitted by limitation (2) above;
8) Buy any securities or other property on margin (except for such
short-term credits as are necessary for the clearance of transactions),
or engage in short sales (unless by virtue of its ownership of other
securities it has a right to obtain at no added cost securities
equivalent in kind and amount to the securities sold) except as set
forth below in (12);
9) Purchase or sell puts or calls, or combinations thereof; provided
however, that a Portfolio may enter into forward foreign currency
exchange transactions except as set forth below in (12);
10) Purchase or sell real estate or real estate limited partnerships
(although it may purchase securities secured by real estate or
interests therein, or issued by companies or investment trusts which
invest in real estate or interests therein), except in the case of the
REIT Index Portfolio which may invest 100% of its assets in real estate
investment trusts;
11) The Fund will not invest in securities of other investment companies,
except as may be acquired as a part of a merger, consolidation or
acquisition of assets approved by the Fund's shareholders or otherwise
to the extent permitted by Section 12 of the 1940 Act. The Fund will
invest only in investment companies which have investment objectives
and investment policies consistent with those of the Fund;
12) Purchase or sell commodities or commodity contracts; provided, however,
that a Portfolio may enter into forward foreign currency exchange
transactions and that each Portfolio may invest in futures contracts
and options to the extent that not more than 5% of the portfolios
assets are required as
6
<PAGE> 33
deposit to secure obligations under futures contracts and not more than
20% of a portfolio's assets are invested in futures contracts and
options at any time, the Portfolio may also invest in bullion as
described in the prospectus;
13) Purchase or retain securities of an issuer if an officer or director of
such issuer is an officer or Director of the Fund or its investment
adviser and one or more of such officers or Directors of the Fund or
its investment adviser owns beneficially more than 1/2% of such shares
or securities of such issuer and all such directors and officers owning
more than 1/2% of such shares or securities together own more than 5%
of such shares or securities; and
14) Invest in companies for the purpose of exercising control of
management.
Notwithstanding these limitations, the Fund may own all or any portion of
the securities of, make loans to, or contribute to the costs or other financial
requirements of, any company which will be wholly owned by the Fund and one or
more other investment companies and is primarily engaged in the business of
providing at cost services, such as management, administrative, distribution or
other related services to the Fund and other investment companies. (See
"Management of the Fund").
In addition, no Portfolio may engage in any of the following activities;
however, these restrictions may be changed by the Directors without shareholder
approval or prior notification:
1) Invest directly in oil, gas, or other mineral exploration or
development programs, including oil & gas or other mineral leases;
provided, however, that if consistent with the designated business
activities of a particular Portfolio, a Portfolio may purchase
securities of issuers whose principal business activities fall within
such areas;
2) Purchase warrants, valued at the lower of cost or market, in excess of
5% of the value of the Fund's net assets. Including within that amount,
but not to exceed 2% of the value of the Fund's net assets, may be
warrants which are not listed on the New York or American Stock
Exchange. Warrants acquired by a Portfolio at any time in units or
attached to securities are not subject to this restriction;
3) Invest more than 5% of its assets, at the time of investment, in the
securities of any issuers which have records of less than three years'
continuous operation, including the operation of any predecessor (other
than obligations issued or guaranteed as to interest and principal by
the U.S. Government or its agencies or instrumentalities).
In order to permit the sale of shares of the Fund in certain states, the
Fund may make commitments more restrictive than the fundamental or
non-fundamental operating restrictions described above. Should the Fund
determine that any such commitment is no longer in the best interests of the
Fund and its shareholders, it will revoke the commitment by terminating sales of
its shares in the state(s) involved.
The above-mentioned investment limitations are considered at the time
investment securities are purchased.
7
<PAGE> 34
MANAGEMENT OF THE FUND
The Officers of the Fund manage its day-to-day operations and are
responsible to the Fund's Board of Directors. The Directors set broad policies
for each Fund and choose its Officers. The following is a list of the Directors
and Officers of the Funds and a statement of their present positions and
principal occupations during the past five years. The mailing address of the
Directors and Officers of the Fund is Post Office Box 876, Valley Forge, PA
19482.
DIRECTORS AND OFFICERS
<TABLE>
<S> <C>
JOHN C. BOGLE, Chairman and Director* JOHN C. SAWHILL, Director
Chairman and Director of The Vanguard Group, President and Chief Executive Officer, The
Inc. and of each of the investment companies Nature Conservancy; formerly, Director and
in The Vanguard Group; Director of The Mead Senior Partner, McKinsey & Co.; and
Corporation, General Accident Insurance, and President, New York University; Director of
Chris-Craft Industries, Inc. Pacific Gas and Electric Company, Procter &
JOHN J. BRENNAN, President, Chief Executive Gamble Company, and NACCO Industries.
