<PAGE> 1
VANGUARD
PRIMECAP FUND
ANNUAL REPORT 1994
THE VANGUARD VOYAGE . . . STAYING THE COURSE
<PAGE> 2
THE VANGUARD VOYAGE . . . STAYING THE COURSE
WE ARE PRESENTLY OBSERVING TWO MILESTONES IN OUR HISTORY: (1) THE 20TH
ANNIVERSARY OF THE VANGUARD GROUP; AND (2) THE 65TH ANNIVERSARY YEAR OF
WELLINGTON FUND, THE OLDEST MUTUAL FUND ASSOCIATED WITH VANGUARD. WE CELEBRATE
THESE TWO EVENTS SINCE THEY HAVE INDELIBLY ALTERED THE MUTUAL FUND INDUSTRY--IN
OUR VIEW, FOR THE BETTER.
Wellington Fund--a pioneer in the mutual fund industry--began operations on June
30, 1929. Its first fifteen years were a struggle for survival in an industry
that was shaken to its roots by the Great Crash of 1929-1933. From an initial
base of $100,000, Wellington's assets had grown to but $27 million by the end of
World War II. The Vanguard Group was founded on September 24, 1974. Soon
thereafter, we assumed responsibility for the management of Wellington Fund and
ten associated funds, with assets aggregating $1.4 billion.
The years that followed the founding of The Vanguard Group were marked by
exceptional growth. Today, Wellington Fund, with assets of nearly $9 billion,
remains one of the largest mutual funds in the nation. And Vanguard, now
managing 85 mutual fund portfolios, is entrusted with assets of $134 billion,
and ranks as the second largest fund complex in the world.
Our durability in an era of change--and our longevity in an era of
challenge--didn't "just happen." What brought us to where we are today is what
we were when we began. Put another way, we set our original investment course
based on sound principles, and our corporate course based on a single focus:
serving solely the interests of our Fund shareholders.
FOUNDING INVESTMENT PRINCIPLES
The founding investment principles of Wellington Fund were, above all,
conservative. The Fund provided a broadly diversified portfolio at a time when
holding individual securities was the conventional strategy. It incurred no debt
in an era of high leverage that would soon come back to haunt less cautious
investors. And it was a "balanced" fund--in fact, Wellington is America's oldest
balanced fund--with holdings from each of the three basic financial asset
classes: cash reserves, bonds, and common stocks. In short, Wellington Fund was
a staid investment in an era of stock speculation that was to become, almost
within moments, an era of conservatism.
For Vanguard, these investment principles endure. "Balance" is still our
watchword, because the three basic financial asset classes have different--and
usually countervailing--investment characteristics. When it began, Wellington
Fund provided a balanced program in a single investment; in 1994, such a balance
is often achieved by a combination of Vanguard money market, bond, and stock
funds.
"Conservatism," too, remains our standard. Over the years, we have tried
to maintain the discipline to eschew offering funds that lack sound financial
principles, often based on marketplace fads that could not--and did not--endure.
Our conservatism applies not only to the funds we offer, but to the instruments
in which they invest. For example, we have steered clear of exotic derivative
securities with unpredictable investment characteristics. Too many fund managers
have been taken in by these highly risky instruments, and their shareholders
have paid a heavy price--except in cases where the manager has "made the fund
whole," when to do otherwise would have shocked investors and impaired their
confidence in the fund complex.
Speculation, it seems, comes and goes, albeit in different guises. But the
investment principles to which we have adhered since Wellington Fund began in
1929 remain firm:
* We offer Funds with sound and durable investment objectives, designed for
long-term investors.
(please turn to inside back cover)
VANGUARD/PRIMECAP FUND SEEKS TO PROVIDE LONG-TERM GROWTH OF CAPITAL BY INVESTING
IN COMMON STOCKS SELECTED ON THE BASIS OF GREATER-THAN-AVERAGE EARNINGS GROWTH
POTENTIAL, CONSISTENCY OF EARNINGS GROWTH, AND QUALITY OF MANAGEMENT.
<PAGE> 3
CHAIRMAN'S LETTER
FELLOW SHAREHOLDER:
The year ended December 31, 1994--Vanguard/PRIMECAP Fund's tenth
anniversary year--was an outstanding one for the Fund in every respect. While
the stock market "went nowhere" during the year, the Fund provided a total
return of +11.4%. It is a special pleasure to have the opportunity to report to
you on a fine year that concludes a fine decade for the Fund.
The following table presents our customary comparison of the total
returns (capital change plus income) of PRIMECAP Fund and the two benchmarks
that we have chosen as our tracking standards: the unmanaged Standard & Poor's
500 Composite Stock Price Index and the average growth mutual fund. In both
cases, our results are exceptional.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
Total Return
-----------------
Year Ended
December 31, 1994
- -------------------------------------------------------------------
<S> <C>
PRIMECAP FUND +11.4%
- -------------------------------------------------------------------
STANDARD & POOR'S 500 STOCK INDEX + 1.3%
AVERAGE GROWTH MUTUAL FUND - 2.2
- -------------------------------------------------------------------
</TABLE>
The Fund's total return is based on net asset values of $18.42 per share on
December 31, 1993, and $19.98 on December 31, 1994, with the latter figure
adjusted to take into account the reinvestment of our annual dividend of $.12
per share from net investment income, and two distributions totaling $.41 per
share from net realized capital gains, of which $.07 per share was carried over
from 1993 and $.34 per share was realized in 1994.
THE FINANCIAL MARKETS IN 1994
During the year, the stock market enjoyed four "ups" and endured four "downs." A
pattern of quarterly declines in the late weeks of March, June, and September
was broken when a November to mid-December decline was aborted by a solid
year-end rally, which recaptured most of the year's earlier lost ground. On
balance, the price of the Standard & Poor's 500 Composite Stock Price Index
edged downward just a notch, from 466 when the year began to 459 at its close,
down -1.5%. The positive total return (+1.3%) on the Index, then, was more than
accounted for by the $13 of dividend income that it generated.
As always, there were some important cross-currents in the financial
markets. And in 1994, many of them were just the reverse of 1993. In particular,
a year ago value stocks (those with above-average yields and below average
market price-to-book value ratios) provided a return of +18.6%, and
overwhelmingly dominated the +1.7% return on growth stocks (those with the
opposite characteristics, and with above-average prospects for consistent
earnings growth). In 1994, however, growth stocks turned the tables and led the
way, if by a far more modest margin (+3.1% versus -0.6%) than for value stocks
in 1993. So, just as last year redounded to the benefit of value-oriented
investors, this past year redounded to the benefit of investors in growth
equities.
If the performance of the stock market was "so-so" during the past
year, nothing that gentle could be said about the bond market. The total return
on the Lehman Long-Term U.S. Treasury Bond Index was -7.6% (-14.5% decline in
price, partly offset by interest income of +6.9%), as long Treasury yields rose
from
[FIGURE 1]
1
<PAGE> 4
[FIGURE 2]
6.4% to 7.8%. Yields on short-term and intermediate-term bonds also rose
sharply; however, because of their shorter maturities, price declines were much
smaller. This rising rate environment was surely a major factor in dampening the
returns on stocks of all stripes.
A primary cause of the interest rate rise was investor fears about a
resurgence of inflation. So far, at least, the U.S. Consumer Price Index gives
little evidence of it. The CPI has risen just 2.7% over the past twelve months,
although more sensitive indicators--such as commodity prices and producer
prices--have been rising at higher rates.
In an effort to quell inflationary fears, the Federal Reserve acted to
"tighten" the money supply in order to slow economic growth and rein in
potential future inflation. Fully six rate increases--in February, March, April,
May, August, and again in November--combined to raise the Federal funds rate (at
which banks borrow from one another) from 3.00% to 5.50%. Still, the specter of
inflation remains, and further rate increases may well lie in prospect.
To add some perspective to the financial market cross-currents in 1994,
the chart above compares the returns of growth stocks and value stocks during
the past five years. While you can see that "cycles of superiority" occurred
throughout the period, when all was said and done, the annual rates of return
were very close: Growth +8.8%; Value +8.3%. This outcome suggests the wisdom of
consistently sticking to your objectives, rather than endeavoring (fruitlessly,
I believe) to switch back and forth between these two market segments in the
search for higher returns. Put another way, most investors would benefit by
"staying the course" that best meets their needs, whether in growth stocks or
value stocks--or some steady mix of the two.
I would call your particular attention to the modesty of both annual
rates of return. With the first half of the decade of the 1990s now behind us,
investors who had expected equity returns in this decade to be a reprise of the
"Golden Eighties" (when the average annual total return of the Standard & Poor's
500 Index was +17.5%) are doubtless disappointed. Nonetheless, we should not
lose sight of the fact that the long-term (since 1926) return of the Index has
averaged +10.2% per annum. History, it seems clear, has a message to give us
about maintaining reasonable performance expectations.
PRIMECAP FUND IN 1994
While stock market returns in 1994 were a pale imitation of 1993, PRIMECAP
defied the trend. Our total return of +11.4% not only substantially exceeded the
+1.3% return of the Standard & Poor's 500 Index, but also surpassed the return
of -2.2% for the average growth-oriented mutual fund. If we were "into" mutual
fund rankings (we are not), I would brag about our numerical ranking, or perhaps
our percentile or decile ranking. But, since a mutual fund's return in a given
year is rarely an omen of its ranking in the subsequent year, I would simply
leave it said that the Fund's competitive performance for the year was highly
superior.
The reasons are not hard to find. Our large edge over the Index was
accounted for (and then some) by our very large commitment to the technology
group. During the year, our technology holdings averaged 44% of Fund net assets,
compared to a weighting of just 9% for the Index. With
2
<PAGE> 5
technology stocks representing the best-performing industry group of 1994
(+20.3%), this concentration clearly paid off for our shareholders. What is
more, the selection of individual issues by PRIMECAP Management Company, the
Fund's investment adviser, added substantial value to our return, with the
stocks in our technology position rising by +33.1% on average. On balance,
the remainder of our portfolio performed at about "par" to the Index, so it was
technology that carried the day.
Pretty much the same story is reflected in our superiority over the
average growth mutual fund. The average competitor maintained a technology
weighting about 7 percentage points greater than that of the Index, about what
you would expect from mutual funds with a growth orientation, but nonetheless
well short of PRIMECAP's weighting.
There is a lesson in all of this: superior industry concentration can
"pay off." But shareholders should recognize that such concentration carries
risks of its own, and a particular industry is unlikely to repeat its
performance superiority year after year. Portfolio concentration, to use a trite
but accurate phrase, is "a two-edged sword." I do not want to belabor this
point, for, on an individual stock basis, the PRIMECAP portfolio is broadly
diversified, owning stocks in 73 companies, with the ten largest holdings
accounting for 31% of net assets--about typical for most major equity mutual
funds.
REVIEWING THE DECADE
The chart below presents PRIMECAP Fund's record over the past decade compared to
our two traditional benchmarks, the unmanaged Standard & Poor's 500 Stock Index
and the average growth mutual fund. During this ten-year period, the Fund's
average annual rate of return was a solid +15.5%, well above the +12.1% return
achieved by the average growth fund and also significantly ahead of the +14.3%
rate of return of the Standard & Poor's 500 Index.
The Index, as you know, is a tough competitor. It is calculated "on
paper," without the "real world" expenses of fund operations, advisory fees,
portfolio transaction costs, and the impact of cash reserves.
(continued)
[FIGURE 3]
<TABLE>
<CAPTION>
Average Annual Total Returns--Periods Ended December 31, 1994
- -------------------------------------------------------------
1 Year 5 Years 10 Years
- -------------------------------------------------------------
<S> <C> <C> <C>
PRIMECAP FUND +11.41% +13.15% +15.54%
AVERAGE GROWTH FUND - 2.17 + 8.45 +12.08
STANDARD & POOR'S 500 INDEX + 1.31 + 8.68 +14.33
</TABLE>
Note: Past performance is not predictive of future performance.
3
<PAGE> 6
Mutual funds, on the other hand, must incur such costs, and it is difficult for
most professional managers to provide more-than-compensatory returns. Indeed,
during the past decade, the Index outpaced fully 101 of the 132 growth funds in
operation throughout the period.
Our performance margin over the average growth fund is not only
generous on an annual basis, but, compounded over a decade, leads to a huge
difference in capital accumulation. The following summary table presents a
comparison of an investment in the Fund with an investment in the most
appropriate "real world" option available--the average growth-oriented mutual
fund.
The table compares the ten-year results assuming, in each case, a
$10,000 investment with all dividends and capital gains reinvested. On December
31, 1994, the investor in PRIMECAP Fund would have accumulated $42,390; the
investor in the average growth fund, $31,280. This $11,110 of extra performance
is equivalent to fully 111%(!) of the initial $10,000 investment.
<TABLE>
<CAPTION>
- -------------------------------------------------------------------
Total Return
------------------------------------
Ten Years Ended
December 31, 1994
------------------------------------
Annual Rate Final Value of Initial
of Return Investment of $10,000
- -------------------------------------------------------------------
<S> <C> <C>
PRIMECAP FUND +15.5% $42,390
AVERAGE GROWTH FUND +12.1 31,280
- -------------------------------------------------------------------
PRIMECAP ADVANTAGE + 3.4% $11,110
- -------------------------------------------------------------------
</TABLE>
It should go without saying that PRIMECAP's returns reflected in the table are
merely history. Future returns of the Fund--both on an absolute basis and
relative to the average growth fund--are unpredictable, and may be better or
worse than those shown in the table.
Hard as it may be to believe, the table actually understates the
relative record of PRIMECAP in two major respects:
First, the comparison ignores income taxes. Given its growth objective
(and despite its relatively low expense ratio), PRIMECAP Fund has generated a
lower level of taxable net investment income than most comparable growth funds.