Officer and Director* JAMES O. WELCH, JR., Director
President, Chief Executive Officer and Retired Chairman of Nabisco Brands, Inc.,
Director of The Vanguard Group, Inc. and of retired Vice Chairman and Director of RJR
each of the investment companies in The Nabisco; Director of TECO Energy, Inc.; and
Vanguard Group. Director of Kmart Corporation.
ROBERT E. CAWTHORN, Director J. LAWRENCE WILSON, Director
Chairman Emeritus and Director of Chairman and Chief Executive Officer of Rohm &
Rhone-Poulenc Rorer, Inc.; Director of Sun Haas Company; Director of Cummins Energy
Company, Inc.; Director of Westinghouse Company; and Trustee of Vanderbilt
Electric Corporation. University.
BARBARA BARNES HAUPTFUHRER, Director RAYMOND J. KLAPINSKY, Secretary*
Director of The Great Atlantic and Pacific Senior Vice President and Secretary of The
Tea Company, Alco Standard Corp., Raytheon Vanguard Group, Inc.; Secretary of each of the
Company, Knight-Ridder, Inc., and investment companies in The Vanguard Group.
Massachusetts Mutual Life Insurance Co. and
trustee Emerita of Wellesley College. RICHARD F. HYLAND, Treasurer*
Treasurer of The Vanguard Group, Inc. and of
BRUCE K. MACLAURY, Director each of the investment companies in The
President Emeritus, The Brookings Vanguard Group.
Institution; Director of American Express
Bank, Ltd., The St. Paul Companies, Inc. and KAREN E. WEST, Controller*
National Steel Corporation. Principal of The Vanguard Group, Inc.;
Controller of each of the investment companies
BURTON G. MALKIEL, Director in The Vanguard Group.
Chemical Bank Chairman's Professor of ---------------
Economics, Princeton University; Director of *Officers of the Fund are "interested persons"
Prudential Insurance Co. of America, Amdahl as defined in the Investment Company Act of
Corporation, Baker Fentress & Co., The 1940.
Jeffrey Co. and Southern New England
Communications Company.
ALFRED M. RANKIN, JR., Director
Chairman, President and Chief Executive
Officer of NACCO Industries, Inc.; Director
of The BFGoodrich Company, and The Standard
Products Company.
</TABLE>
THE VANGUARD GROUP The Fund is a member of The Vanguard Group of
Investment Companies which consists of more than 30 investment companies.
Through their jointly-owned subsidiary, The Vanguard Group, Inc. ("Vanguard"),
the Vanguard Funds obtain at cost virtually all of their corporate management,
administrative and distribution services.
Vanguard employs a supporting staff of management personnel needed to
provide the requisite services to the Funds and also furnishes the Funds with
necessary office space, furnishings and equipment. Each Fund pays its share of
Vanguard's net expenses which are allocated among the Funds under procedures
approved by the Directors (Trustees) of each Fund. In addition, each Fund bears
its own direct expenses such as legal, auditing and custodian fees.
The Officers of the Fund and the Vanguard Funds are also Officers and
employees of Vanguard. No Officer or employee is permitted to own any securities
of any external adviser for the Vanguard Funds.
8
<PAGE> 35
The Vanguard Group adheres to a Code of Ethics established pursuant to Rule
17j-1 under the Investment Company Act of 1940. The Code is designed to prevent
unlawful practices in connection with the purchase or sale of securities by
persons associated with Vanguard. Under Vanguard's Code of Ethics certain
officers and employees of Vanguard who are considered access persons are
permitted to engage in personal securities transactions. However, such
transactions are subject to procedures and guidelines substantially similar to
those recommended by the mutual fund industry and approved by the U.S.
Securities and Exchange Commission.
The Vanguard Group was established and operates under a Funds' Service
Agreement which was approved by the shareholders of each of the Funds. The
amounts which each of the Funds have invested are adjusted from time to time in
order to maintain the proportionate relationship between each Fund's relative
net assets and its contribution to Vanguard's capital. At January 31, 1996, and
July 31, 1996, the Fund had contributed capital of $378,000, and $421,000 to
Vanguard representing 1.9%, and 2.1% of its capitalization. The Fund's Service
Agreement provides as follows: (a) each Vanguard Fund may invest up to .40% of
its current assets in Vanguard, and (b) there is no other limitation on the
amount that each Vanguard Fund may contribute to Vanguard's capitalization.
MANAGEMENT Corporate management and administrative services include: (1)
executive staff; (2) accounting and financial; (3) legal and regulatory; (4)
shareholder account maintenance; (5) monitoring and control of custodian
relationships; (6) shareholder reporting; and (7) review and evaluation of
advisory and other services provided to the Vanguard Funds by third parties.
During the fiscal year ended January 31, 1996, and the six months ended July 31,
1996, the Fund's share of Vanguard's actual net costs of operation relating to
management and administrative services (including transfer agency) totaled
approximately $8,663,000, and $4,924,000.