In addition, with our low rate of portfolio turnover (about 16% annually,
compared to 88% for the average growth fund), we have also generated a
substantially lower level of taxable realized capital gains. As a result, on an
after-tax basis, the Fund's relative return would be substantially enhanced. (I
would note, however, that as a result of our low gain realization in the face of
substantial capital appreciation, significant unrealized capital appreciation is
reflected in the Fund's net asset value. Specifically, 20% of the value of our
portfolio on December 31, 1994, was represented by unrealized appreciation.)
Second, the comparison ignores sales charges. While our Fund is
purchased on a "no-load" (no sales commission) basis, most mutual funds carry
hefty initial sales charges, meaning that the return shown in the table is
earned, not on 100% of the initial investment (as in the Fund), but on about 93%
of the investment (i.e., assuming the initial investment carried a sales charge
of 7%). We estimate, very roughly, that the impact of sales charges would have
reduced the return of the average growth fund by about 0.5% per year, from 12.1%
to 11.6%.
In short, we are satisfied--and we hope you are as well--that our
performance over the past decade has been outstanding on an "unadjusted" basis,
and would be even more outstanding on an "adjusted" basis.
A LIFETIME PERSPECTIVE
As we celebrate our tenth anniversary, I would like to add a bit of perspective.
First, and most importantly, in my Chairman's letter in our initial Annual
Report (1985), I stated in advance the standards we would emulate. They have not
changed over the ensuing decade: (1) "the principal measure will be the Standard
& Poor's 500 Composite Stock Price Index, a pretty good reflection of how `the
market' is doing," and (2) "in order to reflect our adviser's ability to select
stocks from the specific universe we have chosen to emphasize in our portfolio
. . . the average of other mutual funds with a growth objective." To state the
obvious, we have met both objectives.
Potential superior performance, however fragile it may be to forecast,
was but one of the factors that led to the organization of PRIMECAP Fund. We
also stressed the importance of the Fund's adviser, its growth-oriented
philosophy, and the structure of the
4
<PAGE> 7
[FIGURE 4]
portfolios it was then managing. On all counts, we believe that our analysis
was sound. In particular, the senior management team at PRIMECAP Management
Company is virtually the same as it was a decade ago, with Howard B. Schow,
Mitchell J. Milias, and Theo A. Kolokotrones remaining as the firm's senior
partners today. About the only noticeable difference is that all three have
"weathered the storms" of the past decade, and each now has ten more years of
professional investment experience than when the Fund began. We've had a great
run together.
As its record lengthened and the Fund became better known, substantial
asset growth ensued. PRIMECAP Fund's assets crossed the $50 million mark in
1985, $250 million in 1989, and reached nearly $800 million one year ago. Today,
thanks to large asset increases both from capital appreciation and from cash
inflow from investors, assets total $1.6 billion.
On this note, I offer a word of caution to shareholders. The "Achilles
heel" of the mutual fund industry is the strong tendency of investors to
purchase a fund's shares after it has enjoyed one year--or even several
years--of outstanding performance. This tendency is also accompanied by a
reverse effect: to redeem fund shares after a period of sub-par performance.
Taken together--to state what I hope is obvious--these two tendencies are a
formula for investment failure.
All mutual funds--including PRIMECAP--have their ups and downs in
relative performance. To make this point, the chart above shows the annual
performance of our Fund relative to the Standard & Poor's 500 Index(R)5ring each
of the past ten years. If I am sure of anything in this fallible business, it is
that annual fluctuations in relative returns will occur in the future, as in the
past. In PRIMECAP's case, good performance during its first two years was
overwhelmed by distinctly sub-par performance during the next three years. Over
the past five years--especially in 1993 and 1994--the Fund returned to the plus
side of the ledger.
The message, simply put, is that shareholders should look at PRIMECAP
Fund as a long-term
5
<PAGE> 8
investment, not as a vehicle for capturing good returns for a few years
and, when disappointment (inevitable, even if temporary) comes, "moving on."
Fund shareholders who have been with us for a long time are aware of this
hazard, and we underscore it for shareholders who have joined us in 1993 and
1994.
LOOKING AHEAD
A year ago, I wrote to you that "stock yields are near all-time historical lows,
and interest rates are at their lowest level in two decades. So, it would be
imprudent not to offer a word of caution about the stock market, which is surely
due for its share of difficult bumps along the way during the next few years."
Certainly 1994 constituted just such a bump for the stock market, and the
possibility of future bumps cannot be ignored.
On this note, it is worth reemphasizing that investing in stocks is
risky. That is, in essence, why stocks offer higher reward potential than bonds
and short-term reserves. The greatest risk is faced by short-term investors who
look for quick stock market returns or transitory stock market trends. The
lowest risk and the highest rewards--at least in the past--have been achieved by
long-term investors who have "stayed the course" with a sound investment
approach that is consistent with their own financial objectives.
We, too, intend to stay the course with the consistent objectives and
policies that we established for PRIMECAP Fund at the outset and to which we
have hewed ever since. The Fund provides sound participation in a diversified
list of common stocks selected for their capital appreciation possibilities. As
part of a balanced portfolio of mutual funds--including stock funds, bond funds,
and money market funds--PRIMECAP Fund should be a suitable investment in helping
you to implement the investment course you have chosen to follow.
Sincerely,
/s/ JOHN C. BOGLE
- -----------------
John C. Bogle
Chairman of the Board
January 10, 1995
Note: Mutual fund data from Lipper Analytical Services, Inc.
AVERAGE ANNUAL TOTAL RETURNS--THE AVERAGE ANNUAL TOTAL RETURNS FOR THE FUND
(PERIODS ENDED DECEMBER 31, 1994) ARE AS FOLLOWS:
<TABLE>
<CAPTION>
10 YEARS
-------------------------------------
INCEPTION TOTAL CAPITAL INCOME
DATE 1 YEAR 5 YEARS RETURN RETURN RETURN
--------- ------ ------- ------ ------- ------
<S> <C> <C> <C> <C> <C> <C>
VANGUARD/PRIMECAP FUND 11/1/84 +11.41% +13.15% +15.54% +14.58% +0.96%
</TABLE>
ALL OF THESE DATA REPRESENT PAST PERFORMANCE. THE INVESTMENT RETURN AND
PRINCIPAL VALUE OF AN INVESTMENT WILL FLUCTUATE SO THAT INVESTORS' SHARES,
WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN THEIR ORIGINAL COST.
6
<PAGE> 9
REPORT FROM THE INVESTMENT ADVISER
During 1994, PRIMECAP Fund's total return of +11.4% exceeded the +1.3% return
for the unmanaged S&P 500 Index, marking the fifth consecutive year in which the
Fund has outperformed this benchmark. It was the best year of relative
performance in our ten-year history.
As was the case in 1993, PRIMECAP Fund's strong relative performance
was chiefly attributable to a substantial overweighting during the year in the
technology sector (44% of the Fund's net assets versus 9% for the Index) and
excellent stock selection within that sector. Following a +33.8% gain in 1993,
the Fund's technology stocks appreciated +33.1% in 1994. Our technology holdings
continue to be concentrated in semiconductors, telecommunications, and
computers.
The semiconductor group enjoyed another year of excellent performance.