DISTRIBUTION Vanguard also provides all distribution and marketing
services for the Vanguard Funds. The principal distribution expenses are for
advertising, promotional materials and marketing personnel. Distribution
services may also include organizing and offering to the public, from time to
time, one or more new investment companies which will become members of the
Group. The Directors and Officers of Vanguard determine the amount to be spent
annually on distribution activities, the manner and amount to be spent on each
Fund, and whether to organize new investment companies. During the fiscal year
ended January 31, 1996, and the six months ended July 31, 1996, the Fund paid
approximately $552,000, and $387,000 of the Group's distribution and marketing
expenses, which represented an effective annual rate of .02 of 1%, and .01 of 1%
of the Fund's average net assets.
One half of the distribution expenses of a marketing and promotional nature
is allocated among the Vanguard Funds based upon their relative net assets. The
remaining one half of these expenses is allocated among the Vanguard Funds based
upon each Fund's sales for the preceding 24 months relative to the total sales
of the Funds as a Group. Provided, however, that no Fund's aggregate quarterly
rate of contribution for distribution expenses of a marketing and promotional
nature shall exceed 125% of the average distribution expense rate for the Group,
and that no Fund shall incur annual distribution expenses in excess of 20/100 of
1% of its average month-end net assets.
INVESTMENT ADVISORY SERVICES Vanguard provides Vanguard Money Market
Reserves, Vanguard Admiral Funds, Vanguard Municipal Bond Fund, the several
Portfolios of Vanguard Fixed Income Securities Fund, Vanguard Institutional
Index Fund, Vanguard Bond Index Fund, several Portfolios of Vanguard Variable
Insurance Fund, Vanguard California Tax-Free Fund, Vanguard Florida Insured
Tax-Free Fund, Vanguard New Jersey Tax-Free Fund, Vanguard New York Insured
Tax-Free Fund, Vanguard Ohio Tax-Free Fund, Vanguard Pennsylvania Tax-Free Fund,
Vanguard Balanced Index Fund, Vanguard Index Trust, Vanguard International
Equity Index Fund, Vanguard Tax-Managed Fund, the Total International Portfolio
of Vanguard STAR Fund, the Aggressive Growth Portfolio of Vanguard Horizon Fund,
the REIT Index Portfolio of Vanguard Specialized Portfolios, a portion of
Vanguard/Windsor II, and a portion of Vanguard/Morgan Growth Fund, as well as
several indexed separate accounts with investment advisory services. These
services are provided on an at-cost basis from a money management staff employed
directly by Vanguard. The compensation and other expenses of this staff are paid
by the Funds utilizing these services.
9
<PAGE> 36
REMUNERATION OF DIRECTORS AND OFFICERS The Fund pays each Director who is
not also an Officer, an annual fee plus travel and other expenses incurred in
attending Board meetings. During the year ended January 31, 1996, the Fund paid
approximately $12,000 in Director's fees. Directors who are also Officers
receive no remuneration for their services as Directors. The Fund's Officers and
employees are paid by Vanguard which, in turn, is reimbursed by the Fund, and
each other Fund in the Group, for its proportionate share of Officers' and
employees' salaries and retirement benefits. The Fund's proportionate share of
remuneration paid by Vanguard (and reimbursed by the Fund) during the fiscal
year to all Officers of the Fund, as a group, was approximately $106,098.
Under its Retirement Plan, Vanguard contributes annually an amount equal to
10% of each Officer's annual compensation plus 5.7% of that part of an eligible
Officer's compensation during the year, if any, that exceeds the Social Security
Taxable Wage Base then in effect. Under its Thrift Plan, all employees of
Vanguard are permitted to make pre-tax basic contributions in a maximum amount
equal to 4% of total compensation. Vanguard matches the basic contributions on a
100% basis. The Fund's proportionate share of benefits paid by Vanguard under
its Retirement and Thrift Plans to all Officers of the Fund, as a group, during
the fiscal year ended January 31, 1996 was approximately $2,850.
The following table provides detailed information with respect to the
amounts paid or accrued for the Directors for the fiscal year ended January 31,
1996.
VANGUARD SPECIALIZED PORTFOLIOS
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL COMPENSATION
PENSION OR RETIREMENT FROM ALL
AGGREGATE BENEFITS ACCRUED ESTIMATED ANNUAL VANGUARD FUNDS
COMPENSATION AS PART OF BENEFITS PAID TO
NAMES OF DIRECTORS FROM FUND FUND EXPENSES UPON RETIREMENT DIRECTORS(2)
- ---------------------------- ------------ --------------------- ---------------- -------------------
<S> <C> <C> <C> <C>
John C. Bogle(1) -- -- -- --
John J. Brennan(1) -- -- -- --
Barbara Barnes Hauptfuhrer $1,295 $ 222 $ 15,000 $59,000
Robert E. Cawthorn $1,295 $ 185 $ 13,000 $59,000
Bruce K. MacLaury $1,428 $ 218 $ 12,000 $55,000
Burton G. Malkiel $1,317 $ 148 $ 15,000 $60,000
Alfred M. Rankin, Jr. $1,317 $ 117 $ 15,000 $60,000
John C. Sawhill $1,317 $ 138 $ 15,000 $60,000
James O. Welch, Jr. $1,295 $ 170 $ 15,000 $59,000
J. Lawrence Wilson $1,317 $ 123 $ 15,000 $60,000
</TABLE>
- ---------------
(1) As "Interested Directors," Messrs. Bogle and Brennan receive no compensation
for their service as Directors.
(2) The amounts reported in this column reflect the total compensation paid to
each Director for their service as Director or Trustee of 34 Vanguard Funds
(33 in the case of Mr. Malkiel; 27 in the case of Mr. MacLaury).
DIRECTORS' RETIREMENT FEES A Retirement Plan for Directors has been
implemented to provide a fee to retired Directors equal to $1,000 per year of
service on the Board, up to 15 years of service. This fee will remain in place
subsequent to the Director's retirement for a period of 10 years or until a
retired Director's death.
INVESTMENT ADVISORY SERVICES
INVESTMENT ADVISORY AGREEMENT WITH WELLINGTON MANAGEMENT COMPANY, LLP The
Fund employs Wellington Management Company, LLP ("WMC") under an investment
advisory agreement dated as of May 1, 1996 to manage the investment and
reinvestment of the assets of the Fund's Energy, Health Care, and Utilities
Income Portfolios and to continuously review, supervise and administer each
Portfolio's investment program. WMC discharges its responsibilities subject to
the control of the officers and Directors of the Fund.
10
<PAGE> 37
Under the investment advisory agreement, the three Portfolios are required
to pay the Adviser an aggregate fee at the end of each fiscal quarter,
calculated by applying a quarterly rate, based on the following annual
percentage rates, to the aggregate average month-end net assets of the
Portfolios for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
-------------------------------------------------------------------------------- ------
<S> <C>
First $500 million.............................................................. 0.150%
Next $500 million............................................................... 0.125%
Next $1 billion................................................................. 0.100%
Next $1 billion................................................................. 0.075%
Over $3 billion................................................................. 0.050%
</TABLE>
The advisory fee is based on the total assets of the Portfolios and is
allocated to each Portfolio based on the relative net assets of each. In
addition, once the advisory fee to WMC is calculated for the three Portfolios
under this schedule, the total fee will be reduced in order that the advisory
fee paid by the Utilities Income Portfolio does not exceed 0.125%. During the
years ended January 31, 1994, 1995, 1996, and the six months ended July 31,
1996, the Fund paid to WMC advisory fees totaling $2,079,000 $2,192,000,
$2,698,000, and $1,581,000 respectively, which represented an effective annual
rate of .14 of 1%, .14 of 1%, .12 of 1% and .10 of 1% respectively, of the
aggregate average net assets of the Energy, Health Care, and Utilities Income
Portfolios. These fees were paid pursuant to the terms of a previous investment
advisory agreement, which called for a higher rate of fees.
WMC's fees during the fiscal years ended January 31, 1994 were payable
under a prior investment advisory agreement. The assets on which advisory fees
for the 1994 fiscal year were based included the Service Economy and Technology
Portfolios, which are no longer in existence.
DESCRIPTION OF WMC WMC is a Massachusetts general partnership, of which
the following persons are managing partners: Robert W. Doran, Duncan M.
McFarland, and John R. Ryan.
INVESTMENT ADVISORY AGREEMENT WITH M & G GROUP P.L.C. The Fund has also
entered into an investment advisory agreement with M & G Investment Management
Limited ("M & G"), effective February 1, 1987 to manage the assets of the Gold &
Precious Metals Portfolio. Under this agreement M & G manages the investment and
reinvestment of the assets of the Gold & Precious Metals Portfolio and
continuously renews, supervises and administers the Portfolio's investment
program. M & G will discharge its responsibilities subject to the control of the
officers and Directors of the Fund.
DESCRIPTION OF M & G M & G is a wholly-owned subsidiary of the M & G Group
P.L.C. M & G Group P.L.C. is a public company whose shares are quoted on the
London Stock Exchange. Kleinwort, Benson Limited, a merchant bank, and the Esmee
Fairbairn Charitable Trust own respectively 42% and 32% of
total shares outstanding. The remaining 26% of shares are held by individuals,
nominees, pension plans and
M & G employees.
The Gold & Precious Metals Portfolio will pay M & G a fee at the end of
each fiscal quarter, calculated by applying a quarterly rate, based on the
following annual percentage rates, to the aggregate average month-end net assets
of the Portfolio for the quarter:
<TABLE>
<CAPTION>
NET ASSETS RATE
-------------------------------------------------------------------------------- ------
<S> <C>
First $100 million.............................................................. 0.30%
Next $300 million............................................................... 0.25%
Over $400 million............................................................... 0.20%
</TABLE>
During the years ended January 31, 1994, 1995, 1996, and the six months
ended July 31, 1996 the Gold & Precious Metals Portfolio paid advisory fees of
$924,000, $1,116,000, $1,058,000, and $552,000 respectively, to M & G which
represented an effective annual rate of .22 of 1%, .17 of 1% after giving effect
to a fee waiver of (.07 of 1%), .18 of 1% after giving effect to a fee waiver of
$364,000 (.06 of 1%), and .18 of 1% after giving effect to a fee waiver of
$201,000 (.06 of 1%), respectively, of average net assets.