LSI Logic was the fifth best stock on the New York Stock Exchange, posting a
gain of +158%. Burr-Brown appreciated +111%. Texas Instruments and Intel also
contributed positively to the year's results. Earnings gains have accelerated as
semiconductors capture an increasing share of the content in electronic
products.
The revolution in wireless communications and the construction of
interactive broadband networks have produced explosive revenue and earnings
gains for telecommunications equipment suppliers. In 1994, L.M. Ericsson and
Motorola, the market leaders, enjoyed revenue growth rates in their multibillion
dollar wireless businesses exceeding 50%. These results were reflected in good
stock performance during the year. Tellabs, the Fund's best telecommunications
stock in 1994, appreciated +133%.
For the first time in several years, the computer stocks contributed
positively to our results. In last year's Annual Report we suggested that the
restructuring and cost-reduction activities pursued by computer vendors would
"pay off" as product pricing firmed. This indeed occurred in 1994. Computer
vendors have radically adapted their cost structures to a new business
model--one that assumes "commodity like" pricing and margins. Once this
rationalization was complete, it enabled the companies to benefit from the
strong unit growth they have consistently experienced over the last several
years. Tandem Computers, Stratus Computers, and Hewlett-Packard significantly
outperformed the S&P 500.
Most of the technology stocks held in the Fund share several common
characteristics. They are research-and-development-intensive companies that
create intellectual property. They are true growth companies in the sense that
they demonstrate consistent unit growth and serve growing markets. However, in
recent years much of the unit growth had been masked by pricing degradation.
This is the antithesis of many of the stellar-performing consumer growth stocks
of the eighties that were able to obscure deteriorating unit growth by regularly
increasing prices.
As we contemplate the prospects of the Fund's technology holdings going
forward, we are encouraged. We do not believe the stock market shares our
assessment that technology stocks are growth stocks. The earnings growth of
these stocks has materially exceeded their stock price appreciation.
Consequently, the valuation (price to earnings ratio) has declined. Not
surprisingly, this has affected the valuation of the entire Fund. At year-end
1993, the twelve-month price-earnings ratio for PRIMECAP Fund was 22.9. At
year-end 1994, that ratio had declined to 17.2.
PRIMECAP Fund continues to substantially overweight the transportation
sector (14% of net assets versus 2% for the Index). The sector suffered a -21.7%
return for the year, largely offsetting 1993's +28.6% return. The decline was
broad, as both airline and air freight stocks suffered setbacks. We are
obviously disappointed by these results. Transportation stocks are typically
"early cycle" stocks that benefit from an improving economy. Unfortunately, this
was not the case in 1994. However, our confidence in this sector has never been
greater. Capacity continues to exit the airline industry, cost structures are
showing improvement, and international routes, which have depressed results, are
turning profitable. We believe that the stronger airlines such as American
Airlines, Delta Airlines, and Southwest Airlines are becoming more competitive
at the expense of their weaker rivals.
Excellent stock selection within the financial sector also contributed
to the Fund's performance in
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<PAGE> 10
1994. The Fund's financial stocks gained +8.2% versus -3.8% for the S&P
500. During the year, the Fund increased its weighting in the financial sector,
primarily in reinsurance stocks. Capacity has exited the reinsurance market
coincident with an uptick in demand. According to the Reinsurance Association of
America, the number of reporting reinsurers has fallen from 129 in 1982 to 52 in
1994. At the same time, demand for reinsurance has improved as struggling
insurers try to reduce their risk exposure, and market share is gained by
stronger property casualty insurers that traditionally employ greater
reinsurance. This should have a favorable effect on reinsurance pricing going
forward.
Having just completed ten years of managing PRIMECAP Fund, we would
like to review our investment philosophy, and renew our commitment to
shareholders. Our investment process is driven by fundamental research. We try
to know most of our companies very well by directly communicating with their
management teams on a regular basis. This generates the conviction to buy stocks
that are controversial or out of favor with other investors. It affords us the
patience to wait for a thesis to evolve or for fundamentals to be recognized by
the market. Finally, it gives us the courage to frequently buy stocks as they
decline in price (assuming that there has been no change in the underlying
fundamentals).
We are also long-term investors. For the last ten years, the Fund's
average annual turnover has been approximately 16%. The Fund is constructed by
selecting stocks one at a time. Each issue is evaluated on its own merits.
Sector weightings are a function of how many or few attractive stocks we find
within a sector, not by a predetermined model. These are the disciplines
reflected in the management of PRIMECAP Fund. We believe they increase the
likelihood of producing superior long-term investment results for our fellow
shareholders.
Respectfully,
Howard B. Schow
Portfolio Manager
Theo A. Kolokotrones
Portfolio Manager
PRIMECAP Management Company
January 12, 1995
8
<PAGE> 11
TOTAL INVESTMENT RETURN TABLE
The following table illustrates the results of a single-share investment in
VANGUARD/PRIMECAP Fund since inception through December 31, 1994. During the
period illustrated, stock prices fluctuated widely; these results should not be
considered a representation of the dividend income or capital gain or loss which
may be realized from an investment made in the Fund today.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
PERIOD PER SHARE DATA* TOTAL INVESTMENT RETURN**
- -----------------------------------------------------------------------------------------------------------------------------------
S&P 500
PRIMECAP Fund Index
Value with Income --------------------------------- --------
Year Ended Net Asset Capital Gains Income Dividends & Capital Capital Income Total Total
December 31 Value Distributions Dividends Gains Reinvested Return Return Return Return
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INITIAL (11/84) $ 6.25 -- -- $ 6.25 -- -- -- --
- -----------------------------------------------------------------------------------------------------------------------------------
1984 6.56 -- -- 6.56 + 4.9% 0.0% + 4.9% + 0.6%
- -----------------------------------------------------------------------------------------------------------------------------------
1985 8.89 -- $.01 8.90 +35.6 +0.2 +35.8 +31.6
- -----------------------------------------------------------------------------------------------------------------------------------
1986 10.64 $.18 .14 10.99 +21.8 +1.7 +23.5 +18.6
- -----------------------------------------------------------------------------------------------------------------------------------
1987 10.06 .23 .10 10.74 - 3.2 +0.9 - 2.3 + 5.2
- -----------------------------------------------------------------------------------------------------------------------------------
1988 11.18 .25 .09 12.32 +13.7 +1.0 +14.7 +16.5
- -----------------------------------------------------------------------------------------------------------------------------------
1989 12.82 .61 .16 14.98 +20.2 +1.4 +21.6 +31.6
- -----------------------------------------------------------------------------------------------------------------------------------
1990 12.21 .12 .13 14.56 - 3.8 +1.0 - 2.8 - 3.1
- -----------------------------------------------------------------------------------------------------------------------------------
1991 15.36 .68 .15 19.39 +31.8 +1.3 +33.1 +30.4
- -----------------------------------------------------------------------------------------------------------------------------------
1992 16.19 .41 .12 21.13 + 8.2 +0.8 + 9.0 + 7.6
- -----------------------------------------------------------------------------------------------------------------------------------
1993 18.42 .59 .07 24.94 +17.6 +0.4 +18.0 +10.1
- -----------------------------------------------------------------------------------------------------------------------------------
1994 19.98 .41 .12 27.78 +10.7 +0.7 +11.4 + 1.3
- -----------------------------------------------------------------------------------------------------------------------------------
LIFETIME +344.6% +284.0%
- -----------------------------------------------------------------------------------------------------------------------------------
AVERAGE ANNUAL RATE OF RETURN +15.8% +14.2%
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
*All per share data have been adjusted for the 4-for-1 stock split in
February 1990.