INVESTMENT ADVISORY SERVICES Vanguard also provides investment advisory
services to Vanguard Municipal Bond Fund, Vanguard Admiral Funds, Vanguard
Balanced Index Fund, several Portfolios of Vanguard Variable Insurance Fund,
Vanguard Bond Index Fund, Vanguard Index Trust, Vanguard Institutional
11
<PAGE> 38
Index Fund, Vanguard Money Market Reserves, several Portfolios of Vanguard Fixed
Income Securities Fund, Vanguard Tax-Managed Fund, the Total International
Portfolio of Vanguard STAR Fund, the Aggressive Growth Portfolio of Vanguard
Horizon Fund, the REIT Index Portfolio of Vanguard Specialized Portfolios,
Vanguard California Tax-Free Fund, Florida Insured Tax-Free Fund, New Jersey
Tax-Free Fund, New York Insured Tax-Free Fund, Ohio Tax-Free Fund, Pennsylvania
Tax-Free Fund, a portion of the assets of Vanguard/Windsor II, a portion of
Vanguard/Morgan Growth Fund and several indexed separate accounts. These
services are provided on an at-cost basis from money management staff employed
directly by Vanguard. The compensation and other expenses of this staff are paid
by the Funds utilizing these services.
The current agreements will continue until April 30, 1998, with respect to
WMC and January 31, 1997, with respect to M & G, and will be renewable
thereafter, for successive one-year periods, only if each renewal is
specifically approved by a vote of the Fund's Board of Directors, including the
affirmative votes of a majority of the Directors who are not parties to the
agreement or "interested persons" (as defined in the Investment Company Act of
1940) of any such party cast in person at a meeting called for the purpose of
considering such approval. In addition, the question of continuance of the
agreement may be presented to the shareholders of the Fund; in such event,
continuance shall be effected only if approved by the affirmative vote of a
majority of the outstanding voting securities of the Fund. If the holders of any
Portfolio fail to approve the agreement, WMC or M & G may continue to serve as
investment adviser to each Portfolio which approved the agreement, and to any
Portfolio which did not approve the agreement until new arrangements have been
made. The agreement is automatically terminated if assigned, and may be
terminated by any Portfolio without penalty, at any time, (1) either by vote of
the Board of Directors or by vote of the outstanding voting securities of the
Portfolio on sixty (60) days' written notice to WMC or M & G, or (2) by WMC or M
& G upon ninety (90) days' written notice to the Fund.
SECURITIES TRANSACTIONS
The investment advisory agreements with WMC and M & G authorize the
investment advisers (with the approval of the Fund's Board of Directors) to
select the brokers or dealers that will execute the purchases and sales of
securities for the Fund's Portfolio(s) and directs the investment adviser to use
its best efforts to obtain the best available price and most favorable execution
with respect to all transactions for the Portfolio(s). Each investment adviser
has undertaken to execute each investment transaction at a price and commission
which provides the most favorable total cost or proceeds reasonably obtainable
under the circumstances.
In placing portfolio transactions, each investment adviser will use its
best judgment to choose the broker most capable of providing the brokerage
services necessary to obtain best available price and most favorable execution.
The full range and quality of brokerage services available will be considered in
making these determinations. In those instances where it is reasonably
determined that more than one broker can offer the brokerage services needed to
obtain the best available price and most favorable execution, consideration may
be given to those brokers which supply investment research and statistical
information, and provide other services in addition to execution services to the
Fund and/or the investment adviser. Each investment adviser considers the
investment services it receives useful in the performance of its obligations
under the agreement but is unable to determine the amount by which such services
may reduce its expenses.
The investment advisory agreements also incorporate the concepts of Section
28(e) of the Securities Exchange Act of 1934 by providing that, subject to the
approval of the Fund's Board of Directors, each investment adviser may cause the
Fund to pay a broker-dealer which furnishes brokerage and research services a
higher commission than that which might be charged by another broker-dealer for
effecting the same transaction; provided that such commission is deemed
reasonable in terms of either that particular transaction or the overall
responsibilities of the investment adviser to the Fund and the other Funds in
the Group.
Currently, it is the Fund's policy that each investment adviser may at
times pay higher commissions in recognition of brokerage services felt necessary
for the achievement of better execution of certain securities transactions that
otherwise might not be available. An investment adviser will only pay such
higher commissions if it believes this to be in the best interest of the Fund.