**Adjusted to include reinvestment of income dividends and any capital gains
distributions both for the Fund and the Index. No adjustment has been made
for income taxes payable by shareholders on reinvested income dividends and
capital gains distributions.
9
<PAGE> 12
FINANCIAL STATEMENTS
December 31, 1994
STATEMENT OF NET ASSETS
<TABLE>
<CAPTION>
Market
Value
Shares (000)+
- --------------------------------------------------------------------
<S> <C> <C>
COMMON STOCKS (86.3%)
- --------------------------------------------------------------------
BASIC MATERIALS (2.4%)
Engelhard Corp. 1,040,000 $ 23,140
(1) MacDermid, Inc. 189,000 6,898
Quaker Chemical Corp. 140,000 2,555
Stepan Co. 300,000 4,500
---------
GROUP TOTAL 37,093
---------
- --------------------------------------------------------------------
CAPITAL GOODS & CONSTRUCTION (2.2%)
Belden Inc. 133,500 2,970
Donaldson Co., Inc. 540,000 12,758
(1) Granite Construction Co. 840,000 17,010
* Sanifill, Inc. 70,000 1,750
---------
GROUP TOTAL 34,488
---------
- --------------------------------------------------------------------
CONSUMER CYCLICALS (9.1%)
Arvin Industries, Inc. 660,000 15,345
* BET Holdings Inc. Class A 280,000 4,235
Capital Cities/ABC, Inc. 150,000 12,787
* Coherent, Inc. 500,000 8,375
* Electronic Arts 870,000 16,639
* Filene's Basement Corp. 845,000 3,908
* GC Cos. 200,000 5,250
Harcourt General, Inc. 560,000 19,740
Knight-Ridder, Inc. 100,000 5,050
(1) McClatchy Newspapers, Inc. 390,000 8,385
Polaroid Corp. 720,000 23,400
* Price/Costco Inc. 1,420,000 18,283
---------
GROUP TOTAL 141,397
---------
- --------------------------------------------------------------------
ENERGY (1.0%)
Panhandle Eastern Corp. 468,750 9,258
Schlumberger Ltd. 115,000 5,793
---------
GROUP TOTAL 15,051
---------
- --------------------------------------------------------------------
FINANCIAL (9.9%)
American International
Group, Inc. 380,000 37,240
(1) Avemco Corp. 650,000 9,994
City National Corp. 621,485 6,603
General Re Corp. 385,000 47,644
Marsh & McLennan, Inc. 220,000 17,435
Transatlantic Holdings 325,000 18,159
* Zurich Reinsurance Centre
Holdings, Inc. 587,000 16,950
---------
GROUP TOTAL 154,025
---------
- --------------------------------------------------------------------
HEALTH CARE (7.6%)
Block Drug Co. Class A 146,316 5,487
Caremark International, Inc. 200,000 3,425
* Cordis Corp. 525,000 31,500
* Heart Technology, Inc. 800,000 15,600
Johnson & Johnson 102,800 5,628
Eli Lilly & Co. 300,000 19,687
*(2) Lynx Therapeutic 297,000 30
*(2) Lynx Therapeutic Pfd. 432,000 216
Medtronic, Inc. 447,400 24,887
Puritan-Bennett Corp. 260,000 5,395
Upjohn Co. 188,000 5,781
---------
GROUP TOTAL 117,636
---------
- --------------------------------------------------------------------
TECHNOLOGY (35.3%)
- --------------------------------------------------------------------
COMPUTER & COMPUTER RELATED (10.6%)
Adobe Systems, Inc. 1,065,000 31,684
* Digital Equipment Corp. 643,000 21,380
* Evans & Sutherland
Computer Corp. 420,000 5,460
Hewlett-Packard Co. 315,000 31,461
* Stratus Computer, Inc. 440,000 16,720
* Symbol Technologies, Inc. 880,000 27,170
* Tandem Computers, Inc. 1,840,000 31,510
ELECTRONIC COMPONENTS & INSTRUMENTS (12.3%)
AMP, Inc. 225,000 16,369
* Burr-Brown Corp. 240,000 3,240
* Dionex Corp. 255,000 9,435
Intel Corp. 800,000 50,900
* LSI Logic Corp. 412,500 16,655
Molex, Inc. 100,000 3,450
Molex, Inc. Class A 100,000 3,100
Perkin-Elmer Corp. 520,000 13,325
Sony Corp. ADR 104,000 5,837
Tektronix, Inc. 550,000 18,837
Texas Instruments, Inc. 469,000 35,116
Xerox Corp. 150,000 14,850
TELECOMMUNICATIONS (12.4%)
L.M. Ericsson
Telephone Co. ADR 760,000 41,895
L.M. Ericsson
Telephone Co. Cvt. 4.25% 620,000 1,163
Motorola, Inc. 700,000 40,512
* Octel Communications Corp. 680,000 14,110
*(1) Plantronics, Inc. 460,000 13,800
Reuters Holdings PLC ADR 260,000 11,407
* Tellabs, Inc. 860,000 47,730
Vodafone Group PLC ADR 640,000 21,520
---------
GROUP TOTAL 548,636
---------
- --------------------------------------------------------------------
TRANSPORT & SERVICES (13.8%)
* AMR Corp. 1,160,000 61,770
Airborne Freight Corp. 460,000 9,430
* Alaska Air Group, Inc. 250,000 3,750
American President Cos., Ltd. 348,000 8,787
Delta Air Lines, Inc. 950,000 47,975
</TABLE>
10
<PAGE> 13
<TABLE>
<CAPTION>
Market
Value
Shares (000)+
- --------------------------------------------------------------------
<S> <C> <C>
* Federal Express Corp. 1,105,000 $ 66,576
Southwest Airlines Co. 950,000 15,913
----------
GROUP TOTAL 214,201
----------
- --------------------------------------------------------------------
UTILITIES (.9%)
Telephone & Data Systems, Inc. 295,000 13,607
----------
- --------------------------------------------------------------------
MISCELLANEOUS (4.1%)
Manpower Inc. 940,000 26,437
Other (2.5%) 38,172
----------
GROUP TOTAL 64,609
----------
- --------------------------------------------------------------------
TOTAL COMMON STOCKS
(Cost $1,023,822) 1,340,743
- --------------------------------------------------------------------
TEMPORARY CASH INVESTMENT (14.7%)
- --------------------------------------------------------------------
Face
Amount
(000)
--------
REPURCHASE AGREEMENT
Collateralized by U.S. Government
Obligations in a Pooled Cash
Account 5.90%, 1/3/95
(Cost $228,157) $228,157 228,157
- --------------------------------------------------------------------
TOTAL INVESTMENTS (101.0%)
(Cost $1,251,979) 1,568,900
- --------------------------------------------------------------------
OTHER ASSETS AND LIABILITIES (-1.0%)
- --------------------------------------------------------------------
Other Assets--Notes C and E 48,332
Liabilities--Note E (63,519)
----------
(15,187)
- --------------------------------------------------------------------
NET ASSETS (100%)
- --------------------------------------------------------------------
Applicable to 77,778,863 outstanding
$.001 par value shares
(authorized 100,000,000 shares) $1,553,713
- --------------------------------------------------------------------
NET ASSET VALUE PER SHARE $19.98
====================================================================
</TABLE>
+ See Note A to Financial Statements.