Some brokers or dealers who may receive such higher commissions in recognition
of brokerage services related to execution of securities transactions are
12
<PAGE> 39
also providers of research information to the investment adviser and/or the
Fund. However, the investment adviser has informed the Fund that it will not pay
higher commission rates specifically for the purpose of obtaining research
services.
Since the Fund does not market its shares through intermediary brokers or
dealers, it is not the Fund's practice to allocate brokerage or principal
business on the basis of sales of its shares which may be made through such
firms. However, the Fund may place portfolio orders with qualified
broker-dealers who recommend the sale of shares of the Fund and may, when a
number of brokers and dealers can provide comparable best price and execution on
a particular transaction, consider the sale of Fund shares by a broker or dealer
in selecting among qualified broker-dealers.
The total brokerage commissions paid by each of the Fund's Portfolios
during the fiscal years ended January 31, 1994, 1995 and 1996 totaled
$3,334,211, $2,225,321 and $3,080,278 respectively.
Some securities considered for investment by one Portfolio may also be
appropriate for the other Portfolios and the other Funds and/or clients served
by the investment advisers. If purchase or sale of securities consistent with
the investment policies of a Portfolio, the other Portfolios and/or one or more
of these other Funds or clients are considered at or about the same time,
transactions in such securities will be allocated among the Portfolios and the
several Funds and clients in a manner deemed equitable by the respective
investment adviser. Although there will be no specified formula for allocating
such transactions, the allocation methods used, and the results of such
allocations, will be subject to periodic review by the Fund's Board of
Directors.
PURCHASE OF SHARES
The Fund reserves the right in its sole discretion (i) to suspend the
offering of its shares, (ii) to reject purchase orders when in the judgment of
management such rejection is in the best interest of the Fund or any Portfolio,
and (iii) to reduce or waive the minimum investment for or any other
restrictions on initial and subsequent investments for certain fiduciary
accounts such as employee benefit plans or under circumstances where certain
economies can be achieved in sales of the Fund's shares.
STOCK CERTIFICATES Your purchase will be made in full and fractional
shares of a Portfolio calculated to three decimal places. Shares are normally
held on deposit for shareholders by the Fund, which will send to shareholders a
statement of shares owned at the time of each transaction. This saves the
shareholders the trouble of safekeeping the certificates, and saves the Fund the
cost of issuing certificates. Except in the case of the Utilities Income
Portfolio, share certificates are available at any time upon written request at
no additional cost to shareholders. No certificates will be issued for the
Utilities Income Portfolio or for any fractional shares of the Fund's other
Portfolios.
REDEMPTION OF SHARES
The Fund may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange is closed, or trading on
the Exchange is restricted as determined by the Securities and Exchange
Commission (the "Commission"), (ii) during any period when an emergency exists
as defined by the rules of the Commission as a result of which it is not
reasonably practicable for the Fund to dispose of securities owned by it, or
fairly to determine the value of its assets, and (iii) for such other periods as
the Commission may permit.
The Fund has made an election with the Commission to pay in cash all
redemptions requested by any shareholder of record limited in amount during any
90-day period to the lesser of $250,000 or 1% or the net assets of the Fund at
the beginning of such period. Such commitment is irrevocable without the prior
approval of the Commission. Redemptions in excess of the above limits may be
paid in whole or in part, in investment securities or in cash, as the Directors
may deem advisable; however, payment will be made wholly in cash unless the
Directors believe that economic or market conditions exist which would make a
practice detrimental to the best interests of the Fund. If redemptions are paid
in investment securities, such securities will be
13
<PAGE> 40
valued as set forth in the Prospectus under "The Share Price of Each Portfolio"
and a redeeming shareholder would normally incur brokerage expenses if he
converted these securities to cash.
SHARE PRICE OF EACH PORTFOLIO
The share price or "net asset value" per share of each Portfolio is
computed once each day at the close of regular trading on the New York Stock
Exchange (generally 4:00 p.m. Eastern time) on each day the Exchange is open for
trading. Net asset value per share is computed by dividing the total value of
the investment and other assets of each Portfolio, less any liabilities, by the
total number of outstanding shares of such Portfolio.
Securities listed on a U.S. exchange are valued at the latest quoted sales
prices on the day the valuation is made. Securities listed on a U.S. exchange
that are not traded on the valuation date are valued at the mean of the bid and
ask prices. Securities listed on a foreign exchange are valued at the latest
quoted sales price available before the time when assets are valued. All prices
of listed securities are taken from the exchange where the security is primarily
traded. For each Portfolio (with the exception of the REIT Index Portfolio),
unlisted securities for which market quotations are readily available are valued
at the latest quoted bid price. For the REIT Index Portfolio, unlisted
securities that are listed on the Nasdaq National List are valued at the latest
quoted sales price on the day the valuation is made. Unlisted securities that
are included on the Nasdaq National List, but do not trade on the valuation
date, and other unlisted securities are valued at the mean of the closing bid
and asked prices. Other assets and securities for which no market quotations are
readily available are valued in good faith at fair value using methods
determined by, or under the supervision of, the Board of Directors of the Fund.