* Non-Income Producing Security.
(1)Considered affiliated companies as the Fund owns more than 5% of
the outstanding voting securities of such companies.
(2)Restricted securities represent .02 of 1% of net assets.
<TABLE>
<CAPTION>
- --------------------------------------------------------------------
AT DECEMBER 31, 1994,
NET ASSETS CONSISTED OF:
- --------------------------------------------------------------------
Amount Per
(000) Share
---------- -------
<S> <C> <C>
Paid in Capital $1,230,579 $15.82
Undistributed Net
Investment Income 137 --
Accumulated Net Realized Gains 6,076 .08
Unrealized Appreciation of
Investments--Note D 316,921 4.08
- --------------------------------------------------------------------
NET ASSETS $1,553,713 $19.98
- --------------------------------------------------------------------
</TABLE>
11
<PAGE> 14
STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended
December 31, 1994
(000)
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INVESTMENT INCOME
INCOME
Dividends ...................................................................... $ 9,090
Interest......................................................................... 7,094
- -----------------------------------------------------------------------------------------------------------------------------------
Total Income.......................................................... 16,184
- -----------------------------------------------------------------------------------------------------------------------------------
EXPENSES
Investment Advisory Fee--Note B................................................... 3,882
The Vanguard Group--Note C
Management and Administrative................................................ $2,965
Marketing and Distribution................................................... 184 3,149
------
Taxes (other than income taxes).................................................. 86
Custodians' Fees ................................................................ 18
Auditing Fees ................................................................... 11
Shareholders' Reports............................................................ 54
Annual Meeting and Proxy Costs................................................... 19
Directors' Fees and Expenses..................................................... 5
- -----------------------------------------------------------------------------------------------------------------------------------
Total Expenses........................................................ 7,224
- -----------------------------------------------------------------------------------------------------------------------------------
Net Investment Income.............................................. 8,960
- -----------------------------------------------------------------------------------------------------------------------------------
REALIZED NET GAIN ON INVESTMENT
SECURITIES SOLD ................................................................ 31,811
- -----------------------------------------------------------------------------------------------------------------------------------
CHANGE IN UNREALIZED APPRECIATION
(DEPRECIATION) OF INVESTMENT SECURITIES ............................................ 77,964
- -----------------------------------------------------------------------------------------------------------------------------------
Net Increase in Net Assets Resulting from Operations............... $118,735
===================================================================================================================================
</TABLE>
SPECIAL TAX INFORMATION
SPECIAL 1994 TAX INFORMATION (UNAUDITED)
FOR VANGUARD/PRIMECAP FUND, INC.
Corporate shareholders should note that for the fiscal year ended
December 31, 1994, 85.5% of the Fund's investment income (i.e., dividend income
plus short-term capital gains, if any) qualifies for the intercorporate
dividends received deduction.
12
<PAGE> 15
STATEMENT OF CHANGES IN NET ASSETS
<TABLE>
<CAPTION>
YEAR ENDED Year Ended
DECEMBER 31, 1994 December 31, 1993
(000) (000)
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
INCREASE IN NET ASSETS
OPERATIONS
Net Investment Income............................................................ $ 8,960 $ 3,225
Realized Net Gain................................................................ 31,811 25,536
Change in Unrealized Appreciation (Depreciation)................................. 77,964 93,538
- ---------------------------------------------------------------------------------------------------------------------------------
Net Increase in Net Assets Resulting
from Operations........................................................ 118,735 122,299
- ---------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS (1)
Net Investment Income............................................................ (8,890) (3,028)
Realized Net Gain................................................................ (28,580) (25,364)
- ---------------------------------------------------------------------------------------------------------------------------------
Total Distributions....................................................... (37,470) (28,392)
- ---------------------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS (2)
Issued --Regular............................................................... 388,913 154,453
--In Lieu of Cash Distributions......................................... 36,964 27,861
--Exchange.............................................................. 455,358 103,697
Redeemed --Regular............................................................... (93,175) (95,669)
--Exchange.............................................................. (106,509) (139,445)
- ---------------------------------------------------------------------------------------------------------------------------------
Net Increase from Capital Share Transactions.............................. 681,551 50,897
- ---------------------------------------------------------------------------------------------------------------------------------
Total Increase............................................................ 762,816 144,804
- ---------------------------------------------------------------------------------------------------------------------------------
NET ASSETS
Beginning of Year................................................................ 790,897 646,093
- ---------------------------------------------------------------------------------------------------------------------------------
End of Year (3).................................................................. $1,553,713 $ 790,897
=================================================================================================================================
(1) Distributions Per Share
Net Investment Income........................................................ $.12 $.07
Realized Net Gain............................................................ $.41 $.59
- ---------------------------------------------------------------------------------------------------------------------------------
(2) Shares Issued and Redeemed
Issued....................................................................... 43,291 14,702
Issued in Lieu of Cash Distributions......................................... 1,885 1,571
Redeemed .................................................................... (10,327) (13,251)
- ---------------------------------------------------------------------------------------------------------------------------------
34,849 3,022
- ---------------------------------------------------------------------------------------------------------------------------------
(3) Undistributed Net Investment Income.......................................... $ 137 $ 67
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
13
<PAGE> 16
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------------------
For a Share Outstanding Throughout Each Year(1) 1994 1993 1992 1991 1990
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE, BEGINNING OF YEAR ........................... $18.42 $16.19 $15.36 $12.21 $12.82
------- ------- ------- ------- -------
INVESTMENT OPERATIONS
Net Investment Income..................................... .12 .07 .12 .15 .12
Net Realized and Unrealized Gain (Loss)
on Investments......................................... 1.97 2.82 1.24 3.83 (.48)
------- ------- ------- ------- -------
TOTAL FROM INVESTMENT OPERATIONS .................. 2.09 2.89 1.36 3.98 (.36)
- ----------------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS
Dividends from Net Investment Income...................... (.12) (.07) (.12) (.15) (.13)
Distributions from Realized Capital Gains................. (.41) (.59) (.41) (.68) (.12)
------- ------- ------- ------- -------
TOTAL DISTRIBUTIONS ............................... (.53) (.66) (.53) (.83) (.25)
- ----------------------------------------------------------------------------------------------------------------------------------
NET ASSET VALUE, END OF YEAR ................................. $19.98 $18.42 $16.19 $15.36 $12.21
==================================================================================================================================
TOTAL RETURN ................................................ +11.41% +18.03% +8.99% +33.14% -2.79%
- ----------------------------------------------------------------------------------------------------------------------------------
RATIOS/SUPPLEMENTAL DATA
- ------------------------
Net Assets, End of Year (Millions)............................ $1,554 $791 $646 $486 $305
Ratio of Expenses to Average Net Assets....................... .64% .67% .68% .68% .75%
Ratio of Net Investment Income to
Average Net Assets.......................................... .79% .44% .84% 1.09% 1.06%
Portfolio Turnover Rate....................................... 8% 16% 7% 24% 11%
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Adjusted to reflect a 4-for-1 stock split as of February 23, 1990.