Securities may be valued on the basis of prices provided by a pricing service
when such prices are believed to reflect the fair market value of such
securities.
In determining each Portfolio's net asset value per share, all assets and
liabilities initially expressed in foreign currencies will be converted into
U.S. dollars at the bid price of such currencies against U.S. dollars last
quoted by a major bank or broker. If such quotations are not available as of the
close of the Exchange, the rate of exchange will be determined in accordance
with policies established in good faith by the Board of Directors.
COMPARATIVE INDEXES
Vanguard may use reprinted material discussing The Vanguard Group, Inc. or
any of the member funds of The Vanguard Group of Investment Companies.
Each of the investment company members of the Vanguard Group, including
Vanguard Specialized Portfolios, Inc., may, from time to time, use one or more
of the following unmanaged indices for comparative performance purposes.
STANDARD AND POOR'S 500 COMPOSITE STOCK PRICE INDEX -- is a well diversified
list of 500 companies representing the U.S. Stock Market.
WILSHIRE 5000 EQUITY INDEX -- consists of more than 7,000 common equity
securities, covering all stocks in the U.S. for which daily pricing is
available.
WILSHIRE 4500 EQUITY INDEX -- consists of all stocks in the Wilshire 5000 except
for the 500 stocks in the Standard and Poor's 500 Index.
MORGAN STANLEY CAPITAL INTERNATIONAL EAFE INDEX -- is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australasia and the
Far East.
GOLDMAN SACHS 100 CONVERTIBLE BOND INDEX -- currently includes 71 bonds and 29
preferreds. The original list of names was generated by screening for
convertible issues of $100 million or greater in market capitalization. The
index is priced monthly.
14
<PAGE> 41
LEHMAN GNMA INDEX -- includes pools of mortgages originated by private lenders
and guaranteed by the mortgage pools of the Government National Mortgage
Association.
MORGAN STANLEY REIT INDEX -- consist of approximately 90 stocks of equity Real
Estate Investment Trusts (REITs). REITs in the index meet size and liquidity
criteria specified by Morgan Stanley. The index had a market value of $35
billion as of May, 1995.
LEHMAN LONG-TERM TREASURY BOND -- is composed of all bonds covered by the
Shearson Lehman Hutton Treasury Bond Index with maturities of 10 years or
greater.
MERRILL LYNCH CORPORATE & GOVERNMENT BOND -- consists of over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds.
LEHMAN CORPORATE (Baa) BOND INDEX -- all publicly offered fixed-rate,
nonconvertible domestic corporate bonds rated Baa by Moody's, with a maturity
longer than 1 year and with more than $25 million outstanding. This index
includes over 1,000 issues.
LEHMAN BROTHERS LONG-TERM CORPORATE BOND INDEX -- is a subset of the Lehman
Corporate Bond Index covering all corporate, publicly issued, fixed-rate,
nonconvertible U.S. debt issues rated at least Baa, with at least $50 million
principal outstanding and maturity greater than 10 years.
BOND BUYER MUNICIPAL INDEX (20 YEAR) BOND -- is a yield index on current coupon
high-grade general obligation municipal bonds.
STANDARD & POOR'S PREFERRED INDEX -- is a yield index based upon the average
yield for four high-grade, non-callable preferred stock issues.
NASDAQ INDUSTRIAL INDEX -- is composed of more than 3,000 industrial issues. It
is a value-weighted index calculated on price change only and does not include
income.
COMPOSITE INDEX -- 65% Standard & Poor's 500 Index and 35% Lehman Long-Term
Corporate AA or Better Bond Index
COMPOSITE INDEX -- 65% Lehman Long-Term Corporate AA or Better Bond Index and a
35% weighting in a blended equity composite (75% Standard & Poor's/BARRA Value
Index and 25% Standard & Poor's Utilities Index).
LEHMAN LONG-TERM CORPORATE AA OR BETTER BOND INDEX -- consists of all publicly
issued, fixed rate, nonconvertible investment grade, dollar denominated,
SEC-registered corporate debt rated AA or AAA.
RUSSELL 2000 STOCK INDEX -- consists of the smallest 2,000 stocks within the
Russell 3000; a widely-used benchmark for small capitalization common stocks.
LEHMAN BROTHERS AGGREGATE BOND INDEX -- is a market weighted index that contains
individually priced U.S. Treasury, agency, corporate, and mortgage pass-through
securities corporate rated BBB- or better. The Index has a market value of over
$4 trillion.
LEHMAN BROTHERS MUTUAL FUND SHORT (1-5) GOVERNMENT/CORPORATE INDEX -- is a
market weighted index that contains individually priced U.S. Treasury, agency,
and corporate investment grade bonds rated BBB- or better with maturities
between 1 and 5 years. The index has a market value of over $1.3 trillion.