NOTES TO FINANCIAL STATEMENTS
Vanguard/PRIMECAP Fund is registered under the Investment Company Act of 1940 as
a diversified open-end investment company.
A. The following significant accounting policies are in conformity with
generally accepted accounting principles for investment companies. Such policies
are consistently followed by the Fund in the preparation of financial
statements.
1. SECURITY VALUATION: Securities listed on an exchange are valued at the
latest quoted sales prices as of the close of the New York Stock Exchange
(generally 4:00 PM) on the valuation date; securities not traded are valued
at the mean of the latest quoted bid and asked prices. Securities not listed
are valued at the latest quoted bid prices. Temporary cash investments are
valued at cost which approximates market value.
2. FEDERAL INCOME TAXES: The Fund intends to continue to qualify as a
regulated investment company and distribute all of its taxable income.
Accordingly, no provision for Federal income taxes is required in the
financial statements.
3. REPURCHASE AGREEMENTS: The Fund, along with other members of The Vanguard
Group of Investment Companies, transfers uninvested cash balances into a
Pooled Cash Account, the daily aggregate of which is invested in repurchase
agreements secured by U.S. Government obligations. Securities pledged as
collateral for repurchase agreements are held by the Fund's custodian bank
until maturity of each repurchase agreement. Provisions of the agreement
ensure that the market value of this collateral is sufficient in the event
of default; however, in the event of default or bankruptcy by the other
party to the agreement,
14
<PAGE> 17
realization and/or retention of the collateral may
be subject to legal proceedings.
4. OTHER: Security transactions are accounted for on the date the securities
are purchased or sold. Costs used in determining realized gains and
losses on the sale of investment securities are those of specific
securities sold. Dividend income and distributions to shareholders are
recorded on the ex-dividend date.
B. Under the terms of a contract which expires April 30, 1995, the Fund
pays PRIMECAP Management Company an advisory fee calculated at an annual
percentage rate of average net assets. For the year ended December 31, 1994,
the advisory fee represented an effective annual rate of .34 of 1% of average
net assets.
C. The Vanguard Group, Inc. furnishes at cost corporate management,
administrative, marketing and distribution services. The costs of such services
are allocated to the Fund under methods approved by the Board of Directors. At
December 31, 1994, the Fund had contributed capital of $229,000 to Vanguard
(included in Other Assets), representing 1.1% of Vanguard's capitalization. The
Fund's officers and directors are also officers and directors of Vanguard.
D. During the year ended December 31, 1994, the Fund made purchases of
$552,487,000 and sales of $77,176,000 of investment securities other than U.S.
Government securities and temporary cash investments.
At December 31, 1994, unrealized appreciation for financial reporting and
Federal income tax purposes aggregated $316,921,000 of which $349,979,000
related to appreciated securities and $33,058,000 related to depreciated
securities.
E. The market value of securities on loan to broker/dealers at December 31,
1994, was $35,482,000 for which the Fund had received cash collateral
of $37,421,000.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Board of Directors
Vanguard/PRIMECAP Fund
In our opinion, the accompanying statement of net assets and the related
statements of operations and changes in net assets and the financial highlights
present fairly, in all material respects, the financial position of
Vanguard/PRIMECAP Fund (the "Fund") at December 31, 1994, the results of its
operations, the changes in its net assets and the financial highlights for each
of the respective periods presented, in conformity with generally accepted
accounting principles. These financial statements and financial highlights
(hereafter referred to as "financial statements") are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits, which included
confirmation of securities by correspondence with the custodian and brokers and
the application of alternative auditing procedures where confirmations from
brokers were not received, provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP Thirty South Seventeenth Street
February 2, 1995 Philadelphia, Pennsylvania 19103
15
<PAGE> 18
DIRECTORS AND OFFICERS
JOHN C. BOGLE, Chairman and Chief Executive Officer
Chairman and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group.
JOHN J. BRENNAN, President
President and Director of The Vanguard Group, Inc., and of each of the
investment companies in The Vanguard Group.
ROBERT E. CAWTHORN, Chairman of Rhone-Poulenc Rorer Inc.; Director of Sun
Company, Inc.
BARBARA BARNES HAUPTFUHRER, Director of The Great Atlantic and Pacific Tea
Company, Alco Standard Corp., Raytheon Company, Knight-Ridder, Inc., and
Massachusetts Mutual Life Insurance Co.
BRUCE K. MACLAURY, President of The Brookings Institution; Director of
American Express Bank Ltd., The St. Paul Companies, Inc., and Scott Paper
Company.
BURTON G. MALKIEL, Chemical Bank Chairman's Professor of Economics, Princeton
University; Director of Prudential Insurance Co. of America, Amdahl
Corporation, Baker Fentress & Co., The Jeffrey Co., and Southern New England
Communications Company.
ALFRED M. RANKIN, JR., Chairman, President, and Chief Executive Officer of
NACCO Industries, Inc.; Director of NACCO Industries, The BFGoodrich Company,
Reliance Electric Company, and The Standard Products Company.
JOHN C. SAWHILL, President and Chief Executive Officer of The Nature
Conservancy; formerly, Director and Senior Partner of McKinsey & Co. and
President of New York University; Director of Pacific Gas and Electric Company
and NACCO Industries.
JAMES O. WELCH, JR., Retired Chairman of Nabisco Brands, Inc.; retired Vice
Chairman and Director of RJR Nabisco; Director of TECO Energy, Inc.
J. LAWRENCE WILSON, Chairman and Chief Executive Officer of Rohm & Haas
Company; Director of Cummins Engine Company; Trustee of Vanderbilt University
and the Culver Educational Foundation.
OTHER FUND OFFICERS
RICHARD F. HYLAND, Treasurer; Treasurer of The Vanguard Group, Inc., and of each
of the investment companies in The Vanguard Group.
RAYMOND J. KLAPINSKY, Secretary; Senior Vice President and Secretary of The
Vanguard Group, Inc.; Secretary of each of the investment companies in The
Vanguard Group.
KAREN E. WEST, Controller; Vice President of The Vanguard Group, Inc.;
Controller of each of the investment companies in The Vanguard Group.
OTHER VANGUARD GROUP OFFICERS
JEREMY G. DUFFIELD VINCENT S. MCCORMACK
Senior Vice President Senior Vice President
Planning & Development Operations
JAMES H. GATELY RALPH K. PACKARD
Senior Vice President Senior Vice President
Institutional Chief Financial Officer
IAN A. MACKINNON
Senior Vice President
Fixed Income Group
16
<PAGE> 19
THE VANGUARD VOYAGE . . . STAYING THE COURSE
(continued from inside front cover)
* We set specific standards for each Fund's investment policies and
principles.
* We adhere to the highest standards of investment quality, consistent
with each Fund's objectives.
* We offer candor in our Fund descriptions (including full disclosure of
risk) to prospective investors, and in our description to
shareholders of each Fund's success (or, sometimes, lack of the
same).
These principles make at least as much sense today as they did in 1929, perhaps
even more. For we live in an era when many fund organizations have become
asset-gathering machines, capitalizing on past performance that is unrepeatable
and investment fads that today, as yesterday, will come and go. The new
marketing policy is too often "if investors want it, we'll sell it to them." But
our principle remains "if it makes sound investment sense, we'll offer it, even
if it takes years to attract substantial assets."
FOUNDING CORPORATE VALUES
With the founding of The Vanguard Group in 1974, a new concept of values was
brought to bear on mutual fund management. Unlike other fund organizations,
Vanguard alone is structured to serve only its Funds' shareholders. Vanguard's
corporate structure places not the fund management company, but the fund
shareholders, "at the top" of the organizational chart. Vanguard Fund
shareholders are literally the owners of the firm and are entitled to all of the
benefits that, at other fund firms, accrue to the owners of the management
company.
Because of this unique structure, Vanguard has become best known for its
low costs, which we believe are just as essential a consideration in investing
in mutual funds as risk potential and total return. We call this relationship
between risk, return, and cost the "eternal triangle" of mutual fund investing.
We take special pride in our position as (by far) the lowest-cost
provider of financial services in the world. Under our "no-load" offering
structure, shareholders begin their Vanguard investment program with $1,000
of assets (not, say, $950) for each $1,000 investment. Then, under our
"at-cost" operating structure, each $1,000 is managed for only about $3 per
year; our competitors may charge three, four, or even five times that amount.
In all, Vanguard has distinguished itself by providing Funds with sound
and durable goals to investors with long-term time horizons, and doing so at the
fairest financial terms available. We believe that the unique Vanguard structure
"promotes a healthy and viable mutual fund complex within which each Fund can
better prosper; enables the Funds to realize substantial savings from advisory
fee reductions; promotes savings from economies of scale; and provides the Funds
with direct and conflict-free control over distribution functions." We are not
alone in this belief. Indeed, the quotation is taken verbatim from the unanimous
decision of the U.S. Securities and Exchange Commission when, in 1981, it
approved our application for the structure under which we operate today.
A CLOSING THOUGHT
We are proud of what Wellington Fund, the other Vanguard Funds, and The Vanguard
Group have come to represent, and we are grateful for the success and growth
with which we have been blessed. We are an industry leader, and, as a competitor
observed a few years ago, we are "the standard by which all fund organizations
are judged."
In battle terms, "the vanguard" is the first wave of troops or ships, and
Vanguard surely is in the first wave of the battle for investment survival. As
we look behind us, however, the "second wave" is not in sight. No fund
organization has followed our lead, leaving ours a lonely course. No matter. We
have an organization that places the interests of our Fund shareholders first.
We have Funds that shall endure the vicissitudes of the future. Come what may,
we intend to "stay the course," and we shall do our very best to continue to
deserve your confidence and loyalty. We hope that you will stay the course with
us.
<PAGE> 20
THE VANGUARD FAMILY OF FUNDS
FIXED INCOME FUNDS
MONEY MARKET FUNDS
Vanguard Admiral Funds
U.S. Treasury Money Market Portfolio
Vanguard Money Market Reserves
TAX-EXEMPT MONEY MARKET FUNDS
Vanguard Municipal Bond Fund
Money Market Portfolio
Vanguard State Tax-Free Funds
Money Market Portfolios (CA, NJ, OH, PA)
TAX-EXEMPT INCOME FUNDS
Vanguard Municipal Bond Fund
Vanguard State Tax-Free Funds
Insured Longer-Term Portfolios
(CA, FL, NJ, NY, OH, PA)
INCOME FUNDS
Vanguard Admiral Funds
Vanguard Fixed Income Securities Fund
Vanguard Preferred Stock Fund
EQUITY AND BALANCED FUNDS
GROWTH AND INCOME FUNDS
Vanguard Convertible Securities Fund
Vanguard Equity Income Fund
Vanguard Quantitative Portfolios
Vanguard/Trustees' Equity Fund
U.S. Portfolio
Vanguard/Windsor Fund
Vanguard/Windsor II
BALANCED FUNDS
Vanguard Asset Allocation Fund
Vanguard STAR Fund
Vanguard/Wellesley Income Fund
Vanguard/Wellington Fund
GROWTH FUNDS
Vanguard/Morgan Growth Fund
Vanguard/PRIMECAP Fund
Vanguard U.S. Growth Portfolio
AGGRESSIVE GROWTH FUNDS
Vanguard Explorer Fund
Vanguard Specialized Portfolios
INTERNATIONAL FUNDS
Vanguard International Growth Portfolio
Vanguard/Trustees' Equity Fund
International Portfolio
INDEX FUNDS
Vanguard Index Trust
Total Stock Market Portfolio
500 Portfolio
Extended Market Portfolio
Growth Portfolio
Value Portfolio
Small Capitalization Stock Portfolio
Vanguard International Equity Index Fund
European Portfolio
Pacific Portfolio
Emerging Markets Portfolio
Vanguard Bond Index Fund
Vanguard Tax-Managed Fund
Vanguard Balanced Index Fund
[LOGO]
<TABLE>
<S> <C>
Vanguard Financial Center Valley Forge, Pennsylvania 19482
New Account Information: 1-(800) 662-7447 Shareholder Account Services: 1-(800) 662-2739
</TABLE>
This Report has been prepared for shareholders and may be distributed to
others only if preceded or accompanied by a current prospectus. All Funds in the
Vanguard Family are offered by prospectus only.
Q590-12/94
<PAGE> 21
EDGAR APPENDIX
This appendix describes the components of the printed version of this
report that do not translate into a format acceptable to the EDGAR system.
The front cover of the printed version of this report features the
Vanguard ship in the crashing sea.
A small picture of a rear view of the Vanguard ship crashing through
the sea appears at the top of the inside covers of the report.
A running head featuring a sextant appears on pages one through six.
A photograph of John C. Bogle appears at the lower-right of page one.
A line chart depicting the indexed values of the Standard & Poor's
Growth Index and the Standard & Poor's Value Index for the fiscal years 1990 to
1994 appears at the upper-left of page two.
A cumulative performance line chart for the period December 31, 1984,
to December 31, 1994, including average annual total returns, appears on
page 3.
A bar chart depicting Primecap Versus The Standard & Poor's 500 Index,
Annual Performance Margin over one decade appears at the top of page 5.
A running head featuring a map and telescope appears on pages seven and
eight.
A running head featuring a lantern appears on page nine.
A running head featuring a log book and pen appears on pages ten
through fifteen.
A running head featuring a compass appears on page 16.
At the bottom of the back cover there appears a triangle with the sides
labeled "risk," "cost," and "return."
A seagull in flight is featured at the top of the outside back cover of
the report.