LEHMAN BROTHERS MUTUAL FUND INTERMEDIATE (5-10) GOVERNMENT/CORPORATE INDEX -- is
a market weighted index that contains individually priced U.S. Treasury, agency,
and corporate securities rated BBB- or better with maturities between 5 and 10
years. The index has a market value of over $600 billion.
LEHMAN BROTHERS MUTUAL FUND LONG (10+) GOVERNMENT/CORPORATE INDEX -- is a market
weighted index that contains individually priced U.S. Treasury, agency, and
corporate securities rated Baa- or better with maturities greater than 10 years.
The index has a market value of over $900 billion.
LIPPER BALANCED FUND AVERAGE -- an industry benchmark of average balanced funds
with similar investment objectives and policies, as measured by Lipper
Analytical Services, Inc.
15
<PAGE> 42
LIPPER NON-GOVERNMENT MONEY MARKET FUND AVERAGE -- an industry benchmark of
average non-government money market funds with similar investment objectives and
policies, as measured by Lipper Analytical Services, Inc.
LIPPER GOVERNMENT MONEY MARKET FUND AVERAGE -- an industry benchmark of average
government money market funds with similar investment objectives and policies,
as measured by Lipper Analytical Services, Inc.
LIPPER SMALL COMPANY GROWTH FUND AVERAGE -- the average performance of small
company growth funds as defined by Lipper Analytical Services, Inc. Lipper
defines a small company growth fund as a fund that by prospectus or portfolio
practice, limits its investments to companies on the basis of the size of the
company. From time to time, Vanguard may advertise using the average performance
and/or the average expense ratio of the small company growth funds. (This fund
category was first established in 1982. For years prior to 1982, the results of
the Lipper Small Company Growth category were estimated using the returns of the
Funds that constituted the Group at its inception.)
RUSSELL 3000 INDEX -- consists of approximately the 3,000 largest stocks of
U.S.-domiciled companies commonly traded on the New York and American Stock
Exchanges or the NASDAQ over-the-counter market, accounting for over 90% of the
market value of publicly traded Stocks in the U.S.
Advertisements which refer to the use of the fund as a potential investment
for Individual Retirement Accounts may quote a total return based upon
compounding of dividends on which it is presumed no Federal income tax applies.
In assessing such comparisons of yields, an investor should keep in mind
that the composition of the investments in the reported averages is not
identical to the Fund's Portfolio and that the items included in the
calculations of such averages may not be identical to the formula used by the
Fund to calculate its yield. In addition there can be no assurance that the
Fund will continue its performance as compared to such other averages.
YIELD AND TOTAL RETURN
The yield* of each Portfolio of the Fund for the 30-day period ended July
31, 1996 was as follows:
<TABLE>
<S> <C>
Energy Portfolio..................................... 1.43%
Gold & Precious Metals Portfolio..................... N/A
Health Care Portfolio................................ 1.50%
Utilities Income Portfolio........................... 5.06%
REIT Index Portfolio................................. N/A
</TABLE>
-------------------------------
*Yield is calculated daily.
The average annual total return of each Portfolio of the Fund for the one-
and five-year periods ended July 31, 1996 and since the inception of each
Portfolio was as follows.
<TABLE>
<CAPTION>
FIVE YEARS
YEAR ENDED ENDED
JULY 31, 1996 JULY 31, 1996 SINCE INCEPTION**
------------- ------------- -----------------
<S> <C> <C> <C>
Energy Portfolio*............................. +17.73% +10.60% +15.00%
Gold & Precious Metals Portfolio*............. - 0.69% + 6.64% +10.42%
Health Care Portfolio*........................ +25.07% +16.69% +18.28%
Utilities Income Portfolio.................... +12.97% +10.90% ** --
REIT Index Portfolio.......................... + 2.70% ** -- --
</TABLE>
--------------------
*Includes 1% portfolio redemption fee.
**Inception for Utilities Income Portfolio, May 15, 1992; inception for the
REIT Index Portfolio, May 13, 1996.
Total return is computed by finding the average compounded rate of return
over the one-year period set forth above that would equate an initial amount
invested at the beginning of the period to the ending redeemable value of the
investment.
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<PAGE> 43
FINANCIAL STATEMENTS
The Fund's financial statements for the year ended January 31, 1996,
including the financial highlights for each of the periods presented ended
January 31, 1996, as applicable, appearing in the Vanguard Specialized
Portfolios Annual Report to Shareholders, and the report thereon of Price
Waterhouse LLP, independent accountants, also appearing therein, are
incorporated by reference in this Statement of Additional Information. The
unaudited financial statements and financial highlights for the six months ended
July 31, 1996, as set forth in the Vanguard Specialized Portfolios Semi-Annual
Report to Shareholders, are incorporated herein by reference. The Fund's Annual
Report and Semi-Annual Report to Shareholders are enclosed with this Statement
of Additional Information.
17
